Sunday, 31 October 2010

The concept of Rational Value of a Portfolio (Ellis Traub)

Re: Toolkit 5 and rational Value
Financial Literacy for Youth
Thu, 30 Dec 2004 18:34:18 -0800 (PST)


At 08:57 PM 12/30/2004, you wrote:

The Portfolio Report Card Overview section of Toolkit 5 has a new concept,
called rational value. I'm trying to understand how the the number is


You should be able to arrive at it by dividing the current price of
each stock by its relative value and multiplying that result by the
number of shares.

The concept behind this value is that each company has a fairly
constant PE (we like to call it the "signature PE") at which it has
sold. This is its historical average and represents a price (expressed
as a multiple of earnings) that has proven to be reasonable. The PE
is a rate investors are willing to pay for a dollar's worth of earnings
(much like the price or rate for a pound of coffee or gallon of gas).

When the PE is above that signature PE, it's selling at a higher rate
than "normal" and, conversely, when it sells below that value, it's
selling at a lower than "normal" rate.

The "Rational Price" (current price divided by the Relative Value)
is the price at which the stock would be selling were it to have
a Relative Value of 100%. In other words, it's the "normal" price
for the stock based on history. The "Rational Value" is the value
of your holdings if people were to be paying that "rational" price
for the stock.

The value is in setting a realistic value on your portfolio so that
you can see if, in the present market, your portfolio and its
holdings are above or below what it "should" be if people were
paying that rational price. It's supposed to keep you feet on the
ground in a bubble and your head in the clouds in a bust.

Ellis Traub


Signature PE =  The fairly constant PE at which the stock has sold.

Relative (PE) Value = Current PE / Signature PE

Rational Price of Stock 
= Price at which the Stock would be selling were it to have a Relative Value of 100%
= Current Price of Stock / Relative Value

Rational Value of a Stock in a Portfolio 
= Rational Price of Stock X Number of Shares
= [(Current Price of Stock / Relative Value) X Number of Shares]

Rational Value of a Portfolio 
= Sum of the Rational Values of Each Stock in the Portfolio
= Rational Value of Stock A + Rational Value of Stock B + Rational Value of Stock C + ......

Relative Values and Rational Prices of Selected Stocks in KLSE.

Five reasons why my way works

My mission, when I started this blog, was to persuade my readers that “investing,” is not what the securities industry has spent gazillions convincing everyone it is: betting on the stock market, which is risky and unpredictable. Rather, “investing” is a simple means of earning money with your money. It can make you wealthy and is virtually risk-free. 

Here are five reasons why “our” way works, and “their” way doesn’t.

  1. “We” seek to be part-owners of companies that have a proven track record of making money for their owners. “They” buy stocks because their stories sound good.
  2. “We” judge the quality of the companies we invest in by examining their fundamentals—their “lifeblood” and “vital signs.” “They” use technical analysis to decide when to buy and sell—a popular attempt to predict the unpredictable, with no record of consistent success.
  3. “We” know, from history, what multiple of profits would be reasonable to pay for shares of such companies. “They” ignore such fundamentals and can only guess at reasonable purchase price.
  4. “We” rely upon an increase in the actual value of our holdings over time to justify selling at a profit. “They” must rely on luck or someone else’s ignorance to profit from the transaction.
  5. “We” value our portfolios according to their potential—their rational value—because we own shares in companies whose operations continue profitably, regardless of the fluctuations of the stock market. “They” value shares according to their “market value”—whatever they’re selling for at the moment—because “they” don’t have a means of setting an absolute value for those shares.

The only thing “they” have going for them is excitement. There’s nothing like the rush that comes with risk! Especially when you bet your life’s savings on something as uncertain as the stock market.

Asset Allocation: Is it Necessary or Effective?

