Archive for April, 2011
The Fallacy of High P/E’s
Would you pay a P/E ratio (Price-Earnings) of 1x’s future earnings for a dominant market share leading franchise that is revolutionizing the digital industry and growing earnings at an +83% compounded annual growth rate? Or how about shelling out 3x’s future profits for a company with ambitions of taking over the global internet advertising and commerce industries while expanding earnings at an explosive +51% clip? If you were capable of identifying Apple Inc. (AAPL) and Google Inc. (GOOG) as investment ideas in 2004, you would have made approximately +2,000% and +600%, respectively, over the following six years. I know looking out years into the future can be a lot to ask for in a world of high frequency traders and stock renters, but rather than focusing on daily jobless claims and natural gas inventory numbers, there are actual ways to accumulate massive gains on stocks without fixating on traditional trailing P/E ratios.
At the time in 2004, Apple and Google were trading at what seemed like very expensive mid-30s P/E ratios (currently the S&P 500 index is trading around 15x’s trailing profits) before these stocks made their explosive, multi-hundred-percent upward price moves. What seemingly appeared like expensive rip-offs back then – Apple traded at a 37x P/E ($15/$0.41) and Google 34x P/E ($85/$2.51) – were actually bargains of a lifetime. The fact that Apple’s share price appreciated from $15 to $347 and Google’s $85 to $538, hammers home the point that analyzing trailing P/E ratios alone can be hazardous to your stock-picking health.
Why P/Es Don’t Matter
In William O’Neil’s book, How to Make Money in Stocks he comes to the conclusion that analyzing P/E ratios is worthless:
“Our ongoing analysis of the most successful stocks from 1880 to the present show that, contrary to most investors beliefs, P/E ratios were not a relevant factor in price movement and have very little to do with whether a stock should be bought or sold. Much more crucial, we found, was the percentage increase in earnings per share.”
Here is what O’Neil’s data shows:
- From 1953 – 1985 the best performing stocks traded at a P/E ratio of 20x at the early stages of price appreciation versus an average P/E ratio of 15x for the Dow Jones Industrial Average over the same period. The largest winners saw their P/E multiples expand by 125% to 45x.
- From 1990 – 1995, the leading stocks saw their P/E ratios more than double from an average of 36 to the 80s. Once again, O’Neil explains why you need to pay a premium to play with the market leading stocks.
You Get What You Pay For
When something is dirt cheap, many times that’s because what you are buying is dirt. Or as William O’Neil says,
“You can’t buy a Mercedes for the price of a Chevrolet, and you can’t buy oceanfront property for the same price you’d pay for land a couple of miles inland. Everything sells for about what it’s worth at the time based on the law of supply and demand…The very best stocks, like the very best art, usually command a higher price.”
Any serious investor has “value trap” scars and horror stories to share about apparently cheap stocks that seemed like bargains, only to later plummet lower in price. O’Neil uses the example of when he purchased Northrop Grumman Corp (NOC) many years ago when it traded at 4x’s earnings, and subsequently watched it fall to a P/E ratio of 2x’s earnings.
Is Your Stock a Teen or a Senior?
A mistake people often make is valuing a teen-ager company like it’s an adult company (see also the Equity Life Cycle article). If you were offered the proposition to pay somebody else an upfront lump-sum payment in exchange for a stream of their lifetime earnings, how would you analyze this proposal? Would you make a higher lump-sum payment for a 21-year-old, Phi Beta Kappa graduate from Harvard University with a 4.0 GPA, or would you pay more for an 85 year old retiree generating a few thousand dollars in monthly Social Security income? As you can imagine, the vast majority of investors would pay more for the youngster’s income because the stream of income over 65-70 years would statistically be expected to be much larger than the stream from the octogenarian. This same net present value profit stream principle applies to stocks – you will pay a higher price or P/E for the investment opportunity that has the best growth prospects.
Price Follows Earnings
At the end of the day, stock prices follow the long-term growth of earnings and cash flows, whether a stock is considered a growth stock, a value stock, or a core stock. Too often investors are myopically focused on the price action of a stock rather than the earnings profile of a company. Or as investment guru Peter Lynch states:
”People may bet on hourly wiggles of the market but it’s the earnings that waggle the wiggle long term.”
