Saturday, 31 January 2015

Quote for the day

“The best way I know to learn discipline and patience is to think through a trade thoroughly before putting it on. You need to develop a plan of your strategies for various contingencies. That way, you won't get swayed by every news item that hits the market and causes prices to move up or down.” -  Gary Bielfeld

Friday, 30 January 2015

30-Jan-2015 CSE Trade Summary

Quote for the day

"I've learned that people will forget what you said, people will forget what you did, but people will never forget how you made them feel." - Maya Angelou

Thursday, 29 January 2015

29-Jan-2015 CSE Trade Summary

Quote for the day

“Good judgement comes from experience, and experience comes from bad judgement.” - Fred Brooks

Wednesday, 28 January 2015

28-Jan-2015 CSE Trade Summary

Quote for the day

“There is a very good investor I speak to frequently who said, 'All I bring to the party is twenty-eight years of mistakes.' I really believe he is right. When you make a mistake, there is some subconscious phenomenon that makes it less likely for you to make that same mistake again.” - Michael Steinhardt

Tuesday, 27 January 2015

27-Jan-2015 CSE Trade Summary

Quote for the day

“Good traders have a special talent for trading just as good musicians and good athletes have talents for their fields. Great traders are ones who are absorbed by the talent. They don't have the talent — the talent has them.” - Ed Seykota

Monday, 26 January 2015

26-Jan-2015 CSE Trade Summary

Quote for the day

“Beliefs have a function that is not linked to their truth.” -  Paul Troop

Sunday, 25 January 2015

Performance anxiety for traders

Performance anxiety for traders is the fear, or persistent phobia which may arise in a trader by the requirement to take a real trade, in real time, with real money whether actually or potentially.

There are many causes of this anxiety which many times leave a new trader with too much fear to really trade. Fear sends them out of the markets to go join the 90% that did not make it. This fear can arise from past losses that were so big and traumatizing that a trader can’t bear the potential of repeating a mistake like that with all the emotions tied to the previous failure. A new trader can even get a valid entry signal but focus on the real money in the trade and the potential for loss and lose sight of the potential for gain.

A trader that is afraid to lose can’t trade because even the best traders spend a good part of their time being wrong and cutting losses. The good losses in trading are either tuition in your early years or the cost of doing business inside a robust system in your later years. The bad losses are big and are usually the result of the new trader not doing adequate homework so the markets take that new trader to school. These big losses not only hurt the new trader financially but can be traumatizing mentally and emotionally causing a loss of faith in themselves and their system.

More than anything trading is a mental game and if your thoughts are not right then none of this will work. If you have your mindset right about trading then nothing can stop you. A trader must have the ability to point at the target and pull the trigger in the moment when it is time. We must accept the risk and reach for the reward. Here are five tips to make that a possibility.

1. A trader can only build confidence to take a real time trade entry after they have done the necessary homework in back testing through multiple market environments to know the probabilities of success and the possibilities of failure. Understanding how the markets have behaved with past price patterns can give the trader the boldness they need to push the submit button on their broker’s screen.

2. Understanding the price level where your stop loss on a trade will be and also your potential price target will give you a good idea of the risk and reward dynamics of a trade set up. It is easier to trade when you know that you are risking $100 for a chance to make $300 and the odds are on your side with a great entry.

3. Structuring your position sizing so that if your stop is hit you will only lose 1% of your total trading capital will eliminate much of your fear of failure. The urgency and importance of any one trade should be converted into the calm assurance of knowing that the current trade is just one of the next one hundred trades. You can overcome the majority of anxiety around trading when you simply trade small enough so that any one trade or a string of trades will not affect your long term trading success.

4. Trading what you know and are familiar with is low stress trading. Trading a chart pattern, stock, or index that you have traded for years is familiar territory. Also trading markets inside your circle of competence creates confidence. Only trade futures, options, stocks, bonds, forex, and indexes that you understand. Many traders drown chasing unfamiliar waterfalls.

5. A lot of performance confidence comes from having a detailed trading plan on what you will do before the market opens and the faith in yourself to execute that plan after the market opens. Knowing that your decisions will be based on the facts and the reality of price action and that you will not be swept away with emotions and ego while trading can allow you to rise above anxiety and instead operate with faith in yourself and your system.


