Archive for February, 2011
Alligators, Airplane Crashes, and the Investment Brain
“Neither a man nor a crowd nor a nation can be trusted to act humanely or think sanely under the influence of a great fear…To conquer fear is the beginning of wisdom.” – Bertrand Russell
Fear is a powerful force, and if not harnessed appropriately can prove ruinous and destructive to the performance of your investment portfolios. The preceding three years have shown the poisonous impacts fear can play on the average investor results, and Jason Zweig, financial columnist at The Wall Street Journal presciently wrote about this subject aptly titled “Fear,” just before the 2008 collapse.
Fear affects us all to differing degrees, and as Zweig points out, often this fear is misguided – even for professional investors. Zweig uses the advancements in neuroscience and behavioral finance to help explain how irrational decisions can often be made. To illustrate the folly in human’s thought process, Zweig offers up a multiple examples. Here is part of a questionnaire he highlights in his article:
“Which animal is responsible for the greatest number of human deaths in the U.S.?
A.) Alligator; B.) Bear; C.) Deer; D.) Shark; and E.) Snake
The ANSWER: C) Deer.
The seemingly most docile creature of the bunch turns out to cause the most deaths. Deer don’t attack with their teeth, but as it turns out, deer prance in front of speeding cars relatively frequently, thereby causing deadly collisions. In fact, deer collisions trigger seven times more deaths than alligators, bears, sharks, and snakes combined, according to Zweig.
Another factoid Zweig uses to explain cloudy human thought processes is the fear-filled topic of plane crashes versus car crashes. People feel very confident driving in a car, yet Zweig points out, you are 65 times more likely to get killed in your own car versus a plane, if you adjust for distance traveled. Hall of Fame NFL football coach John Madden hasn’t flown on an airplane since 1979 due to his fear of flying – investors make equally, if not more, irrational judgments in the investment world.
Professor Dr. Paul Slovic believes controllability and “knowability” contribute to the level of fear or perception of risk. Handguns are believed to be riskier than smoking, in large part because people do not have control over someone going on a gun rampage (i.e., Jared Loughner Tuscon, Arizona murders), while smokers have the power to just stop. The reality is smoking is much riskier than guns. On the “knowability” front, Zweig uses the tornadoes versus asthma comparison. Even though asthma kills more people, since it is silent and slow progressing, people generally believe tornadoes are riskier.
The Tangible Cause
Deep within the brain are two tiny, almond-shaped tissue formations called the amygdala. These parts of the brain, which have been in existence since the period of early-man, serve as an alarm system, which effectively functions as a fear reflex. For instance, the amygdala may elicit an instinctual body response if you encounter a bear, snake, or knife thrown at you.
Money fears set off the amygdala too. Zweig explains the linkage between fiscal and physical fears by stating, “Losing money can ignite the same fundamental fears you would feel if you encountered a charging tiger, got caught in a burning forest, or stood on the crumbling edge of a cliff.” Money plays such a large role in our society and can influence people’s psyches dramatically. Neuroscientist Antonio Damasio observed, “Money represents the means of maintaining life and sustaining us as organisms in our world.”
The Solutions
So as we deal with events such as the Lehman bankruptcy, flash crashes, Greek civil unrest, and Middle East political instability, how should investors cope with these intimidating fears? Zweig has a few recommended techniques to deal with this paramount problem:
1) Create a Distraction: When feeling stressed or overwhelmed by risk, Zweig urges investors to create a distraction or moment of brevity. He adds, “To break your anxiety, go for a walk, hit the gym, call a friend, play with your kids.”
2) Use Your Words: Objectively talking your way through a fearful investment situation can help prevent knee-jerk reactions and suboptimal outcomes. Zweig advises to the investor to answer a list of unbiased questions that forces the individual to focus on the facts – not the emotions.
3) Track Your Feelings: Many investors tend to become overenthusiastic near market tops and show despair near market bottoms. Long-term successful investors realize good investments usually make you sweat. Fidelity fund manager Brian Posner rightly stated, “If it makes me feel like I want to throw up, I can be pretty sure it’s a great investment.” Accomplished value fund manager Chris Davis echoed similar sentiments when he said, “We like the prices that pessimism produces.”
