Most stock investors lose money because they invest in companies that seem good at a particular point in time, but are lacking the fundamentals of a long-lasting stable company.

The high CAGR in the early years of the investing period, due to buying at a discount, tended to decline and approach that of the intrinsic EPS GR of the companies over a longer investment time-frame.

Chapter 20 - “Margin of Safety” as the Central Concept of Investment

A single quote by Graham on page 516 struck me:

Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.

Basically, Graham is saying that most stock investors lose money because they invest in companies that seem good at a particular point in time, but are lacking the fundamentals of a long-lasting stable company.

This seems obvious on the surface, but it’s actually a great argument for thinking more carefully about your individual stock investments. If most of your losses come from buying companies that seem healthy but really aren’t, isn’t that a profound argument for carefully studying any company you might invest in?

Ben Graham: The chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.

The high CAGR in the early years of the investing period, due to buying at a discount, tended to decline and approach that of the intrinsic EPS GR of the companies over a longer investment time-frame.

Chapter 20 - “Margin of Safety” as the Central Concept of Investment

A single quote by Graham on page 516 struck me:

Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.

Basically, Graham is saying that most stock investors lose money because they invest in companies that seem good at a particular point in time, but are lacking the fundamentals of a long-lasting stable company.

This seems obvious on the surface, but it’s actually a great argument for thinking more carefully about your individual stock investments. If most of your losses come from buying companies that seem healthy but really aren’t, isn’t that a profound argument for carefully studying any company you might invest in?

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.


http://finance.fortune.cnn.com/2010/10/27/the-coming-flight-to-quality-stocks/

Investing for long term is a better strategy

3 Oct, 2010, 05.56AM IST,
Ashish Gupta,ET Bureau

Investing for long term is a better strategy

With the breaching the 20,000 mark and looking good for 21,000, what should be the strategy of individual investors? Should they take the plunge? Normally, during times like these, everything sells. Look at the number of IPOs hitting the market in such a short span of time and demanding huge premiums. And most were a running success.

The fast-growing economy has pushed the growth process. The most important factor has been the sustained foreign institutional investor (FII) interest in the markets that gave the Sensex its big thrust. Inflow of foreign capital and strong economic are behind the optimism in the markets.

FII factor

Although bull phases are good, need to be cautious. A bull run is good news for investors. However, some analysts expect a correction. A deep correction could create panic among investors who may resort to booking profits. Such a situation is more likely as the index rise has been rapid and unexpected. Moreover, as the bull run is largely due to foreign capital flows, the market direction is highly unpredictable.

This is because FII sentiment is impacted by global developments and trends. Many factors may trigger a fall. A slowdown in growth, political developments, employment data, inflation -anywhere in the world -could have an impact. In case the start pulling out, it may lead to a financial concern. It is better for small investors to be cautious lest there is a deep correction.

Go by fundamentals

Further, investors should invest in and stick to fundamentally-strong companies. The stocks of these companies are normally stable and grow at a steady pace. They are neither affected by booms nor by falls. They tend to weather volatile times well. Investors should ideally invest in large-cap stocks. These are less risky than small-cap stocks. Although small-cap stocks have tremendous growth potential, they carry a higher potential of downsides.

Diversify portfolio

You should also diversify your portfolio. There should be a mix of debt and equity. A reasonable portion should be invested in debt, offering secured returns. The entire funds should not be parked in equity. Although it has the potential to provide higher returns, the equity route also carries with it the inherent risks of a downside as well. Also, borrowed funds should not be used to invest in the markets. One should look at strong, growing sectors that hold potential for growth. Even in these growing sectors, you should choose the fundamentally-strong companies.


http://economictimes.indiatimes.com/features/financial-times/Investing-for-long-term-is-a-better-strategy/articleshow/6672767.cms