Quote for the day

"Technical analysis relies upon the idea that smart money will move into a market and give advance warning that a position should be taken. This often occurs when the true major fundamentals are unknown." – Jerry Parker 

Saturday, 24 January 2015

44 Years of Email: A Breif History

In 2015 email will officially turn 44 years old making it nearly middle aged. Email is used so widespread that it is hard to imagine that the first electronic mail was sent only 44 years ago by Ray Tomlinson. Reachmail has put together a very comprehensive infograhpic that covers major milestones in the 44 years of electronic email. Can you even imagine what it was like before email existed? In your opinion what is the biggest milestone in the history of email?

44 years of email: A brief history #infographic

Quote for the day

“If you can dream — and not make dreams your master; If you can think — and not make thoughts your aim; If you can meet with Triumph and Disaster; And treat those two impostors just the same...” - Rudyard Kipling

Friday, 23 January 2015

23-Jan-2015 CSE Trade Summary

Quote for the day

“Given the uncertain nature of the future, and thus the difficulty of being confident your position is the right one—especially as price moves against you—it's challenging to be a lonely contrarian.” - Howard Marks

Thursday, 22 January 2015

22-Jan-2015 CSE Trade Summary

Quote for the day

“The important and difficult job is never to find the right answers, it is to find the right question.” - Peter Drucker

Wednesday, 21 January 2015

21-Jan-2015 CSE Trade Summary

Quote for the day

“Gut feel is important. If ignored, it may come out in subtle ways by coloring your logic. It can be dealt with through meditation and reflection to determine what's behind it. If it persists, then it might be a valuable subconscious analysis of some subtle information. Otherwise, it might be a dangerous sublimation of an inner desire for excitement and not reflect market conditions.” - Ed Seykota

Tuesday, 20 January 2015

20-Jan-2015 CSE Trade Summary

Hot Stock Picks Make Super Gains

One year on, model portfolios built by top fund managers for Echelon Magazine outperforms market

By devan daniel.

The returns blew us away: Echelon Magazine was not prepared for the superlative returns one year after top fund managers built hypothetical stock portfolios for the January 2013 edition in an exercise to understand how long term portfolio investments worked. Ramesh Schaffter of Janashakthi Insurance, Indika Rajakaruna of Ceybank Asset Management and Sumith Perera of Guardian Acuity Asset Management were each asked to create a model portfolio valued at Rs10 million. One year on the Rs30 million combined portfolio has grown to a little over Rs46 million for a combined growth of 53%, outperforming the overall market which grew at 24%. We take a look at how each portfolio performed and present reallocated portfolios which will be reviewed again next year.

Disclaimer: This story is not meant to represent advice or to suggest transactions in securities referred to in it. It is not a substitute for the exercise of independent judgment and readers should consult independent investment advisers in making investments. Neither Echelon magazine nor the investment funds mentioned in this story accept any liability whatsoever for any loss arising from the use of the information presented here.

Comfort zones challenged: Sumith Perera

Guardian Acuity Asset Management (GAAM) is a joint venture, equally owned by Ceylon Guardian Investment Trust, a subsidiary of Carson Cumberbatch, and Acuity Partners, the investment banking arm of DFCC and HNB. Sumith Perera, Fund Manager at GAAM, discusses the performance of his model portfolio and reasons for reallocation.

How did the market perform during the past year and how did your model portfolio fare?
The stock market had a great run over the last year with my portfolio providing a return of 56.41%. The All Share Price Index has given a return of 23.99% for the same time period. Foreign inflows into the CSE continue to be strong and are invested in a wider-than-usual selection of stocks. Declining interest rates has pushed retail investors out of their fixed deposit comfort zones and into higher prospective returns in the CSE. Earnings growth is more encouraging relative to last year and interest rates remaining low will help the stock market along. Softer commodity and energy prices have also brought down costs for many of the listed companies.

What was the best performing stock and what drove its performance?
Hemas Holdings performed the best with a share price growth of 115%. The share price performance was a result of significant foreign and local institutional demand based on strong performance in its FMCG and healthcare sectors and a positive outlook for leisure. As a value investor, I will only buy into a stock if there is a suitable upside based on its intrinsic value. The strong share price movement of Hemas has resulted in the stock closing in on its intrinsic value. As a result, I have reduced my allocation in Hemas for the new portfolio of stocks to 7% from 13% last year.

