Posts filed under ‘Education’
Are you a value investor? If you said “yes,” how would you feel about buying an $18 stock with a P/E (Price/Earnings) ratio of greater than 100x and a Price/Sales ratio of 14x for a company that three years earlier was started in a garage? This may not sound like a value stock, but had you bought this stock at the initial public offering (IPO), it would have been a screaming bargain – priced at less than 1x P/E ratio, based on this year’s earnings estimates.
You may be surprised to know, this company with a meager $18 IPO share price is now worth $9,192 per share today (if you adjust for three stock splits)! Yes, that’s correct, a +50,900% return. If you are wondering to which stock I’m referring, I am talking about Amazon.com Inc. (AMZN). Incredibly, ever since Amazon went public in 1997, the CEO Jeff Bezos has managed to command the start-up e-commerce company from $31 million in revenues to $121 billion (with a “b”) on an annual basis in 2016 (a +389,000% increase).
Discovering the next IPO that turns into a $363 billion behemoth is easier said than done, and unfortunately these types of companies are a rare breed. Even if you are lucky enough to identify these diamonds-in-the-rough, early in their growth cycle, very few investors have the fortitude and discipline to continually own the stocks through the perpetual volatility (i.e., peaks and valleys).
The good news is, although you may be unable to find every unicorn out there, you can still apply the same principles and characteristics to any growth stock you invest in. In order to prudently achieve outsized returns, one must identify innovative market leaders that have gained some type of sustainable competitive advantage, which will serve as the profit and cash flow growth engine for the stock over the long-term.
If a company does not have a unique advantage over industry competitors, they will likely be unable to compound earnings growth – the key to becoming a big winner. Albert Einstein, Nobel Prize winner is credited with identifying compounding as the “eighth wonder of the world,” and without compounding there will be no gigantic results.
Amazon may be a rare breed, but there are plenty of other examples of so-called “expensive” stocks that get dismissed or fall through the cracks as they explode in value to the stratosphere. Consider Starbucks Corp. (SBUX), which at the time of its IPO in 1992 was priced at a very rich P/E of 52x. Sound expensive? Actually, this was a greatest offer in a generation. Adjusted for stock splits, the IPO shares were valued at $0.27 – in the most recent trading session Starbucks shares closed at $55.90, a +20,600% increase. Similar to Amazon, had you purchased Starbucks shares at the IPO price, you would have been paying less than a measly, eye-popping 1x P/E ratio based on 2016 earnings.
Alphabet Inc. (GOOGL), formerly Google Inc., is another case of growth stock appearing pricey on the outside, but really a value of a lifetime on the inside. The hype surrounding the Google IPO was so palpable in 2004, the stock priced at a relatively nose-bleed level of 60x P/E level, approximately. The unconventional auction bidding method to buy the initial shares made investors even more skeptical. Suffice it to say, the greater than +1,600% gain has once again shown that investors can reap handsome rewards, if they do thorough enough due diligence and ignore the illusory big ticket IPO prices.
What most investors fail to realize is that P/E ratios are temporary. By purchasing a growth stock, the numerator of the P/E ratio (price) becomes static or fixed. As earnings of a growth company expand, the stock becomes cheaper by the day. More specifically, the numerator of the P/E (price) is flat, while the denominator (earnings) grows, thereby making the P/E ratio smaller (cheaper). And as you can see from the few previous examples I have provided, if you are able to identify winners, and hold them long enough, you will eventually realize the initial hefty price tag at purchase will be considered almost free after all the earnings compounding.
Legendary growth investor Peter Lynch summed it up concisely when he noted, “People concentrate too much on the P, but the E really makes the difference.” Lynch goes on to highlight the importance of patience in growth investing because stocks often go down or move sideways for long periods of time before dramatic increases occur:
“My best stocks performed in the 3rd year, 4th year, 5th year, not in the 3rd week or 4th week.”
