Saturday, 30 June 2012

Tesco's recent fortunes illustrate how, like economies, companies move cyclically

Cycle path - Tesco's recent fortunes illustrate how, like economies, companies move cyclically

26 Jan 2012
We have discussed in the past how the broader economy moves in cycles – and how value investing looks to exploit how the market responds to different points within those cycles. However, the recent profit warning issued by supermarket giant Tesco illustrates how individual industries and even individual companies can have cycles of their own.
Over the last decade or more, Tesco has enjoyed an extraordinary rise from being just one of the food retailing herd to become, by some distance, one of the biggest beasts in the global retail jungle. At present there is no question the group dominates all aspects of retailing in the UK, from convenience stores, through traditional supermarkets and increasingly the online space as well.
Inevitably, when a company finds a formula that brings it as much success as Tesco has enjoyed in the UK, natural economic forces begin to assert themselves – perhaps, for example, the competition learns from what a winning business has done, or maybe some of the people at the top of the winning business grow so used to success that a bit of complacency slips in. Either of those factors and no doubt plenty of others could have come into play at Tesco in recent years to slowly chip away at the lead it had established from rivals.
Just as value investors will seek to take advantage of extremes of valuation thrown up by economic cycles they will also look to do so with an industry or company-specific cycle. Businesses go through phases of good and bad operational performance and of being liked and disliked by the stock market, indeed until quite recently Tesco has been a relatively loved company.  The negative reaction to its recent setback may turn out to be much more extreme than is actually justified as even if Tesco is no longer the supermarket winner in the UK that does not mean it has become a bad business overnight.
In all probability and provided its management behave sensibly, Tesco can still earn good returns in the UK and operates a large foreign business that has further to grow. Even if the next 10 years does not see it scale the heights of the previous decade relative to competitors, investors who can find the right entry point in terms of valuation could still make good returns from its shares.

Warren Buffett on why he holds Cash

Warren Buffett - The Book that Changed My Life

Warren Buffett's investment advice

Warren Buffett (World's Richest Investor): His Secrets Revealed!!!

Stock investments versus bonds are a ‘no-brainer’, says Warren Buffett

October 6th, 2010 by John Doherty

 Stock investments vs. bonds are a 'no-brainer', says Buffett
Stock investments are superior to investment in bonds, despite the general view that bonds investments are relatively low-risk, according to the world’s most successful investor, Warren Buffett.
Speaking at a conference for top US businesswomen organised by Fortune magazine, Buffett said of stocks investments: “It’s quite clear that stocks are cheaper than bonds. I can’t imagine anyone having bonds in their portfolio when they can have equities.”
For the world’s 3rd-richest man, with a personal net worth estimated at $47 billion in March 2010, low-risk investments may no longer be necessary – but even for the ordinary investor prepared to put their money away for a decade or two, the arguments for stocks and shares investments are what Buffett might call a ‘no-brainer’.
By charting the performance of a long-term investment in stocks and shares made in 1945, figures released recently by Scottish Widows shows that returns over a 60-year term were 70 times greater than investing the same sum as cash in a bank or building society account.
A sum of £100 invested in a building society account in 1945 would have been worth just £1,767 by 2006, according to Scottish Widows. Invested in bonds, the sum would have been worth £4,323.
However, the same £100 invested in the UK stock markets, as measured by the Barclays Equity Index and including dividends reinvested, would have grown to £125,243 over the same time period.
While bonds may be attractive for an investment of 5-10 years, as you are told in advance what your minimum return will be, stocks and shares investments are the clear winner in the longer term.
Warren Buffett’s investment activities are carried on through his investment company Berkshire Hathaway, which has been voted the world’s most respected company by the leading US business publication Barron’s Magazine.