4) Get Away from the Herd: The best investment returns are not achieved by following the crowd. Get a broad range of opinions and continually test your investment thesis to make sure peer pressure is not driving key investment decisions.
Investors can become their worst enemies. Often these fears are created in our minds, whether self-inflicted or indirectly through the media or other source. Do yourself a favor and remove as much emotion from the investment decision-making process, so you do not become hostage to the fear du jour. Worrying too much about alligators and plane crashes will do more harm than good, when making critical decisions.
Read Other Jason Zweig Article from IC
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, 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.
Bears Hibernate During Melt-Up
Source: Photobucket
Here we are 719 days from the market bottom of March 2009, and the S&P 500 has more than doubled from its index low value of 666 to 1343 today. Noticeably absent during the meteoric rise have been the hibernating bears, like economist Nouriel Roubini (aka “Dr. Doom”) or Peter Schiff (see Emperor Schiff Has No Clothes), who blanketed the airwaves in 2008-2009 when financial markets were spiraling downwards out of control. The mere fact that I am writing about this subject may be reason enough to expect a 5-10% correction, but with a +100% upward move in stock prices I am willing to put superstition aside and admire the egg on the face of the perma-bears.
Shape of Recovery
After it became clear that the world was not coming to an end, in late 2009 and throughout 2010, the discussion switched from the likelihood of a “Great Depression” to a debate over the shape of the alphabet letter economic recovery. Was the upturn going to be an L-shaped, V-shaped, square root-shaped, or what Roubini expected – a U-shaped (or bathtub-shaped) recovery? You be the judge — does six consecutive quarters of GDP expansion with unemployment declining look like a bathtub recovery to you?
Chart Source: Yahoo Finance
This picture above looks more like a “V” to me, and the recently reported Institute for Supply Management’s (ISM) manufacturing index figure of 60.8 in January (the highest reading in seven years) lends credence to a stronger resurgence in the economy. Apparently the PIMCO bear brothers, Mohamed El-Erian and Bill Gross, are upwardly adjusting their view of a “New Normal” environment as well. Just recently, the firm raised its 2011 GDP forecast by 40-50% to a growth rate of 3-3.5% in 2011.
The Bears’ Logic
Bears continually explain away the market melt-up as a phenomenon caused by excessive and artificial liquidity creation (i.e., QE2 money printing, and 0% interest rate policy) Bernanke has provided the economy. Similar logic could be used to describe the excessive and artificial debt creation generated by individuals, corporations, and governments during the 2008-2009 meltdown. Now that leveraged positions are beginning to unwind (banks recapitalizing, consumers increasing savings rate, state and government austerity and tax measures, etc.), the bears still offer little credit to these improving trends.
Are we likely to experience another +100% upward move in stock prices in the broader indexes over the next two years? Unlikely. Our structural government debt and deficits, coupled with elevated unemployment and fiercer foreign competition are all factors creating economic headwinds. Moreover, inflation is starting to heat up and a Federal Funds rate policy cannot stay at 0% forever.
The Shapes of Rebounds
To put the two-year equity market recovery in historical perspective, the Financial Times published a 75-year study which showed the current market resurgence (solid red line) only trailing the post-Great Depression rebound of 1935-1938.
Source: Financial Times
Although we are absolutely not out of the economic woods and contrarian sentiment indicators (i.e., Volatility Index and Put-Call ratio) are screaming for a pullback, the foundation of a sustainable global recovery has firmed despite the persisting chaos occurring in the Middle East. Fourth quarter 2010 corporate profits (and revenues) once again exceeded expectations, valuations remain attractive, and floods of itchy retail cash still remain on the sidelines just waiting to jump in and chase the upward march in equity prices. Although the trajectory of stock prices over the next two years is unlikely to look like the last two years, there is still room for optimism (as I outlined last year in Genesis of Cheap Stocks). The low-hanging equity fruit has been picked over the last few years, and I’m certain that bears like Roubini, Schiff, El-Erian, Gross, et.al. will eventually come out of hibernation. For those investors not fully invested, I believe it would be wise to wait for the inevitable growls of the bears to resurface, so you can take further advantage of attractive market opportunities.
Click Here for More on the PIMCO Downhill Marathon Machine
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, 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.