October 29th, 2009

 Asset allocation is a device used by investors and financial planners to populate a portfolio with an appropriate mix of investment vehicles selected from a smorgasbord of stocks, bonds, and occasionally other investments, each deemed to carry with it a uniquely predictable degree of risk.
Its goal is to optimize the return on the portfolio while taking into account  that investor’s tolerance for risk. And,  risk aversion is analyzed using such factors as the point the client has reached in her life cycle, her current and future responsibilities, her earning capacity—as well as the nuances of his or her character and personality.
The assumption is that there is an inverse relationship between  risk and return; and, the more aggressive the portfolio—one invested primarily in common stocks—the more risky it is.
Few amateur investors have the experience or know-how to apply asset allocation without the help of a professional. And, considering the view that most amateurs have of “investing,” the expense of such a professional might easily be justified. But….
I agree with Peter Lynch’s view that one should invest as if she were going to live forever. In my view, the most aggressive portfolio should be expected to generate no higher a return than the potential growth rate of a basket of well managed companies’ earnings—between 10% and 15% a year. And that there’s simply no need to dilute the return of a portfolio with any investment vehicles that would return less than that. I believe that’s all the “asset allocation” anyone needs!
The secret is to recognize that there is virtually no risk when you select those companies for their ability to grow their earnings consistently and adequately; and when you understand that the oscillations of the stock market—and the prices of the shares of the companies you own—have nothing whatever to do with the operation of those companies and the generation of profits for their owners. And, as an owner, you’re in it for those profits

Friday, 29 October 2010

Pimco likens US to 'Ponzi' scheme: Quantitative Easing in the trillions is not a bondholder's friend; it is in fact inflationary.

US authorities are operating a "brazen" Ponzi scheme in government debt by buying trillions of dollars of bonds to stimulate the economy, according to Bill Gross, managing director of Pimco, the world's biggest bond house.

Pimco likens US to 'Ponzi' scheme
Mr Gross said more QE is a huge gamble, but necessary because the US is "in a 'liquidity trap'
In a bid to restart the stalling recovery, the US Federal Reserve is next week expected to unveil a second round of quantitative easing (QE) of as much as $500bn, on top of the $1.2 trillion already completed.
In typically robust comments, Mr Gross said the Fed had run out of other options but warned that more QE would in the long-term mean "picking the creditor's pocket via inflation and negative real interest rates".
"[Cheque] writing in the trillions is not a bondholder's friend; it is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme," he wrote on his investment outlook, arguing that creditors have always expected to be paid out of future growth.
"Now, with growth in doubt, it seems the Fed has taken Ponzi one step further," he said. "The Fed has joined the party itself. Has there ever been a Ponzi scheme so brazen? There has not."
More QE is a huge gamble, he said, but necessary because the US is "in a 'liquidity trap', where interest rates or QE may not stimulate borrowing or lending because consumer demand is just not there."
Mr Gross is best-known in the UK for saying gilts were "resting on a bed of nitroglycerine" as a result of the nation's high debt levels. Pimco has since reversed its position on the UK and advised clients to gamble on a British recovery.

UK: Interest rate rise prospect on inflation outlook

Inflation expectations have edged higher this month, piling pressure on the Bank of England to raise interest rates.

Interest rate rise prospect on inflation outlook
Interest rate rise prospect on inflation outlook Photo: ALAMY
According to a Citi and YouGov public poll, expectations for inflation over the coming year currently stand at 3pc, compared with 2.9pc in September.
"Inflation expectations for the year ahead have not been higher since September 2008," Citi economist Michael Saunders said. Inflation was then running at 5.2pc – a 16-year high – compared with 3.1pc currently.
Policymakers are concerned that rising inflation expectations could become self-fulfilling by working through to prices and wage settlements. Mervyn King, Governor of the Bank of England, has previously warned: "If that were to occur, it would be costly to bring inflation down."
Interest rates would have to rise, potentially ction expectations are becoming embedded. Most pay deals were worth between 2pc and 3pc in recent months, below the rate of inflation, according to a study from Incomes Data Services published today.rippling the recovery which is reliant on a loose monetary policy offsetting the spending cuts and tax rises. Most economists expect interest rates to stay low at least until the second half of next year, and many think the Bank will restart quantitative easing with an additional £50bn.
"The uptick in long-term inflation expectations... may well reflect actual inflation data, with UK inflation well above target and well above [Bank] forecasts," Mr Saunders said.
To date, though, there is little evidence that higher infla

EU 'haircut' plans rattle bondholders

Investors face large potential losses on eurozone debt under German plans likely to win backing from EU leaders on Friday – risking a boycott of Greek, Irish, and Portuguese bonds.

