Maximize Stock Returns Through Share Financing

Share Financing

Share financing is a loan facility offered by banks and brokerages to boost your purchasing power of stocks. You can pledge your stocks as collateral and engage in leveraged trading up to approximately 2 times the value of your pledged shares. As a member of the mass market, I do not get to enjoy the lower rates that Banks offer to priority/private clients. However, what I can do is to search for the best deal in the market and plan my moves accordingly so that I can leverage more effectively when the time comes.


Best Deal in the Market  (Pls post a comment if any reader has a better deal)

After some research and comparison, I feel that OCBC's share financing account offers the best deal. By pledging shares, OCBC allows you to leverage up to 2.5 times. Also, it offers one of the lowest rates at 3.5% to 7.5% for different quality of stocks. For other banks such as DBS & CitiBank, they offer a rate of around 4.5 to 6% regardless of the quality of the stocks that you pledge. To enjoy the lowest rate (3.5%) from OCBC, you have to pledge stocks which are components of the Straits Times Index. If your portfolio comprises stocks of differing grades, the blended interest rate will be calculated based on the relevant interest rates which correspond to the various differing grades. However, the interest rates they offer are pegged to the prime rate and thus subject to periodic adjustments. To assess this risk, I extracted the prime lending rates for the past 20 years from the MAS website and tabulated them as shown below:

Period	Prime Lending Rate		Period	Prime Lending Rate
1993	5.34		2003	5.3
1994	6.49		2004	5.3
1995	6.26		2005	5.3
1996	6.26		2006	5.33
1997	6.96		2007	5.33
1998	5.9		2008	5.38
1999	5.8		2009	5.38
2000	5.8		2010	5.38
2001	5.3		2011	5.38
2002	5.35		2012	5.38

As we can see, prime lending rate has not been changing much since year 2001 and has been hovering in the 5.3% to 5.4% range. It should be safe to say that the prime lending rate will not change drastically in the next 5 years even in the event of a recession.

Also, the margin percentage (Total share value/Loan Amount) for OCBC is 140%. This means that a margin call will occur if the margin percentage falls below 140%.

Now, we have these information:

• Lending Rate = 3.5% to 7.5% depending on the quality of stocks pledged
• Lending Rate is 3.5% if pledged stocks are all components of the Straits Time Index
• Rates would most probably not adjust drastically in the next 5 years
• Margin percentage = 140%
• Leverage Power = 2 times of pledge stocks

Strategy

During the next downturn/major correction, I will acquire stable dividend stocks which are components of the Straits Times Index and yield at least 5%. By purchasing STI component stocks which yield at least 5% and pledging them as collateral, I will be able to borrow money from OCBC share financing account at the lowest rate of 3.5% and also, the dividends will be sufficient to cover the interests. This means that any potential capital gain when the market recovers will be 'free'.

The maximum leverage power I have is 2 times the value of my pledged shares. To utilize this facility without over-leveraging and risking the dreaded margin call, I will borrow only 50% of the value of my pledged shares. For example, assume that I bought $100k worth of stocks during a market recession. I will then pledge these shares as collateral and borrow another $50k to buy more. Now, the total share value is $150k and the loan amount is $50k. My margin percentage(Total share value/Loan Amount) is now 300%. Recall that we have to maintain a margin percentage of 140% or more if not a margin call will occur. So assuming prices continue to drop another 50%, the value of my shares will then be $75k while loan amount is still $50k. Margin percentage is now 75/50 = 150% (still above threshold for margin call). In this example, I acquired stocks at depressed prices during downturn and the chances of the prices dropping another 50% should be unlikely. Risk of margin call is low in this case.

In a nutshell, this strategy is to accumulate STI component dividend stocks during market downturn and pledging them as collateral to enjoy a lower rate for buying more stocks on margin. Dividends should be sufficient to cover interests and investors get to earn the capital gains.