Historical Trampoline Cycles of Fear & Greed
What goes up, eventually comes down, and what goes down, eventually comes up. Like an adolescent jumping on a trampoline, emotions in the financial markets jump sky high before crashing down to earth…and then the process repeats itself. The underlying reasons behind every market gyration are different, but the emotions of fear and greed are similar. Since 1919, there have been 29 recessions, and 29 recoveries (pretty good recovery batting average). Over that 92 year period we have also witnessed the Dow Jones Industrial Average go from around 100 in 1919 to over 12,300 today – not too shabby.
The blood curdling panic experienced in 2008 and early 2009 has turned to ordinary fear among retail investors – although the doubling of the equity markets from two years ago has instilled a good dosage of animal spirits into professional traders and speculators. When trillions of low yielding cash and Treasuries ultimately come barreling into equity markets, thereby extending equity valuations, then I will become extra nervous. Until then, plenty of opportunities still exist – there just is not nearly as much low-hanging fruit as two years ago.
More of the Same
To make the point that “the more things change, the more things stay the same,” you can go all the way back to 1932 and read the words of Dean Witter – I also wrote about the history of panic in the 1970s (see Rhyming History).
Even some 80 years ago, Witter was keenly aware of the doomsday bears:
“People are deterred from buying good stocks and bonds now only because of an unwarranted terror…All sorts of bugaboos are paraded to destroy the last vestige of confidence. Stories of disaster which are incredible and untrue are told to foolish and credulous listeners, who appear willing to believe the worst.”
The bugaboo purveyors I called out in 2009 included Peter Schiff, Nouriel Roubini, Meredith Whitney, and Jimmy Rogers. I’m not sure who the next genius du jour(s) will be, but I am confident they will be prominently paraded over the media airwaves.
Cherry Price for Consensus
As firmer signs of an economic recovery finally take hold, investors slowly regain confidence about investing in risky assets. The only problem is that prices have skyrocketed! Witter captures this dynamic beautifully back in 1932:
“Some people say that they wish to await a clearer view of the future. When the future is again clear the present bargains will no longer be available. Does anyone think that present prices will continue when confidence has been fully restored? Such bargains exist only because of terror and distress.”
Herd Gets Slaughtered
History proves over and over again…the general investing public suffers the consequences of following the herd of fear and greed. Or as Witter states:
“It is easy to run with the crowd. The path of least resistance is to join in the wailings that are now so popular. The constructive policy, however, is to maintain your courage and your optimism, to have faith in the ultimate future of your country and to proclaim your faith and to recommend the purchase of good bonds and good stocks, which are inordinately depreciated.”
In the short-run, markets move up and down in an unpredictable fashion, like an irresponsible teenager jumping on a trampoline. In the long-run, investors can do themselves a favor by ignoring the masses, and sticking to a disciplined, systematic investment approach that includes controlled valuation metrics and contrarian sentiment factors. That way, you won’t fall off the investment trampoline and permanently break your portfolio.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, 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.
Short Interest Coiled Springs
If short interest measures the amount of bearish bets against a particular stock, then what are you supposed to do with that data? The answer really depends on your view regarding the research quality of the bears. If you believe the bears have done excellent homework, then it will pay to pile onto the bearish bandwagon and short the stock. There’s just one problem…it’s virtually impossible to know whether the brains of Warren Buffett are leading the shorting brigade, or the boobs of Snookie from Jersey Shore are driving the negative bets.
The situations that I find especially appealing are the cases in which your research conclusions are extremely bullish, yet a large herd of traders have piled up their pessimistic short positions up to the sky in the belief share prices are going lower. These “crowded shorts” provide a large tailwind of pending buy orders – effectively pouring gasoline on the fire – if you are arrogant enough, like me, to believe your bullish thesis will play out. These “short squeezes” occur often when fundamental momentum lasts longer than the bears expect, or when downbeat expectations do not come to fruition. A classic short squeeze occurred when well-known investor Whitney Tilson recently covered his Netflix Inc. (NFLX) short position (see Whitney the Waffler), pushing a high priced stock even higher. Short interest reached almost 13 million shares in September 2010, and declined to a little more than 11 million shares a few weeks ago (compared to about 53 million shares outstanding). Given the stock’s price action, and Tilson’s response, the short interest has likely declined – at least temporarily.
