Posts filed under ‘Education’
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.
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.
Cutting Losses with Fisher’s 3 Golden Sell Rules
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.
Reasoning with Investment Confusion
Some things never change, and in the world of investing many of the same principles instituted a century ago are just as important today. So while we are dealing with wars, military conflicts, civil unrest, and natural disasters, today’s process of filtering and discounting all these events into stock prices is very similar to the process that George Selden describes in his 1912 book, “Psychology of the Stock Market.”
Snub the Public
Investing in stocks is nowhere close to a risk-free endeavor, and 2008-2009 was a harsh reminder of that fact. Since a large part of the stock market is based on emotions and public opinion, stock prices can swing wildly. Public opinion may explain why the market is peaking or troughing, but Selden highlights the importance of the silent millionaires (today’s billionaires and institutional investors), and that the true measurement of the stock market is dollars (not opinions of the masses):
“Public opinion in a speculative market is measured in dollars, not in population. One man controlling one million dollars has double the weight of five hundred men with one thousand dollars each. Dollars are the horsepower of the markets–the mere number of men does not signify.”
When the overwhelming consensus of participants is bullish, by definition, the small inexperienced investors and speculators are supplied stock from someone else – the silent, wealthy millionaires.
The newspaper headlines that we get bombarded with on a daily basis are a mirror reflection of the general public’s attitudes and when the euphoria or despondency reaches extreme levels, these points in time have been shown to correlate with market tops and bottoms (see Back to the Future Magazine Covers).
In the short-run, professional traders understand this dynamic and will often take a contrarian approach to news flow. Or as Seldon explains:
“A market which repeatedly refuses to respond to good news after a considerable advance is likelely to be ‘full of stocks.’ Likewise a market which will not go down on bad news is usually ‘bare of stock.’”
This contrarian dynamic in the market makes it virtually impossible for the average investor to trade the market based on the news flow of headlines and commentator. Before the advent of the internet, 98 years ago, Selden prophetically noted that the increasing difficulty of responding to sentiment and tracking market information:
“Public opinion is becoming more volatile and changeable by the year, owing to the quicker spread of information and the rapid multiplication of the reading public.”
Following what the so-called pundits are saying is fruitless, or as Gary Helms says, “If anybody really knew, they wouldn’t tell you.”
Selden’s Sage Advice
If trading was difficult in 1912, it must be more challenging today. Selden’s advice is fairly straightforward:
“Stick to common sense. Maintain a balanced, receptive mind and avoid abstruse deductions…After a prolonged advance, do not call inverted reasoning to your aid in order to prove that prices are going still higher; likewise after a big break do not let your bearish deductions become too complicated.”
The brain is a complex organ, but we humans are limited in the amount and difficulty of information we can assimilate.
“When it comes to so complicated a matter as the price of stocks, our haziness increases in proportion to the difficulty of the subject and our ignorance of it.”
The mental somersault that investors continually manage is due to the practice of “discounting.” Discounting is a process that adjusts today’s price based on future expected news. Handicapping sports “spreads” involves a very similar methodology as discounting stock prices (read What Happens in Vegas). But not all events can be discounted, for instance the recent earthquake and tsunami in Japan. When certain factors are over-discounted or under-discounted, these are the situations to profit from on a purchase or shorting basis.
The Dow Jones Industrial Average traded below a value of 100 versus more than 12,000 today, but over that period some things never change, like the emotional and mental aspects of investing. George Selden makes this point clear in his century old writings – it’s better to focus on the future rather than fall prey to the game of mental somersault we call the stock market.
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.
The Illusion of the Reverse Split
Source: Photobucket
“Citi is a fundamentally different company than it was three years ago. The reverse stock split and intention to reinstate a dividend are important steps as we anticipate returning capital to shareholders starting next year.”