Tesco weighs future of Fresh & Easy

By James Davey
CARDIFF (Reuters) - World No. 3 retailer Tesco (TSCO.L) promised to pull the plug on its loss-making Fresh & Easy chain in the United States if it continued to disappoint, and rejected renewed calls for an independent review of its strategy for the venture.
"If we see there is no chance of success, we'll do as we've just done in Japan," said chief executive Philip Clarke, referring to Tesco's deal this month to exit that market.
"It is not about ego, we are businessmen," he told the British grocer's annual meeting in the Welsh capital, Cardiff, on Friday.
The Change to Win Investment Group, which advises U.S. trade union-sponsored pension funds, during the meeting asked Tesco to establish a committee of non-executive directors to review Fresh & Easy's future and set fixed benchmarks to measure its success.
"We will not be doing that," responded chairman Richard Broadbent.
He said the strategy for Fresh & Easy was regularly reviewed by the whole board, with the retailer providing full disclosure on the business in its annual report and accounts.
"We're not hiding anything at all on Fresh & Easy," he said.
Change to Win's proposals have been ignored by Tesco for several years. It regards them as union motivated. Fresh & Easy does not recognize trade unions.
Clarke has this year rejected shareholder calls to pull the group out of the United States.
In April he said he did not expect the chain to break even until its 2013/14 financial year, against a previous target of 2012/13.
This month, Tesco reported underlying sales growth at Fresh & Easy slowed to 3.6 percent in its first quarter from 12.3 percent in the fourth quarter of last year.
"What shareholders want to know is, where is Fresh & Easy going and how much will it cost to get there?," said Michael Zucker, Change to Win's director of retail initiatives.
Once one of the most consistent British companies in terms of earnings growth, Tesco stunned investors in January with its first profit warning in more than 20 years, saying it needed to invest heavily to stem a steady decline in UK market share.
However, it avoided becoming the latest victim of the 'shareholder spring' which has seen investors resist big pay rises at underperforming companies.
The phenomenon has led to the departures of Aviva (LSE:AV.) boss Andrew Moss and Sly Bailey, head of newspaper group Trinity Mirror (TNI.L).
Some 96.9 percent of shareholders who voted at the meeting backed Tesco's executive pay report, even though Pensions Investment Research Consultants (Pirc), a pension fund consultant, had called on investors to vote against it.
Last month's move by Clarke not to take his 372,000 pounds ($576,800) bonus may have headed off any potential rebellion.
He told the meeting Tesco's strategy to revive its core UK business, which accounts for about one in every 10 pounds spent in British shops, and about 70 percent of Tesco's annual trading profit, was making progress as he addressed shareholder concerns ranging from empty shelves to rodent-infested stores.
This month, Tesco reported a fall in first-quarter underlying sales in Britain and said tough trading conditions showed no sign of improving.
Broadbent gave Clarke his backing when one shareholder asked if the latter would resign if he could not deliver recovery in the U.S. and the UK.
"Phil is evidently one of the best retailers in the world. There is absolutely no question of Philip Clarke resigning," said the chairman.
After the meeting Clarke was asked if the British government should be doing more to stimulate economic growth.
"I think there's a case for it," he told reporters.
"Peoples' disposable incomes are squeezed. Until there's some change I think it will be hard for everybody."
But he welcomed this week's move by the government to scrap a planned increase in fuel duty and took some comfort from recent falls in the oil price.
Shares in Tesco, which lags France's Carrefour (CA.PA) and U.S. industry leader Wal-Mart (WMT.N) in annual sales, have lost nearly a quarter of their value over the last year. They closed down 0.6 percent at 310 pence.


Mr. Market vs. The Intelligent Investor

  • The Intelligent Investor uses logical and mathematical analysis and doesn't trade on emotion.
  • The Intelligent Investor buys things that have done bad whose fundamentals are intact.
  • The Intelligent Investor sells things that have done good whose fundamentals are damaged.
  • The Intelligent Investor takes advantage of the economic cycle as opposed to becoming a victim of it.
  • The Intelligent Investor looks forward to economic collapses because that is when we make the most money.
  • The Intelligent Investor fears a great booming economy because that is when we could lose everything.
  • The Intelligent Investor milks the profits of a good business and doesn't sell unless the business has gone bad.
  • The Intelligent Investor is aware that the future cannot be predicted.

The 10 Mistakes Investors Most Commonly Make

All investors make mistakes. Otherwise, we'd all be millionaires. The trick is figuring out what our investing mistakes are -- and then trying to avoid them.

Meir Statman, one of the nation's leading experts in behavioral finance (the study of why people do irrational things with their money), has written a new book on the topic. In What Investors Really Want, published in October by McGraw-Hill, Statman goes a long way toward helping investors understand that many of their mistakes are caused by their own deep-seated emotions rather than, say, a company's unexpectedly poor earnings. 

In an interview with DailyFinance, Statman, a professor of finance at Santa Clara University in California, shared his top 10 errors that trip up average investors:

Meir Statman: What Investors Really Want1. Hindsight error. "One of the most pernicious mistakes," Statman says. Because you can see the past clearly, you think you have a similar ability to tell the future. Hindsight error is common at the moment, Statman says, because many people are convinced they saw the crash coming in 2007. In reality, they may have thought a crash was possible, but they also thought the market might continue to zoom upward. Now, investors are convinced they actually saw the problem in 2007 but just didn't act on it. So, they believe wrongly that they can act correctly today. They think they know to sell at the precise moment the market is high and buy when the market is low. Based on their hindsight of 2007, portfolio diversification doesn't protect you from losses. But market timing rarely works, Statman says.

