Should you Average Down or not?

I first heard of the concept of "Averaging Down" over 3 decades ago.

It started off with positive intention from its cousin "DCA" or "Dollar Cost Averaging".  Instead of investing say RM120,000 at one go, you should consider buying RM10,000 per month over 12 months instead.  If market goes up and goes down and by the end of the 12 months ended up exactly the same price, you'll end up owning more shares, than if you had bought it all at one go at inception.

Dollar Cost Averaging (DCA)

Here's an illustration of DCA.  Imagine you have RM120,000 to invest when Price is RM1.  If you buy at one go, you'll have 120,000 shares.

Now, consider the alternative method - break the RM120,000 into 12 equal parts and invest each month.  Price goes up and down during the next 12 months and if price gets back to the same RM1, you'll end up owning more shares due to the price volatility.  In this illustration, when price went up, then, come down, and then recover back to RM1, you'll own more shares at 124,049 shares, instead of 120,000 shares.

So, why does DCA work in flat markets?   

Simply put, it forces you to buy more shares when price is low, and forces you to buy fewer shares when price are high.  

As a result, 12 months later, you own more shares with the same outlay.

So, summary pros and cons of DCA.

Pros - Works great in 2 kinds of markets:

1. Flat markets and
2. Markets that declines temporarily and 100% sure to recover back (nobody knows the future though).  

Cons - 3 important disadvantages:

1. Not so good in rising markets (you'll end up owning less shares in a rising market)
2. You'll lose much bigger in $ terms if it goes down and stays lower than your entry price forever
3. The worst of it is when it goes down to zero (then, you'll lose everything).

Averaging Down (AD)

So, what's the difference between "Averaging Down" and "DCA"?

The difference is when prices are higher - you don't buy.  You only buy when prices are lower.

So, this has pros and cons too.

Market Type 1 - Volatile flat market - a market that goes up/down and eventually comes back to original price. 

1. In this type of market, Averaging down has pros and cons relative to DCA. 
2. If you believe Position Size determines your final returns more than Entry Price, then, DCA  typically gets you to full Position Size than AD, because in DCA, after "n" month, you'll end up with full Position Size regardless of whether market goes up or goes down.  Whereas AD might only get you a tiny position if after the initial move down to give you 1/12th the position, price then went up higher than stayed higher.  
3. However, if you can get in full position with both methods, the difference is likely to small in the long run after 100 stocks.  In practice, you're unlikely to get a full position with Averaging Down in all 100 stocks.

Market Type 2 - Rising market - the market price keeps rising to be higher than original entry price

1. In this type of market, DCA is superior to AD because it keeps adding more shares on the way up to full position size, to give you a bigger $ win, whereas under AD, you only have 1/12th at entry and then, that's all you have.
2. In a generally rising market (and if you have 100 of such markets), DCA is clearly superior than AD simply due to differences in position size.

Market Type 3 - Declining market - after entry, price keeps getting lower and lower

1. In this type of market, if the total outlay is the same, then, both are similar and the same.
2. Over 12 months, you keep buying more at lower prices and eventually, you'll own a full position.
3. If price goes to zero, in both cases, you lose everything whether DCA or AD!

In conclusion, which is better?  DCA or AD?

According to Buffet teachings on stock selection, neither is better.

What is more important is it's future price action.

If the stock's business economics is of superior quality (e.g. it is in a superior type of business, a monopoly, have an economic moat, etc.), is run by able, honest and trustworthy management, and is available at an attractive price (where future price will be higher), then, it's future price action is likely to be rising.   Then, your risk here is not getting a full position.  You don't want to be owning only 1/12th of a full position - here, DCA is superior than AD, but an immediate buy at full position is superior than DCA, if you have picked the correct stock at the right price.   However, if you have 1-2 months to accumulate, then, odds are usually some form of averaging typically gets you a little bit more shares but in the long run, they don't make much difference, compared to finding that superior stock.

In short, future price action is key.   You want to find a rising market, where the price action is likely to be rising, where "a rising tide raises all boats".

And if its future price action is downtrending, and possibly heading down to zero, then, avoid at all cost.  

• Don't even bother to own a piece.  
• Ignore, disregard and move on to other markets.   
• There are thousands of stock with markets to trade.  Get in them.  
• Don't be stubborn.  Let go of your losses and move on to find new markets where future price prospects are likely to be rising.   
• Invest there, so that your portfolio keeps making new all time highs!

CARLSBG Update

 Previous article on CARLSBG here.

Annual Report Update

CARLSBG published its annual report on 22 March, and reading this over the weekend, I see no major surprises to my long term assessment of this business.  To me, the quality of the business remains decent, above average, I can rely on this to deliver at least 8-9% per annum long term returns, and is worth a neutral position size (3% portfolio or more).   This remains a business where the lower the price, the more I accumulate up to neutral position at the bottom.