“People Concentrate too much on the P (Price), but the E (Earnings) really makes the difference.”
Correctly determining how a company can grow earnings is a more crucial factor than a trailing P/E ratio when evaluating the attractiveness of a stock’s share price.
Valuations Matter
Even if you buy into the premise that trailing P/E ratios do not matter, valuation based on future earnings and cash flows is critical. When calculating the value of a company via a discounted cash flow or net present value analysis, one does not use historical numbers, but rather future earnings and cash flow figures. So when analyzing companies with apparently sky-high valuations based on trailing twelve month P/E ratios, do yourself a favor and take a deep breath before hyperventilating, because if you want to invest in unique growth stocks it will require implementing a unique approach to evaluating P/E ratios.
See also Evaluating Stocks Vegas Style
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, AAPL, and GOOG, but at the time of publishing SCM had no direct position in NOC, 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.
Sigmund Freud the Portfolio Manager
Source: Syracuse.com
Byron Wien, former investment strategist at Morgan Stanley (MS) and current Vice Chairman at Blackstone Advisory Partners (BX), traveled to Austria 25 years ago and used Sigmund Freud’s success in psychoanalytical theory development as a framework to apply it to the investment management field.
This is how Wien describes Freud’s triumphs in the field of psychology:
“He accomplished much because he successfully anticipated the next step in his developing theories, and he did that by analyzing everything that had gone before carefully. This is the antithesis of the way portfolio managers approach their work.”
Wien attempts to reconcile the historical shortcomings of investment managers by airing out his dirty mistakes for others to view.
“I think most of us have developed patterns of mistake-making, which, if analyzed carefully, would lead to better performance in the future…In an effort to encourage investment professionals to determine their error patterns, I have gathered the data and analyzed my own follies, and I have decided to let at least some of my weaknesses hang out. Perhaps this will inspire you to collect the information on your own decisions over the past several years to see if there aren’t some errors that you could make less frequently in the future.”
Here are the recurring investment mistakes Wien shares in his analysis:
Selling Too Early: Wien argues that “profit-taking” alone is not reason enough to sell. Precious performance points can be lost, especially if trading activity is done for the sole purpose of looking busy.
The Turnaround with the Heart of Gold: Sympathy for laggard groups and stocks is inherent in the contrarian bone that most humans use to root for the underdog. Wien highlights the typical underestimation investors attribute to turnaround situations – reality is usually a much more difficult path than hoped.
Overstaying a Winner: Round-trip stocks – those positions that go for long price appreciation trips but return over time to the same stock price of the initial purchase – were common occurrences for Mr. Wien in the past. Wien blames complacency, neglect, and infatuation with new stock ideas for these overextended stays.
Underestimating the Seriousness of a Problem: More often than not, the first bad quarter is rarely the last. Investors are quick to recall the rare instance of the quick snapback, even if odds would dictate there are more cockroaches lurking after an initial sighting. As Wien says, “If you’re going to stay around for things to really improve, you’d better have plenty of other good stocks and very tolerant clients.”
It may have been 1986 when Byron Wien related the shortcomings in investing with Sigmund Freud’s process of psychoanalysis, but the analysis of common age-old mistakes made back then are just as relevant today, whether looking at a brain or a stock.
See also: Killing Patients to Prosperity
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 MS, BX, 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.
Inflation and the Debt Default Paradox
With the federal government anchored down with over $14 trillion in debt and trillion dollar deficits as far as the eye can see, somehow people are shocked that Standard & Poor’s downgraded its outlook on U.S. government debt to “Negative” from “Stable.” This is about as surprising as learning that Fat Albert is overweight or that Charlie Sheen has a substance abuse problem.
Let’s use an example. Suppose I received a pay demotion and then I went on an irresponsible around-the-world spending rampage while racking up over $1,000,000.00 in credit card debt. Should I be surprised if my 850 FICO score would be reviewed for a possible downgrade, or if credit card lenders became slightly concerned about the possibility of collecting my debt? I guess I wouldn’t be flabbergasted by their anxiety.
Debt Default Paradox?