2. Unrealistic optimism. This is loosely related to overconfidence. Psychological studies have shown that when you ask people if they think they have the ability to pick stocks that will have above-average returns, men tend to say yes more often than women. "It's not because men are so smart. It's because men are unrealistically optimistic about their abilities," Statman says. This quality is great for job interviews, where you need to stand out from a crowd, but lousy for investing. "When you are unreasonably optimistic in the stock market, you are just readying yourself for an accident," he says.

3. Extrapolation errors. People expect that trends that existed in the recent past will continue in the future. For example, the fact that gold has gone up for the last 10 years has led many to believe it will always go up. But a study of a longer period -- going back to 1971 when President Richard Nixon ended the gold standard -- shows that gold hit a high of $850 an ounce in 1980 but was selling for $345 as long as 10 years later.

4. Framing errors. Often, Statman says, investing is like a game of tennis. People tend to see themselves hitting a ball against a wall, which seems easy. But that's the wrong frame. Investing is really like playing against another player -- when the other player is Warren Buffett or Goldman Sachs. Investors make framing errors when they see a CEO on TV talking up his stock. If it sounds good and you buy that stock, that's a framing error. Instead, you should be asking yourself: "Who else is watching this program, and what do I know that is uniquely mine?" "The answer is nothing," Statman says.

5. Availability errors. This refers to what information is available in your memory. Investors are often lulled into this error by investment companies. When you see an advertisement for a fund, it's almost invariably for one that has a four- or five-star rating from Morningstar. That way, the one- and two-star funds, with lackluster results, aren't available in your memory. "You say to yourself that there's a 90% chance I will be a winner," Statman says. Instead, look at results of entire fund families -- including the losers, not just the winning funds for a particular period, he says.

6. Confirmation errors. Investors tend to look for information that confirms their hypothesis, but they disregard evidence that contradicts it. Gold bugs, for example, constantly remind us that gold is a good hedge against inflation and a declining dollar. But when confronted with the evidence that gold actually fell price for an entire decade, they dismiss that as a different era because Ronald Reagan changed the rules of the investing game, and that problem won't be repeated.

7. Illusion of control. This is a sense investors have that they can make the market go up or down. It's like gamblers blowing on their dice before rolling. "These investors think they're riding the tiger, when in fact they're holding the tiger by the tail," Statman says. If you think you have a trick that can get the market to go your way, you better think twice: This is the illusion of control. "When you realize the market is actually a wild beast that can devour you, you try to put it in a cage," he says. A much safer approach.

8. Anger. This is an emotion we all know: It leads to things like road rage. In investing, you try to get even with the market. You do such things as double down or even sell all your stocks impulsively. "If you feel angry, it's better to wait 10 days before buying or selling, or you'll regret it later on," Statman says,

9. Fear. The other side of exuberance. When you're afraid, everything looks like a threat, and when you're exuberant, everything looks like an opportunity. Lots of investors are still afraid because of the market crash two years ago. They're sitting on the sidelines in cash earning no return or investing in things like Treasury bills, which aren't much of a bargain. "Risk and return go together," Statman says. "So, if you think the market is risky today, then you should also think the market has a good potential for high returns."

10. Affinity of groups. Also known as herding. You hear from your pediatrician that he's buying gold, so you think you should, too. But what do these people really know? What is the analysis based on? Statman notes that some herds are worth joining and some aren't. Many investors follow Warren Buffett's investment decisions and buy similar stocks. Since Buffett is usually a winner, perhaps that's a herd worth joining. But buying Internet stocks in 1999 or houses in 2005 based on what everyone else was doing was a horrible mistake.

Statman makes no grand conclusions in his book, but he does point out repeatedly that the average investor can rarely beat the market. Therefore, he recommends small investors put their money in index funds that provide average, if not spectacular returns -- and not catastrophic losses

"But if you like the pizazz of investing," he says, you might take a shot on individual stocks. Just be careful. 

A great company with a Durable Competitive Advantage will have a ratio of Capital Expenditures to Net Income of less than 25%. Less is better.

Capital Expenditures are expenses on:
  • fixed assets such as equipment, property, or industrial buildings
  • fixing problems with an asset
  • preparing an asset to be used in business
  • restoring property
  • starting new businesses
A good company will have a ratio of Capital Expenditures to Net Income of less than 50%. 
A great company with a Durable Competitive Advantage will have a ratio of less than 25%. 

