Posts filed under ‘Education’
Sports, Stocks, & the Magic Quadrants
Picking stocks is a tricky game and so is sports betting. With the NFL and NCAA football seasons only a few months away, we can analyze the professional sports-betting industry to better understand the complexities behind making money in the stock market. Anybody who has traveled to Las Vegas, and bet on a sporting event, understands that simply choosing a game winner is not enough for a casino to pay you winnings. You also need to forecast how many points you think a certain team will win or lose by (i.e., the so-called “spread”) – see also What Happens in Vegas, Stays on Wall Street. In the world of stocks, winning/losing is not measured by spreads but rather equities are measured by valuation (e.g., Price/Earnings or P/E ratios).
To make my point, here is a sports betting example from some years back:
Florida Gators vs. Charleston Southern Buccaneers: Without knowing a lot about the powerhouse Southern Buccaneers squad from South Carolina, 99% of respondents polled before the game are likely to unanimously select the winner as Florida – a consistently dominant, nationally ranked powerhouse program. The tougher question becomes trickier if football observers are asked, “Will the Florida Gators win by more than 63 points?”(see picture below). Needless to say, although the Buccs kept it close in the first half, and only trailed by 42-3 at halftime, the Gators still managed to squeak by with a 62-3 victory. Importantly, if you had bet on this game and placed money on the Florida Gators, the overwhelming pre-game favorite, the 59 point margin of victory would have resulted in a losing wager. In order for Gator fans to win money, they would have needed Florida to win by 64 points.
If investing and sports betting were easy, everybody would do it. The reason sports betting is so challenging is due to very intelligent statisticians and odds-makers that create very accurate point spreads. In the investing world, a broad swath of traders, market makers, speculators, investment bankers, and institutional/individual investors set equally efficient valuations over the long-term.
The goal in investing is very similar to sports betting. Successful professionals in both industries are able to consistently identify inefficiencies and then exploit them. Inefficiencies occur for a bettor when point spreads are too high or low, while investors identify inefficient prices in the marketplace by shorting expensive stocks and buying cheap stocks (i.e., undervalued or overvalued).
To illustrate my point, let’s take a look at Sidoxia’s “Magic Quadrant“:
A-B-Cs & 1-2-3s
What Sidoxia’s “Magic Quadrant” demonstrates is a framework for evaluating stocks. By devoting a short period of time reviewing the quadrants, it becomes apparent fairly quickly that Stock A is preferred over Stock B, which is preferred over Stock C, which is preferred over Stock D. In each comparison, the former is preferred over the latter because the earlier letters all have higher growth, and lower (cheaper) valuations. The same relative attractive relationships cannot be applied to stocks #1, #2, #3, and #4. Each successive numbered stock has higher growth, but in order to obtain that higher growth, investors must pay a higher valuation. In other words, Stock #1 has an extremely low valuation with low growth, while Stock #4 has high growth, but an investor must pay an extremely high valuation to own it.
While debating the efficiency of the stock market can escalate into a religious argument, I would argue the majority of stocks fall in the camp of #1, #2, #3, or #4. Or stated differently, you get what you pay for. For example, investors are paying a much higher valuation (high P/E) for Tesla Motors, Inc (TSLA) for its rapid electric car growth vs. paying a much lower valuation (low P/E) for Pitney Bowes Inc (PBI) for its more mature mail equipment business.
The real opportunities occur for those investors capable of identifying companies in the upper-left quadrant (i.e., Stock A) and lower-right quadrant (i.e., Stock D). If the analysis is done correctly, investors will load up on the undervalued Stock A and aggressively short the expensive Stock D. Sidoxia has its own proprietary valuation model (Sidoxia Holy Grail Ranking – SHGR or a.k.a. “SUGAR”) designed specifically to identify these profitable opportunities.
The professions of investing and sports betting are extremely challenging, however establishing a framework like Sidoxia’s “Magic Quadrants” can help guide you to find inefficient and profitable investment opportunities.
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) and TSLA, but at the time of publishing, SCM had no direct position in PBI, 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 the information to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
The Art & Science of Successful Investing
As I described in my book, How I Managed $20,000,000,000.00 by Age 32, I believe successful investing is achieved by integrating aspects of both art and science. The science aspect of investing is fairly straightforward – most of the accounting and valuation math involved could be solved by a 7th grader. The more challenging aspect to successful investing is controlling the vacillating emotions of fear and greed when searching for attractive investments.
When people ask me about my investment philosophy, I do not like to be pigeon-holed into one style box because normally my portfolios hold investments that outsiders would deem both value and growth oriented. Since I am an absolute return investor, I am more concerned about how I can maximize upside returns while minimizing downside risk for my investors.
Because valuation is such an important factor in my process (price always matters), the most accurate description of my style would likely be “high octane GARP” (Growth At a Reasonable Price). While many GARP investors limit themselves to current or historical valuation metrics, my process has allowed me to take a more long-term, forward looking analysis of valuations, which has directed me to participate in some large winners, like Amazon (AMZN), Apple (AAPL), and Google/Alphabet (GOOGL), to name a few. To many observers, positions like these have traditionally been falsely considered “expensive” growth stocks.