Dividend Discount Model (DDM)

The Dividend Discount Model is suitable for:
- Companies that pay dividends consistently (Singpost?)
- Companies that have established a dividend policy (Starhub?)
- Seasoned companies that are profitable non-high growth companies (e.g Utilities)

Here's the formula for DDM:

P = Fair value of stock using DDM

D = Value of dividends

g = growth rate of dividends (can take growth of earnings as proxy)

r = investor's required return

Stockpiling strategy by Phil Town

Requirements:

1) 5 or 10 year average return on Invested Capital (ROIC) > 10%
2) 5 or 10 year average equity growth rate (Book value per share) > 10%
*Check current BV per share by dividing Total Equity by Total Shares Outstanding

3) 5 or 10 year average Sales growth rate > 10% 

4) 5 or 10 year average earnings growth (EPS) > 10%

5) 5 or 10 year average growth rate of cash from operating activities > 10%

6) Total long term debt/Total income < 3
7) Payback time < 10 years
- Find market capitalization of company
- Find ttm earnings
- Grow it forward at 5/10 year average earnings growth rate until the cumulative earnings exceeds market capitalization. 

Find the sticker price:

Sticker price of a business is determined by the kind of surplus cash it can produce for its owners in the future.

1) Earnings per Share (EPS) for the last twelve months(ttm)

2) EPS growth rate for the next ten years

- Use the 5 or 10 year average earnings growth rate
- Retrieve from analyst reports

3) Price to earnings (PE) ratio in ten years
- Find 10 year average PE ratio

- Double the estimated future earnings growth rate (Use analysts' average estimate of future growth of earnings or use 5 to 10 year average earnings growth rate)

- Use the lower figure of the two methods above

4) Minimum Acceptable Rate of Return (MARR) = 15%
5) Run the numbers through calculator on paybacktime.com

Find the Margin of Safety Price

50% of sticker price calculated above

Capital Allocation

Capital	Number of businesses	% of capital allocated to each initial buy
$1,000 - $20,000	1	25%
$20,000 - $40,000	2	25%
$40,000 - $70,000	3	25%
$70,000 - $100,000	4	25%
$100,000 - $100,000,000	5	25%

Note: Time purchases with the help of technical analysis using Floor and Ceilings.
*A price move of over 3 percent above the Ceiling or below the Floor, accompanied by 150% of the average volume, is a significant sign of a breakout that will last

10 Stock Selection Criteria by Benjamin Graham

1. An earnings-to-price yield at least twice the AAA bond rate

2. P/E ratio less than 40% of the highest P/E ratio the stock had over the past 5 years

3. Dividend yield of at least 2/3 the AAA bond yield

4. Stock price below 2/3 of tangible book value per share

5. Stock price below 2/3 of Net Current Asset Value (NCAV)

6. Total debt less than book value

7. Current ratio great than 2

8. Total debt less than 2 times Net Current Asset Value (NCAV)

9. Earnings growth of prior 10 years at least at a 7% annual compound rate

10. Stability of growth of earnings in that no more than 2 declines of 5% or more in year end earnings in the prior 10 years are permissible.

Strategy for the current bear market

Target Price
Keppel corp : $5
STI ETF : $2.30 (buy for every 15% drop)
Ezion Holdings : $0.35

A drop of 20% is the usual threshold for declaring a new bear market. My strategy for a bear market is to enter when stocks barely crossed the 20% threshold and buying one lot of STI ETF for every 15% drop. For example, STI ETF's one year high was $3.39. When i bought 2 lots of it at $2.72, it has already plunged 19.7% which was the borderline of a bear market. At this point, 2 things might happen. The first will see prices rebounding, indicating that the plunge was just a correction. If not, the bear market will start and prices will continue falling. Buying at this point and averaging it out for every 10 to 15% it drops will remove all guesswork and capture the whole bear market. If it is indeed a correction, I would have captured the bottom(or near bottom) of it. This will be the best of both worlds. Therefore, the next buying point for STI ETF will be $2.30, which is a 15% drop from $2.72.