Very few people have gotten rich on their 7th best idea. You'd be much better off putting more money into your best idea.

Warren Buffett:

"There are a lot of things you can learn if you are around securities over the course of your career, and you will find a lot of arbitrage opportunities. However, that probably won't be the primary driver of your investment returns.

If you are not a professional investor, then you should be extremely diversified and you should do very little trading. However, if you want to bring an intensity to the game, and you are going to value businesses, then diversification is a terrible mistake. If you really know business, then you shouldn't own more than 6 businesses. Very few people have gotten rich on their 7th best idea. You'd be much better off putting more money into your best idea. "

The 100 Things I've Learned in Investing

As you'll see in No. 47 on my list, it's very important to step back and gain perspective. In an attempt to stop making the same mistakes over and over, here's my attempt to codify the 100 lessons I've learned in my investing career so far.
1. Most of this list is dedicated to insight on beating the market, but know this: It's darn hard to beat the market. Ninety-nine percent of people are best served steadily buying and holding low-cost index funds at the core of their portfolios -- and I may be understating that 99% figure.
2. Looking for a one-stop index-fund core? For a very reasonable 0.2% in fees a year,Vanguard target date retirement funds will automatically diversify and balance the stock and bond portions of your portfolio -- just pick your retirement date. The Vanguard family of index funds is what I recommend to just about everyone who asks.
3. Being contrarian doesn't just mean doing the opposite. The "contrarian" street-crosser gets run over by a truck.
4. In any financial matter, find out what the other person's incentives are. Discount accordingly.
5. Even a gut investment call should have some numbers to back it up.
6. Mistakes made in your 20s are better than mistakes in your 50s. Mistakes involving $100 are better than mistakes involving $100,000.
7. My all-time favorite Warren Buffett quote: "We like things that you don't have to carry out to three decimal places. If you have to carry them out to three decimal places, they're not good ideas."
8. Never buy stocks on margin, no matter how "can't miss" the opportunity is. That blend of leverage and arrogance is exactly what gets Wall Street in trouble. The difference is that we're not too big to fail.
9. Don't waste time mastering things that simply don't work (see lessons 10 through 12).
10. Example No. 1: day trading. Like playing roulette, you'll have some victories, and you may be able to fool yourself into thinking you're skillful. The house just hopes you keep playing.
11. Example No. 2: technical analysis. The only chart pattern worth noting is the jagged, but likely downward-sloping line of your savings if you follow this technique.
12. Example No. 3: leveraged ETFs. Bastardized ETFs like the Direxion Daily Financial Bull 3X (NYSE: FAS  ) are another great way to lose money. Even if you guess right on direction, the mathematics of the daily reckoning mean these instruments are long-term losers.
13. Stock stories about growth potential (e.g., tech stocks) are sexier than stock stories about track record (e.g., consumer goods stocks). Only the latter are verifiable today, though.
14. Having a strong opinion (let alone acting on it) is overrated. Knowing 20 stocks cold beats being able to challenge Jim Cramer in the lightning round.
15. Albert Einstein allegedly declared compound interest "the most powerful force in the universe." High-interest credit card debt aims that force at your wallet. To get compound interest pointed in the right direction, save (and invest) early and often!
16. A casino makes us use chips in lieu of cash, partially because we forget that the chips represent real money. Stocks may act in screwy ways and invite us to play games, but as investors we can't lose sight of the fact that stocks represent real companies. As Peter Lynch puts it using a different gambling analogy, "Although it's easy to forget sometimes, a share is not a lottery ticket ... it's part-ownership of a business."
17. When talking to other investors, have your BS detector handy. When you hear their "big fish" stories, know that their brilliant track records likely have more to do with selective memory and poor scorekeeping than skill.
18. A great Buffett reason not to fudge our taxes: "We'll never risk what we have for what we don't have and don't need."
19. Those who know what they're doing make complexity seem simple. Folks who don't (or are trying to sell you something) make simplicity complex.
20. A clear sign of the latter: jargon.
21. Asset allocation is more important than stock picking. A silly example: Say you're holding a race among five horses and five human beings. Many investors spend their time trying to rank the five human beings, when they're better off just betting on the five horses.
22. If you don't understand it, don't buy it until you do.
23. Sigh -- hard work is required to beat the market. Per Peter Lynch: "The person that turns over the most rocks wins the game. And that's always been my philosophy."
24. On the plus side, the results of hard work can be breathtaking. In his book Outliers, Malcolm Gladwell gives example after example of people we term "geniuses" who are really hyper-dedicated people who work at their craft relentlessly. Among the examples he uses are Bill Gates and the Beatles. He argues that both got to where they got because of the opportunity (and inclination) to hone their skills for 10,000 hours. That's the equivalent of five full years of work -- or 1,000 weeks of practicing 10 hours a week.