Case in point is Google/Alphabet, which went public at $85 per share in 2004. At the time, the broad Wall Street consensus was the IPO (Initial Public Offering) price was way overheated. As it turned out, the stock has reached $1,000 per share and the Price-Earnings ratio (P/E) was a steal at less than 3x had you bought Google at the IPO price. ($85 2004 price/$33.98 2017 EPS estimate). Google is a perfect example of a dominant market leader that has been able to grow earnings dramatically for many years. In short order after going public, Google’s earnings ended up more than quintupling in less than three years and the stock price quintupled as well, proving that ill-advised focus on stale, traditional valuation metrics can lead you to wrong conclusions. Certainly, finding stocks that can increase in value by more than 11x fold is easier said than done, however, applying longer-term valuation metrics to dominant growth leading franchises will allow you to occasionally find monster winners like Google.
The greatest long-term winners don’t start off as the largest weightings, but due to the compounding of returns, position sizes can explode over time. As Peter Lynch states,
“You don’t need a lot of good hits every day. All you need is two to three good stocks a decade.”
Google/Alphabet proves what can appear expensive in the short-run is, in many cases, wildly cheap based on future earnings growth. Earnings tomorrow may be significantly larger than earnings today. Lynch emphasizes the importance of earnings over current prices,
“People concentrate too much on the ‘P’ (Price), but the ‘E’ (Earnings) really makes the difference.”
“Just because a stock is cheaper than before is no reason to buy it, and just because it’s more expensive is no reason to sell.”
The Google/Alphabet chart below shows the incredible price appreciation that can be realized from compounding earnings growth.
The Google example also underscores the importance of patience. Although the stock has been a massive home-run since its IPO, the stock barely budged from late 2006 through 2011. Accurately picking the perfect timing to make an investment is nearly impossible. I concur with Bill Miller when he stated,
“We expect the stocks we buy today to contribute to our performance several years hence. While it’s nice if they contribute to this year’s performance, this year’s performance should be driven by decisions we made in previous years. If we keep doing this, we hope that we will provide adequate returns in the future.”
Regarding timing, Miller adds,
“Nobody buys at lows and sells at highs except liars.”
The Sidoxia Philosophy
Over time, as I have fine-tuned my investment philosophy, I have not been bashful in borrowing winning ideas from growth gurus like Peter Lynch, Phil Fisher, William O’Neil, and Ron Baron, to name a few. By the same token, I am not shy about stealing ideas from value veterans like Warren Buffett, Seth Klarman, and Bill Miller as well.
While I don’t agree with Warren Buffett’s “forever” time horizon, I do believe in the power of compounding he espouses, which requires a longer-term investment horizon. The power of compounding is accelerated not only by committing to a long-term horizon, but also by the benefits accrued from lower trading costs and taxes. What’s more, taking a long view lowers your blood pressure and creates fewer ulcers. Legendary growth manager, T. Rowe Price, captures the essence of this idea here:
“The growth stock theory of investing requires patience, but is less stressful than trading, generally has less risk, and reduces brokerage commissions and income taxes.”
The Science of Investing
As discussed earlier, successful investing is an endeavor that involves the practices of both art and science – too much of either approach can be detrimental to your financial health. Quantitative screening can be an excellent tool for identifying new securities for research along with streamlining the fundamental analysis process. However, many investment funds rely too heavily on the quantitative science. The adage that “correlation does not equal causation” is an important credo to follow when reviewing various quantitative models (see Butter in Bangladesh).
The collapse of the infamous, multi-billion Long Term Capital Management hedge fund should also be a lesson to everyone (see When Genius Failed ). If world renowned Nobel Prize winners, Robert Merton and Myron Scholes, can single-handedly bring the global market to its knees as a result of using inconsistent and unreliable quantitative models, then I feel validated for my fundamentally-based investment approach.
While there are some artistic facets to valuation techniques, in large part, the valuation science is a fairly straightforward mathematical exercise. Unfortunately, the market consists of emotional and unpredictable individuals who continually change their opinions. Eventually the financial markets prod prices in the right direction, but over shorter time intervals, proper investment analysis requires some imperfect estimation.
Emotions regularly result in individuals overpaying for stocks, and this tendency is a risky strategy for any investment. In many cases investors chase darling stocks highlighted in news headlines, but regrettably these pricy investments often end up performing poorly. When it comes to hot stocks, I’m on the same page as famed value investor Bill Miller,
“If it’s in the papers, it’s in the price. One needs to anticipate, not react.”
Usually a news event that makes headlines is already factored into the stock price. The financial markets are generally forward looking mechanisms, not backward looking.
The Art of Investing
“It’s tough to make predictions, especially about the future.”
-Yogi Berra
Investing is undoubtedly a challenging undertaking, but like almost any profession, the more experience one has, the better results generally achieved. Experience alone does not guarantee extraordinary performance, in large part due to emotional pressures. Investing would be much easier for everyone, if you didn’t have to worry about controlling those pesky emotions of fear and greed. The best investment decisions, and frankly any decision, are rarely made under these heightened emotions.
