Posts tagged ‘Warren Buffett’

Inside the Brain of an Investing Genius

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Those readers who have frequented my Investing Caffeine site are familiar with the numerous profiles on professional investors of both current and prior periods (See Profiles). Many of the individuals described have a tremendous track record of success, while others have a tremendous ability of making outrageous forecasts. I have covered both. Regardless, much can be learned from the successes and failures by mirroring the behavior of the greats – like modeling your golf swing after Tiger Woods (O.K., since Tiger is out of favor right now, let’s say Jordan Spieth). My investment swing borrows techniques and tips from many great investors, but Peter Lynch (ex-Fidelity fund manager), probably more than any icon, has had the most influence on my investing philosophy and career as any investor. His breadth of knowledge and versatility across styles has allowed him to compile a record that few, if any, could match – outside perhaps the great Warren Buffett.

Consider that Lynch’s Magellan fund averaged +29% per year from 1977 – 1990 (almost doubling the return of the S&P 500 index for that period). In 1977, the obscure Magellan Fund started with about $20 million, and by his retirement the fund grew to approximately $14 billion (700x’s larger). Cynics believed that Magellan was too big to adequately perform at $1, $2, $3, $5 and then $10 billion, but Lynch ultimately silenced the critics. Despite the fund’s gargantuan size, over the final five years of Lynch’s tenure, Magellan  outperformed 99.5% of all other funds, according to Barron’s. How did Magellan investors fare in the period under Lynch’s watch? A $10,000 investment initiated when he took the helm would have grown to roughly $280,000 (+2,700%) by the day he retired. Not too shabby.


Lynch graduated from Boston College in 1965 and earned a Master of Business Administration from the Wharton School of the University of Pennsylvania in 1968.  Like the previously mentioned Warren Buffett, Peter Lynch shared his knowledge with the investing masses through his writings, including his two seminal books One Up on Wall Street and Beating the Street. Subsequently, Lynch authored Learn to Earn, a book targeted at younger, novice investors. Regardless, the ideas and lessons from his writings, including contributing author to Worth magazine, are still transferable to investors across a broad spectrum of skill levels, even today.

The Lessons of Lynch

Although Lynch has left me with enough financially rich content to write a full-blown textbook, I will limit the meat of this article to lessons and quotations coming directly from the horse’s mouth. Here is a selective list of gems Lynch has shared with investors over the years:

Buy within Your Comfort Zone: Lynch simply urges investors to “Buy what you know.” In similar fashion to Warren Buffett, who stuck to investing in stocks within his “circle of competence,” Lynch focused on investments he understood or on industries he felt he had an edge over others. Perhaps if investors would have heeded this advice, the leveraged, toxic derivative debacle occurring over previous years could have been avoided.

Do Your Homework: Building the conviction to ride through equity market volatility requires rigorous homework. Lynch adds, “A company does not tell you to buy it, there is always something to worry about.  There are always respected investors that say you are wrong. You have to know the story better than they do, and have faith in what you know.”

Price Follows Earnings: Investing is often unnecessarily made complicated. Lynch fundamentally believes stock prices will follow the long-term trajectory of earnings growth. He makes the point that “People may bet on hourly wiggles of the market, but it’s the earnings that waggle the wiggle long term.” In a publicly attended group meeting, Michael Dell, CEO of Dell Inc. (DELL), asked Peter Lynch about the direction of Dell’s future stock price. Lynch’s answer: “If your earnings are higher in 5 years, your stock will be higher.” Maybe Dell’s price decline over the last five years can be attributed to its earnings decline over the same period? It’s no surprise that Hewlett-Packard’s dramatic stock price outperformance (relative to DELL) has something to do with the more than doubling of HP’s earnings over the same time frame.

Valuation & Price Declines: “People Concentrate too much on the P (Price), but the E (Earnings) really makes the difference.” In a nutshell, Lynch believes valuation metrics play an important role, but long-term earnings growth will have a larger impact on future stock price appreciation.

Two Key Stock Questions: 1) “Is the stock still attractively priced relative to earnings?” and 2) “What is happening in the company to make the earnings go up?” Improving fundamentals at an attractive price are key components to Lynch’s investing strategy.