Gates had access to an ultra-high-end computer terminal because his exclusive middle school started a computer club. In high school, his access went up a notch as he gained access to the computers at the University of Washington. He talks of getting 20 to 30 hours of programming time in each weekend. On weeknights, he'd slip out of his house to take advantage of the open time-sharing slots from 3 a.m. to 6 a.m. And the Beatles were just as obsessed. By the time they broke out on the Ed Sullivan show in 1964, the Beatles had played an estimated 1,200 shows, some lasting eight hours!
25. None of the time spent checking and rechecking Yahoo! Finance portfolios counts toward those 10,000 hours. And here's the real kick in the groin: 10,000 hours is a prerequisite for mastery -- not a guarantee.
26. Common sense is as uncommon in investing as it is in real life.
27. One of my favorite lessons from the poker table: Action is overrated. The best players (and investors) are constantly weighing the opportunities, but rarely are they moved to act.
28. A similar sentiment by Vanguard founder Jack Bogle: "Time is your friend; impulse is your enemy."
29. Selling is overrated. Reason No. 1: We often sell potential multibagger winners that would more than make up for our losers. The greater the quality of the business, the greater the danger of selling too early.
30. Selling is overrated. Reason No. 2: Outside of retirement accounts, selling kicks in voluntary taxes.
31. Selling is overrated. Reason No. 3: Fees.
32. In the hands of a good storyteller, almost every stock looks like a winner. Assume you're not hearing the whole story.
33. A question to ask before buying a stock: "What's my competitive advantage on this stock? Do I really know something the market doesn't?" The more specific the advantage, the better.
35. Most of us are too enamored with "so you're saying there's a chance" opportunities. A Hail Mary belongs on the gridiron or in the pew -- not in the brokerage account.
36. A great rule of thumb for buying a house (the biggest single investment most of us will ever make), from fellow Fool Buck Hartzell back in 2005: "If a home is selling for 150 times the monthly rent (or less), it's generally a good deal. If it's selling for more than 200 times the monthly rent of a comparable property, you're better off renting."
37. One of the toughest facts about investing is that a proper track record takes decades. Charlatans can do quite well for years and years. This is potentially dangerous for our assessment of ourselves and of others. Focusing on process, rather than results, helps.
38. Price matters. A great company can be a great big loss for you if you pay too much.
39. When applicable, use the tax system to your advantage. Retirement accounts like 401(k)s and IRAs can be huge boons.
40. It is twice as easy to sound intelligent being pessimistic about the future as it is being optimistic.
41. Greater risk theoretically yields greater reward, but a stupid investment is just a stupid investment.
42. Sir John Templeton's quote: "'This time it's different' are the four most expensive words in the investing language." The details change, but the basic storylines remain the same.
43. Investing shouldn't be improv. Take the time to write a thoughtful script.
44. A key Buffett quote to understand: "Time is the friend of the wonderful company, the enemy of the mediocre." Why is this so? Partially because "you only find out who is swimming naked when the tide goes out." I really struggle to abide by this advice. I am often the Statue of Liberty when it comes to investing in inferior companies on the cheap: "Give me your tired, your poor, your huddled masses," etc.
45. Options promise big gains in short time periods. The problem? About three out of every four expire worthless. Contrast that with a stock, which doesn't expire.
46. Sorry, market timers: Take it from Peter Lynch, who said, "If you spend more than 13 minutes analyzing economic and market forecasts, you've wasted 10 minutes." Or fellow investing great Ralph Wanger: "If you believe you or anyone else has a system that can predict the future of the stock market, the joke is on you." Or the godfather of value investing, Benjamin Graham: "It is absurd to think that the general public can ever make money out of market forecasts."
47. Keep a journal (or spreadsheet) of your stock picks, complete with your rationale for each move. Then look back on it to see if you were right. We may think we're good dressers, but all it takes is a high-school yearbook to prove otherwise.
48. Step aside, high blood pressure: Inflation is the silent killer.
49. Diversification doesn't entail making a whole bunch of dangerous investments and hoping they cancel out. That's the financial equivalent of stabbing your leg to cure your flu.
50. 13 Steps to Investing Foolishly is excellent.
51. Index ETFs may be the most wildly misused products in the stock market. They are excellent tools for ultra-low-cost buy-and-hold diversification, but many use them to day-trade the market (and sectors thereof).
52. Somewhere around 80% of actively managed mutual funds (as opposed to broad index funds) don't beat the market.
53. The more we learn about investing, the more we want to start doing exotic things (naked straddle options, anyone?) and buying stock in obscure companies no one has heard of. Maybe it's boredom, maybe arrogance, or maybe the desire to impress people at parties. Or perhaps it's seeking the glory of being right when few saw it coming. I'm guilty as charged on all counts. When I'm at risk of going off the deep end, I try to remember that stock picking isn't diving. As Buffett has noted, there are no extra points (or returns) for degree of difficulty.
54. This Einstein maxim is spot-on for stock analysis: "Everything should be made as simple as possible, but no simpler." Both clauses are crucial.