Okay, so Citigroup is paying out a whopping 1/10 of one penny per your current share price (compared to $.49 per share before the financial crisis) and Vikram is telling me I should be excited. Maybe additional ecstasy should be kicking in once shareholders learn they will receive 1 pie with no slices, rather than 1 pie with 10 slices? These same share-slicing and re-piecing gimmicks were implemented in the pre and post dot-com era with no beneficial value. If this truly was such a novel idea, I wonder why smart people like Warren Buffett have chosen not put such amazing, whiz-bang ideas to use. The lauded 1-10 reverse split planned by Citigroup could also be used to raise Berkshire Hathaway’s share price from $127,766 per share to $1,277,660 per share. One share of post reverse-split BRKA could buy you 288,410 shares of Citigroup today.
Proponents of the reverse split cite the institutional benefits provided by the move. Not only will institutions previously prohibited from buying single digit equity securities now be able to buy Citigroup shares, but institutions will also be able to pay lower commissions because the current 29 billion shares outstanding will be reduced to a measly 2,900,000,000 shares. In reality, reducing share count through a reverse split may fool a few unknowledgeable speculators, but prudent investors understand a reverse split does not impact the value of the company one iota.
The fact of the matter is that earnings and cash flow growth will be the main drivers behind institutional shareholder buying of Citigroup’s stock.
Famous investor John Templeton simply stated, “In the long run, the stock market indexes fluctuate around the long-term upward trend of earnings per share.”
Peter Lynch appreciated the importance of earnings too: “People may bet on hourly wiggles of the market but it’s the earnings that waggle the wiggle long term.”
So while Citigroup may not be a horrible stock, the announcing of a 1 for 10 reverse stock split will not be a share price savior. So rather than let the illusion of capital structure gimmicks inform your decisions, investors would be better served by focusing on the sustainability and growth of earnings and cash flows.
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 BRKA/B, C, 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.
Shoring Up Your Investment Stool from Collapse
With March Madness just kicking into full gear, there’s a chance that your gluteal assets may be parked on a stool in the next two weeks. When leaning on a bar countertop, while seated on a stool, we often take for granted the vital support this device provides, so we can shovel our favorite beverage and pile of nachos into our pie holes. OK, maybe I speak for myself when it comes to my personal, gluttonous habits. But the fact remains, whether you are talking about your rump, or your investment portfolio, you require a firm foundation.
The main problem, when it comes to investments, is the lack of a tangible, visible stool to analyze. Sure, you are able to see the results of a portfolio collapse when there is no foundation to support it, or you may even be able to ignore the results when they remain above water. But many investors do not evenperform the basic due diligence to determine the quality of their investment stool. Before you place your life savings in the hands of some brokerage salesman, or in your personal investment account, you may want to make sure your stool has more than one or two legs.
In the money management world, investors typically choose to buy the stool, rather than build it, which makes perfect common sense. Many people do not have the time or emotional make-up to manage their finances. If left to do it themselves, more often than not, investors usually do a less than stellar job. Unfortunately, when many investors do outsource the management of their investments, they neglect to adequately research the investment stool they buy. Usually the wobbly industry stool operates on the two legs of performance chasing and commission generation (see Fees, Exploitation, and Confusion). For most average investors, it doesn’t take long before that investment strategy teeters and collapses.
If the average investor does not have time to critically evaluate managers that take a long-term, low-cost, tax-efficient strategy to investing, those individuals would be best served by following Warren Buffet’s advice about passive investments, “A very low-cost index is going to beat a majority of the amateur-managed money or professionally-managed money.”
The Four Legs of the Investment Stool
For DIY-ers (Do-It-Yourself-ers), you do not need to buy a stool – you can build it. There are many ways to build a stool, but these are the four crucial legs of investing that have saved my hide over my career, and can be added as support for your investment stool:
1.) Valuation: I love sustainable growth as much as anything, just as much as I would like a shiny new Ferrari. But there needs to be a reasonable price paid for growth, and paying an attractive or fair price for a marquis asset will improve your odds for long-term success.
“Valuations do matter in the stock market, just as good pitching matters in baseball.”
-Fred Hickey (High Tech Strategist)
2.) Cash Flows: Cash flows, and more importantly free cash flows (cash left over after money is spent on capital expenditures), should be investors’ metric of choice. Companies do not pay for dividends, share buybacks, and capital expenditures with pro forma earnings, or non-GAAP earnings. Companies pay for these important outlays with cash.