Lynch on Buffett: Lynch was given an opportunity to write the foreword in Buffett’s biography, The Warren Buffett Way. Lynch did not believe in “pulling out flowers and watering the weeds,” or in other words, selling winners and buying losers. In highlighting this weed-flower concept, Lynch said this about Buffett: “He purchased over $1 billion of Coca-Cola in 1988 and 1989 after the stock had risen over fivefold the prior six years and over five-hundredfold the previous sixty years. He made four times his money in three years and plans to make a lot more the next five, ten, and twenty years with Coke.” Hammering home the idea that a few good stocks a decade can make an investment career, Lynch had this to say about Buffett: “Warren states that twelve investments decisions in his forty year career have made all the difference.”

You Don’t Need Perfect Batting Average: In order to significantly outperform the market, investors need not generate near perfect results. According to Lynch, “If you’re terrific in this business, you’re right six times out of 10 – I’ve had stocks go from $11 to 7 cents (American Intl Airways).” Here is one recipe Lynch shares with others on how to beat the market: “All you have to do really is find the best hundred stocks in the S&P 500 and find another few hundred outside the S&P 500 to beat the market.”

The Critical Element of Patience: With the explosion of information, expansion of the internet age, and the reduction of trading costs has come the itchy trading finger. This hasty investment principle runs contrary to Lynch’s core beliefs. Here’s what he had to say regarding the importance of a steady investment hand:

  • “In my investing career, the best gains usually have come in the third or fourth year, not in the third or fourth week or the third or fourth month.”
  • “Whatever method you use to pick stocks or stock mutual funds, your ultimate success or failure will depend on your ability to ignore the worries of the world long enough to allow your investments to succeed.”
  • “Often, there is no correlation between the success of a company’s operations and the success of its stock over a few months or even a few years. In the long term, there is a 100% correlation between the success of a company and the success of its stock. It pays to be patient, and to own successful companies.”
  • “The key to making money in stocks is not to get scared out of them.”

Bear Market Beliefs: “I’m always more depressed by an overpriced market in which many stocks are hitting new highs every day than by a beaten-down market in a recession,” says Lynch. The media responds in exactly the opposite manner – bear markets lead to an inundation of headlines driven by panic-based fear. Lynch shares a similar sentiment to Warren Buffett when it comes to the media holding a glass half full view in bear markets.

Market Worries:  Is worrying about market concerns worth the stress? Not according to Lynch. His belief: “I’ve always said if you spend 13 minutes a year on economics, you’ve wasted 10 minutes.” Just this last March, Lynch used history to drive home his views: “We’ve had 11 recessions since World War II and we’ve had a perfect score — 11 recoveries. There are a lot of natural cushions in the economy now that weren’t there in the 1930s. They keep things from getting out of control.  We have the Federal Deposit Insurance Corporation [which insures bank deposits]. We have social security. We have pensions. We have two-person, working families. We have unemployment payments. And we have a Federal Reserve with a brain.”

Thoughts on Cyclicals: Lynch divided his portfolio into several buckets, and cyclical stocks occupied one of the buckets. “Cyclicals are like blackjack: stay in the game too long and it’s bound to take all your profit,” Lynch emphasized.

Selling Discipline: The rationale behind Lynch’s selling discipline is straightforward – here are some of his thoughts on the subject:

  • “When the fundamentals change, sell your mistakes.”
  • “Write down why you own a stock and sell it if the reason isn’t true anymore.”
  • “Sell a stock because the company’s fundamentals deteriorate, not because the sky is falling.”

Distilling the genius of an investing legend like Peter Lynch down to a single article is not only a grueling challenge, but it also cannot bring complete justice to the vast accomplishments of this incredible investment legend. Nonetheless, his record should be meticulously studied in hopes of adding jewels of investment knowledge to the repertoires of all investors. If delving into the head of this investing mastermind can provide access to even a fraction of his vast knowledge pool, then we can all benefit by adding a slice of this greatness to our investment portfolios.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, including KO, but at time of publishing had no direct positions in DELL, HPQ or any other security mentioned. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

August 15, 2015 at 10:00 am 5 comments

Airbag Protection from Pundit Backseat Drivers

Backseat Driver

Giving advice to a driver from the backseat of a car is quite easy and enjoyable for some, but whether that individual is actually qualified to give advice is another subject. In the financial blogosphere and media there is an unending mass of backseat drivers recklessly directing investors off cliffs and into walls, but unfortunately there are no consequences for these blabbers. It’s the investors who are driving their personal portfolios that ultimately suffer from crashed financial dreams.

