Tuesday, September 28, 2010

Vision: Profiting from long-term trends

The vision to identify major long-term trends that can possibly unfold or can continue unfolding in the future is a very useful ability for an investor to have. Investors who are able to imagine future trends can position their portfolios to profit from those trends or at least identify investments that they might consider staying away from, assuming that the trends they see taking place in the future does in fact materialize.

Fast growth in emerging markets and green technology are trends that have been going on for quite some time, and will probably keep going on for a long time to come. Demand for food and water outpacing supply is a trend that I personally see taking place in the future. But while being able to identify future trends is pretty cool, it wouldn’t mean much if we didn’t position our portfolios to take advantage of the trends we think will take place.

We can take advantage of the trends we foresee or even trends that are already unfolding through exchange traded funds, stocks, and even private businesses. Say a person has the vision of food demand outstripping supply; he can invest in food producers or set up a farm, assuming that he understands how the farming business works.

While it is possible to position our portfolios to profit from long-term trends, there’s the risk that some trends might not materialize as soon as we expect them to, that we might have pulled the trigger much too soon. So, to mitigate this risk, we should invest in companies that we already consider attractive investments and wouldn’t mind holding forever.

What are some of the trends you foresee unfolding in the future? If you have anything to share please feel free to comment. Thank you for reading and may you always sustain good returns on your portfolio. Take care.

Sunday, September 26, 2010

Taking advantage of price sensitivity

There was this university that I attended where there was only one convenience store in the whole campus. I remember on and off hearing some of my friends talk about how the stuff in the convenience store is expensive and that you can buy a can of Coke or whatever for less outside.

While it might not have been a great situation for the students or the consumers, it was a golden opportunity for the convenience store to take advantage of the low price sensitivity of the students for its products (thanks at least in part to the monopoly like control of the convenience store on M&M’s and etc) and reap for itself greater profits, assuming of course that it has a cost structure in line with the average convenience store and that it is run competently. Nobody likes paying less for a can of Coke more than I do, but if there is only one outlet selling Coke, I don’t really mind paying the extra premium the outlet might be charging, I need to get my Coke fix!

Whether taking advantage of customers' low price sensitivity by raising prices and increasing the profit margin, or taking advantage of customers' high price sensitivity by lowering prices and taking market share, business owners can put themselves in positions to enjoy really good profits by understanding their customers’ price sensitivity for their products,

Say a grocery store only sells candy bars, and it sells each candy bar for a dollar making 10 cents of profit for itself. After conducting some research, the owner of the grocery store decides that his customers wouldn’t mind paying 1.20 for a candy bar; he increases the price, and he finds out that his research was right on the mark. The grocery store has tripled its profit simply by understanding and taking advantage of its customers’ price sensitivity.

Entrepreneurs striving to build their company’s brand should look at the big picture before deciding whether or not to take advantage of certain price sensitivity related opportunities that might present themselves. Exploiting certain price sensitivity related opportunities might result in an increase in profits for the short-term, but it can affect the reputation of your brand, which can impair the long-term profitability of your company.

If you have anything that you would like to share, or if you have any questions, please feel free to comment. Thank you for reading, and may you always sustain good returns on your portfolio.

Friday, September 24, 2010

Starting/investing in the right business

I was reading Tony Hsieh’s (The CEO of Zappos) book “Delivering Happiness,” and one of the things that really stood out to me in the book so far was one of the lessons from poker that Tony said could be applied to business as well. That lesson was: Choosing which table to sit at is very important, or in business terms, choosing which business to go into is very important.

A mediocre management team can achieve great returns running a company in a great industry, while a great management team running a company in a bad industry can actually lose money for shareholders. Choosing which industry to go into or to have investments in can have a huge influence on how successful a business venture turns out or how good (or bad) the returns a stock generates. 

Here are some of the things I generally look at before deciding whether or not it makes good financial sense starting a business in a certain industry or buying the stock of a company that’s in a certain industry:

Operating profit margin

We should invest in companies or start businesses in industries with high operating margins as these industries are more resistant to bad economic conditions and the companies in these industries, on average, convert a higher percentage of their sales to profits, leaving them with more money to pay out dividends or reinvest in their operations.

Return on equity

While I think the profit margin is important, return on equity is king, as it is the return that management is able to generate on the money belonging to their shareholders. A company with a 40% operating profit margin but with only a 10% return on equity creates less value for its shareholders than a company with a 5% profit margin but with a 30% return on equity.

So, investors should look to invest in companies in industries that are conducive to the companies achieving a high return on equity. Similarly, entrepreneurs should aim to start businesses in industries where they can enjoy good returns on their capital.

Market potential

Whether you are thinking about investing in a certain stock or planning to embark on your business venture, you might want to think about the market potential of the industry the company you want to invest in or the business you’re going to start will be in. The larger the market potential, the more room there is for the stock you invested in to increase its earnings or for your private business to expand.

Asset light   

Investors and aspiring business owners should try and identify industries where it’s possible to invest in or start companies that are asset light and don’t require much capital expenditure to maintain and expand their operations. Companies like these are generally able to grow faster, generate higher returns for their shareholders, and pay out more cash dividends to their shareholders.

One way investors can identify asset-light companies is by looking at the return on assets of a company, a company with a high return on assets can generally be said to be an asset-light company. For entrepreneurs, they can start businesses that they project can generate good returns on assets.

Whether you are an investor or an entrepreneur, the industry or the type of business matters as it plays a significant part in determining the ultimate success of your investment. If you have any questions or have anything you like to share, please feel free to comment. Thank you for reading, and may you always sustain good returns on your portfolio.