The most successful set of investors I have studied and modeled my investment process after are professionals who have married the quantitative science with the fundamental art of investing. At Sidoxia, we use a disciplined cash flow based valuation approach, along with thorough fundamental analysis to identify attractively valued, market leading franchises that can sustain above average growth. It sounds like a mouthful, but over time, it has worked well for the benefit of my clients and me.
The market leading franchises we invest in tend to have a competitive advantage, whether in the form of superior research and development, low-cost manufacturing, leading marketing, and/or other exceptional functions in the company that allow the entity to consistently garner more growth and more market share from its competitors. Quality franchises tend to also employ first-class management teams that have a proven track record, along with thoughtful, systematic processes in place to maintain their competitive edge. These competitive advantages are what allow companies to produce exceptional earnings growth for extended periods of time, thereby producing outstanding long-term performance for shareholders.
Finding sustainable growth in competitive niche markets is nearly impossible, and that is why I center my attention on large or emerging sectors of the economy that can support long runways of growth. When analyzing companies with durable, long runways of earnings growth, I concentrate on those developing, share-taking companies and dominant market leaders. In other words, disruptive companies that are entering new markets with vast potential and established companies that are gaining significant share in large markets. Well-known growth authority, Phil Fisher summarized the objective,
“The greatest investment rewards come to those who by good luck or good sense find the occasional company that over the years can grow in sales and profits far more than industry as a whole.”
I am privileged and honored to manage the hard earned investments of my clients. If this was a simple profession, everyone would do it, and I would not be employed as an investment manager. I have developed what I believe is a superior way of managing money, but I realize my investment process is not the only way to make money. If you were to assemble 10 different investment managers in the same room, and ask them, “What is the best way to invest money?,” you are likely to get 10 different answers. Having been in the investment industry and managed money for over 25 years, my experience has shown me that the vast majority of professional managers have underperformed the passive benchmarks. However, there are investment managers who have survived the test of time. For those veterans incorporating a disciplined, systematic approach that integrates the artistic and scientific aspects of investing, exceptional long-term returns can be achieved and have been achieved.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, AMZN, GOOG/GOOGL, and AAPL, 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.
Predictions – A Fool’s Errand
Making bold predictions is a fool’s errand. I think Yogi Berra summed it up best when he spoke about the challenges of making predictions:
“It’s tough to make predictions, especially about the future.”
While making predictions might seem like a pleasurable endeavor, the reality is nobody has been able to consistently predict the future (remember the 2012 Mayan Doomsday?), besides perhaps palm readers and Nostradamus. The typical observed pattern consists of a group of well-known forecasters bunched in a herd coupled with a few extreme outliers who try to make a big splash and draw attention to themselves. Due to the law of large numbers, a few of these extreme outlier forecasters eventually strike gold and become Wall Street darlings…until their next forecasts fail miserably.
Like a broken clock, these radical forecasters can be right twice per day but are wrong most of the time. Here are a few examples:
Peter Schiff: The former stockbroker and President of Euro Pacific Capital has been peddling doom for decades (see Emperor Schiff Has No Clothes). You can get a sense of his impartial perspective via Schiff’s reading list (The Real Crash: America’s Coming Bankruptcy, Financial Armageddon, Conquer the Crash, Crash Proof – America’s Great Depression, The Biggest Con: How the Government is Fleecing You, Manias Panics and Crashes, Meltdown, Greenspan’s Bubbles, The Dollar Crisis, America’s Bubble Economy, and other doom-instilled titles.
Meredith Whitney: She made an incredible bearish call on Citigroup Inc. (C) during the fall of 2007, alongside her accurate call of Citi’s dividend suspension. Unfortunately, her subsequent bearish calls on the municipal market and the stock market were completely wrong (see also Meredith Whitney’s Cloudy Crystal Ball).
John Mauldin: This former print shop professional turned perma-bear investment strategist has built a living incorrectly calling for a stock market crash. Like perma-bears before him, he will eventually be right when the next recession hits, but unfortunately, the massive appreciation will have been missed. Any eventual temporary setback will likely pale in comparison to the lost gains from being out of the market. I profiled the false forecaster in my article, The Man Who Cries Bear.
Nouriel Roubini: This renowned New York University economist and professor is better known as “Dr. Doom” and as one of the people who predicted the housing bubble and 2008-2009 financial crisis. Like most of the perma-bears who preceded him, Dr. Doom remained too doom-ful as the stock market more than tripled from the 2009 lows (see also Pinning Down Roubini).
Alan Greenspan: The graveyard of erroneous forecasters is so large that a proper summary would require multiple books. However, a few more of my favorites include Federal Reserve Chairman Alan Greenspan’s infamous “Irrational Exuberance” speech in 1996 when he warned of a technology bubble. Although directionally correct, the NASDAQ index proceeded to more than triple in value (from about 1,300 to over 5,000) over the next three years. – today the NASDAQ is hovering around 6,100.
Robert Merton & Myron Scholes: As I chronicled in Investing Caffeine (see When Genius Failed), another doozy is the story of the Long Term Capital Management hedge fund, which was run in tandem with Nobel Prize winning economists, Robert Merton and Myron Scholes. What started as $1.3 billion fund in early 1994 managed to peak at around $140 billion before eventually crumbling to a capital level of less than $1 billion. Regrettably, becoming a Nobel Prize winner doesn’t make you a great predictor.