55. Just because a company or industry is set to change the world doesn't mean it's a great investment. Beyond looking at valuation, there tends to be a Wild West of players until a few winners emerge. In fact, market beater Ralph Wanger says, "Since the Industrial Revolution began, going downstream -- investing in businesses that will benefit from new technology rather than investing in the technology companies themselves -- has often been the smarter strategy."
56. Jumping from one flavor of the day to the next isn't continuous learning.
57. Long-tail events (a.k.a. black swans) are highly underrated. Nassim Nicholas Taleb explains it best in his book, Fooled by Randomness.
58. Every time I start getting cocky (which is often), I am unceremoniously reminded there are no sure-thing stock picks. As master investor T. Rowe Price noted: "No one can see ahead three years, let alone five or ten. Competition, new inventions -- all kinds of things -- can change the situation in twelve months."
59. I personally get way too excited when a stock hits its 52-week lows or falls 50%. Many sins are washed away in my mind when I see a bargain, but price movement by itself is not a sufficient reason to buy (or sell). Falling knives can be death -- especially when they're rusty and gross.
60. A related point: No one consistently times the bottom or top of a stock's price (let alone the market of stocks!).
61. Don't let the false modesty of investing greats fool you into false confidence.
62. My three strikes against gold. Strike one: Its value can't be estimated with basic math (since it just sits around producing nothing). Strike two: Wharton professor Jeremy Siegel showed that going back to the 1800s, the return on gold has barely kept up with inflation and is left in the dust by stocks and bonds. Strike three: Gold as a doomsday investment doesn't make much sense. If the apocalypse (financial or otherwise) actually comes, you're probably screwed regardless.
63. Discount cash on a company's balance sheet. Managements are brilliant at squandering it.
64. Done properly, value investing -- e.g., focusing on low-P/E, low-P/B, low-TEV/EBITDA stocks for ideas -- has proven to work quite well. But as successful growth-investor Bill O'Neil warns, "What seems too high and risky to the majority generally goes higher, and what seems low and cheap generally goes lower."
65. You may be too smart to be rich.
66. Know thyself. Know your weaknesses and strengths. Here's a specific example from Joel Greenblatt: "For most people, stocks should represent a portion of their investment portfolio because I still believe that over the long term they will provide superior returns relative to most alternative investments. However, whether that portion of an investment portfolio devoted to stock investments should be 40% of an investor's portfolio or 80% is a very individual decision. How much are you willing (or able) to lose before you panic out? There's no sense investing such a large portion of your assets in a long-term strategy if you can't take the pain when your chosen strategy doesn't work out for a period of years."
67. For some help on getting to know yourself, study the common mistakes behavior finance experts have uncovered.
68. Folks say that "success has many fathers, while failure is an orphan." Combine that with our willingness to overvalue streaks owing to one event, and I start to wonder: Do we overvalue managers that leave a successful organization to turn around a woeful organization?
69. If you just heard of the company yesterday, don't buy its stock today.
70. The Internet and better regulations have largely eliminated data advantages. The problem now is isolating which data is actually meaningful. Better results stem from increasing the signal-to-noise ratio.
71. Even if you rely on advice from others, heed the words of bond fund legend Bill Gross: "Finding the best person or the best organization to invest your money is one of the most important financial decisions you'll ever make." As with stocks, familiarity alone isn't protection. Check out our seven-part special report on financial advisors.
72. Stuff that leads to suckerdom: greed, laziness, unearned trust, ignorance, and shortcuts. When in doubt financially, do the opposite of your favorite athlete.
73. Make sure to get the right odds. There should be a vast difference between what we pay for a has-been or never-was and what we pay for a potential superstar company. As George Soros puts it, "It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong."
74. Initial valuation matters, but generally, over longer periods of time (decades, not years), stocks have returned more than bonds. The more decades you have left, the more of your portfolio should be in stocks to stave off inflation.
75. In theory, well-timed share buybacks are better than dividends. They save on taxes and allow the people who know the company best to buy up shares when the market acts crazy. In practice, I'll take dividends. (A tangential bonus fact: Dividend stocks have historically beaten non-dividend stocks).
76. Some of the most misinterpreted words in investing: Peter Lynch's "Buy what you know." It's more like "Research what you know and then consider buying."
77. Don't be an Enron baby. Overweighting your investments in the company you work for is a double-down bet we don't need to be taking. On the other hand, your company's 401(k) match is free money.
78. There are many paths to the top of the investing mountain, but some are more fraught with peril -- and there are very few trailblazers.
79. Numbers frequently lie -- especially in isolation. Say you spot a P/E ratio of eight. Sounds darn cheap! But is that industry's profitability rapidly deteriorating? Was there a one-time item that temporarily juiced the bottom line? Is an upstart competitor hungrily eyeing its lunch? Are new regulations threatening its livelihood? Is it a cyclical industry? Is it in a country that has a really poor reputation for accounting fraud or government interference? You get the idea.