EU 'haircut' plans rattle bondholders
Front row left to right, European Commission President Jose Manuel Barroso, French President Nicolas Sarkozy, and Lithuania's President Dalia Grybauskaite. Back row left to right, Portugal's Prime Minister Jose Socrates and German Chancellor Angela Merkel at the EU summit in Brussels Photo: AP
Germany has agreed to give the EU's €440bn (£383bn) bail-out fund permanent status rather than letting it expire in 2013 as planned, but only as part of a "Crisis Resolution Mechanism" that forces bondholders to share losses from any future bail-outs. The fund must be anchored in EU law through changes to the Treaties in order to head off legal challenges at Germany's constitutional court.
A draft proposal from Berlin – now serving as a working text for the European Commission – calls for "orderly insolvency" by eurozone countries in trouble. Details are sketchy but this "Chapter 11" for sovereign states would include an extension of debt maturities, a "holiday" on interest payments for as long as needed to let debtors recover, and a suspension of bondholder rights. The blueprint is akin to debt-restucturing schemes used by the International Monetary Fund.
Under a Finnish proposal, there are likely to be "Collective Action Clauses" in all new bond issues to prevent minority bondholders blocking a default deal.
European President Herman van Rompuy will be tasked to draw up a blueprint for the crisis mechanism. There may also be a Sovereign Debt Restructuring Mechanism (SDRM).
Berlin is determined to avoid a repeat of the €110bn bailout for Greece when banks were shielded from losses, leaving eurozone taxpayers facing the full cost.
Silvio Peruzzo, Europe economist at RBS, said talk of "haircuts" for bondholder at this delicate juncture could backfire. "The debt crisis in the eurozone periphery has not been sorted out. These countries need markets to keep buying the bonds, but investors are going to stay away if you open the door to private sector pain," he said.
It is unclear whether the latest bond jitters in Greece, Ireland, and Portugal is linked to growing awareness of the German plans. Each country has its own troubles. Yields on Ireland's 10-year bonds briefly rose to a post-EMU high above 7pc on Thursday, partly due to a stand-off between Dublin and angry funds facing losses on the junior debt of Anglo Irish Bank.
However, EU officials fear that the proposals could make it harder for high-debt states to tap debt markets, risking a self-fulfilling crisis.
Germany is likely to win backing in principle at Friday's EU summit in Brussels since it has already struck a deal with France, and Britain has dropped its opposition to treaty changes.
Brussels believes it is possible to invoke Article 48.6, which allows changes to the Lisbon Treaty without the political trauma of referenda or full ratification in all 27 states. This "simplified revision" can be used to cover matters in Part III of the Treaty, but the EU risks a political backlash if it tries to push through such a controversial plan by these means. Viviane Reding, the EU justice commissioner, said it was "suicidal" to tinker with the treaties so soon after the Lisbon storm.
German Chancellor Angela Merkel is also demanding EU powers to strip countries of their voting rights if they breach eurozone rules, but this has been dismissed by Brussels as "totally unacceptable" and will be blocked by other states.
The summit was intended to endorse plans by an EU taskforce for a beefed-up Stability Pact, but as so often at EU meetings France and Germany have run away with the agenda.
The German proposals have a logic since they let struggling states claw their way out crisis by reducing debt. Greece's rescue risks failure because it will leave the country with public debt of 150pc of GDP, near the point of no return

Top 10 most productive companies in the UK

In the top 10 most productive companies, five are in the natural resources industry, while four are in the insurance sector. Just one financial services firm, Intermediate Capital Group, made it into the top 10 – contrary “to what people might assume”, Mr Goodwill said.
A number of companies in the top 100 are not household names, Mr Goodwill added – with the first bank, Lloyds Banking Group, appearing at number 96 on the list with revenue per employee standing at £265,000.
Most productive company 
Revenue per full time employee 
Soco International £6.1m 
St James's Place £5m 
Legal & General Group £4.7m 
Dana Petroleum £3.6m 
Anglo Pacific Group £2.9m 
Intermediate Capital Group £2.2m 
BP £2m 
Standard Life £1.8m 
Royal Dutch Shell £1.8m 
Prudential £1.8m 
Source: Profiles International

Thursday, 28 October 2010

The coming flight to quality stocks

Posted by Scott Cendrowski, reporter
October 27, 2010 1:40 pm

Leave it to Jeremy Grantham to blast Fed Chairman Ben Bernanke and former chairman Alan Greenspan in a rightfully scary missive titled "Night of the Living Fed."