Unlike drivers who mandatorily require a license to drive to the local grocery store, bloggers, journalists, economists, analysts, strategists (aka “pundits”), and any other charismatic or articulate individual can emphatically counsel investors without any credentials, education, or licenses. More importantly than a piece of paper or letters on a business card, many of these self-proclaimed experts have little or no experience of investing real money…the exact topic the pundits are using to direct peoples’ precious and indispensable lifesavings.

It’s easy for bearish pundits like Peter Schiff, Nouriel Roubini, John Mauldin, and David Rosenberg (see also The Fed Ate My Homework) to throw economic hand grenades with their outlandishly gloomy predictions and fear mongering. However, more important than selling valuable advice, the pundit’s #1 priority is selling a convincing story, whether the story is grounded in reality or not. The pundit’s story is usually constructed by looking into the rearview mirror by creatively connecting current event dots in a way that may seem reasonable on the surface.

Crusty investors who have invested through various investment cycles know better than to pay attention to these opinions. As the saying goes, “Opinions are like ***holes. Everybody has one.” Stated differently, the great growth investor William O’Neil said the following:

“I would say 95% of all these people you hear on TV shows are giving you their personal opinion. And personal opinions are almost always worthless … facts and markets are far more reliable.”


Successful long-time investors like Warren Buffett rarely make predictions about the short-term directions of the market. Long-term investors know the only certainty in the market is uncertainty. At the core, investing is a game of probabilities. The objective of the game is to place your bets on those investments that establish the odds in your favor. As in many professions, however, the right process can have a negative outcome in the short-run. Those talented investors who have experience consistently applying a probabilistic approach generally do quite well in the long-run.

There is an endless multitude of investing advice, regardless of whether you choose to consume it over the TV, in newspapers, or through blogs. That’s why it’s so important to be discerning in your financial media consumption by focusing on experience…experience is the key. If you were to undergo a heart surgery, would you want a nurse or experienced doctor who had performed 2,000 successful heart surgeries? When you fly cross-country, do you want a flight attendant to fly the plane or a 20-year veteran pilot? I think you get the point.

The other factor to consider when comparing advice from a media pundit vs. experienced investor is skin in the game. Investment advisers who have their personal dollars at stake typically have spent a significantly larger amount of time formulating an investment thesis or strategy as compared to a loose-cannon TV journalist or inexperienced, maverick blogger.

There is a lot to consider as you maneuver your investment portfolio through volatile markets. With all the dangerous advice out there from backseat drivers, make sure you have experienced investment advice installed as protective airbags because listening to inexperienced air bags (pundits) could crash your portfolio into a wall.


Related Content: Financial Blogging Interview on Charlie Rose w/ Joe Weisenthal, Josh Brown, Felix Salmon, and Megan Murphy

Investment Questions Border

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own a range of positions in certain exchange traded fund positions, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

November 22, 2014 at 11:12 am Leave a comment

Investing with Crayons

Child's Drawing of Family

At one level, investing can be extremely challenging if you consider the plethora of diverse and unpredictable factors such as monetary policy, fiscal policy, wars, banking crises, natural disasters, currency crises, geopolitical turmoil, Ebola, Scottish referendums, etc. On the other hand, investing (not trading or speculating) should be quite simple…like drawing stick figures with a crayon. However, simplicity does not mean laziness. Successful stock research requires rigorous due diligence without cutting corners. Once the heavy research lifting is completed, concise communication is always preferred.

In order to be succinct, investors need to understand the key drivers of stock performance. In the short run, investors may not be able to draw the directional path of stock prices, but over the long run, Peter Lynch described stock predictions best (see Inside the Investing Genius) when he stated:

“People may bet on hourly wiggles of the market but it’s the earnings that waggle the wiggle long term.”


In other words, if revenues, earnings, and most importantly cash flows go up over the long-term, then it is highly likely that stock prices will follow. Besides profits, interest rates and sentiment are other key contributing factors affecting the trajectory of future stock prices.

In high school and college, students often cram as much information into a paper with the goal of layering pages as high as possible. Typically, the heaviest papers got A’s and the lightest papers got C’s or D’s. However, as it relates to stock analysis, the opposite holds true – brevity reigns supreme.

American psychologist and philosopher William James noted, “The art of being wise is the art of knowing what to overlook.”