The Challenge of Timing
Shorting is difficult enough with the theoretical unlimited losses hanging over your head, but timing is of the essence too. Often, a short-seller may be correct on their unconstructive view on a particular stock, but the heat in the kitchen gets too hot for them to stick around for the main course. Shorting stocks in a down market can be just as easy as buying in an up market – making money in your shorts in a rising market is that much more difficult.
Rather than follow the herd of short sellers as a trading strategy, I choose to stick with the credo of legendary investor Benjamin Graham, who stated:
“You’re neither right nor wrong because others agree with you. You’re right because your facts and reasoning are right.”
It’s my strong belief the long-term share price of a stock is driven by the sustainable earnings and cash flows of a company. The direction of price and earnings (cash flow) may diverge in the short-run, but in the long-run the relationship between price and profits converges.
Shorting Criteria
The criteria for shorting a stock are just as varied as the factors used to buy a stock, but these are some of the factors I consider when shorting a stock:
- Weak and/or deteriorating market share positioning.
- Excessive leverage – substandard financial positioning.
- Weak cash flow based quality of earnings.
- Management mis-execution and deteriorating fundamentals.
- Expensive valuations on an absolute and relative basis.
A stock is not required to exhibit all these characteristics simultaneously in order to generate a profitable short position, but the framework works for me.
If long investing is your main focus, then I urge you seek out those heavily shorted stocks that maintain attractive growth opportunities at attractive prices. If you are going to seek out rising stocks, you may as well use the assistance of a coiled spring to get you there.
Click Here to Check Out High Short Interest Stocks
Click Here for NYSE Shorts at WSJ
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and NFLX, 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.
Whitney the Netflix Waffler
Source: Photobucket
No, I am not talking about Meredith Whitney (see Cloudy Crystal Ball), but rather Whitney Tilson, a well-known value and hedge fund manager at T2 Partners LLC. Less than eight weeks ago, Tilson boldly and brashly exclaimed why Netflix Inc. (NFLX) was an “exceptional short” and provided reasons to the world on why Netflix was his largest short position (read Tilson’s previous post). Fifty-five days later, Mr. Tilson evidently was overtaken by a waffle craving and decided to throw in the towel by covering his Netflix short position.
What Changed in Seven and Half Weeks?
Margin Thesis Compromised: Tilson explains, “The company reported a very strong quarter that weakened key pillars of our investment thesis, especially as it relates to margins.” Really? Netflix has grown revenues for nine straight years since its IPO (Initial Public Offering) in 2002, and growth has even accelerated for two whole years (as Netflix has shifted to streaming content over snail-mail), and just in Q4 he became surprised by this multi-year trend? The Q4 growth caught Tilson off-guard, but I guess Tilson wasn’t surprised by the 7.5 million subscribers Netflix added in 2009 and first three quarters of 2010. Never mind the five consecutive years of operating margin expansion either (source: ADVFN), nor the stealthy share price move from $30 to around $225. Apparently Tilson needed the recently reported Q4 financial results to hit him over the head.
Survey Provides Earth-Shattering Results: Tilson conducted an exhaustive study of “more than 500 Netflix subscribers, that showed significantly higher satisfaction with and usage of Netflix’s streaming service than we anticipated.” Come on…Netflix has more than 20 million subscribers, and you are telling me that a questionnaire of 500 subscribers (0.0025%) is representative. Even if these results are a cornerstone of Tilson’s modified thesis, I wonder also why the survey wasn’t taken before Netflix became Tilson’s largest negative short position. In addition, I can’t say it’s much of a revelation that Tilson found “significantly higher satisfaction” among paying subscribers. That’s like me going to a Justin Bieber concert and polling J-Beeb fans whether they like his music – I’ll go out on a limb and say paying customers will generally have a positive bias in their responses.
Feedback Tilts the Scales: Tilson received a “great deal of feedback, including an open letter from Netflix’s CEO, Reed Hastings.” If I received a penny for every time I heard a CEO speak positively about their company, I would be retired on a private island drinking umbrella drinks all day. Honestly, what does Tilson expect Hastings to say, “You know Whitney, you really hit the nail on the head with your analysis…I think you’re right and you should short our stock.”