“In looking for stocks to buy, why do you put so much emphasis on free cash flow? Because it makes the most sense to me. My first job was at a little corner grocery store, and it seemed pretty simple. Cash goes into the register; cash comes out.”
-Bruce Berkowitz (The Fairholme Fund)
3.) Interest Rates: Money goes where it is treated best, so capital will look at the competing yields paid on bonds. Intuitively, interest factors also come into play when calculating the net present value of a stock. Just look at the low Price-Earnings ratios of stocks in the early 1980s when the Fed Funds reached about 20% (versus effectively 0% today). In the long run, higher interest rates (and higher inflation) are bad for stocks, but worse for bonds.
“I don’t know any company that has rewarded any bondholder by raising interest rates [payments] – unlike companies raising dividends.”
-Peter Lynch (Former manager of the Fidelity Magellan Fund)
4.) Quality: This is a subjective factor, but this artistic assessment is as important, if not more important than any of the previous listed factors. In searching for quality, it is best to focus on companies with market share leading positions, strong management teams, and durable competitive advantages.
“If you sleep with dogs, you’re bound to get fleas.”
-Old Proverb
These four legs of the investment stool are essential factors in building a strong investment portfolio, so during the next March Madness party you attend at the local sports bar, make sure to check the sturdiness of your bar stool – you want to make sure your assets are supported with a sturdy foundation.
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 Fairholme, Ferrari, 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.
Killing Patients to Investment Prosperity
All investors are optimistic, every time they open up a position, but just like surgeons, sometimes the outcome doesn’t turn out as well as initially anticipated. When it comes to investing, I think this old Hindu proverb puts things into perspective:
“No physician is really good before he has killed one or two patients.”
So too, an investor does not become really good until he kills off some investment positions. But like surgeons, investors also have to understand the most important aspect of tragic events is learning from them. In many cases, unexpected outcomes are out of our control and cannot be prevented. This conclusion, in and of itself, can provide valuable insights. But on many occasions, there are procedures, processes, and facts that were missed or botched, and learning from those mistakes can prove invaluable when it comes to refining the process in the future – in order to further minimize the probability of a tragic outcome.
My Personal Killers
Professionally, I have killed some stocks in my career too, or they have killed me, depending on how you look at the situation. How did these heartrending incidents occur? There are several categories that my slaughtered stocks fell under:
- Roll-Up, Throw-Up: Several of my investment mistakes have been tied to roll-up or acquisition-reliant growth stories, where the allure of rapid growth shielded the underlying weak fundamentals of the core businesses. Buying growth is easier to create versus organically producing growth. Those companies addicted to growth by acquisition eventually experience the consequences firsthand when the game ends (i.e., the quality of deals usually deteriorates and/or the prices paid for the acquisitions become excessive).
- Technology Kool-Aid: Another example is the Kool-Aid I drank, during the technology bubble days, related to a “story” stock – Webvan, a grocery delivery concept. How could mixing Domino’s pizza delivery (DZP) with Wal-Mart’s (WMT) low-priced goods not work? I’m just lazy enough to demand a service like that. Well, after spending hundreds of millions of dollars and never reaching the scale necessary to cover the razor thin profit margins, Webvan folded up shop and went bankrupt. But don’t give up hope yet, Amazon (AMZN) is refocusing its attention on the grocery space (mostly non-perishables now) and could become the dominant food delivery retailer.
- Penny Stocks = Dollars Lost: Almost every seasoned investor carries at least one “penny stock” horror story. Unfortunately for me, my biotech miracle stock, Saliva Diagnostics (SALV), did not take off to the moon and provide an early retirement opportunity as planned. On the surface it sounded brilliant. Spit in a cup and Saliva Diagnostic’s proprietary test would determine whether patients were infected with the HIV virus. With millions of HIV/AIDS patients spread around the world, the profit potential behind ‘Saliva’ seemed virtually limitless. The technology unfortunately did not quite pan out, and spit turned into tears.