In our digital world of informational overload, knowing what to overlook is quite a challenge. I experienced this dynamic firsthand early on in my professional career when I was an investment analyst. When asked to research a new stock by my portfolio manager, often my inclination was to throw in the data kitchen sink into my report. Rather than boil down the report to three or four critical stock-driving factors, I defaulted to a plan of including every possible risk factor, competitor, and valuation metric. This strategy was designed primarily as a defense mechanism to hedge against a wide range of possible outcomes, whether those outcomes were probable or very unlikely. Often, stuffing irrelevant information into reports resulted in ineffectual, non-committal opinions, which could provide cosmetic wiggle room for me to rationalize any future upward or downward movement in the stock price.

Lynch understood as well as anyone that stock investing does not have to be complex rocket science:

“Everyone has the brainpower to follow the stock market. If you made it through fifth-grade math, you can do it.”


In fact, when Lynch worked with investment analysts, he ran a three-minute timer and forced the analysts to pitch stock ideas in basic terms before the timer expired.

If you went back further in time, legendary Value guru Benjamin Graham also understood brain surgery is not required to conduct successful equity analysis:

“People don’t need extraordinary insight or intelligence. What they need most is the character to adopt simple rules and stick to them.”


Similarly, Warren Buffett hammers home the idea that a gargantuan report or extravagant explanation isn’t required in equity research:

“You should be able to explain why you bought a stock in a paragraph.”


Hedge fund veteran manager Michael Steinhardt held the belief that a stock recommendation should be elegant in its simplicity as well. In his book No Bull – My Life In and Out of Markets he states that an analyst “should be able to tell me in two minutes, four things: 1) the idea; 2) the consensus view; 3) his variant perception; and 4) a trigger event.

All these previously mentioned exceptional investors highlight the basic truth of equity investing. A long, type-written report inundated with confusing charts and irrelevant data is counterproductive to the investment and portfolio management process. Outlining a stock investment thesis is much more powerful when succinctly written with a crayon.

Investment Questions Border

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own a range of positions in certain exchange traded fund positions, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

September 20, 2014 at 3:15 pm 2 comments

Got Growth?


Investing in the stock market can be quite stressful, especially during periods of volatility…but investing doesn’t have to be nerve-racking. Investing legend T. Rowe price captured the beneficial sentiments of growth investing beautifully when he stated the following:

“The growth stock theory of investing requires patience, but is less stressful than trading, generally has less risk, and reduces brokerage commissions and income taxes.”


What I’ve learned over my investing career is that fretting over such things as downgrades, management changes, macroeconomic data, earnings misses, geopolitical headlines, and other irrelevant transitory factors leads to more heartache than gains. If you listen to a dozen so-called pundits, talking heads, journalists, or bloggers, what you quickly realize is that all you are often left with are a dozen different opinions. Opinions don’t matter…the facts do.

Finding Multi-Baggers: The Power of Compounding

Rather than succumbing to knee-jerk reactions from the worries of the day, great long-term investors realize the benefits of compounding. We know T. Rowe Price appreciated this principle because he agreed with Nobel Prize winning physicist Albert Einstein’s view that “compounding interest” should be considered the “8th wonder of the world” – see also how Christopher Columbus can turn a penny into $121 billion (Compounding: A Penny Saved is Billions Earned).

People generally refer to Warren Buffett as a “Value” investor, but in fact, despite the Ben Graham moniker, Buffett has owned some of the greatest growth stocks of all-time. For example, Coca Cola Co (KO) achieved roughly a 20x return from 1988 – 1998, as shown below:

Source: Yahoo! Finance

Source: Yahoo! Finance

If you look at other charts of Buffett’s long-term holdings, such as Wells Fargo & Company (WFC), American Express Co (AXP), and Procter & Gamble – Gillette (PG), the incredible compounded gains are just as astounding.

In recent decades, there is no question that stocks have benefited from P/E expansion. P/E ratios, or the average price paid for stocks, has increased from the early 1980s as long-term interest rates have declined from the high-teens to the low single-digits, but the real lifeblood for any stock is earnings growth (see also It’s the Earnings, Stupid). As growth investor extraordinaire Peter Lynch once said:

“People may bet on hourly wiggles of the market but it’s the earnings that waggle the wiggle long term.”