Tuesday, September 21, 2010

My take on dividend investing for passive income

I’m a huge believer in a portfolio of good dividend paying stocks as a great source of passive income. In this article, I will give you my take on how investors can build a portfolio of dividend paying stocks that can generate for them healthy passive income.

Dividend yield
The dividend yield is the amount of money a company pays out per share as dividends, expressed as a percentage of its share price. So, if you bought a stock with a 5% dividend yield, and assuming that there are no dividend cuts and etc, you can expect pre-tax dividend income of 5% of your initial investment.

The higher the dividend yield when you bought the stock, the higher your passive income. But investors should, however, beware of stocks with high dividend yields, and conduct proper research on the stock to see if the dividend is sustainable.

Free cash flow
 A lot of people look at the dividend payout ratio (the percentage of profit a company pays out as dividends) as a way to analyze the safety of the dividend. While I have nothing against the dividend payout ratio, I think that for the purpose of deciding whether or not a company’s dividend is safe, that investors should instead look at the percentage of free cash flow the company pays out as dividends.

By measuring the dividends a company pays out against its free cash flow (cash from operating activities - capital expenditure), investors can have a better picture of the safety of the dividend as free cash flow takes into account expenditure needed for future growth, so investors can worry less about the company suddenly cutting its dividend to fund its growth. Net income can also be more easily manipulated than cash flow, which can affect the soundness of using the dividend payout ratio to gauge the safety of a company’s dividend.

Generally, the lower the percentage of free cash flow used to pay out dividends, the safer the dividend.

Profit and revenue growth

From a dividend income standpoint, we want the companies we invest in to regularly raise their dividend. And the only way a company can keep raising its dividend in the long-term is for it to have long-term profit and revenue growth. That’s why I believe that investors should invest in dividend paying stocks that are still growing their revenue and income at a decent rate.

Dividend history
Investors should look for companies that have a history of raising its dividend. This shows that the company is willing to give back the wealth to its shareholders. Nothing is for certain, but if the company is still growing profit and revenue, and it has a history of raising its dividend, it won’t be unreasonable to expect that the company may increase its dividend again sooner or later.

Size doesn’t matter
I personally don’t really pay attention to the market cap of a stock, but only look at the financial condition and performance of a company to evaluate if a stock would be a good dividend income generator long-term. In fact, I generally prefer smaller faster growing companies to big cap companies as dividend income generators, as these smaller stocks have more room to grow revenue and profits, which can in turn lead to more growth in their dividend. But for conservative investors, it might be safer to invest in blue chips.

Don’t get dividend tunnel vision
Investors shouldn’t only pay attention to whether or not a company has raised its dividend, but also take into account other things. Things like share buybacks and strategic acquisitions can also create value for a company’s shareholders.

Reinvest your dividends
Albert Einstein once said, “The most powerful force in the universe is compound interest.” Investors that do not need the income from their dividend income stock portfolio, should just reinvest their dividends and let their stock portfolio compound over time, as this can lead to a huge difference in the value of their portfolio and the passive income it generates over the long-term.

Value dividend paying stocks like you would any other stock
At the end of the day, whether or not a stock pays a dividend, it’s still a stock (I know, I’m being captain obvious here), and apart from also looking at certain things like the dividend yield and etc, we should value dividend paying stocks the same way we value any other stock. You can check out some of the things I look at when evaluating the investment appeal of stocks here.

If you have any questions, or would like to share anything, please feel free to comment. Thank you for reading, and may you always sustain good returns on your portfolio. Take care.

Saturday, September 18, 2010

Lessons I think I learned from advertising

Advertising might not be as important as it used to be in the past (at least that’s what I personally think, I will explain later), but advertising still has a place in a company’s business strategy. In this article, however, I will be talking more of the things I learned about advertisements from an entrepreneurial and financial standpoint.

Return on investment is still no.1

Some advertisements pay off more than others depending on the platform used to deliver the ad, the attractiveness of the ad, and who the ad is targeted to. I won’t be talking about ad attractiveness in this article, as I wouldn’t know what I’m talking about.

I will, however, say that depending on whom your target audience is, the platform used to deliver the ad can influence the effectiveness of the ad, and if possible, focusing your advertising campaign on what Adrian Slywotzky calls the share determining segment in his book “The Art of Profitability” can result in increased market share not only in the share determining segment, but the entire market for your product. An example of a share determining segment given in “The Art of Profitability” are medical specialists, that the prescriptions medical specialists write have an influence on the prescriptions general practitioners write.

In the end, companies advertise their products to ultimately get more profits, and companies (from small businesses to multinational corporations) have to think about advertising effectiveness in terms of the returns they can get on their advertising dollars.

Create value for customers

If memory serves me right (my memory can be faulty at times), the CEO of Amazon, Jeff Bezos once said in an interview with Charlie Rose that companies should focus less on advertising their product and focus more on creating a great product or service. I totally agree with this, and that’s why I said earlier in the article that I don’t think advertising is as important as it used to be.

Advertising might get you short-term revenue increases, but it’s the value that you create for your customers that determine the number of people you convert to loyal customers, which in turn determines the long-term profitability of your company. By satisfying your customers with a good quality product or service, you also set your company up for the best form of advertisement: word of mouth advertisement.

True, we might need some advertisement to build our brand, but things like great customer service, delivering on our promises, and quality products goes a much longer way to building a great brand for the long-term.

Adapt to change
About 99.99999% of the world’s population have a Facebook account (maybe I’m exaggerating a little), and companies will be wise to find effective ways to advertise their products on Facebook. I remember reading somewhere in one of the editions of Fortune magazine about an organic farmer advertising its products in the form of virtual produce in Farmville, a game on Facebook.

