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Simple Often Wins in Investing

A few days ago, I had a wonderful dinner with a group of friends who are passionate about investing. During our meal, one of them brought up an interesting anecdote about American billionaire investor Warren Buffett regarding his simple investing approach while buying up Korean shares.

The anecdote was later confirmed when I came across notes taken by Professor David Kass from the University of Maryland during Buffett’s recent Q&A with a group of 20 MBA students.

During the Q&A, Buffett mentioned how he invested in a basket of about 20 Korean stocks that were selling for absurdly cheap valuations (emphasis mine):

Back in 2004, someone told me I should look at Korea. I got a book from Citigroup which had 1 stock to a page. Describes all the publicly traded companies in Korea. Went through it and found about 20 companies…It had book value, eps [referring to earnings per share] and securities. Didn’t tell you anything about the share until you look at the price…

…Found about 20 like that in an afternoon and bought some of all of them, but didn’t know enough about all of them to load up on them. If you buy 20 stocks selling at 2 times earnings, you’re going to make money.

While I certainly can’t speak for Buffett, this excerpt strongly suggested how simple (and profound) his thinking toward the Korean investments was: By diversifying among companies that exhibited three simple criteria – 1) profitability, 2) financial stability, and 3) dirt-cheap valuations – he was almost guaranteeing himself a profit in that entire basket of shares. It didn’t have to be any more complicated than that.

My American colleague Morgan Housel had also once recounted one of money manager Mohnish Pabrai’s successful investments that centred on a simple investing process.

Pabrai was looking at an oil-tanker company, Frontline, back in 2003, when oil shipping rates had fallen to $5,000 per day due to low oil prices. The company, unfortunately, needed daily rates of $18,000 to stay afloat. Needless to say, investors panicked and sold off the company’s shares.

Here’s where Pabrai’s simplicity shone through. Instead of focusing on oil prices and shipping rates (which are extremely difficult to forecast), he looked at the scrap metal value of the company’s fleet, which turned out to be worth a lot more than Frontline’s market capitalisation back then.

While Pabrai couldn’t know ahead of time whether oil prices would rebound and whether shipping rates would charge back up, he knew of one simple fact that was enough for him to make an investment in Frontline: the shipping company was worth a lot more than its market price just based on the scrap metal value of its fleet alone.

And according to Morgan, investors back then who stuck with this simple way of looking at Frontline and invested in it would have earned up to 20 times their investment in two years. “Simplicity at its finest”, as Morgan wrote.

Back home in Singapore, I also took a look at what could happen to the blue chips by ranking them based on a simple criteria: their trailing price-to-earnings (PE) ratio.

I looked at the Straits Times Index’s (SGX: ^STI) 30 constituents back on 13 March 2009 and ranked all of them based on their trailing PE ratio, excluding companies that had made losses.

By comparing the subsequent average total returns from then till today for the top 5 most highly-valued shares with that of the top 5 cheap shares, I found a result that shouldn’t really be a surprise: the cheap shares won.

Top 5 cheap shares

Company

Trailing PE: 13 March 2009

Subsequent total return*

Golden-Agri Resources (SGX: E5H)

2.0

136%

CapitaMall Trust
(SGX: C38U)

3.0

134%

CapitaLand Limited
(SGX: C31)

4.8

57%

Cosco Corporation
(SGX: F83)

5.7

13%

Noble Group (SGX: N21)

5.8

74%

Average

4.3

83%

*Total returns takes into account the effects of cash dividends, stock-splits, rights offering, and spin-offs.

Source: S&P Capital IQ

Top 5 highly valued shares

Company

Trailing PE: 13 March 2009

Subsequent total return*

Singapore Exchange (SGX: S68)

13.8

83%

ComfortDelGro Corporation (SGX: C52)

14.0

73%

Singapore Technologies Engineering (SGX: S63)

14.6

108%

SMRT Corporation (SGX: S53)

15.5

-12%

Neptune Orient Lines (SGX: N03)

17.9

22%

Average

15.1

55%

*Total returns takes into account the effects of cash dividends, stock-splits, rights offering, and spin-offs.

Source: S&P Capital IQ

I’m certainly not suggesting that investors head out to only invest in shares with low PEs. Rather, the tables above are used to show how we can improve our investing results even if we follow just relatively simple investing approaches or rules.

More often than not, you might find that good investment ideas or philosophies aren’t complicated at all. In fact, they really are quite simple.

The problem though, is how often our emotions and psychological biases can con us into making poor investing decisions. Get them out of the way, and you might find that simple often does win in investing.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.