Words From the Wise
Rather than paying attention to crazy predictions by academics, economists, and strategists who in many cases have never invested a penny of outside investor money, ordinary investors would be better served by listening to steely investment veterans or proven prediction practitioners like Billy Beane (minority owner of the Oakland Athletics and subject of Michael Lewis’s book, Moneyball), who stated the following:
“The crime is not being unable to predict something. The crime is thinking that you are able to predict something.”
Other great quotes regarding the art of predictions, include these ones:
“I can’t recall ever once having seen the name of a market timer on Forbes‘ annual list of the richest people in the world. If it were truly possible to predict corrections, you’d think somebody would have made billions by doing it.”
-Peter Lynch
“Many more investors claim the ability to foresee the market’s direction than actually possess the ability. (I myself have not met a single one.) Those of us who know that we cannot accurately forecast security prices are well advised to consider value investing, a safe and successful strategy in all investment environments.”
–Seth Klarman
“No matter how much research you do, you can neither predict nor control the future.”
–John Templeton
“Stop trying to predict the direction of the stock market, the economy or the elections.”
–Warren Buffett
“In the business world, the rearview mirror is always clearer than the windshield.”
–Warren Buffett
In the global financial markets, Wall Street is littered with strategists and economists who have flamed out after brief bouts of fame. Celebrated author Mark Twain captured the essence of speculation when he properly identified, “There are two times in a man’s life when he should not speculate: when he can’t afford it and when he can.” Instead of attempting to predict the future, investors will avoid a fool’s errand by simply seizing opportunities as they present themselves in an ever-changing world.
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.
Managing the Chaos – Investing vs. Gambling
How does one invest amid the slew of palm sweating, teeth grinding headlines of Syria, North Korea, Brexit, expanding populism, Trumpcare, French candidate Marine Le Pen, and a potential government shutdown? Facing a persistent mountain of worries can seem daunting to many. With so many seemingly uncontrollable factors impacting short-term interest rates, foreign exchange rates, and equity markets, it begs the question of whether investing is a game of luck (gambling) or a game of skill?
The short answer is…it depends. Professional gambler Alvin “Titanic” Thompson captured the essence when someone asked him whether poker was a game of chance. Thompson responded by stating, “Not the way I play it.”
If you go to Las Vegas and gamble, most games are generally a zero sum-game, meaning there are an equal number of winners and losers with the house (casino) locking in a guaranteed spread (profit). For example, consider a game like roulette – there are 18 red slots, 18 black slots, and 2 green slots (0 & 00), so if you are betting on red vs. black, then the casino has a 5.26% advantage. If you bet long enough, the casino will get all your money – there’s a reason Lost Wages Las Vegas can build those extravagantly large casinos.
The same principles of money-losing bets apply to speculative short-term trading. Sure, there are examples of speculators hitting it big in the short-run, but most day traders lose money (see Day Trading Your House) because the odds are stacked against them. In order to make an accretive, profitable trade, not only does the trader have to be right on the security they’re selling (i.e. that security must underperform in the future), but they also have to be right on the security they are buying (i.e. that security must outperform in the future). But the odds for the speculator get worse once you also account for the trading fees, taxes, bid-ask spreads, impact costs (i.e., liquidity), and informational costs (i.e., front running, high frequency traders, algorithms, etc.).
The key to winning at investing is to have an edge, and the easiest way to have an investing edge is to invest for the long-run – renowned Professor Jeremy Siegel agrees (see Stocks for the Long Run). It’s common knowledge the stock market is up about two-thirds of the time, meaning the odds and wind are behind the backs of long-term investors. Short-term trading is the equivalent of going fishing, and then continually pulling your fishing line out of the water (you’re never going to catch anything). The fisherman is better off by researching a good location and then maintaining the lure in the water for a longer period until success is achieved.
Although most casino games are based on pure luck, there are some games of skill, like poker, that can produce consistent long-term positive results, if you are a patient professional with an advantage or edge (see Dan Harrington article ). Having an edge in investing is crucial, but an edge is not the only aspect of successful investing. How you structure a portfolio to control risk (i.e., money management), and reducing your personal behavioral biases are additional components to a winning investment strategy. Professional poker player Walter Clyde “Puggy” Pearson summed it up best when he described the three critical components to winning:
“Knowing the 60-40 end of a proposition, money management, and knowing yourself.”
At Sidoxia Capital Management, we have also achieved long-term success by following a systematic, disciplined process. A large portion of our investment strategy is focused on identifying market leading franchises with a long runway of growth, and combining those dynamics with positions trading at attractive or fair values. As part of this process, we rank our stocks based on multiple factors, primarily using data from our proprietary SHGR ranking (see Investing Holy Grail) and free cash flow yield analysis, among other important considerations. Based on the risk-reward profiles of our existing holdings and the pool of targeted investments, we can appropriately size our positions accordingly (i.e., money management). As valuations rise, or risk profiles deteriorate, we can make the corresponding portfolio positions cuts, especially if we find more attractive alternative investments. Having a proven, systematic, unbiased process has helped us tremendously in minimizing behavioral pitfalls (i.e., knowing yourself) when we construct client portfolios.
