The Amazing Story of Ratings agency

In a recent wake of European countries crisis plus the fallen of sub-prime mortgage, investment in bond and asset backed securities issued by countries or corporations are becoming riskier. Defaulted due to economic crisis and inability to meet the legal obligation of repayment plan, bonds issued by European countries especially are seemingly not safe anymore. Would the notion of bond is the safest investment be void?

Investment in bonds is massively relied on the rating agencies to interpret the fundamental credit worthiness of the issuers. +Standard & Poor's Ratings Services (S&P), Moody's, +Fitch Ratings, Malaysia Rating Corporation Berhad (MARC) and Rating Agency Malaysia Berhad (RAM) have been playing a vital role in verifying private, investment banks and institutional investors in choosing the favorable rated bonds in their portfolio. 

Rating agencies provide credit ratings on issuers of commercial papers, bonds, long or short term debts, preferred shares and asset-backed securities. In certain countries including Malaysia, Indonesia and Middle Eastern countries, their functions extend to the issuance of Islamic Bonds (Sukuk) as well. 

Relying on credit ratings in providing an independent verification of issuer own credit-worthiness boosts a significant value especially in marketing purposes. In most cases, bond funds have at least three ratings from the Big Three rating agencies. Without credit ratings, the market confidence would not be likely there and as the result, the issuance may be under-subscribed.  

What is more, the credit rating agencies play a vital role in structured financing including pool financing alike mortgage backed securities. Although the term is often referred as collateralized debt obligation (CDO), the mechanism is still similar. The assessment on the credit-worthiness provided by the rating agencies are based on the same criteria. They assessed usually on tranches with different ratings. The effective interest rate payment will be much lower on the A-rated bonds compared to B-rated bonds.  

Having said that, heavy reliance on credit ratings agencies is not healthy, in my opinion. Although they offer an independent credit-worthiness service, the fact that they are not independent is something everybody should be aware of. For instance, +McGraw Hill Cos, the owner of the world's largest ratings company, is publicly traded whilst Moody's is a publicly held corporation. 

Regardless of what they stated in the brochure, the conflict of interest has to be there. Do you know who are the shareholders of Rating Agency Malaysia Berhad? The biggest is +CIMB Bank Berhad with the majority of 14.425%. RHB Bank and Malayan Banking Berhad are the second and the third respectively. MARC's shareholders are divided to insurance companies, discount house, stockbrokers and investment banks including Hwang-DBS, +Maybank Investment Bank and MIDF Amanah Investment Bank Berhad. Isn't the essence of business to serve the shareholders?  By the way, Berkshire Hathaway owns about 12.75% of Moody's Corp. 

Undoubtedly, the client relationship with management of institutional investors or investment banks may possibly impose inaccurate assessment with 'fair and true' or honest ratings. Issuers do seek advice from rating agencies, as clients, on the strategies of structuring financial products with desired ratings. 

Sub-prime mortgage issue, the bankruptcy of some countries, Freddie Mac and defaulted bonds have highlighted continuous errors of judgement made by credit rating agencies. According to +Bloomberg News, the U.S. government accused Standard & Poor of deliberately misstating the risks of mortgage bonds, whose collapse helped trigger the worst financial crises since the Great Depression. S&P graded more than $2.8 trillion of residential mortgage-backed securities and about $1.2 trillion on collateralized debt obligations (CDO) from September 2004 through October 2007, according to the complaint filed in federal court in Los Angeles. The U.S Justice Department already filed a lawsuit against McGraw-Hill on Feb 4, 2013.  

The best part is the Big Three rating agencies are downgrading each other now! So much for the future of credit ratings. I like their disclaimers. The rating is just an opinion given the information available during the point of assessment as they never guarantee the rating should any change in circumstance related to risk factors analysis do take place. 

If it did, should they change the ratings instantaneously rather than wait for a couple of year to witness the reality to unfold? 

The Importance of Stock Screening

Stock screening is a very important exercise for investor to filter the market and zero in on the companies that meet their criteria. Screening tools that widely available on the net would allow you to quickly and easily search for shares showing high growth, yield or daily price movement.