Some other inconsistencies I’m still trying to figure out in Tilson’s new waffle thesis:
Valuation Head Scratcher: Also frustrating in Tilson’s 180 degree switch is his apparent incongruous treatment of valuation. In his initial bearish piece, Tilson explains how outrageously priced Netflix share are at 63.1x the high 2010 consensus estimate, but somehow a current 75.0x multiple (~20% richer) is reason enough for Tilson to blow out his short.
Competition: Although Tilson went from 100% short Netflix to 0% short Netflix, there does not appear to be any new information regarding Netflix’s competitive dynamics from the Q4 financial release to change his view. Here is what he said in his article eight weeks ago:
“Netflix’s brand and number of customers pale in comparison to its new, direct competitors like Apple (iTunes), Google (GOOG) (YouTube), Amazon.com (AMZN) (Amazon Video on Demand), Disney (DIS) and News Corp. (NWS) (part ownership of Hulu), Time Warner (TWX, TWC) (cable, HBO, etc.), Comcast (CMCSA) (cable, NBC Universal, part ownership of Hulu), and Coinstar’s Redbox (CSTR) (30,000 kiosks renting DVDs for $1/night and email addresses for 21 million customers).”
Little is said in his short covering note, other than these negative dynamics still exist and help explain why he is not long the stock.
Gently Under the Bus
Whitney Tilson was “against Netflix before he was for it,” a stance that could generate a tear of pride from fellow waffler John Kerry. However, I want to gently place Mr. Tilson under the bus with all my comments because his sudden strange reversal shouldn’t be blown out of proportion with respect to his full body of work. As a matter of fact, I have favorably profiled Tilson in several of my previous articles (read Tilson on BP and Tilson on Fat Lady Housing).
One would think given my profitable long position in Netflix that I would be congratulating Tilson for covering his short, but I must admit that I feel a little naked with fewer contrarians rooting against me. The herd is occasionally right, but the largest returns are made by not following the herd. Short interest was about 33% of the float (shares outstanding available for trading) mid-last month, and with the recent melt-up, my guess is that short percentage has shrunk with other short covering doubters. I haven’t decided how much, if any, profits I plan to lock-in with my Netflix positions, but as Tilson points out, they are not giving Netflix away for free.
Credit should also be given to Tilson for having the thickness of skin to openly flog himself and admit failure in such an open forum. I have been known to enjoy a waffle or two in my day as well (more often in the privacy of my own kitchen), and waffling on stocks can be preferable to loving stocks to the grave. Tilson has proven firsthand that eating waffles can be very expensive and detrimental to your profit waistline. By doing more homework on your stock consumption, your waffle eating should be spread further apart, making this habit not only cheaper, but also better for your long-term investment health.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) at the time of publishing had no direct position in DIS, NWS/Hulu, TWX, TWC, CMCSA, and CSTR but SCM and some of its clients own certain exchange traded funds, NFLX, AAPL, AMZN, AAPL, and GOOG, but did not own 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.
“1001 Truths about Investing” Released!
Hot off the printing presses, the much anticipated follow-up book, 1001 Truths about Investing, from Sidoxia Capital Management President and hedge fund manager Wade Slome has arrived.
With Valentine’s Day around the corner, what better way to tell your loved one or special friend that you truly care for them than by purchasing a copy of 1001 Truths. Okay, maybe the purchase wouldn’t be the most romantic gift, but investment portfolios need love too, and adding this to your book collection may be exactly what the investment doctor ordered.
Click Here for the 1001 Truths Press Release
Click Here to Purchase Book on Amazon.com
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and AMZN, 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.
Yacktman’s Triangle of Success
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Donald Yacktman is no ordinary investor. As a matter of fact, he was a runner-up in Morningstar’s Fund Manager of the Decade award (see winner here). Besides stellar performance, how did Yacktman accomplish this honor? The answer is simple…a triangle. Yacktman wasn’t a geometry professor, but his investment philosophy is based on the three corners of this popular shape. Specifically, Yacktman looks to invest in companies trading at good prices, that are good businesses, with good management teams. Stated differently, one side of the investment philosophy represents a low purchase price, while the other sides represent good businesses and shareholder-oriented management.
