Subject: Interest Rate (IR)

Interest rate has a great impact on valuation becos It serve as a discount factor for future cashflow. Investors that invest in the capital mkt faces two options, bonds n equities. both bonds n equities are like weighting machine, when ir rises bond price fall n bond yield rises n drawing funds from equities in it, as a result share price will fall. That' s the reason y everyone is so concern about yellen speech. 

There are different ways we can xplain how interest rate affect valuation n I will use a more simple way, dividend yield n bond yield to share with everyone. Those who are finance savy pls bear with me bcos I need to take care of those who are not trained in finance. Investment in equities besides capital gain, dividend is another form of income. Pension fund or institution fund are long term investors n dividend yield will continue to attract their investment during bad times. however they r also attracted by bond yield that will continue to give them the cashflow when times are bad.

We can extract the 10 years sg government bond yield from public info n currently it is at 1.67%. When we look at DBS, those who bought a sgd15 n below get a minimum dividend yield of 4% (0.6/15 x 100%) assuming the full year dividend is sgd0.60. Since dividend yield is much higher than bond yield, fund managers would choose to park their money in equities. They will only switch out to bonds when dbs dividend yield equalizes or below the bond yield thus DBS share price would have to increases to  sgd35.93 (sgd0.6/1.67%). 

If interest rate rises n resulted the rise in 10 years sg government bond yield to 2.5%, DBS share price would have to increase to sgd24 in order to have dividend yield of 2.5% as well (assume dividend paid remain unchanged). If the 10 years sg government bond yield rises to 3% then DBS share price would b sgd20 in order to produce the same dividend yield. From here we can see that as interest rate increase from current of 1.67% to 3%, valuation decrease from sgd35.93 to sgd20. 

This is a simple illustration to show y stock mkts are so sensitive to rate hike. In reality the valuation calculation is more complicated n mkt also can perceive rate hike positively like showing more confident in a stronger economy.

Thank you :)

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Just to share about Byd, a prc automaker, the leading domestic electric car manufacturer in prc as well. In 2008 warren Buffett invested into Byd at hkd10 per share, it' s CEO n largest shareholder, Mr Wang Chuanfu commented warren Buffett was extremely conservative n squeezed him hard on the purchased price. Within the next two years, it' s price shoot up to about hkd80, fetching more than 700% return in just two years due to the warren buffet effect.

 

In 2011, the euro crisis, Byd share price plunged from its record high to a low of hkd10.92. Many prc  laugh at warren Buffett for being an idiot of not selling his shares. After 5 years from the euro crisis it

is now trading at hkd50 plus n he still made more than 400% in 8 years, which is about 50% return per

year without compounding. This is an astonishing achievement. By holding on to a stock n doing

nothing everyday n yet earn 50% per year comparing to those who spent hours interpreting macro

factors, politic n etc to the impact of their share price, this is a very simple way of making money but

yet ppl choose the tougher way.

 

as mentioned in my previous post, the most important aspect in investment is to buy at an adequate margin of safety from its valuation to protect our capital n once our money is safe over time, making profit is just a matter of time. Although warren did not sell byd during its peak due to his own reason, The price which he entered (hkd10) protected his capital when Byd stock plunge in 2011 n again he is still making good profits all these years.

 

There were many negative news n rumour when Byd prices was at low during the euro crisis. Again it is the prc who bad mouth the most about their own companies. Some said its conventional car quality is  lousy, some said electric car will never pick up in prc, some said Byd doesn' t equip with the required technology in building an electric car, etc n etc. If warren did not have a clear understanding of how this company work, he would has swayed by those negative sentiments n rumours. It is becos he has thoroughly done his home work, he continue to standby Byd even when everyone was dumping its share n not being shaken at all. This is investment.

 

those who got frighten by a 1-2% decline in the mkt n started speculating about end of the world r ppl who usually do not do their homework. It is bcos they have no idea of the company, they r easily shaken when a slightest negative news are presented to them but the funny thing is they insist not to stay out of the mkt, invest to invest, do not want to do their homework n continue to be frightened when negative news are shown upon them. Very unique mindset, very hard to understand.

thank you :)