I’ve illustrated a few successful examples of meteoric growth stocks, but more importantly the misconception many investors place on the current P/E ratio. There still is no substitute for hard-nosed, detailed fundamental research for finding big growth winners, because true growth stocks bought and held for a long enough period, will become cheaper by the day. If you don’t have the time, discipline, or patience to execute this winning strategy, find and hire an experienced investment manager who understands these concepts.
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), AMZN, and GOOGL, but at the time of publishing had no direct position in SBUX, 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.
Will you be able to retire, and what impact will the elections have on your financial future? Answering these questions can be a scary endeavor. And unless you have been living in a cave, you may have noticed we are in the middle of a heated U.S. presidential election campaign between Donald Trump and Hillary Clinton. Regardless of which side of the political fence you stand on, the prospects of your retirement are much more likely to be impacted by your personal actions than by the actions of Washington politicians.
Even if you despise politics and were living in a cave (with WiFi access), there’s a high probability you would be overloaded with detailed and dogmatic online editorials from overconfident Facebook friends. Besides offering self-assured predictions, these impassioned political pleas generally itemize the top 10 reasons your favorite candidate is a moron, and another 10 reasons why their candidate is the greatest.
Your friends’ opinions may have pure intentions, but unfortunately, rarely, if ever, do their thoughts alter your views. A reference from a recent Legal Watercooler article summed it up best:
“Political Facebook rants changed my mind…said nobody, ever.”
Nearly as ineffectual as political Facebook opinions on your politics is the ineffectual influence of presidential elections on your finances. For example, over the last four decades, stock prices have gone up and down during both Republican and Democrat presidential terms. The picture looks much the same, if you analyze the fiscal performance of conservatives and liberals since 1970 – debt burdens as a percentage of economic output have risen and fallen under both political parties. No matter who wins the presidency, many investors forget the ability of that individual to affect change is highly dependent upon the political balance of power in Congress. If Congress holds a split majority in the House and Senate, or the opposition party commands the entire Congress, then the winning presidential candidate will be largely neutered.
Rather than panic over a political loss or celebrate a candidate’s victory, here are some tangible actions to improve your finances:
- Organize. Typically individuals have investment and saving accounts scattered with no cohesive accounting or strategy. Get your financial house in order by gathering and organizing all your accounts.
- Budget. Spend less than you take in. Or in other words…save. You can achieve this goal in one of two ways – cut your spending, or increase your income.
- Create a Plan. When do you plan to retire? How much money do you need for retirement? What asset allocation and risk profile should you adopt to meet your financial goals?
If you have difficulty with any of these actions, then meet with an experienced financial professional to assist you.
Politics can trigger very emotional responses. However, realizing your actions have a much more direct impact on your finances than political Facebook rants and temporary elections will benefit you in achieving your long-term financial goals.
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 and FB, but at the time of publishing 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.
Investing comes in many shapes and sizes. And like religion (see Investing Religion article), most investment strategies are built on the essential belief that following certain rules and conventions will eventually lead to profit enlightenment. When it comes to technical analysis (TA), a discipline used with the principal aim of predicting future prices from past patterns, some consider it a necessity for making money in the market. Others, regard the practice of TA as a pseudoscience, much like astrology.
I feel there is a proper place for TA on selective basis, which I will describe later, but for the most part I agree with some of the legendary investors who have chimed in on the subject:
Warren Buffett: “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.”
Peter Lynch: “Charts are great for predicting the past.”
Technical Analysis Linguistics
Fundamental analysis, the antithesis of technical analysis, strives to predict future price direction by analyzing facts and data surrounding a company, industry, and/or economy. It too comes with its own syntax and versions, for example: value, growth, top-down, bottom-up, quantitative, etc.