What factors prompted you to reallocate your model portfolio?
My top weight in the portfolio this year will be Access Engineering. This company is a great proxy for the thriving construction sector. The large scale ongoing infrastructure projects in Sri Lanka have resulted in companies like Access having a healthy project pipeline to maintain its ongoing earnings momentum. I have increased my allocation this year to the stock by 4% to 14%. Last year my exposure to the banking sector was 26% through NTB and Sampath Bank. Sampath Bank’s share price has recovered well as expected after its exposure to gold pawning affected earnings. NTB has delivered strong results with a high ROE stemming from higher margins and good loan growth relative to peers. I see further upside in both these stocks and have included them back in the portfolio with slightly different allocation based on expected share price upside. I have also included HNB Non-voting in the portfolio due to the bank’s strength in the SME segment and anticipated loan growth recovery in the overall sector. To ensure the portfolio benefits from the growth in the leasing industry, I have included a 10% allocation into Central Finance. Hayleys MGT, one of the largest players in Sri Lanka’s knit fabric manufacturing industry is a new entrant to my list of shares for 2015. Management challenges in 2011-13 saw its share price crash but the new management is expected to herald a strong turnaround. I have also taken a portfolio exposure of 11% to Lanka Tile for 2015. The tile manufacturer is expected to do well with demand increasing as a result of lower interest rates.

Room for more growth: Indika Rajakaruna

Ceybank Asset Management Limited manages five open-ended Unit Trust funds, two of which are directly in the stock market, namely Ceybank Unit Trust and Ceybank Century Growth Fund. Indika Rajakaruna, Fund Manager at Ceybank Asset Management, discusses the performance of his model portfolio and prospects for 2015.

How did your model portfolio perform?
My model portfolio made a return of 47% during the one year period, growing nearly twice as much as the 24% overall market return during this period. The stock that performed the best was Tokyo Cement with a total return of 137.1%. Its performance was primarily driven by its financial performance and construction industry prospects; improving profitability was not factored into the price at the time of selection and was grossly undervalued.

What are the prospects for 2015?
I am bullish on the construction sector, especially Access, due to the business model they adopt (backward and forward integration). I have selected IOC in my reallocated model portfolio because I feel the tumble in oil prices which would give room for the company to improve its profitability. I believe banking, construction, manufacturing and export sectors’ stocks will have room for further growth and with improved econo activities, we may expect higher earnings growth from listed companies which may improve broader market valuations.The outcome of the Presidential elections may have some implications over investor sentiments. Global oil prices are expected to hover below US$ 70 a barrel and would favourably impact on oil exporting countries such as Sri Lanka. The US, EU and China are likely to benefit from lower oil prices and the recovery in the US and EU would benefit our exports,
 however there could be some setbacks to exports to Russia and the Middle East.Lower oil prices are likely to reduce the pressure on imports, however a rise in domestic demand on the back of lower interest rates may stimulate import demand and offset the benefit from lower oil prices. Lower inflation and interest rates would prop up credit growth, and improve private consumption and investment. If capital flows in to the country are sustained at current levels, we could reasonably anticipate the exchange rate to stabilize at present levels. However the growing demand for credit may exert slight pressure on interest rates.

I am bullish: Ramesh Schaffter

Janashakthi Insurance has the fifth largest composite market share in both life and general premium in a highly competitive market of 22 players. Ramesh Schaffter, a Director of Janashakthi Insurance, discusses how his model portfolio fared in 2014 and prospects for 2015.

How did your model portfolio perform?
My portfolio made a 57% return, which was pretty good given that the overall market gained 24% during the same period. Janashakthi Insurance, Lanka Indian Oil Company and Access Engineering performed exceptionally well.

What was the best performing stock and what drove its performance?
I was particularly confident that Janashakthi Insurance would perform well given that the stock was undervalued and financial results continued to improve, it was a no brainer really.