As Lynch also pointed out, it only takes the identification of a few great multi-bagger stocks every decade to compile a tremendous track record, while simultaneously hiding many sins:

“Fortunately the long-range profits earned from really good common stocks should more than balance the losses from a normal percentage of such mistakes.”


The Scarcity of Growth

Ever since the technology bubble burst in 2000, Growth stocks have felt the pain. Since that period, the Russell 1000 Value index – R1KV (Ticker: IWD) has almost doubled in value and outperformed the Russell 1000 Growth index – R1KG (Ticker: IWF) by more than +60% (see chart below):

Source: Yahoo! Finance

Source: Yahoo! Finance

Although the R1KG index has yet to breach its previous year 2000 highs, ever since the onset of the Great Financial Crisis (end of 2007), the R1KG index has been on the comeback trail. Now, the Russell 1000 Growth index has outperformed its Value sister index by an impressive +25% (see chart below):

Source: Yahoo! Finance

Source: Yahoo! Finance

Why such a disparity? Well, in a PIMCO “New Normal & New Neutral” world where global growth forecasts are being cut by the IMF  and a paltry advance of 1.7% in U.S. GDP is expected, investors are on a feverish hunt for growth. U.S. investors are myopically focused on our 2.34% 10-Year Treasury yield, but if you look around the rest of the globe, many yields are at multi-hundred year lows. Consider 10-year yields in Germany sit at 0.96%; Japan at 0.50%; Ireland at 1.98%; and Hong Kong at 1.94% as a few examples. This scarcity of growth has led to outperformance in Growth stocks and this trend should continue until we see a clear sustainable acceleration in global growth.

If we dig a little deeper, you can see the 25% premium in the R1KG P/E ratio of 20.8x vs. 16.7x for the R1KV is well deserved. Historical 5-year earnings growth for the R1KG has been +52% higher than R1KV (17.8% vs. 11.7%, respectively). Going forward, the superior earnings performance is expected to continue. Long-term growth for the R1KG index is expected to be around 55% higher than the R1KV index (14% vs 9%).

In this 24/7, Facebook, Twitter society we live in, investing has never been more challenging with the avalanche of daily news. The ultra-low interest rates and lethargic global recovery hasn’t made my life at Sidoxia any easier. But one thing that is clear is that the investment tide is not lifting all Growth and Value stocks at the same pace. The benefits of long-term Growth investing are clear, and in an environment plagued by a scarcity of growth, it is becoming more important than ever when reviewing your investment portfolios to ask yourself, “Got Growth?”

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold long positions in KO/PG (non-discretionary accounts) and certain exchange traded fund positions, but at the time of publishing SCM had no direct position in TWTR, FB, WFC, AXP, IWF, IWD or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

August 16, 2014 at 6:18 pm 1 comment

The Buyback Bonanza Boost

Trampoline 2

With the S&P 500 off -1% from its all-time record high, many bears have continued to wait for and talk about a looming crash. For the naysayers, the main focus has been on the distorted monetary policies instituted by the Federal Reserve, but as I pointed out in Fed Fatigue is Setting In, QE and tapering talk are not the end-all, be-all of global financial markets. One need not look further than the dozen or so countries listed in the FT that have bond yields below the abnormally low yields we are experiencing in the U.S. (10-Year Treasury +2.75%).

Although there are many who believe a freefall is coming, much like a trampoline, a naturally occurring financial mechanism has provided a relentless bid to boost stock prices higher…a buyback bonanza! How significant have corporate stock repurchases been to spring prices higher? Jason Zweig, in his Intelligent Investor column, wrote the following:

In the Russell 3000, a broad U.S. stock index, repurchased $567.6 billion worth of their own shares—a 21% increase over 2012, calculates Rob Leiphart, an analyst at Birinyi Associates, a research firm in Westport, Conn. That brings total buybacks since the beginning of 2005 to $4.21 trillion—or nearly one-fifth of the total value of all U.S. stocks today.


To further put this gargantuan buyback bonanza into perspective, a recent Fox Business article described it this way:

Companies spent an estimated $477 billion on share buybacks last year. That’s enough to buy every NFL team 12 times over, run the federal government for 50 days or host the next nine Olympic Games with several billion left to spare. This year, companies are expected to ramp up buybacks by 35%, according to Goldman Sachs.