Chart Update

The long term chart is self-explanatory:

1. After the long bull run from 2009-2019, we are now in corrective wave phase.   

2. My guess it if last time took at least 10 years to correct and find bottom, this time will be different.  

3. There is the 61.8% Fibonacci retracement, confluence with previous high and previous lows, suggesting the major bottom to be around RM17.   For this long term chart, that could take a while (months, maybe even longer). 

10 Year Business Updates

 

Self explanatory:

1. 10 year EPS CAGR growth is 5.2% per annum - that's decent, and rates a B.

2. 10 year DPS CAGR growth is 3.0% per annum - that's decent and rates a C+.

3. 10 year NAPS CAGR shrink 3.4% per annum - not quite sure why, but that rates a C-.

4. 10 year RPS CAGR still growing 3.6% per annum - that's slightly higher than inflation rate and rates a C+.

5. Latest dividend yield = 5% (93 sen / 18.5 say) - that's high, and since it's sustainable, rates a B+.  For a dividend investor, combining long term dividend growth with long term business growth, that has very high odds of beating EPF.

Future Price Required, to earn 9% per annum total returns

My long term investment objective is modest - as you know, I aim to beat EPF long term 6% per annum returns.  My personal target is 9% per annum.  The question is how do we know if CARLSBG can deliver 9% total returns per annum over the next 10 years?

The truth is we don't know.  Noone knows the future.  All we know is to align ourselves with probabilities.  

One way for long term investors is to ask this simple question.  If long term dividends give me 5% per annum, what kind of future prices do I need to see, before it delivers 4.5% per annum long term (to give 0.5% buffer)?

My Future Price Required Calculator shows what kind of prices I need to see, in 1, 2, 3, 4, 5 and 10 years time, if I were to sell after commissions.  

It's not a very high ask.  To get 9% total returns per annum over next 5 years, CARLSBG needs to get back up to RM23.3, which is not even the peak of the corrective wave (B).   Over the next 10 years, CARGLSBG needs to get back to RM29.1, well below it's all time high of RM39.

In short, over the next 5-10 years, I think majority odds, that CARLSBG will deliver 9% per annum, if enter at RM18.54.   If you enter at a lower price, the odds increases substantially.

This is not a short term strategy - it's at least a 5-10 year strategy for long term wealth accumulation.

Target Position Sizing

Previously, I shared that my position size is around 2.4% portfolio.   Today, it has shrunk to 2.2% portfolio (excluding past CARLSBG cash dividends received), as my portfolio has grown (from other gains and also CARLSBG past dividends received), and CARLSBG price has shrunk.

My target remains around 3% when CARLSBG gets into my accumulation zone where I think the bottom is around RM17 which can take several months, or even 1-2 years to get there.   Meanwhile, I'll continue to collect the 5% per annum dividends.

Another reason to limit at 3% at the bottom is because I also own HEIM.   Similar target position sizing.

Conclusion

 

For long term wealth accumulation, the investment strategy is simple and easy to follow for someone who wants to spend his life doing other things than investing or trading.  As Buffett says, the key is to "start early".

  

1. Accumulate quality businesses at fair/lower prices.  

2. Have a clear strategy on when to enter and eventually, when to exit.

3. Position size appropriately.  Never bet everything on a single business.  Ideally, diversify at least 30-50 different businesses when the opportunity arises and we are able to accumulate at the right price.

4. Once we secure them, forget about this stock when after it finds the bottom.   

5. Be patient.  It is good to collect 5% per annum dividends every year.   Doesn't quite beat EPF, but close.

6. For CARLSBG, the strategy to beat EPF even though dividend yield is smaller, is the additional price gains.   If previous bull run took 10 years, be very patient and do nothing during the bull run and just wait it out.

7. Eventually, the Price gain in 5-10 years time will deliver total returns exceeding 9% per annum, here, likely by quite a distance if it makes new high (which over next 10 years, has at least a coin toss odds of 50/50).  A doubling of price gains over 10 years is 7% per annum, giving total returns of 12% per annum.  If it gets there in less than 10 years, the CAGR is even higher than 12% per annum.  This is very very good for the long term investor.

This stock is not suitable for the impatient short term trader looking to earn 10%, 20%, 30%, 50% or 100% returns over months (and after 100 trades, see his account dropped or doesn't beat EPF).  CARLSBG is a boring stock.  Precisely because it is boring, and precisely because there is good management team to manage this business to provide returns to shareholders, that you want to have some of your net worth to partially own this business.  Let the professional management team grow your wealth.   