I’m not saying that every business owner have to use Facebook as an advertising platform; I’m just highlighting the need for companies to effectively adapt to change, whether it’s advertising, customer tastes, or etc. By ignoring change we might lose out on opportunities to grow, experience a long-term decline in our businesses, and give our competitors the opportunity to take market share away from us.

Hiring people with complementary skills

I don’t know how to produce an attractive ad, nor do I know stuff about a lot of things. But that’s ok. We might need to understand the business we intend to get into, but we don’t need to know every single business function to start and run a business, we just need to hire good people that have skills that are complementary to ours. We should focus on the things we are great at, and delegate the stuff that we’re not so good at to trustworthy people that can do those things well, as that’s how we unlock the most important assets in our business, human capital.

Have a long-term approach

Another golden nugget from Adrian Slywotzky’s The Art of Profitability, is that companies that continue advertising without cutting back during economic downturns are in a position, when the economy gets better, to increase revenues and profits at a faster pace than their rivals that cut back on their advertising. This highlights the importance of taking a long-term approach to any business activity.

If you have anything you would like to share, please feel free to comment. Thank you for reading, and may you always sustain good returns on your portfolio. Take care.

Tuesday, September 14, 2010

Conquering the world with ETFs

 I personally don’t have the confidence to pick stocks from most of the emerging markets. I am well aware that a lot of emerging economies could probably have become more transparent and adopted better policies for foreign investors, but I just don’t feel comfortable investing a significant portion of my net worth in most stocks from developing countries (except maybe the highest quality blue chips).

Thankfully for me, and for anyone else who feels the same way as I do, there is this wonderful thing called an ETF. Exchange traded funds that are based on an index that measure stocks in an emerging market allow us to take part in the growth of emerging economies, while at the same time lowering our risks, as each ETF invests in a number of stocks, providing us with diversification. ETFs can also be more tax-efficient and have lower costs than mutual funds.

While it’s true that investors can potentially realize higher returns by picking stocks rather than buying an ETF. I do, however, believe that emerging market stocks on average will generate pretty good returns, and I would rather enjoy the returns that stocks of a fast growing country generate on average than take a chance that the stock I pick turns out to be a dud.

Here's an article I wrote about valuing ETFs: Valuing ETFs the Benjamin Graham way.I would just like to  say that investors should not only look at a country’s growth rate when investing in an emerging market ETF , but also take into consideration things like inflation, national debt, population growth, natural resources, trade balance, and other things that can threaten the sustainability of that country’s growth, which in turn threatens the returns of stocks in that country.

Emerging markets (I personally like African markets) still have a long way to go, and I would like to take part in their growth sometime in the near future. I think that investing in ETFs is a very good way for me as well as for a lot of people to invest in developing countries.

Thank you for reading, and may you always sustain good returns on your portfolio.   

Saturday, September 11, 2010

Raising the darn profit margin

The profit margin is the percentage of sales we get to keep as profit. A high profit margin makes your company more resistant to adverse business conditions, requires a lower sales volume to breakeven, and leaves you with more profits to expand your business or payout dividends. 

Needless to say, we all generally want our businesses to earn good margins. In this article, I will look at a few ways we can improve our companies’ profit margins.

Stop selling lower margin products
Business owners can consider discontinuing their non-strategic lower profit margin products, as these products could be bringing down their companies’ overall margins. I know that some companies are able to generate good returns on their equities with a business model involving a low margin and a high volume. But for the sake of this article, we will only focus on the profit margin, and not take into account the return on equity.

Start selling higher margin products
Business owners can try and sell more of their higher margin products. They should make sure, however, that the costs incurred for things like advertising, promotions, and etc, which are done to attract customers to buy their higher margin products are worthwhile.

Business owners should invest in a good accounting system to effectively and efficiently identify higher margin and lower margin products. A good accounting system can help business owners know the costs associated with each of their products, which in turn allow them to price their products better and discontinue non-strategic lower margin or loss-making products.

Busting your suppliers’ balls
Are you buying products or materials in significantly larger volumes than you did when you last negotiated the price or prices with a particular supplier? If so, maybe it’s time to pay the supplier a little visit to renegotiate the price or prices. Lower costs to stock up shelves with products = higher margins. I was just kidding about the busting the suppliers’ balls part though, what I meant to say was to be tough but fair on the suppliers. Our suppliers are our partners, and long-term business success depends on either sharing the wealth or creating value for all stakeholders.

Don’t under-price your product
Customers are willing to pay for value. So, if you can deliver to your customers a product that creates great value for them, then there will be no reason for you to under-price that product.

Re-evaluate your business
Try and find out what activities create value for your customers and what activities don’t, and try and eliminate or reduce the activities that don’t. Also, think about outsourcing some of your activities to other companies that might be able to perform those activities at a lower cost for you. Whether it’s cutting out activities or outsourcing activities, lower costs = higher margins.

Another proven method to improve your business’ profit margin is, of course, by getting more customers or getting your current customer base to buy more, as by selling more products, your fixed costs get more spread out over a bigger sales volume, which reduces the costs associated with each unit of product you sell, which in turn increases your profit margin. I’m planning to publish an article related to the “customer” sometime in the near future. So please, visit my blog soon if you’re interested.

As always, if you have anything you want to share, please feel free to comment. Thank you for reading, and may you always sustain good returns on your portfolio. Take care.

Friday, September 10, 2010

Want a stock idea, just look around

I think it was Peter Lynch that suggested looking around at the products we use as a way to identify stocks for potential investment. I personally feel this is an awesome way to find companies to analyze and potentially invest in as compared to listening to advice from some idiot that uses technical analysis to evaluate if a stock is an attractive investment or not.