The bears continue to scream, while purple in the face, that the Fed’s QE and zero interest rate program (ZIRP) shenanigans are artificially propping up stock prices. The narrative then states the tapering and inevitable Fed Funds rate reversal will cause the market to come crashing down. While there is some truth behind this commentary, history reminds us that not all rate rising cycles end in bloodshed (see 1994 Bond Repeat or Stock Defeat?). Even if you believe in Armageddon, this rate reversal scenario is unlikely to happen until mid-2015 or beyond.

And for those worshipping the actions of Ms. Yellen at the Fed altar, believe it or not, there are other factors besides monetary policy that cause stock prices to go up or down. In addition to stock buybacks, there are dynamics such as record corporate profits, rising dividends, expanding earnings, reasonable valuations, improving international economies, and other factors that have contributed to this robust bull market.

At the end of the day, as I have continued to argue for some time, money goes where it is treated best – and generally that is not in savings accounts earning 0.003%. There is no reason to be a perma-bull, and I have freely acknowledged the expansion of froth in areas such as social media, biotech, Bitcoin and other areas. Regardless, there is, and will always be areas of speculation, in bull and bear markets (e.g., gold in the 2008-2009 period).

Magical Math

Investing involves a mixture of art and science, but with a few exceptions (i.e., fraud), numbers do not lie, and using math when investing is a good place to start. A simple but powerful mathematical formula instituted at Sidoxia Capital Management is the “Free Cash Flow Yield”, which is a metric we integrate into our proprietary SHGR (a.k.a.,“Sugar”) quantitative model (see Investing Holy Grail).

Free Cash Flow Graphic

Quite simply, Free Cash Flow (FCF) is computed by taking the excess cash generated by a company after ALL expenses/expenditures (marketing, payroll, R&D, CAPEX, etc.) over a trailing twelve month period (TTM), then dividing that figure by the total equity value of a company (Market Capitalization). Mechanically, FCF is calculated by taking “Cash Flow from Operations” and subtracting “Capital Expenditures” – both figures can be found on the Cash Flow Statement.  The Free Cash Flow ratio may sound complicated, but straightforwardly this is the leftover cash generated by a business that can be used for share buybacks, dividends, acquisitions, investments, debt pay-down, and/or placed in a banking account to pile up.

The great thing about FCF yields is that this ratio (%) can be compared across asset classes. For example, I can compare the FCF yield of Apple Inc – AAPL (+9.5%) versus a 10-Year Treasury (+2.75%), 1-year CD (+0.85%), Tesla Motors – TSLA (0.0%), Netflix, Inc – NFLX (-0.001%), or Twitter, Inc – TWTR (-0.003%). For growth and capital intensive companies, I can make adjustments to this calculation. However, what you quickly realize is that even if you assume massive growth in the coming years (i.e., $100s of millions in FCF), the prices for many of these momentum stocks are still astronomical.

An important insight about the current corporate buyback bonanza is that much of this price boost is being fueled by the colossal free cash flow generation of corporate America. Sure, some companies are borrowing through the debt markets to buy back stock, but if you were the Apple CFO sitting on $159,000,000,000 in cash earning 1%, it doesn’t make a lot of sense to sit on the cash earning nothing. It also doesn’t take a genius (or Carl Icahn) to figure out borrowing at record low rates (2.75% 10-year) while earning +10% on a stock buyback will increase shareholder value and earnings per share (EPS). More specifically, when Apple borrowed $17 billion  at interest rates ranging from 0.5% – 3.9%, a shrewd, rational human being would borrow to the max all day long at those rates, if you could earn +10% on that investment. It is true that Apple’s profitability could drop and the numerator in our FCF ratio could decrease, but with $45 billion smackers coming in every year on top of $142 billion in net cash on the balance sheet, Apple has a healthy margin of safety to make the math work.

Where the math doesn’t compute is in insanely priced deals. For example, the recent merger in which Facebook Inc (FB) paid $19 billion (1,000 x’s the estimated 2013 annual revenues) for a 50-person, money-losing company (WhatsApp) that is offering a free service, makes zero financial sense to me. Suffice it to say, the FCF yield on WhatsApp could cause Warren Buffett to have a coronary event. Yes, diamond covered countertops would be nice to have in my kitchen, but I probably wouldn’t get much of a return on that investment.

