Posts tagged ‘transactions costs’

Searching for the Growth Stock Holy Grail

Source: Photobucket

Remember Research in Motion (now Blackberry Limited – BBRY)? What about Krispy Kreme Doughnuts? How about Crocs (CROX)? Or maybe even Webvan, the online grocery delivery company that went bankrupt during the bursting of the dot-com bubble? These are all examples of once heralded growth companies that lost their mojo along their growth expansion ways.

Not every stock can grow to the $80+ billion market cap stratosphere like Apple Inc. (AAPL), Starbucks Corp. (SBUX), and Wal-Mart Stores (WMT), so finding companies with the right mixture of growth characteristics can be challenging. Objective stock market observers can disagree on the ingredients of a successful growth stock recipe, but generally speaking, the real explosive appreciation in stock prices come from those companies that can compound earnings growth over longer periods of time.

But how can one discover the Holy Grail of compounding earnings? At Sidoxia Capital Management, there are a handful of key factors we look for in successful growth companies. In the hyper-competitive global marketplace, these are crucial questions we want adequately answered before we invest our clients’ money:

  • Does the company sell a product or service that cuts costs?
  • Does the company offer a product or service with unique entertainment value?
  • Does the company offer a superior product or service compared to its competitors?

Even if a target investment can affirmatively answer two or three of these questions, often the most important question is the following:

  • Does the company have a sustainable competitive advantage in providing a product or service?

If the company does not have some type of durable competitive advantage, then some other company can just copy the product or service, and sell it at a lower price. This sadly leads to margin and P/E (Price-Earnings) multiple compression – both negative outcomes.

The aforementioned factors are not the end-all, be-all for successful growth stocks, but rather the minimum price of admission. Even if the previous criteria boxes are sufficiently checked off, the company being researched must still be fairly or attractively priced. For example, it doesn’t take a genius to figure out Apple is a successful company with unique advantages. More specifically, the company has $240 billion in cash, $50 billion in profits, and $215 billion in revenue. The real question becomes, is the stock fairly or attractively priced?

Although Apple appears attractively valued at current prices, in many other instances that is not the case. Often, great companies have been discovered by a large swath of investors, and therefore trade at significant premiums, which increases the risk profile or reduces the upside potential of the investment.

Sucking the Last Puff

If a company’s product or service isn’t superior, cut costs, or entertain at a reasonable/attractive valuation, then investing is like taking the last puff or drag out of a cigarette butt. Some value investors are good at this craft, but often these managers get caught into so-called “value traps” – ask Bill Ackman about Valeant Pharmaceuticals (VRX). Many value investors thought they found a bargain when they bought Valeant shares after it fell -80% in price. The stock subsequently has fallen another -50%…ouch!.

It’s worth noting that growth can come from many different areas. Even mature industries can produce periods of cyclical growth, however identifying cyclical winners is challenging. The art for the investment manager is determining whether growth in a target investment is sustainable. In many instances, companies temporarily benefit from a rising tide that lifts all boats, before the tide goes out and sinks fundamentals down to lower levels.

Growth investing can be a dangerous hobby for short-term traders because the price volatility stemming from ever-changing earnings growth expectations creates excessive trading, taxes, and transaction costs. However, for long-term investors, the great growth manager, T. Rowe Price, summed it up best 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.”

 

Growth investing is both a science and an art, but does not require a degree in rocket science. If you can focus on the important growth criteria, and combine it with a long-term disciplined valuation process, you will be well on your way to discovering the growth stock Holy Grail.

Investment Questions Border

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AAPL and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in VRX, BBRY, SBUX, WMT, CROX, Krispy Kreme, Webvan, 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.

December 24, 2016 at 11:20 am 1 comment

Speculative Animal (Hamster) Spirits on the Rise

Hamster Wheel

“Winning is a habit. Unfortunately, so is losing.”

– Vince Lombardi

And one thing is for sure…day traders have a habit of losing. Like a hamster on a spinning wheel, day traders use a lot of energy in creating loads of activity, but end up getting nowhere in the process. This subject is important because the animal (hamster) spirits are on the rise as evidenced by the 22% and 17% increase in average client trades per day reported last month by TD Ameritrade (TD) and Charles Schwab (SCHW), respectively.

The statistics speak for themselves, and the numbers are not pretty. An often cited study by Terrence Odeon (U.C. Berkely) and Brad Barber (U.C. Davis) showed that 80% of active traders lose money. The duo came to this conclusion over six years of research by studying 66,465 accounts. More importantly, they “found that if you were to look at the past performance of these traders, only 1 percent of them could be called predictably profitable.” Uggh!

How can this horrendous performance be? Especially when we are continually bombarded with the endless commercials of talking babies and perpetual software bells & whistles that shamelessly promote and pledge a simple path to prosperity. The answer to why active trading fails for the overwhelming masses is the following:

  • Taxes/Capital Gains
  • Transactions costs/commissions
  • Research costs/software
  • Lack of institutional advantages (speed, beneficial rates, I.T./automation, execution, etc.)
  • Impact costs (buying handicaps returns by pushing purchase prices higher, and selling handicaps returns by pushing sale prices lower)
  • Absence from participation in long-term upward drift in equity prices

After considering the horrible odds stacked against the active trader, the atrocious results are not surprising.

The Blemished Investing Brain

So far, we’ve discussed the mechanics behind the money-losing results of active trading, but the underlying reasons can be further explained by the three-pound, 100,000,000,000 amalgamation of cells located between our ears. Evolution has formed our brains to seek pleasure and avoid pain, and trading stocks can create a rush like no other activity. Similar to the orgasmic emotions triggered by making a quick buck at the blackjack table in Las Vegas or scratching off a winning number on a lottery ticket, buying and selling stocks creates comparable effects.

Through the use of high-powered, multi-million imaging technology (i.e., functional-MRI), Brian Knutson, a professor of neuroscience and psychology at Stanford University discovered that active trading for money impacts the brain in a similar fashion as do sex and drugs. The data is pretty compelling because you can see the pleasure center images of the brain light up dynamically in real time.

To put the results of his human trading experiments in context, Knutson noted:

“We very quickly found out that nothing had an effect on people like money — not naked bodies, not corpses. It got people riled up. Like food provides motivation for dogs, money provides it for people.”

Brokerage firms and casinos have figured out the greed-seeking weakness in human brains and exploited this vulnerability to the maximum. By rigging the system in their favor, mega-billion dollar financial institutions and gaming empires continue to sprawl around the globe.

The emotional high experienced by day traders is one explanation for the excessive trading, but there is another contributing factor. The inherent human cognitive bias that behavioral finance academics call overconfidence (or illusory superiority) helps fuel the destructive behavior. Surveys that ask people if they are above-average drivers highlight the overconfidence phenomenon by showing the mathematical impossibility of having 93% of a population as above-average drivers. Similarly, a study of Stanford MBA students showed 87% of the respondents rating their academic performance above median.

Even, arguably the greatest trader of all-time, Jesse Livermore realized the negative impacts of emotions and active trading when he said, “It was never my thinking that made big money for me. It always was my sitting.” As I’ve written in the past, active trading is hazardous to your long-term wealth. Rather than succumbing to the endless pitfalls of day trading and getting nowhere like a hamster on a spinning wheel, it’s better to use a long-term, objective and unemotional investing process to achieve investment success.

See also: Brain Scans Show Link Between Lust for Sex and Money

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold long positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct discretionary position in TD, SCHW, 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.

March 8, 2014 at 1:28 pm Leave a comment


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