Lynch, SAP and my first Option Play

The year was 1994. I’d finished my second stint at University in ’93, graduating with a Bachelor of Applied Science in Information Management. I was a graduate consultant at SAP. Not that anyone knew SAP then, even though it was then the world’s eight largest software company. I recall my final interview, the one with the national consulting manager. He said “there’ll be a lot of travel and hotel rooms, I won’t apologies for that, you need to expect it as it’s part of the job.” I thought he was joking about apologising. Travel and hotel rooms sealed the deal for me. It wasn’t until years later I finally realised that he was serious and while travelling and living out of a suitcase has a fleeting appeal it soon gets tiresome. After ten years or so! Your millage may vary.

To the point. Buy what you know. If you’re new to investing start with that. Look around you at the companies in your life and pick the best ones. Then some easy fundamental checks quickly lets you know whether you may have found a good investment.

I started investing in October 1987, days after the crash, but hadn’t invested since arriving home in 1990 after exploring North and Central America for a couple months. During that first foray into investing I’d been stockbrokered (synonym for words not suitable in general public), so I decided to go it alone. I still had to use a real broker, nice guy, explained the basics of options and European warrants, but it was execution only. RTFM was the catch cry of the day, so I started reading investment books. The first book was probably Peter Lynch’s Beating the Street. It was recently published and I no doubt grabbed a copy from an Airport bookshop on one of my countless flights. Lynch makes investing seem simple, I devoured Beating the Street and then his first, One Up on Wall St.

Lynch said buy what you know. There was no company I knew better than SAP, it’s potential was clear to all employees. The executive board  rewarded all SAP employees with long dated European options, called warrants. Unfortunately the head of SAP USA, which Australia reported to and our warrants flowed through, decided only executives in his regions should partake in this generous sharing of wealth. There was a huge uproar amongst the worker bees, especially those with many years experience and direct access to senior Walldorf staff. One of the most outspoken, Richard Ford, was also a solution oriented guy and shared how to invest in SAP warrants directly.

I had never bought an option and only had a basic understanding. However I did recognise that SAP was inside the Tornado before Geoffrey Moore had named it that. I invested heavily in SAP warrants. At the time I didn’t understand the leverage options provide and invested as much as I would in a full equity position. Fortunately that ‘mistake’ made a good story great and I felt like I’d taken the first step on Lynch’s path of a few good stocks to make a lifetime of investing worthwhile. My first option, European warrant no-less, was a multi-bagger.

Investing was easy, I’d read a couple books and then a few more, it was plain sailing until 1999. Selling out while the market is in the progress of doubling is neither easy nor sensible, it was a painful underperforming year for me, everyone around me were seeing their shares go up multi-fold, everything I sold quickly went on to greater highs. Then buying in too soon on the downside hurt as much. Still by that time I’d backed SAP up with a couple other multi bag winners and with my peak earnings pouring in I continued to plough cash into the Nasdaq market all the way down and back up again.

Since then I’ve invested in and still own part of every company my partner has worked for. All either worked are working or may work out. Though I no longer believe investing is easy, it’s certainly made easier by reading the wisdom others have generously provided us.

You may have heard that investing in the companies you work for is considered ill advised. I’m certainly not advocating everyone invests in their own companies. Many companies are terrible and you shouldn’t invest in them. What I will advocate for younger readers is  that as soon as you can in your career you should work for a growth company that you would invest in. It’s fantastic you’ll learn heaps and get to work with some of the brightest people around. A total blast which has you jumping out of bed in the morning excited about what you’re doing.

Whether you work for it, buy from it, eat at it, see it’s shops, buy it’s products or read a lot about it, you increases your odds of success buying a good growth company early in its growth. You’ll also get more chances when prices fall back close to their historic value lows. Buying what you know also makes it easier and more interesting to follow the story and have an edge on analysts.

If you don’t know the growth story of SAP, it’s a good one. Four German programmers left IBM to write a business program for ICI. SAP became a de-facto finalist in all large and medium business solution purchases. Like IBM in it’s day the choice always came down to SAP or. We were in the final running for all deals and always blew away our targets. IIRC, I was employee i2303, the 2,303th international SAP employee and there were around 3,000 employees. Now, 16 years on SAP employs 44,000 people. Those were extravagantly wonderful days to work in software business consulting and I was fortunate to work with many wonderful companies and people.

The following charts of SAP illustrates another Lynch point. “Time is on your side when you own shares of superior companies. You can afford to be patient –even if you missed Wal- Mart in the first 5 years, it was a great stock to own in the next 5 years.

I invested in SAP late 1994 or maybe early ’95. I’d missed the first six years years of SAP as a public company and it was up 10x times by then, from .50 to five. Over the next five years SAP again went up another 10 fold, before peaking in 2000 up 15,000%.

Is that chart clear? The lower blue chart is an expansion of a five year subset from the chart above.