Share buybacks are not a magical elixir to endless prosperity (see Share Buybacks & Bathroom Violators), but given the record profits and record low interest rates, basic math shows that even if stock prices correct (as should be expected), the trampolining effect of this buyback bonanza will provide support to the market.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold long positions in certain exchange traded funds (ETFs), AAPL and a short position in NFLX, but at the time of publishing SCM had no direct position in TSLA, TWTR, FB, Bitcoin, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

March 22, 2014 at 1:17 pm 1 comment

Stock Market: Shrewd Bet or Stupid Gamble?

Playing Cards and Poker Chips

Trillions of dollars have been lost and gained over the last five years. The extreme volatility strangled investment portfolios, and as a result millions of investors capitulated by throwing in the towel and locking in losses. Melted 401ks, shrunken IRAs, and beat-up retirement accounts bruised the overarching psyche of Americans to the point they questioned whether the stock market is a shrewd bet or stupid gamble?

The warmth and safety of bonds provided some temporary relief in subsequent years, but the explosive rebound in stock prices to new record highs in 2013 coupled with the worst year in a decade for bonds still have many on the sidelines asking whether they should get back in?

As I’ve written many times in the past (see Timing Treadmill), timing the market is a fruitless effort. Elementary statistics, including the “Law of Large Numbers” will demonstrate that blind squirrels can and will beat the market on occasion, but very few can consistently beat the stock market indices for sustained periods (see Dart-Throwing Chimps).

However, there have been some gun-slinging hedge fund managers who have accumulated some impressive track records. Because of insanely high management fees, many overpaid hedge fund managers will swing for the fences by using a combination of excessive leverage and/or concentration. If the hedge funds connect with lucky returns, the managers can take the money and run. If they swing and miss…no problem. Close shop, hang out a shingle across the street, change the hedge fund’s name, and try again. Of course there are those successful hedge fund managers who have learned how to manipulate the system and exploit information to their advantage, but many of those managers like Raj Rajaratnam and Steven Cohen are either behind bars or dealing with the Feds (see fantastic Frontline piece on Cohen).           

But not everyone cheats. There actually are a minority of managers who consistently beat the market by taking a long-term approach like Warren Buffett. Long-term outperforming managers are like lifetime .300 hitters in Major League Baseball – the outperformers exist, but they are rare. In 2007, did a study that showed there were only 12 active career .300 hitters in Major League Baseball.

Another legend in the investment industry is John Bogle, the founder of the Vanguard Group, a firm primarily focused on passive, index-based investment strategies. Although it is counter-intuitive to most, just matching the market (or index) will put you in the top-quartile over the long-run (see Darts, Monkeys & Pros). There’s a reason Vanguard manages more than $2,000,000,000,000+ (yes…trillion) of investors’ money. Even at this gargantuan size, Vanguard remains a fraction of the overall industry. Regardless, the gospel of low-cost, tax-efficient, long-term horizons is slowly leaking out to the masses (Disclosure: Sidoxia is a devoted user of Vanguard and other providers’ low-cost Exchange Traded Funds [ETFs]).

Rolling the Dice?

Unlike Las Vegas, where the odds are stacked against you, in the stock market the odds are stacked in your favor if you stay in the game long enough and don’t chase performance. Dr. Ed Yardeni has a great chart (below) summarizing stock market returns over the last 85 years, and what the data highlights is that the market is up (or flat) 69% of the time (59/86 years). The probabilities are so favorable that if I got comparable odds in Vegas, I’d probably live there!

Source: Dr. Ed's Blog

Source: Dr. Ed’s Blog

Unfortunately, rather than using this time arbitrage in conjunction with the incredible power of compounding (see A Penny Saved is Billions Earned), many individuals look at the stock market like a casino – similarly to betting on black or red at a roulette wheel. Speculating about the direction of the market can be fun, and I’ve been known to guess on occasion, but it’s a complete waste of time. Creating a long-term plan of reaching or maintaining your retirement goals through a diversified portfolio is the way to go – not bobbing in out of the market with cash and bonds.

At Sidoxia, we don’t actively trade and time individual stocks either. For the majority of our client portfolios, we follow a growth philosophy similar to the late T. Rowe Price:

“The growth stock theory of investing requires patience, but is less stressful than trading, generally has less risk, and reduces brokerage commissions and income taxes.”

Nobody knows the direction of the stocks with certainty, and irrespective of whether the market goes down this year or not, history has proven the stock market has been a shrewd, long-term bet.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct position in  any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

February 8, 2014 at 1:10 pm 2 comments

Bernanke: Santa Claus or Grinch?