The world is under assault…but that has always been the case. Throughout investment history, there have been wars, assassinations, unexpected election outcomes, banking crises, currency crises, natural disasters, health epidemics, and more. Unfortunately, millions have gambled and bet their money away based on these frivolous, ever-changing, short-term headlines. On the other hand, those investors who understand the 60-40 end of a proposition, coupled with the importance of money management and controlling personal biases, will be the skillful winners to prosper over the long-run.
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.
You Can’t Kiss All the Beauties
When I was in high school and college, kissing all the pretty girls was not a realistic goal. The same principle applies to stock picking – you can’t buy all the outperforming stocks. As far as I’m concerned, there will always be some people who are smarter, better looking, and wealthier than I am, but that has little to do with whether I can continue to outperform, if I stick to my systematic, disciplined process. In fact, many smart people are horrible investors because they overthink the investing process or suffer from “paralysis by analysis.” When it comes to investing, the behavioral ability to maintain independence is more important than being a genius. If you don’t believe me, just listen to arguably the smartest investor of all-time, Warren Buffett:
“Success in investing doesn’t correlate with I.Q. once you’re above the level of 125. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”
Even the best investors and stock pickers of all-time are consistently wrong. When selecting stocks, a worthy objective is to correctly pick three outperforming stocks out of five stocks. And out of the three winning stocks, the rationale behind the outperformance should be correct in two out of those three stocks. In other words, you can be right for the wrong reason in one out of three outperforming stocks. The legendary investor Peter Lynch summed it up when he stated, “If you’re terrific in this business you’re right six times out of 10.”
Yes, it’s true, luck does play a role in stock selection. You just don’t want luck being the major driving force behind your success because luck cannot be replicated consistently over the long-run. There are so many unpredictable variables that in the short-run can work for or against the performance of your stock. Consider factors like politics, monetary policy, weather, interest rates, terrorist attacks, regulations, tax policy, and many other influences that are challenging or impossible to forecast. Over the long-run, these uncontrollable and unpredictable factors should balance out, thereby allowing your investing edge to shine.
Although I have missed some supermodel stocks, I have kissed some pretty stocks in my career too. I wish I could have invested in more stocks like Amazon.com Inc. (AMZN) that have increased more than 10x-fold, but other beauties like Apple Inc. (AAPL), Alphabet Inc. (GOOG), and Facebook Inc. (FB), haven’t hurt my long-term performance either. As is the case for most successful long-term investors, winning stocks generally more than compensate for the stinkers, if you can have the wherewithal to hold onto the multi-baggers (i.e., stocks that more than double), which admittedly is much easier said than done. Peter Lynch emphasized this point by stressing a focus on the long-term:
“You don’t need a lot of good hits every day. All you need is two to three goods stocks a decade.”
Sticking to a process of identifying and investing in well-managed companies at attractive valuations is a much better approach to investing than chasing every beauty you see or read about. If you stick to this simple formula, you can experience lovely, long-term results.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AAPL, FB, GOOG, AMZN, 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.
What’s Important? Moving on Beyond Politics…
On a daily basis we turn on the TV or read about Democrats screaming at Republicans, or vice versa. Despite screams from the opposition, a Democratically-led Congress was able to successfully push Obamacare through the House and Senate in 2010 in a partisan fashion. The Republicans, however, were unable to jam repeal Obamacare legislation seven years later – at least on their first attempt.
While many Americans who sit at the opposite end of the political spectrum continue to scream at each other until they’re purple in the face, data indicates it is the Independents who are controlling the outcomes of elections. More specifically, a recent Gallup poll shows that 43% of voters identify as political independents, while over the last decade the percentage of voters identifying themselves with the traditional parties of Democrats and Republicans have declined to 30% and 26%, respectively.
It is true, President Trump potentially has a very limited party majority window before next year’s midterm elections. While Republicans do currently have an advantage over Democrats, as I’ve stated before, there are more important issues than these political ones, especially when it relates to your finances.
Whether the discussion revolves around healthcare, tax reform, defense spending, or immigration, the amount of influence you as a voter have on the political outcomes pales in comparison to the amount of control you ultimately have over your personal financial situation. As I’ve written in the past (see also Getting to Your Number), creating a secure financial plan will impact your long-term monetary success much more than senseless cheering or screaming for Obamacare’s long-run success or failure.
More critical than focusing on politics, the importance of calculating your budget, income sources, time horizon, and risk tolerance should be higher priorities. Everybody’s personal situation is different, therefore it is essential to explore a variety of other essential questions, including the following:
- How many more years do you plan to work?
- How much income will you need in retirement?
- What is your expected return on investments, given your asset allocation?
- How much debt do you presently have, and what are your plans to reduce it?
- What are the probabilities of you gaining an inheritance, and at what estimated value?
- Do you have an estate plan in place?
- Do you have children, and if so, what are your educational goals, and what type of inheritance or financial support are you looking to provide your children?