Where the Magic Began
Like any legendary investor, experience plays a huge role in becoming a market master. Yacktman is no exception. Yacktman is the President and Co-Chief Investment Officer of Yacktman Asset Management Co., overseeing about $7 billion in assets. Prior to founding the firm in April 1992, he worked for 10 years as a portfolio manager at Selected Financial Services, Inc. and before then he served 14 years as a portfolio manager at Stein Roe & Farnham. Geographically, he has been all over the map. He earned his economics degree from the University of Utah and an MBA with distinction from Harvard University. After working for a longtime in Chicago, he decided to start the Yacktman Funds in Austin, Texas. Who knows, maybe the next stop will be Alaska or Hawaii?
Despite all the successes, life has not always been a bed of roses for Yacktman. As a matter of fact, during the late-1990s, the fund board attempted to oust him and investors left in a mass exodus. Even after posting stellar results in 2000-2003 relative to the S&P 500, Yacktman underperformed significantly in three out of four years from 2004 – 2007.
Managing to sidestep the technology bubble in 2000 and then the financial sector bubble in 2008 contributed tremendously to Yacktman’s outperformance (see graph).
Source: Morningstar.com
As you can see, the long-term track record of the Yacktman fund has been exceptional (#1 fund on a 3 yr., 5 yr., and 10 yr basis), but anyone can eventually lose the Midas touch – Bill Miller’s 15 consecutive market-beating returns subsequently reversed into a financial disaster in the following years (see Revenge of the Dunce). Even with all the boos and cheers Yacktman has received over the years, some of that attention should be directed towards his son Stephen Yacktman (Co-Manager of Yacktman funds) and other Co-Manager Jason Subotky.
More Yacktman Investment Nuts & Bolts
There are other key elements to the Yacktman strategy beyond the triangle philosophy. For example, Yacktman preaches the importance of patience, long-term thinking, and the ability to develop a repeatable process.
And how does Yacktman find these great opportunities for his funds? Driving the process of picking stocks is the ability to price equity securities like bonds. Using cash flows, inflation expectations, and forecasted growth, the Yacktman team derives a forward rate of return that they can compare against a broad set of investment alternatives, including bonds. This framework is very consistent with my free cash flow yield ranking system I use. If opportunities do not present themselves, Yacktman is not afraid to raise cash levels to unorthodox levels (e.g., around 30% cash near the 2007 peak).
Since the differential in return opportunities has narrowed between what Yacktman defines as high quality and low quality, he has shifted more of the portfolios toward Blue Chip companies, like News Corporation (NWS), PepsiCo, Inc. (PEP), Coca-Cola Company (KO), Procter & Gamble Company (PG), and Microsoft Corporation (MSFT). Since the return opportunity spreads have narrowed, Yacktman feels he can get more bang for his risk buck by investing in quality large capitalization stocks.
With a long-run magical track record like Donald Yacktman’s, it is difficult to critically critique his systematic investment process. By implementing a few cornerstones of Yacktman’s investment philosophy, we should all be able to triangulate a better investment strategy four ourselves.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in YACKX, YAFFX, NWS, PEP, PG, KO, MSFT, 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.
Microsoft’s Hand Caught in Google Cookie Jar
Source: Photobucket
The globalized world we live in has become ever-more connected (see Globalization Train), and the recent events in Egypt where mass protests were organized, in large part by Facebook and Twitter, only goes to show the importance technology plays in our daily lives. As a result of our tight global links and the advancement of technology, product cycles have only become shorter and more competitive, raising the stakes for business success. The expanded field of cut-throat competitors in a digital age has also increased the value of intellectual property (IP). Increasingly, lawyers and judges are being forced to decipher the obscure realm of bits and bytes and vigorously defend unique IP from competitors.
If You Can’t Beat Them, Copy Them
Case in point is the current war of code-words between Google Inc. (GOOG) and Microsoft Corp. (MSFT). Google claims they have caught Microsoft’s hand in the corporate espionage cookie jar by watching Microsoft effectively steal Google’s algorithmic search code for the software giant’s Bing search service. How can Google make such harsh and direct accusations? Google claims to have set up “synthetic” searches, which were designed as digital booby traps. Based on Google’s story, Microsoft appears to have taken the bait…hook, line, and sinker.