Anyway, I decided to conduct a little experiment and see if I can identify 10 public listed companies from the products and services in my house.


Yesterday when I woke up, I went to the bathroom to take a shower. I used Pantene shampoo from Procter and Gamble. I also brushed my teeth using Colgate toothpaste from Colgate-Palmolive.

After I had my shower, I made breakfast. I fixed myself a sandwich with cheese from Kraft as one of the ingredients,  I also had some Minute Maid orange juice from Coca-Cola. While fixing breakfast I also spotted a box of cornflakes from Nestle.

I then logged on my computer to surf the net. The search engine I used was Google, and I looked up Amazon.com to check out the price of some books.

I then went to play on my X-Box 360 (from Microsoft) on my Sony TV, and while I was playing, I received a call on my Nokia phone.

If you have anything to share, please feel free to comment. Take care, and may you always sustain good returns on your portfolio.

Wednesday, September 8, 2010

How to keep buying when stocks are cheap

Build up cash when stocks are expensive
When stocks are irrationally high, investors can consider building up cash instead of buying shares in overvalued companies and taking the risks of potentially large paper losses that might take years to recover from, depending on how overvalued the stocks are.

Cash is certainly not king, and investors should never have a large percentage of their portfolio in cash for the long-term, as cash historically generate poor returns. There is nothing wrong, however, in building up cash when there’s nothing attractive to invest in, as having excess cash on hand allow us to take advantage of situations where stocks are trading at a discount.   

Generate passive income
By owning operating businesses, investors get constant cash flows to keep on buying stocks for as long as the stocks stay undervalued. If you do not own operating businesses, you can also generate passive income by having a portfolio of good dividend paying blue chips. An investor can just reinvest the dividends their blue chip stocks generate and let that portfolio compound during normal times, and invest the dividends in undervalued stocks when the market is low (or maybe just keep reinvesting the dividends as the investor’s blue chip holdings might have also dropped to very attractive prices).    

Take on some debt

Investors can consider taking on some debt, as long as the interest on the debt is low, the debt is long-term, and they can easily make the interest payments from their salary or from the cash generated from their operating businesses or blue chips portfolio. To be safe, investors should also have some cash in reserve so that they can  still make interest payments for a while (hopefully they can figure things out in that time) if something happens to their income streams. Investors should always make sure not to take on too much debt, and if they do decide to take on debt, investors need to be sure that they know what they are doing. (I know you probably heard this a million times before, but it’s so important that I don’t mind being the millionth person to state this).

Be frugal, make cutbacks
Investors can choose to tighten their belts and postpone big-ticket plans like going on an overseas holiday, buying a new car, or renovating the house. The cash they save can then be channeled to buying stocks on the cheap.

Investors need to decide which is more important to them; spend less short-term for the potential of bigger future profits or just spend as planned and miss out on being able to pour more money into an undervalued market. To me, this is a personal choice, and neither makes for a bad financial decision.    

If you have any ideas on how to keep buying stocks when they are cheap, or if you have any questions, please feel free to comment.

Saturday, September 4, 2010

Another 3 tips for your new business venture

In one of my previous articles, I wrote about 5 tips for aspiring entrepreneurs wanting to embark on their business ventures (If you’re interested, you can check out the article here). This article will expand on the original article by introducing another 3 tips for people interested in starting their own business.
Have a great, customer-focused mission statement that people can relate to
A lot of people think that a mission statement is just some nice words put together as a lame attempt for a company to placate its customers or shareholders; and it is, unless you really emphasize on making it a core part of your business culture and always base the decisions your company makes and the activities it performs on how close they get your company to the mission it has established for itself.
Your mission statement doesn’t need to look like it has been written by Shakespeare, something simple will do. Say you’re planning to open a diner; you could maybe have a mission statement that looks something like this: Putting together a combination of fast service, tasty food, and a pleasant ambience that makes our customers feel good. After you have established your company’s mission statement, make sure that the decisions your company makes is relevant to the mission statement, and review your operations from time to time to make sure that they are in line with your company’s mission.
Take care of your employees
I can’t remember the exact quote, but J.W. Marriott once said, “Take care of your employees and they will take care of the customers.”
It doesn’t matter if it’s the Marriott hotel chain or a neighborhood bakery; companies need to take care of their employees if they want to be truly successful. It’s after all the employees that will be the ones making contact with your customers and determining if your customers get a good experience or not, they are the ones that customers talk to, and they are the ones that can either unlock value in your business or destroy the reputation of your business.
Entrepreneurs should strive to build a team of great people around them. To do that, business owners have to do things like: share the wealth, involve employees in the decision making process, promote from within, help employees share in your vision, create a great culture, and etc. There’s no single way to keep your employees happy; but through a combination of incentives, you can retain great, loyal employees.      
Just because we might be starting out small, doesn’t justify us having ideas like: getting a few people to work for us, pay them a few bucks an hour, and watch them closely so they don’t screw up. The faster you put in place the incentives as well as the culture to retain and attract good employees, the faster you will be on track to unlock value in your company, and the easier it will be for you to successfully expand your business without making major overhauls that can be costly.
 Imagine the situation your company will be in if business doesn’t go as planned
While we need to be optimistic about how successful our businesses will turn out, we should also be realistic and think about how our business will fare when times are bad. To do this, simply take away x% from your estimated sales and increase your estimated costs by x%, then ask yourselves these questions: Will your business still break even? What will your return on investment and profit margins be like? What are your company’s plans for growth, now that you have lowers profit to work with?
If you still believe, after answering these questions, that your business venture makes financial sense, then you can consider starting that company.  