Since every investor’s situation is unique, there are plenty of other items to investigate. Politics is a state of mind, so don’t let the vicissitudes of Washington DC affect your long-term financial well-being.
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.
March Madness or Retirement Sadness?
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (March 1, 2017). Subscribe on the right side of the page for the complete text.
“March Madness” begins in a few weeks with a start of the 68-team NCAA college basketball tournament, but there has also been plenty of other economic and political madness going on in the background. As it relates to the stock market, the Dow Jones Industrial Average index reached a new, all-time record high last month, exceeding the psychologically prominent level of 20,000 (closing the month at 20,812). For the month, the Dow rose an impressive +4.8%, and since November’s presidential election it catapulted an even more remarkable +13.5%.
Despite our 45th president just completing his first State of the Union address to the nation, American voters remain sharply divided across political lines, and that bias is not likely to change any time soon. Fortunately, as I’ve written on numerous occasions (see Politics & Your Money), politics have no long-term impact on your finances and retirement. Sure, in the short-run, legislative policies can create winners and losers across particular companies and industries, but history is firmly on your side if you consider the positive track record of stocks over the last couple of centuries. As the chart below demonstrates, over the last 150 years or so, stock performance is roughly the same across parties (up +11% annually), whether you identify with a red elephant or a blue donkey.
Nevertheless, political rants flooding our Facebook news feeds can confuse investors and scare people into inaction. Pervasive fake news stories regarding the supposed policy benefits and shortcomings of immigration, tax reform, terrorism, entitlements, foreign policy, and economic issues often result in heightened misperception and anxiety.
More important than reading Facebook political rants, watching March Madness basketball, or drinking green beer on St. Patrick’s Day, is saving money for retirement. While some of these diversions can be temporarily satisfying and entertaining, lost in the daily shuffle is the retirement epidemic quietly lurking in the background. Managing money makes people nervous even though it is an essential part of life. Retirement planning is critical because a mountain of the 76 million Baby Boomers born between 1946 – 1964 have already reached retirement age and are not ready (see chart below).
The critical problem is most Americans are ill-prepared financially for retirement, and many of them run the risk of outliving their savings. A recent study conducted by the Economic Policy Institute (EPI) shows that nearly half of families have no retirement account savings at all. The findings go on to highlight that the median U.S. family only has $5,000 in savings (see also Getting to Your Number). Even after considering my tight-fisted habits, that kind of money wouldn’t be enough cash for me to survive on.
Saving and investing have never been more important. It doesn’t take a genius to understand that government entitlements like Social Security and Medicare are at risk for millions of Americans. While I am definitely not sounding the alarm for current retirees who have secure benefits, there are millions of others whose retirement benefits are in jeopardy.
Missing the 20,000 Point Boat? Dow 100,000
Making matters worse, saving and investing has never been more challenging. If you thought handling all of life’s responsibilities was tough enough already, try the impossible task of interpreting the avalanche of instantaneous political and economic headlines pouring over our electronic devices at lighting speed.
Knee-jerk reactions to headlines might give investors a false sense of security, but the near-impossibility of consistently timing the stock market has not stopped people from attempting to do so. For example, recently I have been bombarded with the same question, “Wade, don’t you think the stock market is overpriced now that we have eclipsed 20,000?” The short answer is “no,” given the current factors (see Don’t Be a Fool). Thankfully, I’m not alone in this response. Warren Buffett, the wealthiest billionaire investor on the planet, answered the same question this week after investing $20,000,000,000 more in stocks post the election:
“People talk about 20,000 being high. Well, I remember when it hit 200 and that was supposedly high….You know, you’re going to see a Dow [in your lifetime] that certainly approaches 100,000 and that doesn’t require any miracles, that just requires the American system continuing to function pretty much as it has.”
Like a deer in headlights, many Americans have been scared into complacency. To their detriment, many savers have sat silently on the sidelines earning near-0% returns on their savings, while the stock market has reached new all-time record highs. While Dow 20,000 might be new news for some, the reality is new all-time record highs have repeatedly been achieved in 2013, 2014, 2015, 2016, and now 2017 (see chart below).
While I am not advocating for all people to throw their entire savings into stocks, it is vitally important for individuals to construct diversified portfolios across a wide range of asset classes, subject to each person’s unique objectives, constraints, risk tolerance, and time horizon. The risk of outliving your savings is real, so if you need assistance, seek out an experienced professional. March Madness may be here, but don’t get distracted. Make investing a priority, so your daily madness doesn’t turn into retirement sadness.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in FB 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.
Stocks: Be My Long-Term Valentine
With Valentine’s Day just around the corner, stock bulls remain in love as the major indexes once again hit another new, all-time record high this week (Dow 20,269). Unfortunately, however, there are many other investors afraid of going through another 2008-2009-like break-up, so they remain single as they watch from the sidelines. In a recent post, I point out, as repeated record highs continue to be broken, the skeptics remain fearful of divorcing their cash. While it is indeed true that since the end of the 2016 presidential election, some investors are beginning to date stocks again, there are still wide swaths of conflicted observers very afraid of potential rejection.