You be the judge. Here was the synthetic search result for “indoswiftjobinproduction” when entered in Google:
Source: Search Engine Land
This is the response when the same search term “indoswiftjobinproduction” was keyed in on Microsoft’s Bing search service:
Source: Search Engine Land
Coincidence? Perhaps. Likely? No.
Well, maybe lightning just struck with the “indoswiftjobinproduction” search term gibberish – why not try another?
This is what Google’s search results created when “mbzrxpgjys” was entered:
Source: Search Engine Land
When the same “mbzrxpgjys” term was inputted into Microsoft’s Bing, here was the result:
Source: Search Engine Land
Hmmm, I seem to be detecting a pattern here.
Is Microsoft’s apparent copycat behavior illegal? The evidence for the moment doesn’t appear to be clear, thanks mostly to the fine-print legalese of confusing check boxes that nobody reads when downloading or using any internet service. Evidently, many Microsoft Internet Explorer (IE) users have unknowingly provided Google search information typed in through Microsoft’s IE browser, and the Redmond behemoth has been using this information to sharpen their search algorithms.
So if this behavior is not illegal, then should this activity be considered cheating? Here’s what Amit Singhal, a Google executive who oversees the company’s search engine ranking algorithm has to say about the issue:
“It’s cheating to me because we work incredibly hard and have done so for years but they just get there based on our hard work…I don’t know how else to call it but plain and simple cheating. Another analogy is that it’s like running a marathon and carrying someone else on your back, who jumps off just before the finish line.”
I’m sure this will not be the last we hear on the subject of technology and corporate cheating. As a matter of fact, in the field of intellectual property crimes, French-Japanese car giant Renault-Nissan recently brought the case of industrial espionage, corruption, theft, stolen goods, and conspiracy against three senior Renault executives. The allegations of selling crucial electric car information to the Chinese raised concerns to a feverish pitch in the tabloids because so much can be gained or lost by those involved in this estimated $2 trillion electric car market.
The committing of crimes is nothing new, but the types of new crimes are changing. In a globalized world increasingly dominated by technology, perpetrators better think twice about committing these invisible crimes. Cheating may taste sweet, until you get caught with your hand in the cookie jar.
Read More about the Google–Microsoft Tiff
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and GOOG, but at the time of publishing SCM had no direct position in MSFT, Facebook, Twitter, Renault, Nissan, 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.
Creating Your Investment Dashboard
Navigating the financial markets can be difficult in this volatile environment we’ve experienced over the last few years, which is why it is more important than ever to have a financial dashboard to ensure you do not drive off a cliff. If investors do not have the time or focus to drive their financial future, then perhaps for the safety of themselves and others, they may consider taking the bus or hiring a chauffeur. For those committed to handling their finances on their own, the road may become rocky, so here are some important factors to monitor on your financial dashboard:
1) Fundamental Direction: Before you decide on an investment destination, it is important to know whether trends are accelerating (speeding up) or deteriorating (slowing down) – see also Forecasting – Trend Analysis.
2) Are You Going the Speed limit? Nobody wants to get a costly speeding ticket, therefore assessing valuation metrics on your dashboard is a beneficiary tool. If you are speeding along the highway at a 100 miles per hour in an expensive stock (e.g., trading at a 50x+ Price/Earnings multiple), then there is little room for error. When traveling that fast you can forget about the price of a speeding ticket, because hitting a pothole at those speeds (valuation) can be much more costly to your portfolio, if you are not careful.
3) Temperature Outside: There’s a huge difference between driving in the icy-cold snow and in 100 degree heat. Each environment has its own challenges. The same principle applies to the financial markets. On occasion, sentiment can become red hot, forcing heightened caution, whereas during other periods, chilling fear can scare everyone else off the roads, leaving clear sailing ahead.
4) Optimal Tire Pressure: Low pressure or bald tires can lead to treacherous driving conditions. A company with healthy cash flow generation relative to its market capitalization can make your investment ride a lot more stable (see also Cash Flow Register). Dividends and share buybacks are generated from healthy and stable cash flows…not earnings.