80. Mergers and acquisitions are overrated. Somewhere between 50% and 85% of mergers fail to boost value. The frequency of achieving promised "synergies" should be filed somewhere between unicorns and no-hitters.
81. It's hard to be an independent thinker when the pressures to conform are daily and good investment theses can look ugly for years before paying off. Ben Graham said it this way: "Even the intelligent investor is likely to need considerable willpower to keep from following the crowd." Famed investor John Templeton talked of his defense against crowd-following: "When asked about living and working in the Bahamas during his management of the Templeton Group, Templeton replied, 'I've found my results for investment clients were far better here than when I had my office in 30 Rockefeller Plaza. When you're in Manhattan, it's much more difficult to go opposite the crowd.'" The digital equivalent today is turning off real-time news and Internet feeds and reading more thoughtful analysis.
82. The best book I've ever read on the basics of stock picking: Joel Greenblatt's The Little Book That Still Beats the Market. It's literally written so that a small child can understand it. It also does a great job of explaining why return on capital is a measure to pay attention to.
83. It's not the rewards you don't understand that'll burn you, but the risks you don't understand.
84. The guy who invented the P/E ratio (James Slater) on small caps: "Most leading brokers cannot spare the time and money to research smaller stocks. You are therefore more likely to find a bargain in this relatively under-exploited area of the stock market." Of course, because there is less interest and less Wall Street coverage, doing your own due diligence is that much more important. The same holds for other underfollowed areas of the market, like special situations.
85. If you can learn quickly from your own mistakes, you're ahead of the game. If you can learn quickly from others' mistakes, you've won the game.
86. Jim Sinegal of Costco on why you can't pay too much attention to Wall Street: "You have to recognize -- and I don't mean this in an acrimonious sense -- that the people in that business are trying to make money between now and next Thursday. We're trying to build a company that's going to be here 50 and 60 years from now."
87. If it seems too good to be true...
88. Buffett's concept of the "circle of competence" is important: "There are all kinds of businesses that I don't understand, but that doesn't cause me to stay up at night. It just means I go on to the next one, and that's what the individual investor should do." Also consider Steve Jobs' quote: "Focus is about saying no." For a great book on saying no, read Seth Godin's tiny book The Dip.
89. The stock moves I've made based solely on the advice of others -- e.g., "He's a good energy analyst and he loves this oil stock," or "This famous stock picker is buying X!" -- have generally been disasters.
90. If you can read a dissenting opinion without resorting to an ad hominem attack, you're at an advantage.
91. Downer alert: We like control, but we can't control everything. Life and luck can (and will) trump investment plans. You can do everything right and still die penniless. All we can do is give ourselves a better chance to succeed.
92. That said, if you're reading this article, there's a good chance the genetic lottery has smiled favorably upon you.
93. Here's something to think about the next time you get antsy to buy immediately into the latest must-act-now opportunity (e.g., a hot IPO). The year 1986 marked Coca-Cola's 100-year anniversary. If you had bought shares to commemorate the occasion, you'd be sitting on something like 15 to 20 times your initial investment. Time waits for no man -- but stocks will.
94. How can we get rich? Per Ohio State economics professor Jay Zagorsky: "Staying married, not getting divorced, [and] thinking about savings." To those, I would add having the proper insurance coverage.
95. There are more than 5,000 stocks on major U.S. exchanges. A great stock picker finds one great stock idea a year. Don't let the ones that got away frazzle you into buying the ones you should have ignored.
96. The Pink Sheets and over-the-counter markets are where sketchy penny stocks live. Do yourself a favor and stick to stocks on major U.S. exchanges -- preferably ones with market caps of more than $200 million. And never, ever heed penny stock spam emails.
97. When I learned to drive, I nervously focused on each upcoming parked car. My father told me to focus down the road and the parked cars would take care of themselves. Perhaps my first lesson in investing.
98. Do not buy low and sell high; rather, buy low and don't sell often.
99. For the penultimate lesson, let's turn once more to Warren Buffett, who briefly said in his 2004 shareholder letter what took me 98 bullet points to say:
Over the 35 years, American business has delivered terrific results. It should therefore have been easy for investors to earn juicy returns: All they had to do was piggyback Corporate America in a diversified, low-expense way. An index fund that they never touched would have done the job. Instead many investors have had experiences ranging from mediocre to disastrous.
There have been three primary causes: first, high costs, usually because investors traded excessively or spent far too much on investment management; second, portfolio decisions based on tips and fads rather than on thoughtful, quantified evaluation of businesses; and third, a start-and-stop approach to the market marked by untimely entries (after an advance has been long under way) and exits (after periods of stagnation or decline). Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.
100.  Despite my best efforts, I will repeatedly and thoroughly fail to heed these lessons. Let's hope you're better at No. 85 than I am.