Stock screening tool could be used for your technical and fundamental analysis. Personally, I prefer to use fundamental ratios before narrow down based on the technical indicators. Financial websites such as Financial Times or finviz.com provide maps or heat maps indicating the favourable and unfavourable industry of the day.  

Nonetheless, the screening tool would filter the fundamental data including:

i.   company basics information such as closing price and market capital.

ii.  share performances such as price rise or fall in a day, a week, a month or a year.

iii. growth ratios such as Earning per Share (EPS) growth and dividend growth

iv. incomes ratios such as dividend yield and dividend cover

v.  valuation ratios such as price-to-book ratio, price per earning, highest price per earning in a year

vi.  financial strength such as net gearing and net asset value per share

vii. management effectiveness such as return on assets and return on capital employed

viii.Profit & Loss account such as operating costs and revenue

ix.  balance sheet such as total current assets and net assets

x.   broker or analyst recommendations on whether sell, buy or hold

xi.  director deals

The screening tool could also be set to filter technical information such as percentage movement of price within 52 week low or high and percentage of price break above or below moving average lines.

With the comprehensive market data, the screening and analysis are more possible to be carried online. Stock exchange like NASDAQ has a comprehensive section for investors to use the stock screener.  In fact, it already has predefined stock screener that could help you to find the stocks that meet your criteria.

Financial Times also has a global equity screener that you could try out at http://markets.ft.com/screener/predefinedScreens.asp It has more than 50 customisable screening criteria. Under FT predefined screens, you could try screening criteria predefined by the world best investors including Warren Buffet and Ben Graham.

Before using the screening tool, you should have an idea on what criteria to search for. The fundamental and technical variables make the possibilities nearly endless and you might end up betting on the wrong stock. In the same time, it is crucial to ascertain that your search is using the updated databases. Otherwise, your search would be meaningless. Perhaps for a start, you could adopt some predefined stock criteria. 

The bottom line is the screening tool offer purely quantitative considerations. Some ratios are not accurately filter stock from specific industry. Technology stocks may high a slightly higher P/E because a low P/E ratio does not necessarily mean a stock is cheap. Similarly, a high P/E ratio does not mean a stock is expensive. Auto industry or retail industry for instance has a low P/E but it does not mean that those retail stocks should not been considered.

The Essential of New Year Trading Strategy 2013.

In my opinion, this is a must-have trading strategy for 2013 for medium-term traders or investors. This strategy is more or less emulate the big cap list strategy with a little twist. It would consume less of your time monitoring your portfolio on daily basis but could offer a fairly good return with a minimal risk.

I have been back-testing this strategy at The Star business 'My Portfolio' section. 

Big Market Capital 
Screen for listed companies on the Main Board that have more than RM 10 billion market capital. There are considered as blue chips companies with strong fundamental business and revenue streams. The FTSE Bursa Malaysia KLCI Index comprises of the largest 30 companies by full market capitalisation on Bursa Malaysia's Main Board. You may see stocks like PPB Group Berhad, YTL Power International, Axiata Group Berhad, Felda Global Ventures and Petronas Gas Berhad. 

Government Linked Companies
From the largest 30 companies, identify companies that have government linked companies (GLC) status. GLC companies are controlled by Malaysian government via Federal Government-Linked Investment Companies. In addition, Malaysian government also has a power to appoint members of board of directors and senior management positions. 

From that 30 companies, GLC are including Malayan Banking Berhad, Sime Darby Berhad, CIMB Group Holdings Berhad, Petronas Chemical Berhad and Axiata Group Berhad. 

Dividend Yield
Again, a simple calculation of dividend yield would mark an ability of a company to pay out dividend each year. It may pay on quarterly or annually basis. However, the bottom line is it represents the return on investment for owning a stock. So hence, you should be interested to look for stocks that have high dividend yield. 

On Bloomberg, the easiest indicator would be 'Dividend Indicated Gross Yield'. The yield range that we are looking for is between 2% - 7%.  