Wednesday, September 1, 2010

Create the experience: the profits will follow

The ability to create great memories for your customers can be a really defining competitive advantage. Ikea, Disney, and, to a certain extent, McDonald’s with its “Happy Meals” are all companies that do a good job at creating great memorable experiences for their customers.
Many aspiring entrepreneurs talk about creating a good experience for their customers, but seem to fall short most of the time. In this article, I will talk about some of the ways how creating unique memories for customers can benefit the bottom line.
Loyal customers or loyal generations of customers
When we were kids, my brother and I would always look forward to Friday, as that was the day my mum would take us out for McDonald’s. I didn’t ask for a happy meal (the burgers in there were too small for me), but would instead get my mum to buy me a double cheese burger and whatever toy they had for that week.
It is these memories that make me put McDonald’s at the top of the list when deciding which fast food restaurant I want to eat at. It is also these memories that will make me want to bring my kids in the future to McDonald’s to let them experience what I experienced and enjoyed when I was a kid, and if they enjoy it as much as I did, I think they too will become loyal customers of McDonald’s.
So, companies that can create happy, unique memories for customers will have more loyal customers and maybe even generations of loyal customers. Fun business fact: According to the article “Zero Defections: Quality Comes to Services” in the Harvard Business Review, companies are able to increase their earnings by up to almost 100% by retaining 5% more customers.
Increased sales at a company’s other business divisions
Customers that had a good experience with a particular company through contact with one of its business divisions will be more likely to buy products from that company’s other divisions. Take Disney for example, kids that enjoyed one of its movies might persuade their parents to take them to Disneyland or buy Disney merchandise related to the movie.
More sales as a by-product of the experience
Some companies are really known for the experience they create that people just go their outlets just to go there. For example: You’ve people tagging along with their friends to Ikea just to walk around checking out cool furniture and living spaces and eat Swedish meatballs. These customers might have no intention of buying anything, but there’s still always the possibility that while walking around, these customers spot a piece of furniture or two that they might like and decide to make a purchase.
So, by creating a great experience, companies get the opportunity of making sales to customers that might not originally have any intentions to buy. The extra sales these companies generate will have an impact on their bottom lines.    
Premium pricing
A great experience or a great memory is a distinguishing factor that really sets a company and its products apart. By being differentiated and having products that are differentiated, companies are able to command higher prices which will translate to higher margins and profits.

In conclusion, the ability to create a great experience and memory for the customers should be taken into account by investors when evaluating the competitive advantage and investment appeal of companies, and aspiring entrepreneurs should try and build their businesses to be able to provide value to customers in the form of a unique and good experience.If you have any questions or have anything to add, please don't hesitate to comment.

The eternal battle of REIT vs. Physical Real Estate

Owning shares in REITs or directly owning real estate (or even owning both asset classes) can be part of an effective investment strategy. REITs and physical real estate can provide investors with nice passive income and if bought at the right price with the right fundamentals, can turn out to be great investments.
 There are benefits of owning each of these asset classes, and in this article, I will talk about some of the advantages of investing in REITs as well as some of the advantages of investing in physical real estate.
Unless you’re really rich, you might not be able to directly invest in hotels, office towers, shopping malls, and warehouses. Investing in REITs will allows you to become a part-owner of these types of assets, which can potentially produce better returns than residential properties or other lower value real estate.
Being big is not always a great thing, as REITs might not be able to take advantage of smaller opportunities, which won’t have much of an impact on their bottom lines. This is where individual investors that really understand real estate have an advantage in terms of being able to directly invest in real estate that REITs don’t consider, and which might produce better returns than REITs.
REITs can prudently take on more debt, percentage-wise, than most individual investors as they have a much more diversified portfolio of real estate, which cash flows are sufficient to make interest payments and cover other costs even if occupancy rates fall. Investors should, however, beware of REITs that take on more debt than what the investors believe is prudent, as too much debt is always bad, no matter what the asset class. REITs can also potentially have significantly lower cost of funds than individual investors.
REITs like companies are run by management teams. If you’re not experienced or don’t like the activities involved in procuring and holding real estate directly, it might be a good idea to just buy shares in REITs. Some REITs might have really good management in place, which is capable of identifying real estate investment opportunities that can potentially produce significantly better returns than opportunities individual real estate investors can find by themselves.
Individual investors that really understand real estate can also potentially earn higher returns than a lot of the REITs out there. REITs can also be run by bad management teams, and instead of creating value for shareholders, these management teams can very well destroy shareholder value instead.
 After taking into account some of the costs incurred in the operations of a REIT (selling, general, & administrative expenses), investors might actually earn lower returns than if they were to directly hold and manage real estate themselves. A good management team can, however, achieve better profit margins and better returns on their real estate portfolio than the profit margins and returns achieved on the real estate portfolios of a lot of individual investors, as their experience, expertise, and knowledge of the business allows them to manage the portfolio more efficiently and at a lower overall cost percentage-wise.
Low entry cost and liquidity
Investors require much less capital to invest in REITs than directly investing in real estate, and REITs have better liquidity than physical real estate, as buying and selling shares in REITs is just like buying and selling shares in publicly traded companies. So, REITs have physical real estate beat in these 2 categories, but investors with sufficient capital and a long-term horizon shouldn’t have much to worry about in terms of entry cost and liquidity when directly investing in real estate. 
In his “Conservative Investors Sleep Well” writing, Philip A. Fisher wrote, “It has already been pointed out that in this rapidly changing world companies cannot stand still. They must either get better or worse, improve or go downhill. The true investment objective of growth is not just to make gains but to avoid loss.”
If you don’t like or don’t really know how to manage a real estate portfolio for growth, you would be better off investing in REITs, as the management teams of the REITs will manage for growth (or at least try to) for you. REITs with good management can actually achieve pretty good growth rates based on their size and the industry.
Individual real estate investors that know what they are doing can opt to manage and grow the profits of their real estate portfolios on their own, as some of the individual investors that really understand real estate are able to grow profits at a higher rate than a lot of REITs. Individual investors also have quite a significant advantage when it comes to growth, as unlike REITs, individual investors don’t have to pay out 90% of the taxable profits from their properties as dividends, and can reinvest the profits to grow their portfolio.
If you’re interested in investing in REITs and physical real estate you might want to check out this article I wrote Real Estate Real Returns. If you have any questions or would like to add anything, please feel free to comment.