Jeremy Grantham, the institutional money manager in Boston who oversees nearly $100 billion, has been as critical of the Fed's interest rate policies over the past 15 years as he has been adept at spotting bubbles fueled by the low rates. He warned clients of tech stocks more than a decade ago and more recently called a worldwide asset bubble before the meltdown in 2008. (Though he's labeled a perma-bear, Grantham pounces on opportunities: on March 10, 2009, at the market's lows, he encouraged clients to load up on stocks in a note titled "Reinvesting When Terrified.")

His latest quarterly note reminds investors how dangerous it is for Bernanke and Co. to rely on ultra-low interest rates, and the resulting cheap debt, to promote economic growth. "My heretical view is that debt doesn't matter all that much to long-term growth rates," he writes. "In the real world, growth depends on real factors: the quality and quantity of education, work ethic, population profile, the quality and quantity of existing plant and equipment, business organization, the quality of public leadership (especially from the Fed in the U.S.), and the quality (not quantity) of existing regulations and the degree of enforcement."

A graph of total debt compared to U.S. GDP growth drives home the point: as the U.S. tripled its debt compared to GDP in the past three decades, GDP growth slowed to 2.4% from its 100-year average of 3.4%.

Read Grantham's entire note below (and we really encourage you to do so, even if it takes the better part of an afternoon). The most sobering section must be the effect that near zero percent interest rates has on retirees in the U.S.

"When rates are artificially low, income is moved away from savers, or holders of government and other debt, toward borrowers," Grantham writes. "Today, this means less income for retirees and near-retirees with conservative portfolios, and more profit opportunities for the financial industry; hedge funds can leverage cheaply and banks can borrow from the government and lend out at higher prices or even, perish the thought, pay out higher bonuses. This is the problem: there are more retirees and near-retirees now than ever before, and they tend to consume all of their investment income."

Flight to quality

Since Grantham is foremost a stock investor, we'll let you read his criticisms and instead highlight what he thinks it means for stocks. Grantham's takeaway: don't fight the Fed.

Stocks, which are overvalued by historical standards, can still run up 20% or more, he says.

Year three of a presidential cycle is typically a good time for stocks. Since FDR's presidency, some 19 cycles have passed with only one bear market. That, coupled with low short-term interest rates, leads Grantham to affix 50/50 odds on the S&P 500 Index reaching 1,400 or 1,500 in the next year.

"There is also the definite possibility that we could slide back into a double dip, so we may get lucky and have a chance to buy cheaper stocks," he writes. "But probably not yet. And, of course, if we get up to 1400 or 1500 on the S&P, we once again face the consequences of a badly overpriced market and overextended risk taking with six of my predicted seven lean years still ahead."

To cope with seven lean years (more here), Grantham still proselytizes high-quality stocks: the 25% of companies in the S&P 500 with low-debt and high, stable returns.

"For good short-term momentum players, it may be heaven once again," he writes. "Being (still) British, this is likely to be my nth opportunity to show a stiff upper lip." And it may be easier even for average investors, he observes, to buy high-quality blue chips because they are getting "so cheap" relative to the market.

Recently, in the largest stock rally since 1932, Grantham often notes, high-quality blue chips have trailed the speculative, debt-laden companies within the S&P 500. He writes that chances are one in three that, come another rally in the next year, high-quality stocks will join in. "….Quality stocks are so cheap that they will 'unexpectedly' hang in," he writes.