With the recent S&P rating adjustment, pundits over the airwaves (see CNBC video) make the case that the U.S. cannot default on its debt, because the U.S. is a sovereign nation that can indefinitely issue bonds in its own currency (i.e., print money likes it’s going out of style). There is some basis to this argument if you consider the last major developed country to default was the U.S. government in 1933 when it went off the gold standard.
On the other hand, non-sovereign nations issuing foreign currencies do not have the luxury of whipping out the printing presses to save the day. The Latin America debt defaults in the 1980s and Asian Financial crisis in the late 1990s are examples of foreign countries over-extending themselves with U.S. dollar-denominated debt, which subsequently led to collapsing currencies. The irresponsible fiscal policies eventually destroyed the debtors’ ability to issue bonds and ultimately repay their obligations (i.e., default).
Regardless of a country’s strength of currency or central bank, if reckless fiscal policies are instituted, governments will eventually be left to pick their own poison…default or hyperinflation. One can think of these options as a favorite dental procedure – a root canal or wisdom teeth pulled. Whether debtors get paid 50 cents on the dollar in the event of a default, or debtors receive 100 cents in hyper-inflated dollars (worth 50% less), the resulting pain feels the same – purchasing power has been dramatically reduced in either case (default or hyperinflation).
Of course, Ben Bernanke and the Federal Reserve Bank would like investors to believe a Goldilocks scenario is possible, which is the creation of enough liquidity to stimulate the economy while maintaining low interest rates and low inflation. At the end of the day, the inflation picture boils down to simple supply and demand for money. Fervent critics of the Fed and Bernanke would have you believe the money supply is exploding, and hyperinflation is just around the corner. It’s difficult to quarrel with the printing press arguments, given the size and scale of QE1 & QE2 (Quantitative Easing), but the fact of the matter is that money supply growth has not exploded because all the liquidity created and supplied into the banking system has been sitting idle in bank vaults – financial institutions simply are not lending. Eventually this phenomenon will change as the economy continues to recover; banks adequately build their capital ratios; the housing market sustainably recovers; and confidence regarding borrower creditworthiness improves.
Scott Grannis at the California Beach Pundit makes the point that money supply as measured by M2 has shown a steady 6% increase since 1995, with no serious side-effects from QE1/QE2 yet:
- Source: Calafia Beach Pundit
In fact, Grannis states that money supply growth (+6%) has actually grown less than nominal GDP over the period (+6.7%). Money supply growth relative to GDP growth (money demand) in the end is what really matters. Take for instance an economy producing 10 widgets for $10 dollars, would have a CPI (Consumer Price Index) of $1 per widget and a money supply of $10. If the widget GDP increased by 10% to 11 widgets (10 widgets X 1.1) and the Federal Reserve increased money supply by 10% to $11, then the CPI index would remain constant at $1 per widget ($11/11 widgets). This is obviously grossly oversimplified, but it makes my point.
Gold Bugs Banking on Inflation or Collapse
Gold prices have been on a tear over the last 10 years and current fiscal and monetary policies have “gold bugs” frothing at the mouth. These irresponsible policies will no doubt have an impact on gold demand and gold prices, but many gold investors fail to acknowledge a gold supply response. Take for example Freeport-McMoRan Copper & Gold Inc. (FCX), which just reported stellar quarterly sales and earnings growth today (up 31% and 57%, respectively). FCX more than doubled their capital expenditures to more than $500 million in the quarter, and they are planning to double their exploration spending in fiscal 2011. Is Freeport alone in their supply expansion plans? No, and like any commodity with exploding prices, eventually higher prices get greedy capitalists to create enough supply to put a lid on price appreciation. For prior bubbles you can reference the recent housing collapse or older burstings such as the Tulip Mania of the 1600s. One of the richest billionaires on the planet, Warren Buffett, also has a few thoughts on the prospects of gold.
The recent Standard & Poor’s outlook downgrade on U.S. government debt has caught a lot of press headlines. Fears about a technical default may be overblown, but if fiscal constraint cannot be agreed upon in Congress, the alternative path to hyperinflation will feel just as painful.
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 FCX, 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.