Big blue chips not always beautiful

John Wasiliev

September 28, 2010

Blue chip shares are supposed to be the best stocks an investor can own. They are regularly put forward by brokers, analysts and commentators as solid and dependable with the capacity to deliver reliable returns over the long term.
This image is helped by the fact they are mostly among the largest companies on the share market and when times get tough big can often be better. Or is it?
After the share market crashed in 2007 to 2008, it was the blue chips that were recommended as the safest options for investors or prospective share investors looking to establish a core portfolio.
Back in September 2008, for instance, the recommended blue chips included BHP Billiton and Rio Tinto, all the big four banks, gold miner Newcrest, oil giant Woodside, transport services company Brambles, the health industry twins CSL and Cochlear, retailer Woolworths, energy sector leader AGL and telecommunications leader Telstra.
It's worth looking back to see how these shares have performed. Two years ago, for example, in late September 2008, BHP shares were trading at around $35.80 and Rio shares were priced at $79.60. Newcrest shares were trading at around $21 and Woodside at $49.60 with Brambles at $8.40. Westpac shares were trading at $24 and Commonwealth Bank shares at $44.40. CSL shares were at $38.20, Woolworths at $28.10 and Telstra at $4.35.
By comparison as September 2010 comes to a close, BHP shares are trading higher at $39.20, Rio shares are lower at $76, Newcrest has soared to $41, Woodside has dropped to $44.40, Westpac is flat at $24, Commonwealth shares are better are $52.40, CSL has slipped to $33.70, Brambles is down to at $6.20, Woolworths is holding at $28.90 and Telstra has plunged to $2.70. What this performance scoreboard shows is that over this period there have been winners and losers among the blue chips.
Some investors who listened to the blue chip story would be happy, while others might regard investing in what are promoted as the best shares you can buy as being an easy way of losing money.

The lesson in this missed bag of returns, says Elio D’Amato of share market researcher Lincoln Indicators, is that just because a company is big does not guarantee its success. Big is not necessarily beautiful and because a big company is or isn’t doing as well as others often has little to do with its size.

Rather than size, he says, what determines whether a company is performing well on the share market will have more to do with factors such as the business it is in and how well it is responding to different challenges.

It is an argument, he says, in favour of investing in profitable companies of all sizes rather than just big companies. That’s not to say big companies can’t stand out at times. Gold miner Newcrest, for example, has benefited from the fact the price of gold has risen from about $US800 an ounce in September 2008 to just under $US1,300, a more than 60 per cent gain.
At the other end of spectrum, Telstra’s profit performance has been lacklustre and this is reflected in its depressed price. It’s been a similar disappointing profits story with Brambles.
D’Amato says there might be special reasons why some are lagging. For example, CSL has had to face the challenges of a rising Australian dollar because a sizeable proportion of its profits are earned overseas and must be converted back to Australian dollars when they are distributed to investors.
Two years ago the $US-Australian dollar exchange rate was US83c compared to the most recent price of US95c.

http://www.smh.com.au/money/on-the-money/big-blue-chips-not-always-beautiful-20100924-15pul.html

****Know your company to stay Streets ahead

The management thinking can be best understood by reading the management discussion and analysis mentioned in the annual report. One can start with reading three year’s annual reports. This will allow you to compare the management analysis from past reports with what really transpired in the following year. The next important thing that will help you is the corporate governance details in the annual report.

“Management’s intentions towards the minority shareholders must be carefully understood,” advises Kunj Bansal, chief investment officer of Sanlam SMC India. If the business has just been sold, the promoters collecting a non-compete fee does not bode well for smaller shareholders.

Some investors find buy back programmes done at suppressed stock prices and unrelated diversifications detrimental to the minority shareholders. Management actions in the past while handling surplus cash can be good signalling device. One quantitative element that comes handy is the quantum of management compensation. One can look at payout to the management as a percentage of the net profit and decide if the management is fair.

Related Party Transactions

Good companies do business with related parties at fair market prices. The same is disclosed in the annual report for the benefit of the shareholders. Few related party transactions, along with high transparency, is an indicator of a good business. Promoters’ presence in the same business through a privately-held entity is a clear dampener as the investor in the publicly-listed entity runs the risk of promoter placing the ‘cream business’ in the privately-held entity.
Business model

Simply put, it means where and how the company earns its bread and butter. You have to figure out what products the company produces or markets. Five Ws — who, when, where, what, why, will help you understand the raw materials that go in, the time and skill set required, the risks faced by the company and probably all those variables that can influence your returns as a shareholder.

During tech boom of 2000, investors poured in their hard earned money into hundreds of dotcom companies. A few avoided these companies as they found that there were no meaningful revenues or they were bleeding at operational level. Undoubtedly those who stayed clear of that boom were the eventual winners. A thorough understanding of the business can help determine the potential of business and the risks the business is subject to.

Pricing Power

If you grasp the business model well, you stand to understand the pricing power. Customers and suppliers can influence the profit if they possess the pricing power. Generally, businesses with a few customers or sole suppliers typically do not have pricing power. Hence it makes sense to stay with companies that have a large customer base and have many suppliers and still a monopoly player in the business.
Power of intangibles

Intangibles such as brands play a significant role in the performance of a company. In the long-run, consumer preferences tilted in favour of a brand can bring in high visibility of income for a business. Intellectual property rights are also important as they offer an edge over others. They become the deciding factors in the knowledge-driven businesses.