I do not claim to be a TA expert, however in my many years of investing I have come across a smorgasbord of terms and flavors surrounding the discipline. Describing and explaining the density of material surrounding TA would encompass too large of a scope for this article, but here are some prevalent terms one should come to grips with if you want to become a technical analysis guru:
Technical Analysis Approaches
- Elliot Wave
- Relative strength / Momentum (see Momentum Investing article)
- MACD (Moving Average Convergence / Divergence)
- Fibonacci retracement
- Dow Theory
- Bollinger bands
- Head and shoulders
- Double bottom
- Cup and handle
- Pivot points
- Dead cat bounce (my personal favorite)
Each of these patterns are supposes to provide insight into the future direction of price. At best, I would say the academic research surrounding the subject is “inconclusive,” and at worst I’d say it’s considered a complete “sham.”
The Lob Wedge
As I’ve stated earlier, I fall in the skeptical camp when it comes to TA, since fundamental analysis is the main engine I use for generating and tracking my investment ideas. For illustrative purposes, you may consider fundamental analysis as my group of drivers and irons. I do, however, utilize selective facets of TA much like I use a lob wedge in golf for a limited number of specific situations (e.g., shots over high trees, downhill lies, and fast greens). When it comes to trading, I do believe there is some value in tracking the relationship of extreme trading volume (high or low), especially when it is coupled with extreme price movement (high or low). The economic laws of supply and demand hold true for stock trades just as they do for guns and butter, and sharp moves in these components can provide insights into the psychological mindset of investors with respect to a security (or broader market). Beyond trading volume, there are a few other indicators that I utilize as part of my trading strategies, but these tactics play a relatively minor role, since most of my core positions are held on a multi-year time horizon.
Overall, there is a stream of wasteful noise, volatility, and misinformation that permeates the financial markets on a daily basis. A major problem with technical analysis is the many false triggered signals, which in many cases lead to excessive trading, transaction costs, and ultimately subpar investment returns. Although I remain a skeptic on the subject of technical analysis and I may not read my horoscope today, I will continue to keep a lob wedge in my golf bag with the hopes of finding new, creative ways of using it to my advantage.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own exchange traded funds and various securities, including BRK.B, but at time of publishing had no direct position in BRK.A or any company mentioned 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.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (July 1, 2016). Subscribe on the right side of the page for the complete text.
What Just Happened?
Breakups are never easy, especially when they come as a surprise. That’s exactly what happened with last week’s “Brexit” (British exit) referendum results. History was made when 51.9% of the United Kingdom (U.K.) voters from England, Scotland, Wales and Northern Ireland cast their vote to divorce (“Leave”) their country from the European Union (EU). In the end, the 48.1% of U.K. voters could not generate enough support to “Remain” in the EU (see chart below). Despite torrential downpours in southern Britain, voter turnout was extraordinarily high, as 72% of the 46.5 million registered voters came out in full force to have their voices heard.
Divorce is never cheap, and UK Prime Minister David Cameron paid the ultimate price with his defeat in the Brexit referendum…the loss of his job. Immediately following the release of the referendum results, Cameron, the British Prime Minister since 2010 and leader of the Conservative Party, immediately announced his resignation, effective no later than October 2016 after the selection of his successor.
One of the reasons behind the shock of the Brexit Leave decision is the longstanding relationship the U.K. has had with the EU. European Union membership first began in 1957 with Belgium, France, Germany, Italy, Luxembourg, and Netherlands being the founding countries of this new political-economic union.
A few decades later, the U.K. officially joined the EU in 1973 with Ireland and the Denmark, shortly before Margaret Thatcher came into power. If you fast forward to today, some 43 years after U.K. originally joined the EU, the Brexit decision represents the largest turning point in European political history. Not since the 1989 falling of the Berlin Wall and the subsequent demise of the Cold War in the Soviet Union has such a large, earth-moving political shift occurred.
Today, there are 28 member countries in the EU with Croatia being the newest member in 2013. Despite the Brexit outcome, there still is a backlog of countries wanting to join the EU club, including Turkey, Serbia, Albania, and Montenegro (and this excludes Scotland, which has voiced an interest in leaving the U.K. for the EU).