So where am I now on Lynch’s path of a few good stocks? Home runs like SAP, Amgen, Omega Health and Biota, ably assisted by many singles and a few doubles papers over the many mistakes. It’s been a wonderful journey with a great partner, the ancient catholic within this agnostic frame feels blessed. The arrogant me thinks it’s the product of a little knowledge and smart hard work, the kid within giggles and thinks great game. The realist looks forward to the next adventure.

Disclosure: Long Amgen and Biota. If anyone ever buys a book from Amazon by clicking through a link on this site I should get paid. It hasn’t happened yet, I’ll let you know if it does.

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  • Hi Dan, I tend to think some of Bill Bonner’s stuff is extreme but his recent idea to go long Japanese stocks was interesting.

    The last time I waded in that area was about 2004 when I bought a Japanese unhedged index type fund. Unfortunately it went nowhere for 2 years and I eventually sold out break even. I suppose if I had held it would be lower now than it was then.

    I’m not sure when Japanese stocks will reach a bottom. There is also the problem of currency risk with the yen likely to devalue with the amount of sovereign debt. The currency risk devalues the investment if unhedged but makes the company more profitable if it is an exporter.

    Small caps are supposedly good value at the moment in Japan. The main problem is that they are competitors to Chinese companies which do not have to turn much of a profit. From my limited experience, it’s been better to invest in lower cost base countries such as Vietnam in the last 5 years than China or Japan.

    Still there must be a price at which they are worth a small punt again. What are your thoughts on Japanese small caps Dan ?

  • Hi Sean, I’ve got no opinion on Japanese small caps. In the US and Australia small caps outperformed in 2009, so based on history I’d be surprised if they outperformed this year.
    Cheers – Dean

  • Hi Dean, there’s some better value again. Bought some WOW, CSL, RIO and STW today. RIO retraced about 15% and is back into reasonable valuation range in my mind.

  • Hi Dean, I was running the ruler over WPL this weekend. I think I will go buy some on monday. With resources, I think they got ahead of themselves but I’ve started to bite again with the pullback. I think the commodity bull market is still there. There has been a bit of press about Chinese overinvestment and overheating economy but inflation is still low (ie 4-5%). I think the government is more worried about a future bad debt problem than inflation and they are taking the appropriate measures. Although I’m not fan of central planning, the Chinese government seems to be playing the copybook ok.

    As Soros said in an interview recently, if they wanted to reduce inflation, they could do it quite easily by allowing the Yuan to appreciate. They have plenty of bullets left at this stage anyway.

    In terms of an overvalued housing sector, I can’t see too much of a bubble there currently. The price of land in some areas has appreciated a lot, 1000% in some areas in the last 5 years. But this has occurred in other developing nations. It’s a function of industrialisation and urbanisation.

    In terms of a housing bubble or Dubai or US type debt problem, there isn’t the capacity there (yet). Only 25% of homebuyers actually have loans. Housing expenditure is less than 10% of total consumption. Aggregate mortgage servicing cost was less than 2% of national disposable income in 2008.

    I’ve put my discretionary investing portfolio back to 40% invested and I think I’ll buy some more if things correct further. In the medium term (next 7 years) I still think the world will be short resources, particularly oil.

    Dean, what are your thoughts on resource stocks ? And don’t say Buffet wouldn’t buy them because he has (eg. Conoco Phillips at the peak) and I notice that you’ve invested in tech stocks which Buffet wouldn’t so why not resources ?

  • Hi Sean, I’m not a Buffett clone and generally don’t refer to other people as to why something should be done or not, except as general examples to learn by. I’m not even a value investor per se. I generally don’t invest in commodity companies as I used to consult to them and saw first hand their appalling capital allocation and decision making. If I wanted exposure to commodities I’d look to invest directly in the commodities. Why take company risk, unless it is for leverage which neither RIO or BHP offer. My other reason is that I have no edge in commodities any more. When I consulted to them I had an edge, but now on the outside I would be the last person to know anything. If I have no edge I don’t invest.

    While I admire Soros he is prone to flimsy reasoning (like most of us) and I would not make any decisions on what he was saying publicly.

    When investing in trends I like investing early in the trend. I totally missed the commodity boom and though it could go on for many more years for someone like me without and edge in the area, there is too much risk. Is buying RIO or BHP a no brainer? Are they the best pitch I’m going to get this year? I don’t think so, though freely admit that really I don’t know.

    Sean, I’m not sure how long you’ve been investing, but you seem to swinging at a lot of pitches in a lot of different sectors and even countries. Unless you’re backed by an analytical team I have no idea how you can have an edge in all those. You bought four stocks in one day the other day. Why? Or should I say why not spread those purchases out? Could all fours been such great pitches? I’m really simply trying to be helpful here and hope you don’t take any of this as an attack. You may have an edge in all those stocks, sectors and countries.