“Investors must check the ownership of such intangibles. If the promoters own the brands in the personal capacity, then it is a case of promoters making money at the expense of the shareholders,” says Avinash Gorakshkar. This is especially true if the business is doing well, as the promoter can take home a sizeable amount of profits by way of higher fees.

Point of Reference:  Information Sources

Company annual reports:

--> An annual communication to shareholders

--> Available to all shareholders

--> High authenticity

--> Good companies also keep them on their websites

Broker reports:

--> Prepared by brokers to solicit business and advise clients

--> Can be helpful in understanding micro or company-specific issues

--> May contain scenario analysis that exhibits impacts of changes in fundamentals
Company presentations:

--> These are prepared by companies from time to time

--> Meant for analysts and give update on business

--> You have to discount the contents as company may paint an overoptimistic picture

--> Available on company websites

Industry reports:

--> Prepared by consulting firms and industry bodies such as FICCI

--> Offers good business insights

--> Useful in tracking changes in regulatory, technological changes

--> Available on websites of industry bodies or websites of manufacturers

--> You have to discount the interested parties' views
Stock exchange filings:

--> Periodic communications by the company

--> High authenticity

http://economictimes.indiatimes.com/quickiearticleshow/6407657.cms

****What differentiates winners from losers in a stock market: Qualitative Variables

What differentiates winners from losers in a stock market? Some may religiously follow the recommendations of a ‘hit’ stock broker. And some may even dig a bit deeper to know about the stock and the company they plan to invest in by going through the earnings and valuations multiples. But the real winners could still be a league ahead of such investors. That’s because they keep an eye on the qualitative variables. Let’s look at them: 

People 

This is the most important variable. You should know both the promoters and the professional managers who run the company. If the business is managed by a first-generation entrepreneur, check if the promoter is professionally and technically qualified to run the business. Of course, this is not a necessary condition and one has to exercise judgment. If the management consists of professionals, look at their employment history to understand their track record. For instance, before setting up HDFC Bank’s operations in 1994, Aditya Puri was a successful country head of Citibank in Malaysia. 

The management thinking can be best understood by reading the management discussion and analysis mentioned in the annual report. One can start with reading three year’s annual reports. This will allow you to compare the management analysis from past reports with what really transpired in the following year. The next important thing that will help you is the corporate governance details in the annual report. 

“Management’s intentions towards the minority shareholders must be carefully understood,” advises Kunj Bansal, chief investment officer of Sanlam SMC India. If the business has just been sold, the promoters collecting a non-compete fee does not bode well for smaller shareholders. Some investors find buy back programmes done at suppressed stock prices and unrelated diversifications detrimental to the minority shareholders. 

Management actions in the past while handling surplus cash can be good signalling device. One quantitative element that comes handy is the quantum of management compensation. One can look at payout to the management as a percentage of the net profit and decide if the management is fair. 

Related party transactions 

Good companies do business with related parties at fair market prices. The same is disclosed in the annual report for the benefit of the shareholders. Few related party transactions, along with high transparency, is an indicator of a good business. Promoters’ presence in the same business through a privately-held entity is a clear dampener as the investor in the publicly-listed entity runs the risk of promoter placing the ‘cream business’ in the privately-held entity. 

Business model 

Simply put, it means where and how the company earns its bread and butter. You have to figure out what products the company produces or markets. Five Ws — who, when, where, what, why — will help you understand the raw materials that go in, the time and skill set required, the risks faced by the company and probably all those variables that can influence your returns as a shareholder. During tech boom of 2000, investors poured in their hard earned money into hundreds of dotcom companies. 


http://economictimes.indiatimes.com/personal-finance/savings-centre/analysis/What-differentiates-winners-from-losers-in-a-stock-market/articleshow/6404286.cms




Related:  
Read how a company used its large cash reserve:
Review of Fima Corp's Earnings
http://whereiszemoola.blogspot.com/2010/08/review-of-fima-corps-earnings.html

The Value Equation

Buffett (1978):"Turnarounds" seldom turn. Be in a good business purchased at a fair price than in a poor business purchased at a bargain price.