What Were Investors’ Reactions?
Financial markets around the world were caught off guard, given many pre-referendum polls were showing the Remain camp with a slight edge, along with British betting parlors that were handicapping an overwhelming victory for the Remain camp. Here’s a summary of stock market reactions around the globe from June 23rd to June 30th:
U.S. (S&P 500): -0.7%
U.K. (FTSE 100): +2.6%
Japan (Nikkei): -4.1%
Germany (DAX): -5.6%
Hong Kong (Hang Seng): +0.4%
China (Shanghai): +1.3%
India (BSE): -0.0%
Surprisingly, modest monthly gains achieved in the S&P 500 prior to the Brexit vote (up +0.8%) were quickly pared after the results came in but remained positive for the entire month (up +0.1%). For the year, U.S. stocks are up a limited +2.7%, which isn’t too bad considering investors’ current mood.
Stocks were not the only financial market disrupted after the Brexit announcement, foreign exchange currency rates were unstable as well. The British pound dived to a 30-year low shortly after the vote to a level of approximately $1.33/£, and was down more than -10% on the day of the announcement (see chart below). UK banks like Barclays PLC (BCS) and Lloyds Banking Group PLC (LYG) also saw their share prices significantly pressured as EU regulatory risks of losing access to European customers and negative global interest rates further squeeze the banks’ profit margins.
To put the currency picture into perspective, the value of the British pound ($2.64/£) peaked in March 1972 at a rate about double the U.S. dollar today. On the positive side of the ledger, a weaker British pound could help boost exports and vacation time to Stonehenge or London, but there is also a risk for a spike of inflation (or stagflation) on the country’s roughly $740 billion in imports (e.g., food, energy, and raw materials).
Source: Calafia Beach Pundit
Why Did it Happen?
While economically prosperous regions like London and Scotland voted heavily for Remain, the message for change of the Leave camp resonated well with working class towns and rural areas of England (seen here). Besides a geographic split, there was also a demographic divide between voters. As you can see from the YouGov poll below, the majority of younger citizens overwhelmingly voted for Remain, and vice versa for older citizens as it relates to the Leave vote.
18-24: 75% Remain
25-49: 56% Remain
50-64: 44% Remain
65+: 39% Remain
While geography and demographics certainly played a key role in the outcome of the EU Leave referendum result, at the core of the movement also was a populist discontent with immigration and the negative economic consequences created by globalization. There are many reasons behind the sluggish economic global recovery, even if the U.S. is doing best out of the developed countries, but rightly or wrongly, immigration policies and protectionism played a prominent part in the Brexit.
At the heart of the populist sentiment of lost control to Brussels (EU) and immigration is the question of whether the benefits of globalization have outweighed the costs. The spread of globalization and expanded EU immigration has disenfranchised many lower skill level workers displaced by eastern European immigrants, Syrian refugees and innovative solutions like automated machinery, software, and electronic equipment. Economic history clearly shows the answer to the effectiveness of globalization is a resounding “yes”, but the post-financial crisis recovery has been disappointingly sluggish, so a component of the populist movement has felt an urgency to find a scapegoat. The benefits of globalization can be seen in the chart below, as evidenced by the increases in per capita GDP of the UK relative to Germany and France, after joining the EU in 1973. Many observers are quick to identify the visible consequences of globalization (i.e., lower-paying job losses), but fail to identify the invisible benefits (i.e., productivity, lower prices, investment in higher-paying job gains).
Source: The Wall Street Journal
What happens next?
While some EU leaders want to accelerate the Brexit transition, in actuality, this will require a long, drawn-out negotiation process between the still-unnamed new UK Prime Minister and EU officials. The complete EU-Brexit deal will take upwards of two-years to complete, once Article 50 of the EU Lisbon Treaty has been triggered – likely in October.