    As I said I am not a value investor. I’m a growth investor who has folded value in and continues to learn and try to improve. I miss a lot of opportunities, but don’t care as there are always plenty of other opportunities coming along.

    If you are 35-36 and have a high paying job, then you might consider swinging for the fences with some of your investments. BHP and RIO are likes bunts in the hope of getting to first base. In your mid thirties, earning capacity is usually a lot more important than investing returns, but if you get a few multi bagger picks right then suddenly your investing returns are more important.

    Of course all this is just my opinion and even if I’m right there is little doubt that you’ll need to learn it all for yourself anyway, that’s why we keep making the same mistakes others have made before us.

    Sean, thanks for you comments, I hope you keep them coming and that one day I’ll be able to add something of value. A quick look at Woodside makes me think it is worth looking at if you’re into energy.

  • Hi Dean, your comments are appreciated ! Thank you for your thoughts. I do tend to swing a bit too often, particularly with individual stock purchases. I really have no strategy with individual stocks and I need to improve this part of my game. I’ve been investing since 1998, but I have been very episodic in my activity. If I look at my activity over the last decade I tend to be attracted to equity markets after a correction. I was active in 1998-99 after the Asian crissis. Then again in 2005-7 and now.

    I think my only edge is that I can choose to be not fully invested. I tinker with the asset allocation in super but don’t try to time the market with that. Currently with my super I’m 100% australian equities. I think I might shift to a more international exposure at some stage in the next year.

    I have about 500k in super and about 500k in a discretionary account which I attempt to invest with. With my discretionary investing, I reentered the market when it was about 3800 and increased the exposure until I was fully invested by 4600. I mainly have STW. I did get some SLF also but realised the yield is not franked and 50% of it is WDC which I felt increasingly queasy about how long it will take to turn around. So I sold the SLF. Then when the market got to 4900, I also sold out of the STW and RIO as they had run pretty hard. I actually thought it might keep going but it’s pulled back.

    As you guessed I’m in my mid 30’s (34) and as my taxable income has gone up, I’ve found my investments have not been as tax effective as would have been if I had thought about it a bit more. I should hold things for a year for CGT reasons and invest in lower yielding core stocks.

    I haven’t ever thought much about buying individual stocks other than blue chips. The majority of my investment is in index trackers and the individual stocks are a bit of a gamble. I think I’ve been good at market timing and asset allocation but below average at stock selection. I hope at some stage I’ll improve the stock selection part of my game.

    Your idea of investing in potential 10 baggers is interesting. I’ve never been able to do that. Probably because I sell out too early and as I have very little confidence in my individual stock selection. My only outperformance has been in the market timing and asset allocation area. Recently I missed the first 20% of the rally but I also missed the decline prior to that.

    With what I have bought recently I expect to hold for a year. My investing strategy, which is not that well thought out is this currently :
    1. I think the market has put in a low at 3200 or whatever it was.
    2. With my discretionary investment, I’ll be about 40% invested at 4600. I am thinking of increasing this to 80% at 4200. I suppose if it gets to 3800 I’ll be 100% invested.
    3. I intend to exit the sharemarket completely if it gets to be overvalued by more than 20% by what I guesstemate to be fair value.
    4. If it gets to be overvalued by 10% I sell all noncore holdings (currently TLS and WOW) and wait for a retracement. I may have to rethink this last part in view of CGT implications on my current marginal rate of tax. The tax implications make 4. marginal return for the effort of attmpting micro timing which is more likely to be incorrect than assesment 3.

    I haven’t found it possible to not refrain from buying things if I continue to follow the market, so what I do is sell everything discretionary and have a break for at least a year when it reaches major overvalued territory.

    The problem is when you return in a few years, things have changed significantly.

    One thing I should do in the future is to follow the market for 10mins a week when I am out of the market to have some sense of continuity. But then I worry I would buy into it again.

    Another idea I was thinking of trying out is to just reading the business section of the paper for 10mins a week and scan for good stocks that are temporarily being hammered (eg QBE after terrorist thing), which are still fundamentally sound. I’m not sure how effective I would be at that so would try it out on a very small scale.

    I’m not very confident of my stock selection skills at all in fact. At some stage I might become an average or even good stock picker but I’m not at the moment. So my investments in the individual stocks are pretty small compared to the index. In my discretionary account currently it’s 10% core stocks (TLS, WOW), 80% index, 10% other individual (punt/gamble – RIO, BHP, soon to be WPL).

  • Wow Roger Montgomery answered one of my questions! (penned as “squigly”) on WDC.

    I’m not sure about him applying a cap rate of 11-13% though, but interesting nevertheless.

    Someone wrote something to me interesting today :
    “…that’s a contradiction. Value investors are the BIGGEST market timers. sorry buying low and selling high is doing market timing.”

    I suppose there are various permutations possible and I apply value investing to the index to try to get a higher return than the index. Thanks for your site and comments which are both much appreciated !

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