Gospel from 20th Century Investment King
Source: Compendius.com
Exceptional returns are not achieved by following the herd, and Sir John Templeton, the man Money magazine called the greatest global stock investor of the 20th century, followed this philosophy to an extreme. This contrarian, value legend put his money where his mouth was early on in his career. After graduating from Yale and becoming a Rhodes Scholar at Oxford, Templeton moved onto Wall Street. At the ripe young age of 26, and in the midst of World War II tensions, Templeton borrowed $10,000 (a lot of dough back in 1939) to purchase 100 shares in more than 100 stocks trading at less than $1 per share (34 of the companies were in bankruptcy). When all was said and done, only four of the investments became worthless and Templeton made a boatload of money. This wouldn’t be the end of Templeton’s success, but rather the beginning to a very long, prosperous career -Templeton ended up living a full life to age 95 (1912 – 2008).
Shortly after his penny stock buying binge in 1939, Templeton parlayed those profits into buying an investment firm in 1940 – this move served as a precursor for his Templeton Growth Fund that was launched in 1954. How successful was Templeton’s fund? So successful that an initial $10,000 investment made at the fund’s 1954 inception would have compounded into $2 million in 1992 (translating into a +14.5% annual return) when Templeton’s company was sold to Franklin Resources Inc. (BEN) for $913 million.
Mixing Religion & Science
But this pioneer of global investing didn’t stop after accumulating big bucks from all his investments. His pursuit for investment divinity was coupled with a thirst for spiritual knowledge. In 1987 he established the Templeton Foundation, which grew total assets to well north of $1 billion in the 2000s. The mission of the Templeton Foundation was to reconcile science and religion. Here is what Templeton had to say about the foundation:
“We are trying to persuade people that no human has yet grasped 1% of what can be known about spiritual realities. So we are encouraging people to start using the same methods of science that have been so productive in other areas, in order to discover spiritual realities.”
Going Against the Tide
Central to Templeton’s contrarian investment philosophy was to purchase superior stocks at cheap prices at points of “maximum pessimism.” Like a lot of excellent investors, Templeton was never afraid to go against the tide and make big bets.
In the 1960s, Templeton held more than 60% of his fund’s assets in Japan. More than three decades later he was astute enough to recognize the tech bubble in 1999 and to profit from this trend by shorting the tech sector. He famously predicted that 90% of the new internet companies would go bankrupt within five years.
Templeton’s Tutelage
Although Sir John Templeton is no longer with us, he has left numerous books and writings that investors of all shapes and sizes can draw upon. One of the best distilled pieces of knowledge distributed by Templeton is his 22 investment maxims.
1.) For all long-term investors, there is only one objective-“maximum total real return after taxes.”
2.) Achieving a good record takes much study and work, and is a lot harder than most people think.
3.) It is impossible to produce a superior performance unless you do something different from the majority.
4.) The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.
5.) To put “Maxim 4” in somewhat different terms, in the stock market the only way to get a bargain is to buy what most investors are selling.
6.) To buy when others are despondently selling and to sell what others are greedily buying requires the greatest fortitude, even while offering the greatest reward.
7.) Bear markets have always been temporary. Share prices turn upward from one to twelve months before the bottom of the business cycle.
8.) If a particular industry or type of security becomes popular with investors, that popularity will always prove temporary and, when lost, won’t return for many years.
9.) In the long run, the stock market indexes fluctuate around the long-term upward trend of earnings per share.
10.) In free-enterprise nations, the earnings on stock market indexes fluctuate around the book value of the shares of the index.
11.) If you buy the same securities as other people, you will have the same results as other people.
12.) The time to buy a stock is when the short-term owners have finished their selling, and the time to sell a stock is often when the short-term owners have finished their buying.
13.) Share prices fluctuate more widely than values. Therefore, index funds will never produce the best total return performance.
14.) Too many investors focus on “outlook” and “trend.” Therefore, more profit is made by focusing on value.
15.) If you search worldwide, you will find more bargains and better bargains than by studying only one nation. Also, you gain the safety of diversification.
16.) The fluctuation of share prices is roughly proportional to the square root of the price.
17.) The time to sell an asset is when you have found a much better bargain to replace it.
18.) When any method for selecting stocks becomes popular, then switch to unpopular methods. As has been suggested in “Maxim 3,” too many investors can spoil any share-selection method or any market-timing formula.