Santa - Grinch

I’ve written plenty about my thoughts on the Fed (see Fed Fatigue) and all the blathering from the media talking heads. Debates about the timing and probability of a Fed “taper” decision came to a crescendo in the recent week. As is often the case, the exact opposite of what the pundits expected actually happened. It was not a huge surprise the Federal Reserve initiated a $10 billion tapering of its $85 billion monthly bond buying program, but going into this week’s announcement, the betting money was putting their dollars on the status quo.

With the holiday season upon us, investors must determine whether the tapered QE1/QE2/QE3 gifts delivered by Bernanke are a cause for concern. So the key question is, will this Santa Claus rally prance into 2014, or will the Grinch use the taper as an excuse to steal this multi-year bull market gift away?

Regardless of your viewpoint, what we did learn from this week’s Fed announcement is that this initial move by the Fed will be a baby step, reducing mortgage-backed and Treasury security purchases by a measly $5 billion each. I say that tongue in cheek because the total global bond market has been estimated at about $80,000,000,000,000 (that’s $80 trillion).

As I’ve pointed out in the past, the Fed gets way too much credit (blame) for their impact on interest rates (see Interest Rates: Perception vs Reality). Interest rates even before this announcement were as high/higher than when QE1 was instituted. What’s more, if the Fed has such artificial influence over interest rates, then why do Austria, Belgium, Canada, Denmark, Finland, France, Germany, Japan, Netherlands, Sweden, and Switzerland all have lower 10-year yields than the U.S.? Maybe their central banks are just more powerful than our Fed? Unlikely.

Dow 128,000 in 2053

Readers of Investing Caffeine know I have followed the lead of investing greats like Warren Buffett and Peter Lynch, who believe trying to time the markets is a waste of your time. In a recent Lynch interview, earlier this month, Charlie Rose asked for Lynch’s opinion regarding the stock market, given the current record high levels. Here’s what he had to say:

“I think the market is fairly priced on what is happening right now. You have to say to yourself, is five years from now, 10 years from now, corporate profits are growing about 7 or 8% a year. That means they double, including dividends, about every 10 years, quadruple every 20, go up 8-fold every 40. That’s the kind of numbers you are interested in. The 10-year bond today is a little over 2%. So I think the stock market is the best place to be for the next 10, 20, 30 years. The next two years? No idea. I’ve never known what the next two years are going to bring.”


Guessing is Fun but Fruitless

I freely admit it. I’m a stock-a-holic and member of S.A. (Stock-a-holic’s Anonymous). I enjoy debating the future direction of the economy and financial markets, not only because it is fun, but also because without these topics my blog would likely go extinct. The reality of the situation is that my hobby of thinking and writing about the financial markets has no direct impact on my investment decisions for me or my clients.

There is no question that stocks go down during recessions, and an average investor will likely live through at least another half-dozen recessions in their lifetime. Unfortunately, speculators have learned firsthand about the dangers of trading based on economic and/or political headlines during volatile cycles. That doesn’t mean everyone should buy and do nothing. If done properly, it can be quite advantageous to periodically rebalance your portfolio through the use of various valuation and macro metrics as a means to objectively protect/enhance your portfolio’s performance. For example, cutting exposure to cyclical and debt-laden companies going into an economic downturn is probably wise. Reducing long-term Treasury positions during a period of near-record low interest rates (see Confessions of a Bond Hater) as the economy strengthens is also likely a shrewd move.

As we have seen over the last five years, the net result of investor portfolio shuffling has been a lot of pain. The acts of panic-selling caused damaging losses for numerous reasons, including a combination of agonizing transactions costs; increased inflation-decaying cash positions; burdensome taxes; and a mass migration into low-yielding bonds. After major indexes have virtually tripled from the 2009 lows, many investors are now left with the gut-wrenching decision of whether to get back into stocks as the markets reach new highs.

As the bulls continue to point to the scores of gifts still lying under the Christmas tree, the bears are left hoping that new Fed Grinch Yellen will come and steal all the presents, trees, and food from the planned 2014 economic feast. There are still six trading days left in the year, so Santa Bernanke cannot finish wrapping up his +30% S&P 500 total return gift quite yet. Nevertheless, ever since the initial taper announcement, stocks have moved higher and Bernanke has equity investors singing “Joy to the World!

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

December 22, 2013 at 1:45 am Leave a comment

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