Warren Buffett: Forget gold, buy stocks

Warren Buffett: Forget gold, buy stocks Ben Stein, contributor

FORTUNE -- The first thing I notice on my most recent visit with Warren E. Buffett, who recently turned 80, is how incredible he looks. He would look terrific for 50; for 80, he looks like Charles Atlas. He's modest about it, as he is about everything. "It all works great," he says. "The eyes, the hearing -- everything works great ... which it will until it all falls apart."
The second thing you notice is that he is so smart it curls your hair.
My first question, as I sit there on the couch in his office, is: "What about gold? Is this a classic bubble or what?"
"Look," he says, with his usual confident laugh. "You could take all the gold that's ever been mined, and it would fill a cube 67 feet in each direction. For what that's worth at current gold prices, you could buy all -- not some -- all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?"
Okay, so gold is not a screaming buy to Buffett. What should a typical upper-middle-class person in the U.S. buy to prepare for retirement?
"Equities," Buffett answers without a moment's hesitation.
"The VTI?" I ask.
"That's good enough. Maybe a selection of high-dividend-paying stocks that are likely to raise their dividends. Maybe the top 100 dividend payers of the S&P 500."
Then, after a second's thought, he adds, "Well, maybe not that, but equities."
On the $64,000 question -- whether the recovery was real -- Buffett has no doubt. "Yes," he says, "it's a recovery. It's a slow recovery, but it's a recovery. We're calling back some people at Burlington Northern. We are still letting a few go in other businesses, but we see a pickup in business of heavy users of American Express (AXPFortune 500), in freight car loadings at BNSF -- across our businesses, we see slow recovery."
"When would you start hiring a lot more people?" I ask him.
"When demand picks up," he says. "We don't hire because we get a tax break or because someone in the government tells us to. We hire when there's more demand for what we are making or moving or selling. It's that simple."
"Where will the demand come from if a business as big as yours is being so cautious?" I ask.
"It's already coming," he says. "It's already happening, and it will pick up. Look," he adds, "we needed a really big stimulus in the fall of 2008 -- a really, really big stimulus. We didn't get it. It was a miracle that Bank of America (BACFortune 500) bought Merrill for $29 when it was probably worth 29 cents if left on its own for a few days. If that hadn't happened, everything would have collapsed. The whole commercial-paper market would have stopped. Every domino would have fallen. Berkshire (BRKA,Fortune 500) would have been the last, but it would have fallen too. Ken Lewis saved the whole system for a while, until TARP could rescue it. But now we're just going to get a very slow recovery because people are still scared. But we are seeing recovery, definitely."
"How about in housing?"
"That recovery is still a long way off. That market got way out of equilibrium, and it's going to take a long while for it to get fixed."
Buffett goes into his life and childhood, but I don't see how we can make any money out of that, so I will leave that part out.
What about taxes? Buffett thinks that taxes should be raised on really rich Americans -- ones making $5 million a year, say, and especially ones making $1 billion a year.
"Why would we want to do that" I ask, "if we have a fiscal policy that is explicitly about running large deficits?"
The three of us -- Buffett, my colleague Phil deMuth,and I -- talked for a long time about the size of the deficits relative to "normal peacetime" and World War II, when they were far higher than they are even now. Then Buffett sums up his feelings about it, saying his wish to raise taxes on the very rich is really about social justice more than about fiscal policy.
"I would give anyone an exemption from the higher rates if he had a son or grandson in Afghanistan," he said. "I meet a lot of people at these conferences of rich people, of billionaires," he said. "None of them have anyone in their family in combat."
We talk awhile longer, and then Phil and Warren and I go out for a memorable Italian meal at Piccolo Pete's, which Warren considers the best restaurant in America. I look at him as he chews his meatballs. (He has perfect table manners.)
"This guy is so smart -- it's like he's a machine, but a very friendly, polite, affable machine," I think.
I keep thinking of what I would do if I had even the tiniest fraction of his money. But I never will, so I'll skip that too.
Buffett drives us back to the hotel in his lovely Cadillac. "I bought it because a couple of years ago I saw Congress giving Rick Wagoner (the former CEO of GM) such a going-over that I thought I should help him out by buying a Cadillac."
"Cadillac," I think, remembering an old Bob Dylan song. "Good car to drive, after a war."
Ben Stein is an economist, actor, lawyer, writer and quiz show host from 1988 to 1996 was a professor of law and economics at Pepperdine University School of Law. To top of page