What factors prompted you to reallocate your model portfolio?
Whatever the election outcome may be, the stock exchange will have a buoyant year. Even if interest rates were to increase, there would be a lag so the market would still be an attractive place. So overall, I am bullish for 2015. I have reallocated more funds to Access Engineering and included Kelsey Developments to the portfolio, because the construction sector will continue to drive GDP growth. It is unfortunate that there are not enough stocks in this sector.

ACL Plastics is another inclusion which has promise. The stock is undervalued and growth prospects are good. Citizens Development Bank has continued to outperform the sector in terms of financial performance, so this is another stock I want to be exposed to.

I will exit Lanka Indian Oil Company because falling global fuel prices will affect its profitability because regardless of whoever comes to power, there will be a reduction in domestic prices. I have exited from Expo Lanka and United Motors Lanka as well.

Quote for the day

“Most people view the future as likely to repeat past patterns, which it may or may not do. They tend to think of the future in terms of a single scenario, whereas it really consists of a wide range of possibilities.” - Howard Marks

Monday, 19 January 2015

19-Jan-2015 CSE Trade Summary

Quote for the day

“The single most crucial factor in trading is developing the appropriate reaction to price fluctuations. Investors must learn to resist fear, the tendency to panic, when prices are falling, and greed, the tendency to become overly enthusiastic when prices are rising.” -  Seth Klarman

Sunday, 18 January 2015

Traditional vs Collaborative Leaders: 8 Key Indicators

What is collaborative leadership? Collaborative leadership is a philosophy of leadership where the leader becomes a facilitator instead of an authority figure and allows the team or a group of people to collectively discuss problems, make decisions and innovate solutions.


Quote for the day

“Economics theory tried to imitate physics. Classical economists took Newton as their model — forgetting that Newton lost a fortune in the South Sea Bubble. The only way they could imitate physics was by eliminating reflexivity from their subject. Hence the assumption of perfect knowledge, which was later amended to perfect information.” -  George Soros

Saturday, 17 January 2015

Important Milestones of Modern Technology

Technology has grown and changed at an incredible rate since the early 1960s when the first form of internet came into play. 

The popular software, Microsoft Windows, made its first appearance in 1985. 

Recordable CDs were available in 1988, followed by MP3 five years later. 

The Playstation came out in 1994 followed by Pixar in 1995 with Toy Story. 

In 1999, Napster became popular but was shortly after shutdown, followed by the ILOVEYOU virus in 2000 creating a need for fighting against cybercrime (cjonline.uc). Wikipedia was created in 2001 along with the announcement of the iPod. 

In 2003, Facemash was created and the next year turned into Facebook. In 2006, the revolutionary Nintendo Wii made video games interactive. 

2011 brought the Bitcoin, a fully-digital currency. With the advancement of smartphones and mobile apps, by 2017 it is anticipated that there will be over $77 billion in app sales.

Important Milestones of Modern Technology #infographic


Quote for the day

“It's difficult identifying someone who is a good trader versus someone who is a good analyst because the two don't always mesh. There are some people who are really good thinkers but can't make money and there are other people who aren't the greatest thinkers but who end up making tons of money trading.” -  Jim Leitner

Friday, 16 January 2015

16-Jan-2015 CSE Trade Summary

Quote for the day

“To enjoy the advantages of a free market, one must have both buyers and sellers, both bulls and bears. A market without bears would be like a nation without a free press. There would be no one to criticize and restrain the false optimism that always leads to disaster.” -  Bernard Baruch

Thursday, 15 January 2015

What leads to Success?

Quote for the day

"An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative." - Benjamin Graham

Wednesday, 14 January 2015

Are you a Psychopath? Take our test

Quote for the day

“In a nutshell, if you're too conservative, you won't do any trades, and if you're too aggressive, you're going to get picked off a lot. The trick is to try to strike a balance between the two.” -  Jeff Yass

Tuesday, 13 January 2015

13-Jan-2015 CSE Trade Summary

Quote for the day

“You can have many great ideas in your head, but what makes the difference is the action. Without action upon an idea, there will be no manifestation, no results, and no reward”  - Miguel Ruiz

Monday, 12 January 2015

12-Jan-2015 CSE Trade Summary

Quote for the day

“The way to make money is to make it. The way to make big money is to be right at exactly the right time. In this business a man has to think of both theory and practice. A speculator must not be merely a student, he must be both a student and a speculator.” -  Reminiscences of a Stock Operator