19.) Never adopt permanently any type of asset, or any selection method. Try to stay flexible, open-minded, and skeptical. Long-termy changing from popular to unpopular the types of securities you favor and your methods of selection.
20.) The skill factor in selection is largest for the common-stock part of your investments.
21.) The best performance is produced by a person, not a committee.
22.) If you begin with prayer, you can think more clearly and make fewer stupid mistakes.
Sir John Templeton lived a rich life of many interests spanning investments, science, and religion. Applying a few points of this investor of the 20th century can only improve your results.
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 BEN, 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.
Spoonfuls of Investment Knowledge
When it comes to investment advice, I’m a sucker for good quotes, so it should come as no surprise that I am highlighting some rousing material I stumbled upon from a 1978 Financial Analyst Journal article written by Gary Helms (Toward Bridging the Gap). Helms is a Wall Street veteran who managed major mutual funds in the 1970s, the research department for Loeb Rhoades & Co. in the 1980s, and the University of Chicago’s endowment in the 1990s. In an attempt to codify conventional investment wisdom he learned in his career, he established the Helms Ultimate Truths (HUT) system, which cataloged the tenets of real world investment wisdom consistent with practical experience. In order to satisfy the numerical needs of quant-jocks programming for an investment Holy Grail, Helms spoon-feeds readers with a list of tenets – each truth has a nine-digit HUT code attached (with tongue firmly in Helms’s cheek). Here is a partial list of my conventional wisdom favorites bundled into categories that I organized:
Hodgepodge Truisms
“Never confuse brilliance with a bull market.”
“You can’t spend relative performance.”
“If anybody really knew, they wouldn’t tell you.”
“None of the old rules work anymore, but then they never did.”
“When everybody likes a stock, it must go down; when nobody likes a stock, it may go up.”
“You never understand a stock until you’re long (or short).
“A penny saved will depreciate rapidly.”
“Chart breakouts don’t count if your own buying does it.”
“The new high list will do better in the subsequent six months than the new low list will.”
Common Sense Commandments
“In a bull market, be bullish.”
“Two things cause a stock to move – the expected and the unexpected.”
“The stock doesn’t know you own it.”
“The market will fluctuate.”
“A portfolio that goes down 50 per cent and comes back 50 percent is still down 25 per cent.”
“An outstanding portfolio always contains an outstanding stock.”
Numerical Rules of Thumb
“You can be 200 per cent wrong when you switch.”
“Money management is 10 per cent inspiration and 90 per cent perspiration.”
“More stocks double than go to zero.”
“The market is a random walk up a 9.3 per cent grade.”
“Nobody has been right three times.”
“Turnarounds take seven years.”
“The bottom is always 10 per cent below your worst case expectation.”
“If you have a great thought and write it down, it will look stupid 10 hours later.”
“If the idea is right, eighths and quarters won’t matter.”
Principles of Selling
“Sell the stock when it runs off the top (or bottom) of the chart.”
“Sell down to your sleep point.”
“Sell the stock when the company announces a new corporate headquarters.”
“Sell when the research file gets full.”
“Sell your losers and let your runners run.”
Investment Management Realities
“The best thing about money management is that it’s indoor work with no heavy lifting.”
“A good portfolio manager never asks a question unless he knows the answer.”
“The first word in analyst is anal.”
“A bright and energetic guy can make all the mistakes in this business in five years, but fools and sluggards can take a lifetime.”
“Analysts write long research reports when they don’t have time to write short ones.”
“Someone will always have a better record.”
“The trouble with managing money is that everybody once made a successful investment.”
“Every time a trade is made, somebody was wrong.”
“Don’t apologize for acting on your instincts if you’ve spent years developing them.”
“Be long term but watch the ticks.”
“You’ll never know who your friends are until you’ve had two bad years in a row.”
“A guy who likes a stock but doesn’t own it has no right to an opinion.”
Ha-Ha Truths
“Bulls make money and bears make money, but pigs get swine flu.”
“The truth will set you free, but Scotch isn’t bad either.”
“Babe Ruth once led the league in strikeouts.”
“Trust everybody but cut the cards.”
“You can’t kiss all the girls.”
“Get caught bluffing once a night.”