As I’ve documented on numerous occasions, the skepticism is evident in the depressing long-term trends found in the weekly fund flows data and the disheartening record-low stock ownership statistics.
Long-Term Relationships
For some, casually dating can be fun and exciting. The same principle applies to short-term traders and speculators. In the short-run, the freedom to make free-wheeling, non-committal stock purchases can be exhilarating. Unfortunately, the fiscal and emotional costs of short-term dating/trading often outweigh the fleeting benefits.
How can you avoid the relationship blues? In short…focus on the long-term. Like any relationship, investing takes work, and there will always be highs, lows, and bumps in the road. It is better to think in terms of a marathon, rather than a sprint. The important lesson is to maintain a systematic, disciplined approach that you can apply irrespective of the changing investment environment. In other words, that means not loosely reacting (buying or selling) to presidential tweets of the day.
Famed investor Peter Lynch spoke about long-term stock fund investing in this manner
“If you invest in mutual funds and make mutual funds investment changes in less than 10 years…you’re really just ‘dating.’ Investing in mutual funds should be marital – for richer, for poorer, and so on; mutual fund decisions should be entered into soberly and advisedly and for the truly long term.”
No relationship survives without experiencing wild swings, and stocks are no exception. Establishing deep roots to your investments via intensive fundamental analysis provides stability, especially if you are managing your portfolio personally. Even if you are outsourcing your investment management to an advisor like Sidoxia Capital Management, it is still important to understand your advisor’s investment process and philosophy. That way, when the economic and political winds are blowing fiercely, you won’t overreact emotionally and see your gains fly away.
Investing legend Warren Buffett has discussed the importance of intensive research on long-term investment performance through his “20-Hole Punch Card” rule:
“I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches – representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all. Under those rules, you’d really think carefully about what you did, and you’d be forced to load up on what you’d really thought about. So you’d do so much better.”
Patience is a Virtue
In the instant gratification society we live in, patience is difficult to come by, and for many people ignoring the constant chatter of fear is challenging. Pundits spend every waking hour trying to explain each blip in the market, but in the short-run, prices often move up or down regardless of the daily headlines.
Explaining this randomness, Peter Lynch said the following:
“Often, there is no correlation between the success of a company’s operations and the success of its stock over a few months or even a few years. In the long term, there is a 100% correlation between the success of a company and the success of its stock. It pays to be patient, and to own successful companies.”
Long-term investing, like long-term relationships, is not a new concept. Investment time horizons have been shortening for decades, so talking about the long-term is generally considered heresy. Rather than casually dating your investments, perhaps you should commit to a long-term relationship and divorce your bad short-term centric habits. Now that sounds like a sweet Valentine’s Day kiss your investment portfolio would enjoy.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AAPL, T, FB 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.
Become the Landlord of Your Stocks
“Why do you buy stocks?” Unfortunately, many people do not truly understand how to answer that particular question. If they were honest with themselves, many stockholders would respond by saying, “Because they are going up in price,” or maybe, “My neighbor told me to buy stock XYZ.” However, if somebody asked the same question regarding the purchase of a real estate property or an apartment building, would the answer be the same? The short answer is…probably not. There certainly could be some people who answer the stock versus real estate valuation question in the same way, but in general, real estate investors understand the tangibility and relevant factors of a property better than equity investors understand the jargon and abstract nature of most stocks.
There are many ways to value an asset, but in many cases, the value of an asset is spontaneously left in the eye of the beholder. Nevertheless, there is one common approach, applicable across asset classes, which is the net present value or discounted cash flow approach. This valuation methodology basically states any asset is worth the cumulative value of cash inflows minus the value of cash outflows, after adjusting that netted figure for time and interest rates.
In the case of an apartment building, a layman generally understands the basic valuation concept behind adding up the relevant cash inflows and cash outflows. For example, being a landlord of an apartment building involves simple rent collection (cash inflows) in addition to maintenance, repairs, construction costs, employee wages, taxes, and other payments (cash outflows). After making additional assumptions about future rent increases, occupancy levels, wage inflation, and a few other variables, many outside observers could probably come up with a decent estimated value of the property.
The variables relating to an apartment building may be more stable, predictable, and understandable, if compared with the variables of a stock, but the same exact principles apply to both asset classes. Wal-Mart may not collect stable rent checks, but it does collect money from product sales in its 11,500 stores around the world (cash inflows). Wal-Mart’s cash inflows are much less predictable than real estate rent check inflows due to the many retail-specific variables, such as store openings/closings, online competition, promotions, seasonality, inventory levels, and geographic economics. Expenses (cash outflows) are challenging to predict as well due to wage fluctuations, energy cost variability, capital project timing, erratic raw material prices, and other factors. In the end, stock variables may be more volatile and less predictable, but the valuation process should be the same. Valuing stocks requires estimating the cumulative value of cash inflows minus the value of cash outflows, and then adjusting those results for time and interest rates.