Lowest Price
The last filter is to select probably five stocks with the lowest price. With no preference, now you have a top five big market caps government linked companies with a good dividend payout record at a bargain price. 

At the beginning of the year, buy equal amount of each stock. The aim is to hold these stocks before liquidating them in the final quarter of the year. Check your position and stock performance perhaps once a month or a quarter. If the performance of the stocks went south for more than 5%, you should be selling it to cut your loss. However, it also depends on your risk tolerance. 

Happy New Year and Happy Trading!

The Essential: Basic 3Ms to be a Trader or Investor

I couldn't help myself repeating the same answer to people who trade stocks or people who think they are stock traders. In any given gathering or talk, expect common questions such as:
i.   which method do you use to decide whether to buy or sell?
ii.  how much money should I put into each trade?
iii. should I worry about not calling the top or bottom of the price?

Of course the answers are as absurd as the questions. There is no right or wrong answer. It is more in between, depending on your trading style. But usually self-traders or private traders or individual traders or whatever you wanna call them, imposing these questions. 

Institutional traders are far superior in term of market reach, capital, leverage, trading systems and support services. They have a very systematic algorithmic trading in place to say the least. They called themselves market-makers, since a pool of them could shape the movement of stock indirectly. 

So, how could you be, at least, a sound trader? 

By now, you should have THREE BASIC Ms; money management, method (trading system) and mind (trading pyschology).

Money Management

I have to put money management as the no 1 ingredient. This is a skill that would differentiate between a novice or a professional. It is very crucial for a trader to understand the risk and reward in his or her trading method. A good money management would help traders to manage the risk at the acceptable rate. 

I do not intend to touch too much on the technicality of several principles such as positive expectancy, stop loss and target levels. 

In essence, money management sometimes dictate your risk tolerance rate and profitability of your trading. A positive expectancy should produce a profitable trading system. Stop loss, on another hand, would help you to reduce uncertainty and further loss in unfavorable trading environment. Whilst target levels usually would be point of your exits in any trading session. 

Method (Trading System)

Trading system is a sum of parameter or variable that determine entry and exit points for any given instruments. These points are also known as signals. On the other hand, many would relate trading systems to the method of choosing the stock or stock screening. 

Having a trading system may sound simple but having a system that produces profit, would be the hardest part. I gather that it would take some times to experiment or to tweak in finding the Holy Grail of trading system by yourself. Maybe for a start, you could consider adapting the existing proven trading systems in the market. Some of the proven system are published like Turtle Trading System developed by Richard Dennis and Bill Eckhardt, Joel Greenbalt and The Naked Trader. 

Mind (Trading Psychology)

It is equally important to have a good set of mind in trading. If possible, you should shut down your emotions while trading. Some people even develop a trading mind software to basically to train your mind for trading. I remember reading about the psychology of trading in which the stock movement is a sum of emotion of traders. 

In trading, you need to be as objective as possible. No indecision. It would eliminate uncertainties in your chosen trades and it would increase your confidence in every trade you made. The stock movement does not reflect on your gut feeling. By using the right trading system, you should have a solid foundation as long as you detach your emotion in your trading session, if possible.

In conclusion, trading is a discipline. Having these 3Ms probably is the best start to get into the game. You can learn them. Maybe for a start, subscribe to one proven trading method that you are comfortable with. Do back-testing, paper trading simulation and establish your own discipline en route to find your ways to be a trader.  

Enjoy!

Fundamental Analysis vs. Technical Analysis

Yes there is an undeclared financial war among fundamental and technical analysts. Pure 'fundamentalists' will enforce the superiority of objectiveness in fundamental analysis systems in relation to the 'correct' price against the market price. Certainly, being 'technical', they rely on the accuracy basing on historical and present data that are already encapsulated in the stock price. Their price or price movement predictions extrapolated from historical price patterns.

In essence, these models distinguished the analysis approach towards the 'value' and 'price' of the stock.

