Posted by: donmihaihai | September 8, 2008

Lessons from current crisis.

All major stock markets roar back to life after Fannie Mae and Freddie Mac being put into conservatorship. STI jumped 122.82 point to hit 2697.03. Last Friday 2574.21 will be a bottom for near term if this rally sustains itself.

Is this a sucker rally? I don’t know. But I would bet that many speculators will use this opportunity to buy and sell or just unload stock for some gains. Many will think that this is a sucker rally and stock will fall off the cliff someday in the near future. Perhaps it will but I will rather be a contrarian at this moment without betting any money that one of these is a not a sucker rally.

Current crisis provide me with many valuable lessons but 3 stand out because it is very hard to forget them. I wish I will never need to learn the 3rd lesson myself.

1st lesson : Leverage

This is not a new lesson but one that I need to remind myself ever now and then. There are more than enough examples in current crisis what show leverage kills.

2nd lesson : cash cushion.

I am not too sure this lesson will be well learnt. My biggest misery in this bear market is not having enough cash to keep buying. I already game over and watching from the sideline for the latest slump as all my money already spend purchasing all kind of bargains I found.

There is a different between holding on cash because thinking the market has more to drop than holding on a certain level of cash so that unexpected throw away bargain can be pick up with those cash. Bruce R. Berkowitz belongs to the 2nd type and it work wonder for him. Many good companies that I read about belong to the 2nd type as well and start buying as cheap assets are available when competitors are loaded with debts. With that it is possible that I will be loading up more Celestial at <$0.55, Sarin at <$0.30, SP Chem at <$0.50, Beauty China at $<0.50 and even Full Apex, Pfood and Jaya at <$0.20, < $0.85 and <$1.00 respectively rather than watching.

Time to start thinking on how to do it.

3rd lesson : Business model that depend on capital market will not work if capital market is “closed”

I will not forget this. Once capital market is “closed”, their business model breakdown. This is not a good model. Locally, REIT, Shipping Trust or infrastructure trust belong to this model. By paying out all generated cash and rely on capital market for equity and debts, an unfavourable capital market mean they are chocked even during the time when they are not facing much headwind in term of their businesses.. What if they are facing headwinds like those hedge funds, private funds, financial institutions, Fannie Mae and Freddie Mac? These Trusts are not anything strategic or too big to fail.

It is still ok if it confined to REIT and Trusts. But the fact is it can happen to any company as long as they are manage in a way where constant feeding of low cost cash from finance side is require for being healthy. When low cost cash is not available, it is not just the company started to be shaky, shareholder may require pumping in more money because these companies have not much other options available. Now that is a double hit as besides pumping in money, share price usually drop big time.

These 3 lessons are interlinked but it is only until recently, I have started to think in this way. Companies that avoid one and three while doing two are those that I love to invest in as it show what kind of management they are.

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