Real estate has its own industry language, but the language of stocks has an endless number of acronyms, which can be quite challenging if you consider the dozens of industries and thousands of stocks. Here are a few of my favorite obscure acronyms used across the technology, healthcare, energy, and retail sectors:
Technology: 4G, CDMA, DSLAM, LTE, MPLS, SaaS, SRAM
Energy: BCF, BOE, BTU, EIA, Gwh, kWh, LNG, MWh, WTI
Healthcare: AARP, CRM, DRG, EENT, FDA, HIPAA, MI, SARS
Retail: B2B, EDI, EDLP, GMROI, POS, RFID, SCM, SKU, UPC
As noted earlier, the language and complexity for valuing stocks may be more complicated than valuing other more straightforward asset classes, but the methodology is essentially the same.
The opportunities and rewards stemming from stock ownership are almost endless. While it’s true that successful long-term stock investing is rarely easy, anything worthwhile in life is never simple. If you are able to understand the principal concepts of how to become an effective landlord of real estate, then applying the same principles on how to become an effective landlord of your stock portfolio is highly achievable.
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 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.
Brain or Machine? Investing Holy Grail
Source: Photobucket
Paul Meehl was a versatile academic who held numerous faculty positions, covering the diverse disciplines of psychology, law, psychiatry, neurology, and yes, even philosophy. The crux of his research was focused on how well clinical analysis fared versus statistical analysis. Or in other words, he looked to answer the controversial question, “What is a better predictor of outcomes, a brain or an equation?” His conclusion was straightforward – mechanical methods using quantitative measures are much more efficient than the professional judgments of humans in coming to more accurate predictions.
Those who have read my book, How I Managed $20,000,000,000.00 by Age 32 know where I stand on this topic – I firmly believe successful investing requires a healthy balance between both art and science (i.e., “brain and equation”). A trader who only relies on intuition and his gut to make all of his/her decisions is likely to fall on their face. On the other hand, a quantitative engineer’s sole dependence on a robotic multi-factor model to make trades is likely to fail too. My skepticism is adequately outlined in my Butter in Bangladesh article, which describes how irrational statistical games can be misleading and overused.
As much as I would like to attribute all of my investment success to my brain, the emotion-controlling power of numbers has played an important role in my investment accomplishments as well. The power of numbers simply cannot be ignored. More than 50 years after Paul Meehl’s seminal research was published, about two hundred studies comparing brain power versus statistical power have shown that machines beat brains in predictive accuracy in the majority of cases. Even when expert judgments have won over formulas, human consistency and reliability have muddied the accuracy of predictions.
Daniel Kahneman, a Nobel Prize winner in Economics, highlights another important decision making researcher, Robyn Dawes. What Dawes discovers in her research is that the fancy and complex multiple regression methods used in conventional software adds little to no value in the predictive decision-making process. Kahneman describes Dawes’s findings more specifically here:
“A formula that combines these predictors with equal weights is likely to be just as accurate in predicting new cases as the multiple-regression formula…Formulas that assign equal weights to all the predictors are often superior, because they are not affected by accidents of sampling…It is possible to develop useful algorithms without any prior statistical research. Simple equally weighted formulas based on existing statistics or on common sense are often very good predictors of significant outcomes.”
The results of Dawes’s classic research have significant application to the field of stock picking. As a matter of fact, this type of research has had a significant impact on Sidoxia’s stock selection process.
How Sweet It Is!
In the emotional roller-coaster equity markets we’ve experienced over the last decade or two, overreliance on gut-driven sentiments in the investment process has left masses of casualties in the wake of losses. If you doubt the destructive after-effects on investors’ psyches, then I urge you to check out my Fund Flow Paradox article that shows the debilitating effects of volatility on investors’ behavior.
In order to more objectively exploit investment opportunities, the Sidoxia Capital Management investment team has successfully formed and utilized our own proprietary quantitative tool. The results were so sweet, we decided to call it SHGR (pronounced “S-U-G-A-R”), or Sidoxia Holy Grail Ranking.
My close to two decades of experience at William O’Neil & Co., Nicholas Applegate, American Century Investments, and now Sidoxia Capital Management has allowed me to build a firm foundation of growth investing competency – however understanding growth alone is not sufficient to succeed. In fact, growth investing can be hazardous to your investment health if not kept properly in check with other key factors.
Here are some of the key factors in our Sidoxia SHGR ranking system:
Valuation:
- Free cash flow yield
- Price/earnings ratio
- PEG ratio
- Dividend yield
Quality:
- Financials: Profit margin trends; balance sheet leverage
- Management Team: Track record; capital stewardship
- Market Share: Industry position; runway for growth
Contrarian Sentiment Indicators:
- Analyst ratings
- Short interest
Growth:
- Earnings growth
- Sales growth
Our proprietary SHGR ranking system not only allows us to prioritize our asset allocation on existing stock holdings, but it also serves as an efficient tool to screen new ideas for client portfolio additions. Most importantly, having a quantitative model like Sidoxia’s Holy Grail Ranking system allows investors to objectively implement a disciplined investment process, whether there is a presidential election, Fiscal Cliff, international fiscal crisis, slowing growth in China, and/or uncertain tax legislation. At Sidoxia we have managed to create a Holy Grail machine, but like other quantitative tools it cannot replace the artistic powers of the brain.
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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