Business lessons from a low-cost carrier

A lot of great businesses are based on a low-cost model and creating value for customers. Companies like McDonald’s and Wal-Mart are just a few examples. In this article, we will take a look at a few things we can learn from Air Asia’s rise to being the largest low-cost carrier in Asia.
Building strong brands
Having strong identifiable brands is one of the greatest sources of competitive advantage for a company, as the brands differentiate the products of the company. This will translate into consumers looking to the products or services of the company as a top choice to satisfy their needs, and this allows the company to command a premium on the price of its products (even if the business model of a company like Air Asia chooses to forego charging a premium and keep prices low). Companies like Disney and Coca-Cola created hugely successful empires on the basis of having a strong brand or a portfolio of strong brands.
Air Asia has been successful in building its brand into a regional powerhouse, and leveraged the Air Asia brand into the largest low-cost carrier in Asia. Air Asia is also taking advantage of its strong brand to branch out and get a stronger foothold in the air cargo business.     
The founders of Air Asia understand how important branding is, and are also building brands in the budget hotel, mobile operator, and consumer financial services businesses, as well as other businesses. 
Business model
Air Asia doesn’t only cut costs the typical way such as acquiring more cost-efficient planes, but also cuts out services that might not provide a lot of value or might not be as relevant to customers as compared to much lower air-fares. A person who happens to be travelling light on a particular trip might not get much value out of being able to check-in heavy baggage for free.
Customers’ needs do change, and not all customers want the same thing at any one time, and some customers are willing to pay for additional services on top of the basic air-travel service. Air Asia tries to provide good value to as many of its customers as possible by adopting a “pay-for-what-you-want” concept. The company provides customers with the basic service of getting them from one point to another at low prices, and those customers who want additional services such as on-board food or heavy baggage check-in pay extra for the additional services they consume.     
 Taking control of other parts of the value chain can enable a company to further cut costs. While technically not really qualifying as taking control of part of the value chain, Air Asia once had plans to build a low-cost carrier terminal to further reduce costs. When deciding on whether to take control of part of the value chain, a company has to look at the returns it can expect to obtain on the investment needed to take control of that part of the value chain, the opportunity costs in terms of the return on investment that could be achieved by pursuing other projects, and the ability of the company to manage a part of the value chain that could be significantly different from its core business.    
Air Asia is able to experience lower costs due to the sheer size of its operations, which allows it to enjoy economies of scale and other size-related advantages. The company is also digitalizing its business and encouraging customers to use their website as the point of transaction. This can result in lower-costs for the company as well as increased convenience for the customers.
Here are some pretty general things, but are also things that are beneficial to think about in terms of perishable services and price sensitivity:
 Airlines provide a perishable service in the sense that when their planes take off, the revenue lost from the empty seats cannot be recouped. Air Asia understands this and offers super-low prices for people who book in advance and advertises these low-prices in its advertisements, which not only informs its customers about the low prices, but also reinforces the Air Asia brand as the airline to go to for rock-bottom airfares.
 Air Asia gradually raise ticket prices as the date of the flight approaches, this allows them to take advantage of the lower price sensitivity of customers that travel on short notice.

Being a bigger part of the experience
The founders of Air Asia are also building their budget hotels, mobile operator, and consumer financial services businesses. While fine on their own, these businesses tie in very well with the budget airline business and are all part of the “travel experience.”
Someone who wants to travel from one place to another needs transportation; this is where Air Asia comes in. That person might also need a place to sleep at night; this is where the budget hotels come in. The traveler might also need to make phone calls back home or might need a convenient and secure way to buy stuff; this is where the prepaid mobile cards and prepaid debit cards come in.  
Companies that successfully build businesses around an experience are able to enjoy cross-selling opportunities and increased share of their customers’ wallet. But like efforts to control other parts of the value chain, companies should look at things like return on investment and current expertise and capabilities.
Huge market potential
Air Asia serves a huge market in the form of low-income to middle-income consumers in general that are looking for affordability and value in terms of air-travel. This market provides the opportunity for Air Asia to sizably increase its sales for the long-term (assuming of course that management is capable), which ties in well with one of the fifteen points highlighted by Philip A. Fisher in the book “Common Stocks and Uncommon Profits” as things an investor should look for in a stock, that is, “Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years?”
Increase in sales is only good if there is a similar or greater percentage increase in profits over the long-term. There are many cases of companies overpaying for acquisitions or committing to costly expansions in an effort to increase revenue, only to find they are racking up huge losses down the road.
In conclusion, this article looks at some of the things that we can learn from a budget airline, and that can be applied to other real-life businesses or looked out for when analyzing stocks.
 I personally enjoy thinking about business models and trying to fit these business models with companies that I’m analyzing for potential investment, or trying to come up with business ideas applying these models or a combination of models. Both investors and business owners can benefit from learning about different business models as investing in stocks and owning businesses should be thought of as the same thing.   