In light of the unchartered nature of the Brexit Leave vote, nobody truly knows if this decision will ultimately compromise the existential reality of the EU. Time will tell whether Brexit will merely be a small bump on the long EU road, or the beginning of a scary European domino effect that causes the 28 EU country bloc to topple. If the U.K. is successful in negotiating EU trade agreements with separate European countries, the Brexit even has a longer-term potential of benefiting economic activity. Regardless of the EU outcome, the long-term proliferation of capitalism and democracy is likely to prevail because citizens vote with their wallets and capital goes where it is treated best.
What does Brexit Mean for Global Markets?
The short answer is not much economically, however there have been plenty of less substantial events that have roiled financial markets for relatively short periods of time. There are two basic questions to ask when looking at the economic impact of Brexit:
1) What is the Brexit impact on the U.S. economy?
If you objectively analyze the statistics, U.S. companies sold approximately $56 billion of goods to the U.K. last year (our #7 trading partner). Even if you believe in the unlikely scenario of a severe U.K. economic meltdown, the U.K. trade figure is a rounding error in the whole global economic scheme of things. More specifically, $56 billion in trade with the U.K. equates to about .003 of the United States’ $18+ trillion GDP (Gross Domestic Product).
2) What is the Brexit impact on the global economy?
The U.K.’s GDP amounts to about $3 trillion dollars. Of that total, U.K. exports to the EU account for a reasonably insignificant $300 billion. As you can see from the chart below, $300 billion in UK exports to the EU are virtually meaningless and coincidentally equate to about .003 of the world’s $78 trillion estimated GDP.
Source: The National Archives
What to Do Next?
Like many divorces, the U.K. Brexit may be messy and drawn out, until all the details are finalized over the next couple years. It’s important that you establish a strong foundation with your investments and do not divorce the sound, fundamental principles needed to grow and preserve your portfolio. As is usually the case, panicking or making an emotional decision relating to your investments during the heat of some geopolitical crisis rarely translates into an optimal decision over the long-run. As I repeatedly have advised over the years, these periods of volatility are nothing new (see also Series of Unfortunate Events).
If you catch your anxiety or blood pressure rising, do yourself a favor and turn off your TV, radio, or electronic device. A more productive use of time is to calmly review your asset allocation and follow a financial plan, with or without the assistance of a financial professional, so that you are able to achieve your long-term financial goals. This strategy will help you establish a more durable, long-lasting, and successful marriage with your investments.
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 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.
Markets are efficient. Individuals behave rationally. All information is reflected in prices. Huh…are you kidding me? These are the beliefs held by traditional free market economists (“rationalists”) like Eugene Fama (Economist at the University of Chicago and a.k.a. the “Father of the Efficient Market Hypothesis”). Striking blows to the rationalists are being thrown by “behavioralists” like Richard Thaler (Professor of Behavioral Science and Economics at the University of Chicago), who believes emotions often lead to suboptimal decisions and also thinks efficient market economics is a bunch of hogwash.
Individual investors, pensions, endowments, institutional investors, governments, were left sifting through the rubble in the aftermath of the 2008-2009 financial crisis because common beliefs were thrown out the window. Experts and non-experts are still attempting to figure out how this mass destruction occurred and how it can be prevented in the future. Economists, as always, are happy to throw in their two cents. Right now traditional free market economists like Fama have received a black eye and are on the defensive – forced to explain to the behavioral finance economists (Thaler et. al.) how efficient markets could lead to such a disastrous outcome.
Religion and Economics
Like religious debates, economic rhetoric can get heated too. Religion can be divided up in into various categories (e.g., Christianity, Islam, Judaism, Hinduism, Buddhism, and other), or more simply, religion can be divided into those who believe in a god (theism) and those who do not (atheism). There are multiple economic categorizations or schools as well (e.g., Keynsians, monetarists, libertarians, behavioral finance economists, etc.). Debates and disagreements across the rainbow of religions and economic schools have been going on for centuries, and the arrival and departure of the 2008-09 financial crisis further ignited the battle between the “behavioralists” (behavioral finance economists) and the “rationalists” (traditional free market economists).
