STOCK RESEARCH TICKER: BY ADTRADER

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June 17, 1997 My Investment Principles

Investment Goal My goal is to consistently and substantially increase my net worth over the long haul by investing in sound businesses with good future prospects. Depending on the opportunities and capital available, I am open to buying majority control of businesses or owning parts of them via publicly listed common stocks. For the purpose of discussions in ID, I'll focus on investing in marketable common stocks. However, the approach to buying a private business outright and investing in common stocks is exactly the same. They are outlined below. Type of Business I look for businesses that generate cash instead of consuming it, even during their rapid-growth phase. Strong cash-generating businesses are usually non-capital-intensive and almost always have high returns on equity capital. I want to be in businesses that can reinvest the cash generated to further grow their profits and cash flow over the long run. My focus is entirely on listed companies in the US. I have no intention of looking elsewhere for the foreseeable future. Understanding A Business When searching for businesses to invest in, I stick to those that I can understand. It is only by understanding a company's business that allows me to make a sound judgment about its future profits and cash flow. I avoid those businesses that I can't understand (e.g. I am not good at evaluating fast-moving high-tech businesses). The first question I ask myself when I look at a company is "Do I understand the business?" If the answer is no, then the next question is "Am I capable of understanding the business on further research?" If the answer is no to both questions, I'll just move onto the next company no matter how hot that particular company is. This approach will at times lead me to miss the next Microsoft, but more importantly, it will keep me away from the twenty other Microsoft-wannabes that will eventually fade into obscurity. What I might miss is not important if I don't understand the business. The far more crucial thing is getting it right with what I do decide to invest in. Most people expect successful investors to know a lot of stocks and be able to comment on them. However, in investing, defining realistically what you don't know is more important than pretending to know a lot. Management The management of the businesses I look for must first be able to run the businesses capably and realize its full potential. Second, management must be able to wisely deploy the cash generated by the business to create more value for shareholders. A great business can be severely depressed by management that misallocates capital. Last, but not least, management must have strong integrity so that they won't take advantage of their positions for their own gain. All insiders of a company have ample opportunities to enrich themselves at the expense of shareholders. It takes integrity and honesty to resist such temptations. In short, I place equal emphasis on the jockey and the horse. Finding Them When They Are Small I try to find good businesses when they are small, or at least when they still have a lot of growth left in them. When you find them small, you can achieve fantastic gains by sticking with them as they grow. However, I don't consider myself to be a small-cap or mid-cap investor. Size is all relative. When Wal Mart was doing $4 billion in annual sales many years ago, it was considered a big company in all respects. However, it was still arguably small at $4 billion considering all the growth ahead of the company (Wall Mart did $103 billion in sales for fiscal year ended January 1997). I have no particular capitalization in mind when I search for a business. Naturally my personal experience in buying and running small businesses predisposes me towards businesses of smaller size rather than huge multi-national corporations. Buying When I find the right business with the right management, I try to buy the stock at a reasonable, or better, at an unreasonably low price. I price rather than time my common stock purchases. The former involves calculation of values to determine at what price a stock should be purchased irrespective of stock market movements, whereas the latter entails speculation on the future movement of the stock market and the stock price itself, i.e. buying in anticipation of the stock going up or selling in anticipation of the stock or market going down. I continue to be amazed by the number of people in the stock market who are fixated on market movements, — all the media and professional fund managers focused on what is going to happen to the Dow, asset allocation models urging investors to go into cash in anticipation of market declines, etc. It is all the more amazing considering the highly visible success of people like Warren Buffett, Ben Graham, Phil Carret, and Philip Fisher whose successes are partly attributed to pricing their investments rather than timing them. Not many people seem to want to follow their methods. I guess it is more exciting to talk about something volatile and speculative rather than sound investment principles. I view common stock purchases as similar to budget-conscious grocery shopping. In grocery shopping, I'll compare the grocery prices of all the supermarkets in my neighborhood to find the best deal. Being an avid grocery shopper, I'll know my grocery prices very well and will be able to tell instantly when I find a bargain. If I find a supermarket with grocery prices that make sense to me and give me the best value for money, then I am going to buy the groceries today. I am not going to defer my purchase to wait for a cheap sale. For one thing, I don't know when or whether the cheap sale will happen, and when it does happen, I don't know what the grocery prices will be at that time. If the prices happen to be lower, making them even more of a bargain than my last purchase, then I'll stock up if I happen to have some spare cash available at the time . The most ludicrous thing to do is to defer my grocery purchase and wait until the prices are moving up (which is what investors frequently do with stock market timing). What doesn't make sense in grocery shopping doesn't make sense in investing either. If it makes sense to do something today, then Just Do It! All the components have to be there, — the business, management, and the price — before I'll buy the stock. I'll not buy if any of the ingredients are missing. The rationale of this strict discipline is largely defensive. I believe it will prevent me from making mistakes with my investments in addition to helping me find winners. Selling Finding a good business with sound management and a reasonable price is very difficult. When I do find a rare gem, I prefer to keep it instead of selling it. I'll only sell when I have made a mistake in my judgment (and trust me this will happen) or when the company or its management deteriorates, or when the price becomes totally irrational and irresistible. Otherwise I just sit still and do nothing. Inactivity is the friend of the long-term investor in a great business. At one point in Microsoft's evolution, Bill Gates offered to sell half of the company to IBM for around $70 million (I can't recall the exact figure). While $70 million might have seemed like a