Jun Hao Tay On Tesla: Good Business, Bad Stock
Lessons From A Value Investor: A Meeting With Jun Hao Tay by Anton F. Balint
A few days ago I had the pleasure and the opportunity to meet with Jun Hao Tay, a successful, kind and down to earth value investor that runs his own fund. We discussed a variety of topics: from oil prices and new industries to Tesla’s valuation and financial statement’s ‘bizarre’ numbers. Below follows a summary of the most important lessons I took from my meeting with Tay.
- There is no single way to invest
This was not necessarily new information to me as I was aware that investment is a profession that results in success if it is combined with one’s personality and view of the world. Moreover, if anyone interested in investment or finance ought to read books on names such as Charles Munger, Warren Buffett, George Soros, Peter Lynch, John Templeton and Guy Spier (to name a few ‘star’ investors) then it will be even more obvious that the way these people approached the investment profession was in a unique manner that reflects the way they are as persons: from a very philosophical approach taken by George Soros to a journey seeking method adopted by Guy Spier. However, Jun Hao Tay confirmed this for me: he made it clear that depending on your aim (stable income, capital preservation, etc.) and on how you see the business world (i.e. how pessimistic or optimistic you are about the future of the businesses that you read about) will determine, generally speaking, what kind of investor you will be. Moreover, he suggested that in order to improve and regardless of what path one chooses to take, reading a wide variety of books, company reports and other materials is necessary – I could not agree more on this point: reading is one of the keys for life-long success.
- The future is unknown (especially the future of the oil industry)
Nothing surprising here – some might say that this is an obvious comment. And yet, so many of us tend to allow our emotions to control our faith in our convictions: I recommend to anyone reading this to buy and ready thoroughly Influence by P. Cialdini and Fooled by Randomness by Nassim N. Taleb. These two books will clarify why we are prone to think that the past is a good base to measure the future and why we tend to overly accentuated our faith in statistics, numbers or any form of scientific information. However, Tay explained to me very clear that industries fall and rise all the time: 15 years ago the planet Earth was running out of oil and we were thinking of exploring Mars for resources. Today, we have so much oil that supply greatly exceeds demand. Moreover, demand for non-electric cars is increasing and the pace of electric cars to punch through the established market of automobiles is still not strong enough to offer a stable projection as to when in the future the majority of the world’s population will be driving electric vehicles: the future is unpredictable. Therefore, focus on the fundamentals of the business and not on market predictions.
Moreover, Jun Hao Tay made it clear that it is important to make the difference between a good investment and a good business: a good business is not always a good investment and a good investment is not always a good business. For example, Tay explained this situation using Tesla as a model. We both share immense admiration for Elon Musk and for his companies. However, Tesla is haemorrhaging cash! A quick look at the financial reports will reveal that cash from financing is consistently positive and that the company is losing money for each car it sells – this means that the company has been raising cash to stay out of liquidation. This achievement is attributed primarily to Mr. Musk’s salesmanship skills. However, despite the company’s noble aim and great skills of Mr. Musk, it makes little sense from an investor’s perspective to put any money in this company: a good business is not always a good investment.
- Emerging markets and information asymmetry
The reason why emerging markets are an attractive prospect for investors is because more and more local investors have access to the market but they lack the necessary skills, information and experience to actually engage in a fruitful and productive manner in the stock buying and selling ‘dance’. Consequently, there is high volatility and many, many mispriced companies. The US market at the moment is expensive because the interest rates are low and investors are overly optimistic about the US economy and market stability.
- Free cash flow
As a new and enthusiastic value investment scholar, I read most of the books on Warren Buffett. Consequently, I heard of a concept called ‘owner’s earning’. Mathematically, this concept is translated into net reported income plus depreciation, amortization and depletion (DAD) charges minus capital expenditure (that is capital that the company needs to stay in business). Mr. Buffett explained that he uses this measure instead of free cash flow (FCF) because FCF is measured as net income plus DAD charges. However, this is non-sense as one must also account for the costs of doing business. However, I knew that the free cash flow was defined as cash flow from operating activities minus capital expenditure. Peter Lynch, one of Fidelity’s star managers and a legendary value investor, also uses FCF as operating cash flow less capex. Therefore, confusing hit my mind and I asked Jun Hao Tay if he can clarify this for me. He suggested to use Peter’s Lynch measure for simplicity’s sake. However, he strongly recommended to measure the FCF for a period of at least 5 years in order to get a sense of how a business is doing: remember free cash flow is the amount of money you as a business owner are left with at the end of the financial year – you cannot pay your bills or buy new business with reported net income but with cash only!
- Mean Reversion
Prices, in long-term, will return to their mean. This is also John Bogle’s way of looking at the market though a general picture point of view. Moreover, mean reversion will help the investor to identify possible bubbles-wild fluctuations of prices that tend to sky-rocket and then plummet back to earth to reflect a number closer to the real value of the company. This does not mean that markets are rational! It means that in long-term, it is the business value that wins and not the short-term market vicissitudes.
- Enterprise Value
Jun Hao Tay suggests that a more accurate way of ascertain the market value of a business is to look at its enterprise value (EV) instead of looking at its market capitalization. Market capitalization is the result of number of shares outstanding times the share price. However, EV is calculated by adding the net debt to the market capitalization and subtracting the cash and cash equivalents from that number. EV is not to be used on its own: most investors use EV to EBITDA to compare firms with different degrees of financial leverage and to value capital-intensive businesses with high levels of depreciation and amortization. Tay also cautioned me that EV/EBITDA is not to be used alone but together with P/B, ROIC and FCF.
- Recommended reading
Of course, Jun Hao Tay is a very well read individual and he was kind enough to suggest some of his most important books with me. The reading list is as follows: anything Howard Marks from Oaktree Capital Management writes, Bull by Maggie Mahar, Deep Value and Quantitative Value both by Tobias E. Carlisle and There’s Always Something to Do: The Peter Cundill Investment Approach by C. Risso-Gill.
Finally, Security Analysis by B. Graham is outdated. What? Yes, the Bible of investment is outdated: the principles within it were very, very relevant to a particular moment in time and were of immense help in a period of corporate governance and disclosure were a rare thing. Nowadays, it is nearly impossible to find a company that ticks the boxes of Ben Graham. However, I recommend that the book is still relevant from a historical perspective: learn from history even if we, psychologically, are not programmed to do so – this is another key to long-term success.
Note: Jun Hao Tay also has his own blog which is a well of information for anyone interested in becoming and investor. His blog can be found here: http://theasiareport.com