“There is more than one way to skin a cat, and six ways to roll a seven.”
Economic Truths
“Cyclic stocks should be bought when their multiples are high and sold when their multiples are low.”
“Growth will bail you out – if you live long enough.”
“All growth is temporary.”
“Half of your portfolio is cyclic, but you don’t know which half.”
“Own West Coast companies in bull markets, Boston companies in bear.”
Helms’s rules can be very helpful, but I think heeding his advice provided in HUT #: 272451-79-9, “All generalizations are false, including this one,” is an important truth. As you can tell from the abbreviated but extensive list, these spoonfuls of investment gems can be both playfully messy and informatively tasty.
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 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.
6 Traits of a Winning Aggressive Investor
“Winning” means different things to different people, including Charlie Sheen. As I have stated in the past, there is a diverse set of strategies to win in the investment business, much like there are numerous paths to enlightenment among the extensive choices of religions. Regardless of the differences, followers of a strategy or religion generally believe their principles will lead them to prosperity (financial and/or spiritual). One specific flavor of investment religion follows a path of aggression, which Douglas Bellemore describes in his book The Strategic Investor, published in 1963.
Modern finance and textbooks teach us the virtues and powers of diversification, but Bellemore has learned from the school of Warren Buffett, who stated, “Put all your eggs in one basket and then watch that basket very carefully.” Buffett also believes, “Diversification is protection against ignorance.” It’s no surprise that Buffett’s partner Charlie Munger also harbors some skepticism on the topic, “Wide diversification, which necessarily includes investment in mediocre businesses, only guarantees ordinary results.”
Bellemore’s Big 6
In his book, Bellemore builds upon this bold, concentrated strategy that he taught at New York University for four decades. He believed there are six basic traits necessary for a successful aggressive investor. Here is a synopsis of the characteristics:
1) Patience: Bellemore explains that success in the investment world does not come overnight, and much of the same thought processes necessary to prosper can be found in the in corporate management world.
“Success depends, in large measure, on the ability to select undervalued situations not presently recognized by the majority of investors and to wait for expected developments to provide capital gains which may only come after several years… Many of the personal qualities for successful business management are the same as those for an aggressive investor.”
2) Courage: When it comes to investments, hiding in a cave will not get you very far. On the topic of courage, Bellemore believed:
“The investor must have solid convictions and the courage and confidence emanating from them –that is, courage, at times, to ignore those who disagree…It is this willingness to differ and accept responsibility that distinguishes the top executive and the top investor.”
3) Intelligence: One need not be a genius to be a successful investor, according to Bellemore, but common sense is much more important:
“Many highly intelligent investors have had poor investment records because they lacked common sense, i.e., the down-to-earth, practical ability to evaluate a situation.”
4) Emotional Stability: Bellemore acknowledges the similarities of this trait to patience but emotional stability encompasses a broader context. Here he describes the necessary trait of emotional stability:
“It is needed to prevent the investor from being engulfed in waves of optimism and pessimism that periodically sweep over Wall Street. Moreover, it is required to separate the facts from the entangled web of human emotions.”
5) Hard Work: Ignorance is not an asset in the investment business, therefore in order to become a successful investor it requires hard work. Bellemore underscores the following:
“[An investor] must be knowledgeable about the company in which he considers making an investment, the industry, the position of the company in the industry, and the place and future of that industry in the economy as a whole.”
6) Willingness to Sacrifice Diversification: By definition, Bellemore asserts outsized gains cannot be achieved with diversification:
“Although wide diversification reduces risks by offsetting mediocre selections with good ones, it also reduces substantially the profit or capital gain potential of a portfolio.”
Bellemore acknowledges aggressive investing is not for everyone, and if the six tenets are not followed, the unqualified investor would be much better off by following a conservative, diversified investment approach. The cost of the conservative path, however, is the potential of winning outsized returns. If winning is a priority for you, and your goal is to achieve outperformance, then you and Charlie Sheen would be in agreement to follow Douglas Bellemore’s six traits of an aggressive investor.
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 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.