Behavioral Finance on the Offensive
In the efficient market world of the “rationalists,” market prices reflect all available information and cannot be wrong at any moment in time. Effectively, individuals are considered human calculators that optimize everything from interest rates and costs to benefits and inflation expectations in every decision. What classic economists fail to account for are the emotional and behavioral flaws made by individuals.
Claiming financial market decisions are not impacted by emotions becomes more challenging to defend, if you consider the countless irrational anomalies occurring throughout history. Consider the following:
- Tulip Mania: Bubbles are nothing new – they have persisted for hundreds of years. Let’s reflect on the tulip bulb mania of the 1600s. For starters, I’m not sure how classic economists can explain the irrational exchanging of homes or a thousand pounds of cheese for a tulip bulb? Or how peak prices of $60,000+ in inflation-adjusted dollars were paid for a bulb at the time (C-Cynical)? These are tough questions to answer for the rationalists.
- Flash Crash: Seeing multiple stocks and Exchange Traded Funds (ETFs) temporarily plummet -99% in minutes is not exactly the sign of an efficient market. Stalwarts like Procter & Gamble also collapsed -37%, only to rebound minutes later near pre-collapse levels. All this volatility doesn’t exactly ooze with efficiency (see Making Millions in Minutes).
- Negative Interest Rates: Plenty of so-called pundits are arguing that equity markets are expensive, but what about the $8 trillion in negative interest rate bonds? Prices for many of these bonds are astronomical. Paying someone to take my money doesn’t make a lot of sense, but trillions in speculative investments are still being made today.
- Technology and Real Estate Bubbles: Both of these asset classes were considered “can’t lose” investments in the late 1990s and mid-2000s, respectively. Many tech stocks were trading at unfathomable values (more than 100 x’s annual profits) and homebuyers were inflating real estate prices because little-to-no money was required for the purchases.
- ’87 Crash: October 19, 1987 became infamously known as “Black Monday” since the Dow Jones Industrial Average plunged over -22% in one day (-508 points), the largest one-day percentage decline ever.
The ever-growing list of nonsensical anomalies only makes the rationalists’ jobs that much tougher in refuting the illogical behavior. Risk aversion has been alive and well in the post financial crisis environment as wild swings have resulted from a wide range of concerns, including: the U.S. debt downgrade; Arab Spring; potential Greek exit from the EU; Sequestration; Fed Taper Tantrum; Obamacare implementation; Russian invasion of Ukraine; Gaza conflict; Fukashima disaster; Ebola outbreak; Ferguson tensions; Paris/San Bernardino/Brussels terrorist attacks; China recessionary fears; oil price volatility; Mideast turmoil – ISIS expansion; Federal Reserve rate increases; and many other worries. Often, the human lizard brain is what leads to sub-optimal decision making. Maybe the rationalists can use the same efficient market framework to help explain to my wife why I ate a whole box of Twinkies in one sitting?
The growing list of market inefficiencies has given the rationalists a black eye, but they are not going down without a fight. Here are some quotes from Fama and fellow Chicago rationalist pals:
On the Crash-Related Attacks from Behavioralists: Behavioralists say traditional economics has failed in explaining the irrational decisions and actions leading up to the 2008-09 crash. Fama states, “I don’t see this as a failure of economics, but we need a whipping boy, and economists have always, kind of, been whipping boys, so they’re used to it. It’s fine.”
Rationalist Explanation of Behavioral Finance: Fama doesn’t deny the existence of irrational behavior, but rather believes rational and irrational behaviors can coexist. “Efficient markets can exist side by side with irrational behavior, as long as you have enough rational people to keep prices in line,” notes Fama. John Cochrane treats behavioral finance as a pseudo-science by replying, “The observation that people feel emotions means nothing. And if you’re going to just say markets went up because there was a wave of emotion, you’ve got nothing. That doesn’t tell us what circumstances are likely to make markets go up or down. That would not be a scientific theory.”