Sunday, 11 January 2015

Really true for Life & Trading

Quote for the day

“Losing an illusion makes you wiser than finding a truth.” -  Ludwig Borne

Saturday, 10 January 2015

The Old Man and the Tree: A Parable of Valuation

Once there was an old, wise man who owned an apple tree. It was a fine tree. With modest care it yielded a crop of apples which he sold for $100 each year. The man wanted money for new pursuits and thought of selling the tree. So, hoping to teach a good lesson, he placed an ad in the Business Opportunities section of the Wall Street Journal: "For sale, apple tree - best offer."

Salvage value

A lumberjack was the first to answer the ad. He offered to pay $50. "That's what it would fetch if I cut it down for firewood." The old man moaned, "You are foolish. You see only the tree's salvage value. Perhaps, your price would be good for a pine tree or perhaps even an apple tree no longer bearing fruit. Or perhaps if apple wood had become prized, more than apples. But my tree is worth much more than $50. No, thank you."

Current production

A grocer was next. She offered $100. "I will harvest and sell this year's crop." The old man smiled, "You are not quite so foolish as the first one. You see this tree has more value as a producer of apples than as a source of firewood. But $100 is not the right price. What of next year's crop? And the many crops after? Your price will not do."

Future (undiscounted) production

A marketer then answered the ad. He lived by the adage, "Buy low, sell high." So he offered $1499. "I figure the tree should live for at least another fifteen years. If I sell the apples for $100 a year, that will total $1,500." The old man wrinkled his nose, "You think ahead, but not carefully enough. Will the $100 you earn by selling apples fifteen years from now be worth $100 to you today? Stop and consider that if you placed $41.73 today in a bank account paying 6% interest, compounded annually, you would have $100 at the end of fifteen years. The present value of $100 worth of apples fifteen years from now, assuming an interest rate of 6%, is only $41.73, not $100. You offer to buy high and sell low. I cannot take your money."

Market price

A wealthy physician was next. "You get what you pay for," she announced. "I'll pay the market price -- whatever your last serious offer." The old man laughed, "You can't be serious, doctor. Now if there were truly a market in which apple trees were traded with some regularity, the prices at which they traded would be an indicator of their value. But there is no such market. The isolated offer I just received tells very little. If you had only heard the other foolish offers I had today!! You should seek advice before you invest."

Book value

An accountant soon answered the ad, demanding first to see the old man's books. The old man had kept careful records and gladly shared them. After examining them, the accountant declared, "You paid $75 for this tree ten years ago. You have made no deductions for depreciation. Assuming this conforms with generally accepted accounting principles, the book value of your tree if $75. I will pay that." The old man chided the accountant, "It is true the tree has a book value of $75, but is that its worth? Why, in just one year I can sell more than $75 in apples. Your accounting numbers look to the past, not the future."

Discounted future earnings

A young stock broker was next. She too asked to examine the books and after several hours announced she was prepared to offer. "I will value the tree on the basis of the capitalization of its earnings." The old man's interest was piqued. The broker continued, "While the apples sold for $100 last year, those weren't your profits from the tree. You had expenses. There was the cost of fertilizer and tools. You paid for others to prune the tree, to pick the apples, to cart them to market, to sell them. These costs and expenses should charged against the revenues from the tree. Moreover, the purchase price of the tree was an expense, a portion of which should be taken into account each year of the tree's useful life. Finally, there were taxes. Your profit from the tree was a mere $50 last year." The old man exclaimed, "Wow. I thought I made $100 off that tree."
Net returns

"You should have matched expenses with revenues, in accordance with generally accepted accounting principles," she explained. "And you don't actually have to write a check to be charged with an expense. For example, you bought a station wagon some time ago and you sometimes used it to cart apples to market. Some of the wagon's original cost has to be matched against revenues. A portion of the amount has to be deducted each year even though you expended it all at one time. Accountants call that depreciation. I'll bet you never figured that in your calculation of profits." The old man said, "No, I didn't. Tell me more."