Reality More Fascinating than Fiction
Make-believe is fun, but reality is often more fascinating than fiction. The same can be said for the books I read. Actually, all the books reviewed at Investing Caffeine have been non-fiction. My movie-viewing preferences happen to be quite similar – comedies and dramas are terrific, but I’m also a documentary fanatic. As a matter of fact, I have rented or watched more than 125 documentaries (and mockumentary, This is Spinal Tap) over the last six years.
There have been a slew of non-fiction books written about the recent global financial crisis, including the ones I reviewed: Too Big to Fail, The Greatest Trade Ever, and The Big Short. When it comes to videos, I have seen several TV-based documentaries covering various aspects of the global meltdown, but the Inside Job did an exceptionally good job of providing a global perspective of the financial collapse. The film was produced, written, and directed by Charles Ferguson (you can call him “doctor” thanks to the Ph.D he earned at MIT) and also narrated by Academy Award winner Matt Damon. The Inside Job provided a comprehensive worldly view by filming on location in the United States, Iceland, England, France, Singapore, and China. Not only did Ferguson break down the complex facets of the crisis into easily digestible pieces for the audience, but he also features prominent journalists, politicians, and academics who describe the complicated global events from a birds-eye view. Hedge fund manager George Soros, former Federal Reserve Chairman Paul Volcker, former New York Governor Eliot Spitzer, and economist Nouriel Roubini, are a small subset of the heavy-hitters interviewed in the movie.
A wide range of causes and effects were explored – everything from derivatives, lack of regulation, excessive banker compensation, and the pervasive conflicts of interest throughout the financial system. Bankers and politicians shoulder much of the blame for the global crisis, and Ferguson does not go out of his way to present their side of the story. Ferguson does a fairly decent job of keeping his direct personal political views out of the film, but based on his undergraduate Berkeley degree and his non-stop Goldman Sachs (GS) bashing, I think someone could profitably prevail in wagering on which side of the political fence Ferguson resides.
Although I give Inside Job a “thumbs-up,” I wasn’t the only person who liked the movie. The Inside Job in fact won numerous awards, including the 2010 Academy Award for Best Documentary, Best Documentary from the New York Film Critics Circle, and the Best Documentary Screenplay from the Writers Guild.
Slome’s Oscar Nominees
As I mentioned previously, I am somewhat fanatical when it comes to documentaries, although I have yet to see Justin Bieber’s Never Say Never. Besides the Inside Job, here is a varied list of must-see documentaries. There may be a conflict of personal tastes on a few of these, but I will provide you a hand-written apology for anybody that falls asleep to more than one of my top 15:
1) Murderball
5) Hoop Dreams
6) Lewis and Clark: The Journey (Ken Burns)
8) Enron: The Smartest Guys in the Room
10) Paradise Lost
11) The Endurance
14) The Devil Came on Horseback
15) Emmanuel’s Gift
I’m obviously biased about the quality of my recommended documentaries, but you can even the score by sharing some of your favorite documentaries in the comment section below or by emailing me directly. I will be greatly indebted for any suggestions offered. Regardless, whether watching a truth-revealing thought-piece like the Inside Job or A Crude awakening, or an inspirational story like Murderball or Touching the Void, I’m convinced that these reality based stories are much more fascinating than the vast majority of recycled fiction continually shoveled out by Hollywood. For those adventurous movie-watchers, check out a documentary or two – who knows…there may be an inner-documentary fanatic in you too?
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 GS, 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.
Rebuilding after the Political & Economic Tsunami
Excerpt from Free April Sidoxia Monthly Newsletter (Subscribe on right-side of page)
The Start of the Arab Uprising
The Arab uprising grew its roots from an isolated and disgraced Tunisian fruit vendor (26- year-old Mohammed Bouazizi) who burned himself to death in protest of the persistent, deep-seeded corruption prevalent throughout the government (view excellent 60 Minutes story on Tunisia uprising). The horrific death ultimately led to the swift removal of Egypt’s 30-year President Hosni Mubarak, whose ejection was spurred by massive Facebook-organized protests. Technology has flattened the world and accelerated the sharing of powerful ideas, which has awoken Arab citizens to see the greener grass across other global democratic nations. Facebook, Twitter, and LinkedIn can be incredible black-holes of productivity destroyers (I know firsthand), but as recent events have proven, these social networking services, which handle about 1 billion users globally, can also serve valuable purposes.