Description of Panics: “Panic” is not a term included in the dictionary of traditional economists. Fama retorts, “You can give it the charged word ‘panic,’ if you’d like, but in my view it’s just a change in tastes.” Calling these anomalous historic collapses a “change in tastes” is like calling American Idol judge Simon Cowell, “diplomatic.” More likely, what’s really happening is these severe panics are driving investors’ changes in preferences.
Throwing in White Towel Regarding Crash: Not all classic economists are completely digging in their heels like Fama and Cochrane. Gary Becker, a rationalist disciple, acknowledged the blind-siding of the 2008-2009 financial crisis when he admitted, “Economists as a whole didn’t see it coming. So that’s a black mark on economics, and it’s not a very good mark for markets.”
Settling Dispute with Lab Rats
The boxing match continues, and the way the behavioralists would like to settle the score is through laboratory tests. In the documentary Mind Over Money, numerous laboratory experiments are run using human subjects to tease out emotional behaviors. Here are a few examples used by behavioralists to bolster their arguments:
- The $20 Bill Auction: Zach Burns, a professor at the University of Chicago, conducted an auction among his students for a $20 bill. Under the rules of the game, as expected, the highest bidder wins the $20 bill, but as an added wrinkle, Burns added the stipulation that the second highest bidder receives nothing but must still pay the amount of the losing bid. Traditional economists would conclude nobody would bid higher than $20. See the not-so rational auction results here at minute 1:45.
- $100 Today or $102 Tomorrow? This was the question posed to a group of shoppers in Chicago, but under two different scenarios. Under the first scenario, the individuals were asked whether they would prefer receiving $100 in a year from now (day 366) or $102 in a year and one additional day (day 367)? Under the second scenario, the individuals were asked whether they would prefer receiving $100 today or $102 tomorrow? The rational response to both scenarios would be to select $102 under both scenarios. See how the participants responded to the questions here at minute 4:30.
Rationalist John Cochrane is not fully convinced. “These experiments are very interesting, and I find them interesting, too. The next question is, to what extent does what we find in the lab translate into how people…understanding how people behave in the real world…and then make that transition to, ‘Does this explain market-wide phenomenon?,’” he asks.
As I alluded to earlier, religion, politics, and economics will never fall under one universal consensus view. The classic rationalist economists, like Eugene Fama, have in aggregate been on the defensive and taken a left-hook in the eye for failing to predict and cohesively explain recurring market inefficiencies, including the financial crash of 2008-09. On the other hand, Richard Thaler and his behavioral finance buds will continue on the offensive, consistently swinging at the classic economists over this key economic mind versus money dispute.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in PG and certain exchange traded funds (ETFs), but at the time of publishing 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.
Do you love working 40-50+ hour weeks? Do you want to be a Wal-Mart (WMT) greeter after you get laid off from your longstanding corporate job? Do you love relying on underfunded government entitlements that you hope won’t be insolvent 10, 20, or 30 years from now? Are you banking on winning the lottery to fund your retirement? Do you enjoy eating cat food?
If you answered “Yes” to one or all of these questions, then do I have a sure-fire investment program for you that will make your dreams of retiring at age 90 a reality! Just follow these three simple rules:
- Buy Low Yielding, Long-Term Bonds: There are approximately $7 trillion in negative yielding government bonds outstanding (see chart below), which as you may understand means investors are paying to give someone else money – insanity. Bank of America recently completed a study showing about two-thirds of the $26 trillion government bond market was yielding less than 1%. Not only are investors opening themselves up to interest rate risk and credit risk, if they sell before maturity, but they are also susceptible to the evil forces of inflation, which will destroy the paltry yield. If you don’t like this strategy of investing near 0% securities, getting a match and gasoline to burn your money has about the same effect.