Fundamental Analysis

Fundamental analysis is taking into account the intrinsic value of the stock. Meaning, it considers company, industry and economy values in order to determine the rightful or true value of the stock. So hence, when a stock labelled as a BUY, it means that the intrinsic value is higher than the market price. You HOLD when the intrinsic value is equalled to the market price and you should SELL when the market price is higher than the intrinsic value.

Investors that subscribe to fundamental analysis look at macro financial information such as business model, the industry outlook, governance and government policy. Quantitatively, they look at company financial information such as ratios, financial statement analysis, price/earning to growth (PEG) ratio and return on capital (ROCE).

Technical Analysis

Unlike fundamental analysts, technical analysts believe that the intrinsic value of the stock is already reflected in the price. Therefore, they evaluate the stock based on the historical performance of prices and volumes. Based on these findings, technical analysts use charts to generate patterns and trends. The latter, in fact, is used to determine the future movement of price.

In order to predict the direction of the future price movement, technical analysts use technical indicators such as Moving Average Convergence Divergence (MACD), Relative Strength Index (RSI) and Stochastics. These indicators are derived from the generic movement in the price of a stock. Normally, technical indicators are very helpful in defining your entry and exit point.

So, which one is better? I don't have the answer. In my experience, investors use both analysis to complement their existing stock analysis methods like Capital Asset Pricing Model (CAPM) or efficient market hypothesis (EMH).

Personally, I would use the top-down approach. Like from macro to micro level. For example, using fundamental analysis:

1. narrow down the performing economy, market, sector, industry and companies.
2. assess the fundamental values; ratios, economic cycle
3. choose and create the list of performing sector

Then, choose stocks based on your familiarity with the technical analysis or charts.

In conclusion, the issue of superiority of these two analysis regimes is not a case. The potential of using both to complement existing stock analysis should be highly considered by investors. Many said that fundamental analysis usually for long term investors. Whilst, technical analysis may be suitable for short-term investors. You decide.

Stock Screening : Dow Jones 30

In general, stock screening is associated with fundamental and ratio analysis. Literally, you filter stocks with predefined key fields that suit your trading styles; growth, valued, conservative or aggressive. Personally, I always use fundamental data such as dividend yield, Beta, operating margin, Return on Capital Employed (ROCE), ratios derived from Balance Sheet and Profit/Loss Account as the first stage of my stock research.

With that information, you can set up screening strategies using specific fundamental criteria to extract suitable stocks to trade. Many practitioners have developed predefined and back tested screening strategies. Some of them may be complex to general public and some of them are as simple as ABC.

I think you may hear about screening the big market cap stocks, hold and sell them after a year. Perhaps, I could put extra details on this method. You may want to apply to all stock exchanges though. However, I believe this method is useful for medium-term investors who do not want to spend too much time on research.

Big Cap list

Get a list of big market cap of Dow Jones which is usually known as Dow Jones 30. Or get a similar list from S&P, FTSE, CAC40, DAX, Nikkei, Hong Kong or even Johannesburg Stock Exchange. Big market cap stocks usually are prominent blue chip stocks with strong fundamental business and financial models.

Dividend Yield

A simple calculation of dividend yield would mark an ability of a company to pay out dividend each year. It may pay on quarterly or annually basis. However, the bottom line is it represents the return on investment for owning a stock. So hence, you should be interested to look for stocks that have high dividend yield. 

Roughly, it could be in the range from 2% to 7%. If it’s more than 7%, re-compute the yield; dividing dividend per share by the current share price. The yield may be distorted by the current share price. Otherwise, you may get yourself will-be a jackpot. Insofar, you need to select ten big market cap stocks with the highest dividend yield.

Lowest Stock Price

The golden rule in trading is buy low and sell high. So, apply that rule and select five stocks with the lowest price. Please don’t make any preferences on the stock selection. You must eliminate any emotional attachment. You should not be saying’ ‘I feel these stocks would go further up’ although you know the prices are among the highest. 

Finally, you would have five big market cap stocks with a good dividend payout record at a bargain price. If you are thinking of diversifying your portfolio, apply this screening method on other markets as well. 