As the flames of unrest have been fanned across the Middle East and Northern Africa, autocratic dictators haven’t had the luxury of idly sitting on their hands. Instead, these leaders have been pushed to relent to the citizens’ wishes by addressing previously taboo issues, such as human rights, corruption, and economic opportunity. These fresh events feel like new-found changes, but these major social tectonic shifts have been occurring throughout history, including our lifetimes (e.g., Tiananmen Square massacre and the fall of the Berlin Wall).
Good News or Bad News?
Recent headlines have created angst among the masses, and the uncertainty has investors asking a lot of questions. Besides radioactive concerns in both Japan and the Middle East (one actual, one figurative), the “worry list” of items continues to stack higher. Oil prices, inflation, the collapsing dollar, exploding deficits, a China bubble, foreclosures, unemployment, quantitative easing (QE2), mountainous debt, 2012 elections, and the end of the world among others, are worries crowding people’s brains. Incredibly, somehow the market still manages to grind higher. More specifically, the Dow Jones Industrial Average has climbed a very respectable +6.4% for 2011.
With the endless number of worries, how on earth could the major market indexes still advance, especially after a doubling in value from 24 months ago? For one, these political and economic shocks are nothing new. History has shown us that democratic, capitalistic markets ultimately move higher in the face of wars, assassinations, banking crises, currency crises, and various other stock market frauds and scandals. I’m willing to go out on a limb and say these worrisome events will continue this year, next year, and even over the next decade.
Most baby boomers living in the early 1980s remember when 30-year mortgage rates on homes reached 18.5%, inflation hit 14.8%, and the Federal Funds interest rate peaked near 20%. Boomers also survived Vietnam, Watergate, the Middle East oil embargo, Iranian hostage crisis, 1987 Black Monday, collapse of the S&L banks, the rise and fall of the Cold War, Gulf War I/II, yada, yada, yada. Despite all these cataclysmic events, from the last birth of the Baby Boomers (1964), the Dow Jones Industrial catapulted from about 890 to 12,320. This is no April Fool’s joke! The market has increased a whopping 14-fold (without dividends) in the face of all this gruesome news. You won’t find that story on the front-page of The Wall Street Journal.
Lost Decade Goes on Sale
The gains over the last four and half decades have been substantial, but much more is said about the recent “Lost Decade.” Although it has generally been a lousy decade for most investors in the stock market, eventually the stock market follows the direction of profits. What the popular press negates to mention is that S&P 500 operating earnings have more than doubled from about $47 in 1999 to an estimated $97 in 2011. Over the same period, the price of the market has been chopped by more than half (i.e., the Price – Earnings multiple has been cut from 29x to 13.5x). With stocks selling at greater than -50% off from 1999, no wonder smart investors like Warren Buffett are buying America – Buffett just spent $9 billion in cash on buying Lubrizol Corp (LZ). Retail investors absolutely loved stocks in 2000 at the peak, believing there was virtually no risk. Now the tables have been turned and while stock prices are trading at a -50% discount, retail investors are intensely skeptical and nervous about the prospects for stocks. Shoppers don’t usually wait for prices to go up 30% and then say, “Oh goody, prices are much higher now, so I think I will buy!” but that is what they are saying now.
I don’t want to oversell my enthusiasm, because the deals were dramatically better in March of 2009. Hindsight is 20-20, but at the nadir of the stock market, stock prices traded at bargain basement levels of 7x times 2011 earnings. We may not see opportunities like that again in our lifetime, so sitting in cash may not be the most advisable positioning.
Although I would argue every investor should have some exposure to equities, an investor’s time horizon, objectives, constraints and risk tolerance should be the key determinants of whether your investment portfolio should have 5% equity exposure or 95% exposure.
So while the economic and political dominoes may appear to be tumbling based on the news du jour, don’t let the headlines and the so-called media pundits scare you into paralysis. Bad news and tragedy will continue, but fortunately when it comes to prosperity, history is on our side. As you attempt to organize and pickup the financial pieces of the last few years, make sure you have a disciplined, long-term investment plan that adapts to changing market and personal 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 LZ, Facebook, Twitter, LinkedIn, BRKA/B, 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.
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