Sunday 16 October 2016

What is My Target Price?

A reader asked me what was my target price for a particular stock in one of my blog posts. I was stumped for a while, and realised that I do not really have a target price for my stocks! I do have valuation limits on what price I could buy or sell a stock, but they are not the same as target prices. Let me elaborate further on the buy side and sell side separately.

Buy Side

Having a target buy price suggests that there is a particular stock that you like to buy but is waiting for the price to fall to the right level. To prevent myself from overpaying for stocks, the maximum price I would pay for a stock is 1.8 to 2.0 times the book value of the stock. It looks like a target price, but it is actually a stock selection criterion. All stocks that fail the criterion would not be considered for purchase. The Price/Book (P/B) criterion works the same way as the Debt/Equity criterion. The stocks either pass or fail the criteria; it is not quite the same as waiting for the price to fall to the right level. The litmus test of whether the P/B threshold is a target price is to consider what happens when the price falls to that level. Nothing happens, until the next review. If, in the next review, the stock is still below the P/B threshold, it would be considered for purchase, assuming it passes all other criteria. Thus, it is possible that the stock is bought at a P/B ratio lower than 1.8 to 2.0.

There are also stocks that I wait on the sidelines before buying. However, I am not waiting for the right price, but the right moment. Take for example, Keppel Corp, which I am interested to average down. Based on my assessment, Keppel Corp has not seen the worst of the Oil & Gas winter yet. Thus, if it revisits its low of $4.64 reached earlier this year, I would not be keen to buy the stock. On the other hand, if visibility improves on its business environment 2 years later but the stock then rises to $6, I would be interested to buy at the higher price. The main reason is to wait for the price to reflect fully the business conditions as well as assess whether the company is able to recover fully. All these take time. I view Keppel Corp as a long-term investment, thus it is much more important to understand the business conditions fully than to buy at a low price.

Sell Side

Having a target sell price means that you are waiting for the price of a stock to rise to a particular level before selling. It also means that if the price does not reach the target level, the stock would not be sold. Similar to the buy side, I have valuation limits on when I must sell a stock, no matter how much I like it. The P/B ratio for selling is 3.5 to 4.0 times. However, it does not constrain me from selling even if the stock does not reach the P/B threshold when the need to sell arises. In fact, rarely has a stock in my portfolio reached the P/B threshold mentioned above. Typical reasons for selling include changes in business fundamentals, triggering of trailing stops, or simply risk management.

Having said the above, I have loss aversion bias. There are some stocks that I regretted buying and no longer wish to hold on to them, but the price has dropped below my cost price. For these stocks, I am usually reluctant to sell at a lower price. Thus, the original cost price becomes a target price for selling these stocks. Nevertheless, if the loss is manageable and there are overriding concerns, e.g. changes in business fundamentals or risk management purposes, the stock would generally be sold at a loss. Just last week, I wrote that I had a 19% concentration in Global Logistic Properties but would be happy to reduce the concentration to 15% if the price recovers to my cost price. This is loss aversion bias at work. On reflection, I realised that the position limit on this stock is 20%, which means that I only have a 1% headroom for averaging down if the need arises. I sold 3% at a loss this week. The same goes for the growth stocks in my portfolio which were at the position limit.

Conclusion

Generally, I do not have target prices for buying stocks. On the sell side, I do have target prices for stocks that I no longer wish to hold and are under-water but not for stocks that are above-water. I think it is more correct to say that I have loss aversion bias rather than have target prices for selling stocks. So, the next time someone asks me what is my target price for a particular stock, I will be more confident in replying that I have no target prices.


6 comments:

  1. Hi Chin Wai

    Thanks for sharing your strategy there. Ive been thinking of doing the same thing too one day.

    Just curious, your preferred stretegy seems to be towards asset based investment using the book value method. How did you buy service related industry where the book value methodology is not the most appropriate to value them?

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    1. Hi B,

      That's the reason why I don't have many services companies. But I agree with you that services companies should command a higher P/B ratio as they have less assets.

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  2. Hi Chin Wai ,
    Some said " buying stocks is a science and selling is an art " ,, hahaha ,,for me the "target price " only apply to analysts from brokerage firms .. :) it vary much from one an others ... and it swing like YOYO sometimes ..
    Cheers ..

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  3. 1) "I view Keppel Corp as a long-term investment, thus it is much more important to understand the business conditions fully than to buy at a low price."
    >> so someone who started following KepCorp 10 yrs ago & knows it inside out would have a target buy price today, as he/she would know it inside out now, while you don't.

    2) what happens if u had started covering KepCorp, & had a 5% position in it from 8 years ago, & it drops to $1 tmr and nothing has fundamentally changed, as a long term investor/co-owner of the biz, would you not buy some of it at that price, like u did GLP? you must have a current "target buy price", by pricing in the uncertainty in O&G.

    thus it seems more like you do have a target price for counters that you are familiar in. Everything's got a price all else equal (pricing in oil price uncertainty, mgmt changes (you also won't know when this management will retire, when they will be susceptible to fraud, when processes change, when disruptors come in). There is really so much more risks saying you're a long term investor when you're actually a short term investor with a larger appetite for changes, cuz in reality, you are reviewing a company's viability constantly (whatever your review frequency is), and you're making a decision to buy more, hold, or sell, all the time.

    If you were truly a co-owner of the company, say of Blackberry, starting in 2006, you'd have seen it go from 70, to 230 down to 7. in just 12 years. Change is always on the horizon, and one needs to constantly evaluate ones portfolio (even holding is a deliberate decision).

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    1. Frankly speaking, this question of whether I have a target price is a difficult one, because it is about understanding myself. I thought a long time about it and concluded that I have a target timeline, but not a target price.

      You asked me if I would buy Keppel Corp at $1. Yes, I would. But I still don't have a target price. Having one means that if the price is $1.01, I won't buy and will wait for the price to reach $1. No. On the day I review Keppel Corp, if I like its prospects and valuation, I would buy. There's no waiting for the price to reach a target level.

      You mentioned we should constantly evaluate our portfolios. Yes, I agree with you. As a co-owner of GLP, I am regularly checking whether the company is following its business model closely and what are the risks facing it. GLP has long-term growth potential. The main thing that can derail its growth is risks. Thus, in GLP, I am a long-term investor looking out for short-term risks.

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