The Misfortune Silver Lining
These stock tragedies are no fun, but I am not alone. Fortunately for me, and other professionals, there is a nine-lives feline element to investing. One does not need to be right all the time to outperform the indices. “If you’re terrific in this business you’re right 6 times out of 10 – I’ve had stocks go from $11 to 7 cents (American Intl Airways),” admitted investment guru Peter Lynch. Growth stock investing expert, Phil Fisher, added: “Fortunately the long-range profits earned from really good common stocks should more than balance the losses from a normal percentage of such mistakes.”
Warren Buffett takes a more light-hearted approach when he describes investment mistakes: “If you were a golfer and you had a hole in one on every hole, the game wouldn’t be any fun. At least that’s my explanation of why I keep hitting them in the rough.”
Some investors purposely forget traumatic investment experiences, but explicitly sweeping the event under the rug will do more harm than good. So the next time you suffer a horrendous stock price decline, do your best to log the event and learn from the situation. That way, when the patient (stock) has been killed (destroyed), you will become a better, more prosperous doctor (investor).
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, WMT, and AMZN but at the time of publishing SCM had no direct position in DZP, Webvan, Saliva Diagnostics, American intl Airways, 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.
Share Buybacks and Bathroom Violators
We all have our own unique pet peeves that drive us crazy, and I am no exception. More grating than fingernails scraping down the chalkboard or rude drivers who refuse to let you merge lanes are those citizens that unabashedly exercise poor public bathroom etiquette. The only thing worse than listening to the loud-mouth cell phone talker in the neighboring stall is watching a restroom participant move straight from zipper closure (if they remember), immediately to the bathroom exit. I mean really, would it kill you at a minimum to pay a visit to the sink and feign a phantom hand-swipe under some running water? Don’t those people understand that I have to grab the same handle they use to exit the facility after they conduct their bathroom business? OK, now that I have gotten this issue off my chest, I feel better and I can get off my soapbox (no pun intended).
Something Stinks in Share Buyback Land
Beyond potty etiquette, there is another maddening pet peeve that drives me nuts in the realm of corporate capital allocation. I like to call this particular scheme the “empty share buyback.” Those companies that announce the empty share buyback do it with the intention of either getting a quick, short-term jump in stock price, or use the ploy as a way to indirectly line their pockets with future stock and option grants.
Here are a few ways on how the ruse works:
Scheme #1 – The Empty Pump-Fake: In one form or another, here is what the CEO basically says, “We plan to buyback zillions of shares from time to time, based on market conditions, and do not have any set expiration date for the plan.” In other words, the company executives are committing to absolutely nothing, but are hoping to confuse traders into buying shares to temporarily increase the stock price, so management can unload their shares for a swift profit. In actuality the management team is not obligated to purchase one share and may keep the pseudo-share buyback plan in place for years with no benefit to shareholders.
Scheme #2 – The Pocket Swap: Another one of my favorites, I like to call the pocket swap. Management effectively exchanges money from one pocket to the other. Typically management starts off by stating, “We treasure investor feedback, so we have initiated a new program to return capital to our valued shareholders in the form of a share buyback.” What they usually don’t tell investors is that the shares are being purchased (with shareholder money), so the executives can give more shares back to themselves (and a few other fortunate employees). That’s great for them, but what about me?!
At the end of the day, if the management team is truly working for the shareholder, the game is all about reducing the outstanding share count, which thereby increases earnings per share (and better yet free cash flow per share). Despite the recent climb in interest rates, yields are still near multi-decade lows. Corporations are flush with cash after cutting expenses to the bone, delaying hiring, and riding the global recovery wave. For those real investors not trading a position for a few days, weeks, or months, it behooves you to hold management’s feet to the fire to make sure “empty pump-fakes” or “pocket swap” share buybacks are not occurring.
If you have difficulty gauging the integrity of those management teams announcing share buybacks, I have a litmus test that can be used to judge the executive’s true intentions. It’s quite simple – just follow the CEO into the bathroom (same gender required) and see whether they honorably follow bathroom etiquette by washing their hands after completing their duty. Sleuth work can be tricky, but failure in determining the genuine purpose of management’s capital allocation decisions can lead to a share buyback program that will get flushed down the toilet.
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.
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.
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