"I also noticed in your books that in some years the tree produced less apples than in other years, and the prices varied and the costs were not exactly the same each year. Taking an average of only the last three years, I came up with a figure of $45 as a fair sample of the tree's earnings. But we're only halfway to figuring the value." The old man asked, "What's the other half?"

Discounting future returns

"The tricky part," she told him. "We now have to figure how much I value owning something that produces $45 in earnings every year. If I believed the tree were a one-year wonder, I would say 100% of its value -- as a going business -- was represented by one year's earnings. But if I believe, as we both do, that the tree is like a corporation that will keep producing earnings year after year. What am I willing to pay to receive $45 in earnings every year into the future. That will be the capitalized value of the tree." The old man was ready to hear an offer, "Do you have something in mind?" he asked.

"I'm getting there. If this tree's earnings were steady and predictable, like a U.S. Treasury bond, it would be easy. But its earnings are not guaranteed. So we have to take into account risk and uncertainty. If the risk of its ruin is high, I would insist that a single year's earnings represent a higher percentage of the value of the tree. After all, apples could glut on the market one day and you would have to cut the price and increase the costs of selling them. Or some doctor could discover that eating an apple a day is linked to heart disease. A drought could cut the yield of the tree. Or the tree could become diseased and die. These are all risks. And, on top of this, we don't know what will happen to costs related to the tree." The old man sought to brighten her perspective, "There are treatments, you know, that could be applied to increase the yield of the tree. In fact, this tree could spawn a whole orchard."

Computing risk (capitalization rate)

"I know," she assured him. "We will include that in the calculus. The fact is, we are talking about risk, and investment analysis is a cold business. We don't know with certainty what's going to happen. You want your money now and I'm supposed to live with the risk. Your tree isn't the only game in town. I have to choose between your tree and the strawberry patch down the road. I cannot do both and the purchase of your tree will deprive me of alternative investments. That means I have to compare the opportunities and the risks."

"To determine the proper rate at which we should capitalize earnings, I have looked at investment opportunities that are comparable to the apple tree, particularly in the agribusiness industry where these factors have been taken into account. I have concluded that an appropriate rate of return is 20%. In other words, assuming the average earnings over the last three years are representative, I am willing to pay a price that will earn me a 20% return on my investment. If you say I should take a lower rate of return, I'll simply go buy the strawberry patch instead. Now, to figure the price, we simply divide $45 by .20." The old man hesitated, "Long division was never my long suit. Is there a simpler way of doing the figuring?"

"There is," she assured him. "The reciprocal of .20 is 5. If you don't want to divide by the capitalization rate, you can multiply by its reciprocal, which we Wall Street types prefer. We call that reciprocal the price-earnings (or P-E) ratio. To compute the ratio, we divide 100 by the percentage rate of return we are seeking. If I was willing to take an 8% return, the P-E ratio would be 12.5 to 1. Since I want to earn 20%, by P-E ratio is 5:1. I'm willing to pay five times the tree's estimated annual earnings or $225 -- $45 times 5. The old man sat back. "I appreciate the lesson. Let me think about your offer. Can we meet again tomorrow?"

Cash flows

The next day when the young woman returned she found the old man emerging from a sea of work sheets, small print columns of numbers and a calculator. "Glad to see you," he said. Perhaps we can do business. It's easy to see how you Wall Street smartened make money, buying people's property for a fraction. But I think you'll agree my tree is worth more than you figured." The broker was willing to listen, "I'm open minded."

"You worked so hard over my books to come up with something you called profits, or earnings. I'm not so sure it tells you anything that important." She protested, "Yes, it does. Profits measure efficiency and economic utility."

"Maybe," he mused, "but it sure doesn't tell you how much money you've got. Yesterday I looked in my safe and found some stocks that hadn't ever paid much of a dividend. The company sent me reports telling me how great earnings were, but I couldn't spend them. It's just the opposite with the tree. You figured the earnings were lower because of some amounts you called depreciation that I never had to spend. It seems to me these earnings, after depreciation, are an idea worked up by the accountants. Now ideas are useful, but you can't fold them and put them in your pocket." The broker was surprised, "What's important, then?"

"Cash flow," the old man declared. "I'm talking about dollars you can spend, or save or give to your children. This tree will go on for years yielding revenues after costs." She sputtered, "what about the risks, the uncertainties?"