Profitable Diversification

When investing, you should only diversify when you do not know what you are doing, as this will reduce the risk of losing a significant portion of your money in a few bad investments. Aiming for diversification when you understand how to value stocks or have identified a lucrative business opportunity isn’t really a great thing as you run the risk of adding to your portfolio mediocre investments and experience overall portfolio returns that are lower than what you could have achieved if you invested your money only in the good stuff.
In this article, however, I will look at diversification from the angle of the companies or businesses. I will look at situations where private businesses and listed companies created good value for their shareholders by diversifying their operations.
Market Diversification
Setting up their core businesses in new markets is one way for companies to grow by replicating their success in different markets, and diversify where they generate their revenues, which somewhat protects companies from a downturn in some of the markets they operate in, as profits generated in their other markets can, to a certain extent, make up for the shortfall in profits or at least cancel out some of the losses from markets that they are not doing so well in.
Whether it’s going into a new market or investing in a whole new business, one of the main reasons for diversification is to spread out and reduce risks.  Take the recent financial crisis for example, the investment banking divisions of quite a few integrated financial companies contributed significantly in shoring up these banking groups’ profits.
Product Offering Diversification
Product offering diversification can increase a company’s profits by appealing to a different market segment or increasing the company’s share of its existing customers’ wallets by selling them stuff that they already buy from other companies. McDonald’s introducing its McCafe product line is a great example and is now a significant contributor to McDonald’s revenue growth.
Related business line diversification
This is similar to the diversification efforts discussed above, but instead of just offering a new product line that is more or less an extension of its existing business operations; the company goes into a different, but still somewhat related business. For example: A lot of luxury fashion brands are in the apparels business, fine watches business, the perfume business, as well as other luxury fashion related businesses.
  Like the luxury fashion companies, some companies are able to leverage their brand and expertise and go into related businesses with somewhat of a head start in terms of a ready customer base. Firstly, these companies export their brand from their core operations to their new ventures, this will significantly reduce the efforts needed to build a well-established brand, and customers are more likely to buy stuff with a recognized brand. Secondly, the company’s customer bases from their existing core operations might opt to switch to the products offered by the company’s new venture; this too will contribute to the new business line’s starting customer base.    
Diversifying into related businesses really shines when a company is able to create more value for its customers through its diversified operations and cross-sell to its customers, products from its various business divisions. Take those integrated financial companies for example, they make it convenient for their customers to do stuff like invest, pay bills, save, and use their credit cards. This convenience creates value for the customers. The integrated financial companies also get the opportunity to increase revenue by cross-selling their various financial products to the customer.
Unrelated business line diversification
This is where companies go into businesses that might not be related to their existing core businesses. There’s nothing wrong with that though, as long as the company goes into businesses where it can get good returns for shareholders. Berkshire Hathaway invests in or owns many different kinds of businesses, and it has created great long-term value for its shareholders. 
So, why and why not diversify?
 We have discussed the benefits of diversification in terms of cross-selling, appealing to different market segments, and channeling shareholders’ funds into businesses that can generate above average returns. Now, let’s look into some of the other reasons for diversification:
Diversification can in some situation be an easy way for companies to generate additional revenue. I remember watching some news channel and there was this story about offices being built on top of open-space parking lots. This is one of the examples where diversification can be a way for companies to maximize the utility of their current resources and increase revenues without a lot of effort. I don’t know if this counts as diversification, but turning industrial waste into useful products is also a good way to earn extra revenue and maximize utility of resources.
Diversification can be a way for companies to defend their business from changing trends and new competitors. Take a fast food chain for example, if it’s in a situation where customers are moving up to casual dining restaurants, it might do well to set up its own casual dining restaurant brand to try and recapture revenue lost due to a smaller customer base.
 Some companies can effectively transfer its knowledge, technology, and expertise from its core business to other lines of business and be successful in those business lines. If proper research is done, companies like this can profitably diversify its operations.
In some cases, the value of the company’s diversified business divisions put together as one greatly exceeds the sum of all the company’s business divisions measured individually. Take Disney for example: Most of its business divisions add value to the other divisions.   
Here are some reasons why companies shouldn’t diversify:
Diversifying into businesses where returns are low is a not a good thing, and shareholders will be better off if the company paid out dividends instead of going into businesses with low returns.
A company should not diversify its operations if there is still a lot of room for its core businesses to grow, and its options as to new businesses to invest in are not as good as its core businesses in terms of long-term profitability.
Companies should also avoid diversifying into businesses that they do not have and are not easily able to build expertise in.
Companies that are short on liquidity should put off diversifying their operations and conserve cash, least they spread themselves too thin. Many companies have destroyed significant shareholder value if not completely wiping out shareholder value because of a lack of liquidity. Companies also shouldn’t focus on diversifying if they have too much debt, and should instead pay down some of its debt and build up book value before investing in new businesses.
 So, these are my thoughts on diversification, and I hope they can be of some use to anyone who reads this article in terms of decisions to diversify their private businesses or when evaluating the diversification efforts of public listed companies you can buy shares in. How about you guys, any thoughts on diversification that you would like to share? Or perhaps I missed something out or you might have some questions. Whatever it is, please feel free to comment and share. Thanks for reading.