5) Driver Skill Level: People generally believe they are better than average drivers, however statistics tell a different story. By definition, half of all drivers must be below average. If you are going to put your life’s retirement assets into stocks, you might as well select those companies led by seasoned management teams with proven track records.
Many investors drive blindly without relying on a dashboard. In the investment world, visibility is not very clear. Often, weather conditions in the financial markets become rainy, dark, and/or foggy. If you don’t want your portfolio to crash, it makes sense to build a reliable dashboard to navigate through the hazardous investment road conditions.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, 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.
Foreign Frights & Debt Doubts
Excerpts from Sidoxia monthly newsletter (Subscribe on right side of page)
Over the last few years the globalized nature of the financial crisis has forced a diverse set of world leaders to deal with obscure international flare-ups in countries ranging from Iceland to Dubai, and Greece to Tunisia. The crisis du jour is the popular revolt in Egypt against 30-year president Hosni Mubarak and his autocratic, authoritarian government. The situation for the U.S. becomes a little sticky because Egypt, although creating a GDP (Gross Domestic Product) of less than the state of Illinois, is still the largest Arab country by population (approximately 82 million – even larger than Iran); a staunch ally with the U.S. in keeping peace with Israel; has contributed important intelligence to our country’s war on terror; and has been a responsible partner in controlling commerce through the all-important Suez Canal. The problem with Egypt and Mubarak’s regime is that the Egyptian economy is in relative shambles (they do not have oil reserves like their neighbors), unemployment is through the roof, and the government has been slow to push democratic advancements forward for the Egyptian people.
As emerging market “haves” increasingly join the ranks of the middle class, the people representing the “have-nots” of Yemen, Jordan, Algeria, Tunisia, Egypt, and others are thirsting for a cocktail of democracy and a higher standard of living, like some of their wealthier neighbors. These autocratic, authoritarian regimes can do their best to slow or delay the democratizations of their countries, but they cannot put the genie back in the bottle. Information is flowing faster than ever, and societies previously kept in the dark are now seeing the light of democracy.
Like any volatile government situation, there are threats and opportunities, depending on whether Mubarak stays in power, and if not, the nature of the new leadership. If an extremist government fills the leadership void, the U.S. may wish to rewind the clock and put the slow-moving reformist, Mubarak, back in power.
The short-term impact of the popular revolt may create additional volatility in the markets, but in the long-run, if the turmoil introduces more open, transparent, less corrupt, and democratic ideals to the new agenda, then the world will become a better place.
Bitter Debt Pill Tough to Swallow
There is never a shortage of issues to worry about, and from an economic standpoint, the suffocating amount of debt our country is dealing with is at the top of the concern list. The 2008-2009 financial crisis hole that we are still climbing our way out of is a friendly reminder of what happens to countries adopting irresponsible fiscal policies. The choking amount of debt the U.S. is swallowing remains a central issue for the current administration and will be a core topic to be debated through the 2012 Presidential election cycle.
How serious is the issue? The problem is serious enough the Congressional Budget Office (CBO) just raised its budget deficit forecast for fiscal 2011 to hit a record $1.5 trillion (9.8% of GDP), a level higher than $1.3 trillion in fiscal 2010. The blame for the new record can be largely attributed to the recent extension of the $858 billion in Bush tax-cuts and other benefits/breaks. Kicking the can down the road recently led Moody’s Investors Services of threatening the U.S. with a downgrade of its triple-A rated debt.
Source: The Peterson Institute
The President addressed some of our fiscal problems in his State of the Union Address recently (e.g., proposing a freeze on discretionary spending), but the rubber really hits the road when he comes out with his budget proposal later this month. How serious is he about reducing our hemorrhaging deficits? We’ll soon find out when the individual budget line-items are distributed for everyone to see. Shortly thereafter, around the end of March, the debt ceiling impasse will become a game of political “chicken.” Each side, Democrats and Republicans, will attempt to withdraw concessions from the other party, in exchange for a vote that will prevent a disastrous default of our government’s debt payments. Basically, our government is effectively looking to expand its credit card credit line, because our government credit limit is maxed out.
The situation isn’t hopeless if our politicians can show leadership by making difficult, unpopular fiscal decisions, but if America ignores our painful debt problems and does not take its bitter medicine, then prepare for an economy on the verge of keeling over.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, 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.
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