Expected returns

"Ah, yes," the old man observed, "I think we can deal with that. Chances are that you and I could agree, after some thought, on the possible range of revenues and costs. I suspect we would estimate that for the next five years, there is a 25% chance that the cash flow will be $40, a 50% chance it will be $50 and a 25% chance it will be $60. That makes $50 our best guess, if you average it out. Then let us figure that for the next ten years that the average will be $40. And that's it. The tree doctor tells me the tree won't last longer than 15 years. Now all we have to do is figure out what you pay today to get $50 each year for the next five years, and $40 each year for ten more years. Then, throw in the $50 we can sell the tree for firewood at the end of 15 years."

Discount rate (and comparable P/E ratio)

"Simple," she said, again on familiar ground. "You want to discount to the present value of future receipts. Of course, you need to determine the rate at which you discount."

"Precisely," he noted. "That's what all these charts and the calculator are doing." She nodded knowingly as he showed her discount tables that revealed what a dollar received at a later time is worth today, under different assumptions of the discount rate. It showed, for example, that at a 8% discount rate, a dollar delivered a year from now is worth $.93 today, simply because $.93 today, invested at 8%, will produce $1 a year from now.

"You could put your money in a bank and receive 5% interest, insured. But you could also put your money into obligations of the U.S. Government and earn 8% interest. That looks like the risk free rate of interest to me. Anywhere else you put your money deprives you of the opportunity to earn 8% risk free. Discounting by 8% will only compensate you for the time value of the money you invest in the tree rather than in government securities. But I concede that the cash flow from the apple tree is not riskless, sad to say, so we can use a higher discount rate to compensate you for the risk in your investment. Let us agree that we discount the receipt of $50 a year from now by 15%, and so on with the other deferred receipts. That is about the rate that is applied to investments with this magnitude of risk. You can check with my cousin who sold his strawberry patch yesterday. 

According to my figures, the present value is --

That is, the total present value of all the net cash flows is $273.56. You can see how much I'm allowing for risk because if I discounted the stream at 8%, it would come to $398.07. I'll take $270 -- to round it off."

After a few minutes reflection, the young broker said to the old man. "It was a bit foxy of you yesterday to let me appear to be teaching you something. Where did you learn so much about finance as an apple grower?" He counseled her softly, "Don't be foolish, my young friend. Wisdom comes from experience."

Comparison DCF and capitalization of earnings

The young woman smiled. "I have enjoyed this lesson. But I'll tell you something that some financial whiz kids say whether you figure value on the basis of the discounted cash flow method or the capitalization of earnings, so long as we apply both methods perfectly we should come out at exactly the same point."

"Of course," the old man exclaimed. "But which method is more likely to be misused? I prefer my method because I don't have to monkey around with depreciation. You have to make assumptions about useful life and how fast you're going to depreciate. That's where you went wrong in your figuring."

"You are crafty," she rejoined. "But your calculations aren't perfect, either. It's easy to discount cash flows when they are nice and steady, but what if you have some lumpy expenses? For example, several years from now that tree will need pruning and spraying that you didn't include in your cash flow. The costs of that will throw off your calculations. Tell you what. "I'll offer $250. My cold analysis says I'm overpaying, but I've come to like that tree. Maybe I'll sit in its shade."

"It's a deal," said the old man. "I never said I was looking for the perfect offer, but only the best offer. You make good sense."


There are several. First, methods are useful tools, but good judgement comes from mixing methods and experience. And experience comes from mistakes. Second, listen closely to the experts, and hear what they don't say. Behind all their elegant sounds, there is much discordance and uncertainty. One wrong assumption can carry you far off track. Finally, you are never too young or old to learn.

Quote for the day

“I constantly try to figure out how the market can trick or fool the majority of investors. Then after the majority have been fooled I get in at what I call the 'point of smooth sailing.' A so-called failed signal can actually be the beginning of a more complex pattern that is far more reliable than the initial signal based on a conventional pattern.” -  Mark Minervini

Friday, 9 January 2015

09-Jan-2015 CSE Trade Summary

Quote for the day

“Think. Prepare. Plan in advance when there's no time pressure. Then, in real life, do what you said.” -  Mike Bloomberg