BAT Declining EPS/DPS - How much is the stock worth?

Intrinsic Value / Valuation is tricky.  There are many different ways to value a business.  Buffet and Graham's method is to have an adequate Margin of Safety.  In other words, we want to be prudent, by giving ourselves an ample Margin of Safety so that even when we are wrong, we still make monies.

I've blogged about BAT before here.  

BAT recently published its quarterly report and closed the year.  To keep it simple, FYE2023 EPS and DPS is 68.2 sen and 63 sen respectively.  8 years prior, BAT EPS and DPS was 318.7 sen and 312 sen.   This means that the EPS and DPS CAGR over the past 8 years are -17.5% and -18.1% per annum respectively.   

Let that sink for a minute.

Every year over the past 8 years, BAT EPS and DPS shrunk around 17%-18% per annum consistently.

BAT current price is RM8.2.  

• With EPS of 68 sen, its P/E is 12 times
• With DPS of 63 sen, its P/DPS is 13 times.

The question is - is the business worth 12 times current earnings (or 13 times current dividend)?

It really depends on future EPS and DPS growth rates.

This is where it gets tricky - everyone will have different views about the future growth rates.

Will it continue to shrink?

Will it stop and turn around?

Does anyone knows the future?

This is where Buffet and Graham's brilliance lies.

When nobody knows the future, they want ample Margin of Safety.

In other words, make conservative assumptions, calculate the Intrinsic Value, and wait for Price to fall below Intrinsic Value at a margin and then, only trigger the buy.

So, what conservative assumptions should we make?

I offer you 3 scenarios, to understand the mathematics of Intrinsic Value.

Scenario 1 - Aggressive - assume no shrinkage, no reduction, i.e. assume EPS and DPS has found the bottom.  In my opinion, this is a very aggressive assumption over the next 10-20 years.   

Scenario 2 - Ambitiously realistic? - assume the rate of shrinkage reduces by 2% per annum, i.e. eventually earnings is flat forever.  This gives credit to current Management who tries to reduce the shrinkage in earnings and dividends.

Scenario 3 - Prudent - assume rate of shrinkage reduces by 2% per annum from -16% down to -6% and earnings shrink at -6% per annum flat thereafter.

What does the results look like?

I project the EPS for only 20 years for prudence.

My discounting rate is 8%.  Why 8%?  Because I can safely invest and earn 8% p.a.  This is my required rate of return.  

So, how much is BAT's Intrinsic value worth under 3 different scenarios?

In Scenario 1, if BAT's earnings remain flat at 68.2 sen forever, then, the stock is only worth RM6.70 to me.

In Scenario 2, if earnings initially shrink by 16% but improves over the years and eventually stays flat, then, it could be worth RM4.00.

In Scenario 3, if earnings keep shrinking at an ultimate rate of -6%, then, it could be worth RM3.60.

Sanity check.  BAT Net Tangible Asset (NTA) is RM1.32.

Summary and Conclusion

BAT's price has crashed substantially the past decade.

It's peak price is near RM75.  Today it's only RM8.2.  Is this a cheap stock?

Unfortunately for BAT business, its EPS and DPS continues to shrink the past 8 years.

It's business appears to be sun-setting.  

It's revenue continues to shrink.

It's hard to imagine for hard core smokers but there are less customers smoking BAT's products.

Instead, it's being persistently replaced with alternatives.

And these alternatives doesn't bring in the same level of profit margins and revenues like it did before.

The huge question mark is how long will it take the business to settle.

Nobody knows the answer to that question.

Because of that huge uncertainty, that's where Buffet's and Graham's brilliance comes in.

They insist on having an ample Margin of Safety in the valuations.

3 out of an infinite scenarios are offered here for prudence.

They indicate that the fair value is probably around RM3.50 to RM4.00 based on today's Intrinsic value.

Which means RM8.2 is still not cheap.

Final thoughts

Noone knows the future.

As retail investors ("bilis"), we can't afford to under-perform EPF returns.

EPF gives us 5.5% to 6.0% per annum long term returns for "doing nothing".

If we want to invest in stocks ourselves (instead of parking in EPF), then, we demand at least 9% per annum returns (or at the bare minimum, 7%-8% per annum returns if we DIY).

We don't lose any monies if we don't invest.  

We make 5.5%-6.0% per annum long term if we park in EPF.

My illustration above showed that to earn 8% p.a. returns in a declining EPS/DPS scenario, the stock needs to be trading at around RM3.60-RM4, before I start to be interested.  

In fact, I probably need another Margin of Safety, of possibly 30% buffer.  

This suggests, I could probably trigger a long term buy at around RM2.50-RM3.

In short, RM8.20 is still too rich for me.

To each, his own.