Real Estate Real Returns

Real estate like stocks is an asset class, and some investment principles and valuation methods that apply to stocks also applies to real estate. In this article, I will look at some of the things that we should take into account when analyzing the investment appeal of real estate.
While it’s true that stocks generally provide investors with higher returns than real estate, there are situations where, if proper research is done and if bought at an attractive price, real estate can turn out to be great investments.
Real estate is also a good source of passive income that can contribute to the spending power of retirees and allow them to enjoy their golden years more comfortably. Passive income generated by real estate investments can also allow younger people the freedom of not relying too much or at all on their jobs, and gives them a safety net to strike out on their own. Income from real estate assets can allow you to keep buying when the market is undervalued and everyone but the smart guys are selling.    
Occupancy Rate
Whether you’re buying an apartment or investing in REITs, investors should look for a high occupancy rate. It is supply and demand; a high occupancy rate means that there is less rental space supply and this will increase the odds that rent can be raised successfully. For REITS, you can usually find the overall occupancy rate for a REIT’s properties in their annual report. For real estate like an apartment or a house in a suburb, investors should look at areas where houses are mostly occupied (if anyone knows how to check the occupancy rates for housing areas, please feel free to share, thanks).
Investors can also try and approximate the occupancy rate of their properties needed to make mortgage payments and cover maintenance costs. For example: A property investor might own 5 condo units, and need to rent out at least 2 units to break even on interest and maintenance costs.
Here are the steps I use to roughly determine the occupancy rate needed to breakeven for a REIT (This is assuming that majority of the REIT’s revenue comes from rental and not property management or etc):
Step 1: I find out the revenue that can be achieved at 100% occupancy. I assume 100% occupancy = max revenue and make the necessary adjustments with current revenue and current occupancy rate.

Step 2: I minus depreciation from total expenses.

Step 3: I express the expenses ex-depreciation figure in terms of a percentage of maximum revenue, and that percentage will be the occupancy rate I think is needed to breakeven.

 Liquidity and Cash
Whether you own a few condominiums or have bought stock in a REIT, cash is important to protect you from adverse conditions where occupancy rates are low and rental yield is falling. If you own a few rental properties, you need to make sure you have enough cash to at least make mortgage payments and maintain your properties in case some of your tenants suddenly shift out.
REITs with high occupancy rates don’t need to carry much cash, as unlike individual property investors, REITs own many properties and have many tenants; this diversification of income sources reduces their financial risk in the event where some of their tenants decide to move out.  
It’s important to lock in low mortgage rates whenever possible as any increase in the mortgage payments you need to make affects the returns you earn. But when mortgage rates are affordable but not cheap, investors may consider having a mix of fixed-rate and adjustable-rate mortgages on their investment properties, as this will allow them to enjoy overall lower rates if mortgage rates fall, and be somewhat protected if mortgage rates rise.
How conservative you are should also determine the type of mortgage you should opt for. Investors looking for stable income should get a fixed-rate mortgage and stably earn the difference between rent and costs every month. I personally will not take out adjustable-rate mortgages on my investment properties if I only have in my portfolio one or two properties, as the risk of lower cash-flows or even negative cash-flows due to an increase in mortgage rates is too much for me.
For a REIT, I look at the average interest rate of its debt, to see whether it’s acceptable or not.  I also look whether the REIT has a significant portion of debt coming due in the short- to medium-term, and if it can build up enough cash from now to then to finance the portion of debt coming due. I also find out how exposed the REIT is to increases in interest rates by looking at how much of their debt have variable rates.
Adding value
One of the ways REITs are able to add value to their properties is by renovating their properties to fit in more units they can rent out or increase the appeal of the malls to attract more shoppers which will be followed by the REIT being able to charge their tenants higher rent.
Individual property investors can also add value to their property investments. They can furnish their properties, build more rooms in their properties, or etc. What matters is that the investment made to enhance the value of the property results in higher rental income where the estimated additional rental that will be earned represents healthy returns on the value enhancing investment.
 Valuing Real Estate
To value a property, investors should discount the estimated future rental cash-flows minus estimated future maintenance costs back to the present. If investors are looking for high returns and not just stable income, then the discount rate should be higher (I use 12%) than the discount rate of 6-7% that I recommend for stocks, as unlike stocks, rental income from real estate can’t grow much (increases in rental earned due to inflation don’t count, as you will still get the same purchasing power with your increased rental income; selecting good locations might result in long-term rental income growth that outpace inflation, but it will be more prudent not to take this potential growth into account).
After discounting back to the present the future net cash-flows the property is estimated to generate, we get a figure that’s almost the value we think the property should be worth. I say almost because we still need to add to the figure legal costs, and any other costs associated with acquiring the property. Investors should buy properties that are at a discount to the value the investors think they are worth.

The price of physical real estate hardly ever drop so low that you can earn double digit  returns from the rental (at least I don't think it does from where I come from), but like a company, the returns from real estate can be improved by taking on debt. But investors should make sure that they can comfortably service whatever debt they intend to take on. You would probably have guessed by now that I'm not a physical real estate investor, or I wouldn't even think of demanding a 12% return on a real estate investment without using any debt(that just goes to show how much more attractive I think some companies are as compared to real estate right now  that I would need such a good return before I would consider investing in real estate).

But when stocks aren't as attractive anymore, then I would of course seriously consider physical real estate as an investment if I can earn 12% returns, maybe even 10%, by employing modest leverage.

The things I talk about in this article are by no means everything an investor needs to know about real estate investments, whether it’s buying shares in a REIT or buying real estate directly. For example: Investors planning to invest directly in real estate like a condo unit should also pay attention to things like location and etc.
I value REITs the same way I value stocks. Here’s my article on some of the things I look at when evaluating stocks for potential investment: Things I think about before making investment decisions

If you have any questions or have anything that you would like to share please feel free to comment. Thank you for reading, and may you always sustain good returns on your portfolio. Take care.