At the beginning of the year, buy equal amount of each of these five stocks. Hold them for a year. Then, sell them before Christmas or perhaps before the correction periods of stock exchanges (usually during last quarter of the year). Simple, isn’t it? How long does it take you to come out with five bargain big market cap stocks? Is your portfolio in the positive territory?

In conclusion, the timeframe for this method should be about a year. In essence, it tries to capture a year cycle of stock market. Having said that, the pre-requisite for this discipline does not implied that investors should hold for a full year. It is just a guideline not a rule.

Initial Public Offering : IPO

In the current economic uncertainties, initial public offering or IPO is not going to be
famous. Essentially, IPO is the first sale of stock of a private company, new or old, to the public. So often, smaller or private companies use IPO as the main platform to seek capital injection for growth or expansion programs and to become publicly traded companies. Statistically speaking, according to Bursa Malaysia, the highest number of new listings was 92 in 1996. The number was massively declined during a period from 1998 to 2001, when Malaysia was hit with the financial crisis. In 2002, the number was starting to grow especially new listings on MESDAQ market.

In the process of getting listed on Main or Second Board, an underwriting firm assists the issuer in shaping the criteria of the IPO including type of security, the best offering price and the best time to offer to the market. For average investors or beginners, you might need to be concerned on the offering price. However, I need to warn you on the risk of investing in IPO.

For private investors, it is fairly difficult to forecast how the stock would react on the first day of listing especially if you could only refer to the lengthy prospectus of the issuers and some good words from your brokers. You probably would not have any historical data to analyse. You may need to put your entire belief on the management team and the projected performance that they ought to achieve in the next 5 years or so. Thus, many risk adverse or conservative investors concur that the uncertainties looming around their future values would deter them from putting their cash on IPOs. Having said that, after taking into account the potential reward, I am confident you would include IPO in your investment list.

To buy or not to buy
The timeframe to trade IPO should be very short. Take a day or two. And I, personally, would not go beyond 5 trading days. On these initial days, most investors rush to buy a new stock in frenzy, but then, like everything else, interest wanes when as the true picture of the company emerges and the market will determine the fair value of the new stock. You would not want to be caught at this moment.

What is more, many IPOs issued last year had never been able to recover to their initial opening prices. Usually on the day two of listing, you should be able to assess the responsive of the market and to figure whether the market would just go sideways. I favour to monitor the volume. It would tell the whole story especially the momentum of the investor ’crowd’.
The capital market in 2008 were so bearish even Perwaja (5146) and TM International
(also known as Axiata) had lost more than halves of their expected value. Everybody
seemed to preserve their capital and played a wait-and-see game.

But in 2009, you might want to re-consider IPOs. For the last three new listings, the
market seems to be more optimistic and bullish. For example, Samchem Holdings
(5147) was opened at RM 0.69 and at the highest RM 0.95 on the second day of listing.
About 38% gain in two days. Not bad aye? Handal Resource (7253) was opened on 30 July 2009 at RM 0.90 though the original price was 72 cents. Handal Resource continued to gain heavy interest in the market when it recorded the highest price on the second day at RM 1.47. Amazingly almost 100% return.

Although the figures look overwhelmingly appealing, you may also want to assess the principal activities and the industry of the IPOs. Given at certain stage of economy, some sectors might be bearish and normally the market would not respond as you expected. Is it too late to join the crowd? I believe not.

Some IPOs are still at the early stage. In fact, the Securities Commission of Malaysia (SC) had approved seven IPOs, so far. Five IPOs were for the Main Board and the balance for the Second Board. The performance of the previous three aforementioned IPOs indicates that the capital market is responding well.

Conclusion
Investing in IPOs is a risky business but it may come with startling rewards. Even so, some factors should be taken into considerations such as offering price, timing, the principal activities in the industry and overall market sentiment (bullish or bearish). There is no perfect blueprint on what is working and what is not. The best thing to do is assess available information and then make your judgement call. If it didn’t work, cut your losses. Re-visit when things calms down.