Source: Financial Times
- Speculate on the Timing of Future Fed Rate Hikes/Cuts: When the economy is improving, talking heads and so-called pundits try to guess the precise timing of the next rate hike. When the economy is deteriorating, aimless speculation swirls around the timing of interest rate cuts. Unfortunately, the smartest economists, strategists, and media mavens have no consistent predicting abilities. For example, in 1998 Nobel Prize winning economists Robert Merton and Myron Scholes toppled Long Term Capital Management. Similarly, in 1996 Federal Reserve Chairman Alan Greenspan noted the presence of “irrational exuberance” in the stock market when the NASDAQ was trading at 1,350. The tech bubble eventually burst, but not before the NASDAQ tripled to over 5,000. More recently, during 2005-2007, Fed Chairman Ben Bernanke whiffed on the housing bubble – he repeatedly denied the existence of a housing problem until it was too late. These examples, and many others show that if the smartest financial minds in the room (or planet) miserably fail at predicting the direction of financial markets, then you too should not attempt this speculative feat.
- Trade on Rumors, Headlines & Opinions: Wall Street analysts, proprietary software with squiggly lines, and your hot shot day-trader neighbor (see Thank You Volatility) all promise the Holy Grail of outsized financial returns, but regrettably there is no easy path to consistent, long-term outperformance. The recipe for success requires patience, discipline, and the emotional wherewithal to filter out the endless streams of financial noise. Continually chasing or reacting to opinions, headlines, or guaranteed software trading programs will only earn you taxes, transaction costs, bid-ask spread costs, impact costs, high frequency trading manipulation and underperformance.
Saving for your future is no easy task, but there are plenty of easy ways to destroy your savings. If you want to retire at age 90, just follow my three simple rules.
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 had no direct position in WMT or 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.
Returning readers to Investing Caffeine understand this is a location to cover a wide assortment of investing topics, ranging from electric cars and professional poker to taxes and globalization. Investing Caffeine is also a location that profiles great investors and their associated investment lessons.
Today we are going to revisit investing giant Phil Fisher, but rather than rehashing his accomplishments and overall philosophy, we will dig deeper into his selling discipline. For most investors, selling securities is much more difficult than buying them. The average investor often lacks emotional self-control and is unable to be honest with himself. Since most investors hate being wrong, their egos prevent taking losses on positions, even if it is the proper, rational decision. Often the end result is an inability to sell deteriorating stocks until capitulating near price bottoms.
Selling may be more difficult for most, but Fisher actually has a simpler and crisper number of sell rules as compared to his buy rules (3 vs. 15). Here are Fisher’s three sell rules:
1) Wrong Facts: There are times after a security is purchased that the investor realizes the facts do not support the supposed rosy reasons of the original purchase. If the purchase thesis was initially built on a shaky foundation, then the shares should be sold.
2) Changing Facts: The facts of the original purchase may have been deemed correct, but facts can change negatively over the passage of time. Management deterioration and/or the exhaustion of growth opportunities are a few reasons why a security should be sold according to Fisher.
3) Scarcity of Cash: If there is a shortage of cash available, and if a unique opportunity presents itself, then Fisher advises the sale of other securities to fund the purchase.
Reasons Not to Sell
Prognostications or gut feelings about a potential market decline are not reasons to sell in Fisher’s eyes. Selling out of fear generally is a poor and costly idea. Fisher explains:
“When a bear market has come, I have not seen one time in ten when the investor actually got back into the same shares before they had gone up above his selling price.”
In Fisher’s mind, another reason not to sell stocks is solely based on valuation. Longer-term earnings power and comparable company ratios should be considered before spontaneous sales. What appears expensive today may look cheap tomorrow.
There are many reasons to buy and sell a stock, but like most good long –term investors, Fisher has managed to explain his three-point sale plan in simplistic terms the masses can understand. If you are committed to cutting investment losses, I advise you to follow investment legend Phil Fisher – cutting losses will actually help prevent your portfolio from splitting apart.
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.