Wednesday, 27 June 2012

Be Wary of IPOs. It's Probably Overpriced.

Do you think you can make lots of money by getting in on the ground floor of the initial public offering (IPO) of a company just coming to market?

My advice is:
  • that you should not buy IPOs at their initial offering price and 
  • that you should never buy an IPO just after it begins trading at prices that are generally higher than the IPO price.  
Historically IPOs have been a bad deal.  In measuring all IPOs five years after their initial issuance, researchers have found that IPOs underperform the total stock market by about four percentage points per year.  
  • The poor performance starts about six months after the issue is sold.  
  • Six months is generally set as the "lock up" period, where insiders are prohibited from selling stock to the public.  
  • Once that constraint is lifted, the price of the stock often tanks.
The investment results are even poorer for individual investors.  You will never be allowed to buy the really good IPOs at the initial offering price.  The hot IPOs are snapped up by the big institutional investors or the very best wealthy clients of the underwriting firm. 

If your broker calls to say that IPO shares will be available for you, you can bet that the new issue is a dog. 
  • Only if the brokerage firm is unable to sell the shares to the big institutions and the best individual clients will you be offered a chance to buy at the initial offering price.  
  • Hence, it will systematically turn out that you will be buying only the poorest of the new issues.  
  • There is no strategy I am aware of likely to lose you more money, except perhaps the horse races or the gaming tables of Las Vegas.

A Random Walk Down Wall Street
by Burton G. Malkiel

Five key questions in considering investment opportunities:

1.  Is this a good business run by smart people?

This may include items such as quality of earnings, product lines, market sizes, management teams, and the sustainability of competitive positioning within the industry.

2.  What is this company worth?

Value investors perform fair value assessments that allow them to establish a range of prices that would determine the fair value of the company, based on measures such as normalized free cash flow, break-up , takeout, and/or asset values.  Exit valuation assessment provides a rational "fair value" target price, and indicates the upside opportunity from the current stock price.

3.  How attractive is the price for this company, and what should I pay for it?

Price assessment allows the individual to understand fully the price at which the stock market is currently valuing the company.  In this analysis, the investor takes several factors into account by essentially answering the question.  Why is the company afforded its current low valuation?  For example, a company with an attractive valuation at first glance may not prove to be so appealing after a proper assessment of its accounting strategy or its competitive position relative to its peers.

4.  How realistic is the most effective catalyst?

Catalyst identification and effectiveness bridges the gap between the current asking price and what value investors think the company is worth based on their exit valution assessment.  The key here lies in making sure that the catalyst identified to "unlock" value in the company is very likely to occur.  Potential effective catalysts may include the breakup of the company, a divestiture, new management, or an ongoing internal catalyst, such as a company's culture.

5.  What is my margin of safety at my purchase price?

Buying shares with a margin of safety is essentially owning shares cheap enough that the price paid is heavily supported by the underlying economics of the business, asset values, and cash on the balance sheet.  If a company's stock trades below this "margin of safety" price level for a length of time, it would be reasonable to believe that the company is more likely to be sold to a strategic or financial buyer, broken up, or liquidated to realize its true intrinsic value - thus making such shares safer to own.