lot of money at the time, it is a pittance compared to what Microsoft is worth today. By dumb luck, IBM turned down Gates' offer. I don't think Gates would be the richest man in America today if he had succeeded in the sale. With a good business, the time to sell is almost never. Diversification My psyche is toward concentration of investments as opposed to wide diversification. If one is really honest with oneself, then one will admit that there is only a limited number of businesses out there that one can understand with conviction. The additional requirements of good management and a reasonable price further reduce the universe of businesses available for investment. As a result of this difficulty in finding good businesses to invest in, I tend to really load up (relative to my own net worth) when I find them. There is no need to find too many stocks in one's life time to do well. For example, was there any need for Sam Walton to diversify his holdings in Wal Mart's stock? Diversifying out of Wal Mart's stock would have actually hurt Walton's wealth accumulation. The Wal Mart stock was all he ever needed in his life to become a billionaire. If I find a winner, then I am more worried about can't getting enough of it than diversifying my risks. It makes sense to stick to the winners. When I'm evaluating a stock, I'll ask myself whether I am willing to buy the entire business outright based on all the factors I know. Say the total market capitalization of the business is $300 million; I will ask myself whether or not I am willing to spend $300 million to buy the entire business. Assuming all I have is $300 million, and this is the only business I can be in for the next ten years once I buy it, do I feel comfortable enough to do it? If I am unwilling to put my entire $300 million net worth into buying the company outright, then I am also unwilling to take a punt on parts of the company, even if it is only for $300 dollars. With an uncertain stock, I do not believe you should give it a try by putting a small amount of money into it, i.e. money that you can afford to lose because you are adequately diversified. I am either totally convinced that I should buy a stock or not at all. Such a concentrated approach will actually decrease risk because it forces me to really research and think things through. Besides, diversification can give a false sense of security. Since no single investment will cause you to lose everything, it's easy to become sloppy. If you lose a little bit of this and a little bit of that, then eventually you will have nothing. My goal is to be able to find one good company to invest in every year. Considering most of the Forbes 400 got there by owning a single business, finding ten companies over a ten year period is more than sufficient diversification. Excessive diversification is for those who don't know what they are doing. To sum it up — less is more. Why America? My friends often ask me why I focus solely on American stocks instead of companies back home (home is Asia), given that the economies in Asia are growing at a much faster rate than the US (when one compares emerging Asian markets versus a mature US market). This is partly personal. For some inexplicable reason, I am drawn to the US. I feel more at home in the US than in various parts of Asia, despite having better contacts and relationships here (my late grandfather founded a group of businesses in Asia that did $400 million in sales last year; the group now has ventures in China and India; I guess these are all useful contacts that can be taken advantage of if desired). I feel liberated and stimulated everytime I set foot in the US. I need to get my fix every few months by visiting the US. More importantly, I function much better in an environment where there is a clear and established rule of law and fair competition. In most (but not all) parts of Asia, who you know counts more than what you know. Personally I have a strong distaste of the need to cozy up to people in order to win business. Don't get me wrong, it is important in business to network and establish relationships. However, I don't like it when relationships become too important an element in success. I am not sneering at it as for certain people with certain personality, this type of business environment produces far quicker and more substantial wealth than in a competitive and open environment like the US. However, I feel suffocated in such an environment. From an investment perspective, the US has much stricter securities and disclosure laws than Asia and offers better protection to investors. Naturally, abuses of shareholders still happen in the US. However, all the hungry lawyers prowling around with their class action lawsuits serve as a good deterrent, or at least reminder, to those management who may want to enrich themselves at the expense of shareholders. In Asia, most listed businesses are controlled by families, and outside minority shareholders are definitely not considered part of the family. There is not much shareholders can do except to dump their stock and move on. The final reason for focusing on American companies is the size of the US market. America is still the largest economy in the world, and it is a relatively homogenous market with one language. National distribution of products and services can be achieved. As such, a small niche in the US can enable a company to grow into a sizable business with hundreds of millions of dollars in turnover, thereby achieving a critical scale where certain economies and competitive advantages are possible. A company can grow for many years by just focusing on the US market before it taps out domestic growth. In contrast, Asia is not a single, homogenous market and consists of many individual country markets with different languages and cultures. Each of these individual country markets is of a much smaller size compared to the US (this is true for China and India as well, despite their massive population). Just getting distribution of products and services to run smoothly in the different country markets is a major undertaking. The economics and durability of returns are very different. I frequently observe that there is a lot of what I call temporary good businesses in Asia. Often a company shows good growth and returns for a few years while it focuses on its smaller home market. When it has tapped out its home market and is forced to look overseas for growth, it frequently cannot replicate its success overseas. Consequently, losses are racked up in such overseas expansion, and growth stalls. Some of these companies are accustomed to a protective and closed home market where connections help them achieved illusory competitive advantages. Once they go to a different environment and lose their home edge, they usually stumble. It is difficult to apply a long term buy-and-hold strategy with these companies. I would much rather participate in the growth of Asia by investing in a US company that has a strong franchise at home but is also expanding prudently into overseas markets such as Asia. Conditions conducive to producing great companies like one finds in the US will eventually develop in countries like China and India. However, for the time being I am quite content to let other people look for needles in the haystack while I continue to focus on a more obvious place like the US.