Warren Buffett in his 1978 letter to his shareholders places a great deal of importance on the quality of business and also the fact that he had to let go of many attractive investment opportunities just because the price was not right. In the following write up, let us see what the master has to offer in terms of investment wisdom in his 1979 letter:

"The inflation rate plus the percentage of capital that must be paid by the owner to transfer into his own pocket the annual earnings achieved by the business (i.e., ordinary income tax on dividends and capital gains tax on retained earnings) - can be thought of as an "investor's misery index". When this index exceeds the rate of return earned on equity by the business, the investor's purchasing power (real capital) shrinks even though he consumes nothing at all. We have no corporate solution to this problem; high inflation rates will not help us earn higher rates of return on equity."

The above paragraph clearly demonstrates that in order to improve one's purchasing power, one will have to earn after tax returns that are higher than the inflation rate at all times. Imagine a scenario where the inflation rate touches 9%, which means that a commodity that you purchased at Rs 100 per unit last year will now cost you Rs 109. Further, assume that you put Rs 100 last year in a business that earns 10% return on equity and the tax rate that currently prevails is 20%.

Thus, while you earned Rs 10 by virtue of the 10% return on equity, the tax rate ensured that only Rs 8 has flown to your pocket. Not a good situation since your purchasing power has diminished as while your returns were only 8% post tax, you will have to shell out Re 1 extra for buying the commodity as inflation has remained higher than the after tax returns that you have earned. Further, high inflation does not help the business too unless it has some inherent competitive advantages, which enables it to pass on the hike in inflation to the end consumers. Little wonder, investors lay such high emphasis on businesses that earn returns way above inflation so that the purchasing power is enhanced rather than diminished.

"Both our operating and investment experience cause us to conclude that "turnarounds" seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price."

In the above paragraph, the master once again extols the virtues of a good quality business and says that he would rather pay a reasonable price for a good quality business than pay a bargain price for a poor business. It would be worthwhile to add that in the early part of his investing career, the master himself was a stock picker who used to rely only on quantitative cheapness rather than qualitative cheapness. However, somewhere down the line, he started gravitating towards good quality businesses and out of this thinking came such quality investments as 'Coca Cola' and 'American Express'. These were the companies that 

• had virtually indestructible brands (a very good competitive advantage to have), 
• generated superior returns on their capital and 
• had ability to grow well into the future.

We prod you to find similar businesses in the Indian context, pick them up at a reasonable price and hold them for as long as you can. For if the master has made millions out of it, we don't see any reason as to why you can't.

http://www.equitymaster.com/detail.asp?date=7/5/2007&story=1

Some thoughts on Analysing Stocks (Keep It Simple and Safe).

Ideally a stock you plan to purchase should have all of the following charateristics:

• A rising trend of earningsdividends and book value per share.

• A balance sheet with less debt than other companies in its particular industry.

• A P/E ratio no higher than average.

• A dividend yield that suits your particular needs.

• A below-average dividend pay-out ratio.

• A history of earnings and dividends not pockmarked by erratic ups and downs.

• Companies whose ROE is 15 or better.

• A ratio of price to cash flow (P/CF) that is not too high when compared to other stocks in the same industry.

The most important determinants of your success in investing

The most important determinants of your success in investing are QVM:

QUALITY - the quality of the company you own,

VALUE - the price you paid for your stock, and,

MANAGEMENT - the integrity of its management.

But how do you know if a stock is "quality"?

Go for dividends.

It's a no-brainer that quality matters in a market like this. But how do you know if a stock is "quality"?


Dividends are one indicator. That's because dividend income--which is essentially a portion of company profits paid out to shareholders--helps offset fluctuations in a stock's share price, creating a cushion during turbulent markets. 


"During trying times, dividend-paying stocks tend to do well," says Paul Alan Davis, portfolio manager of the Schwab Dividend Equity Fund. Davis also looks for companies on solid footing, which have plenty of cash and aren't in "financial straits."  During the first 11 months of year, Davis says, the S&P's dividend-paying stocks fell by roughly 36 percent; meanwhile, nondividend payers were down about 45 percent. 


You'll find those dividend payers in more developed industries such as consumer staples, utilities, and healthcare. Examples include Philip Morris, Coca-Cola, General Mills, Bristol-Myers Squibb, and Pfizer.

Quality is king

Quality is king, says Oak Value's Coats

While last year's recovery lifted low-quality stocks, this year's market will reward companies with strong balance sheets

By Jeff Benjamin
February 24, 2010

Stock picking in the current market requires a renewed focus on corporate economics and balance sheets, said Larry Coats, manager of the Oak Value Fund (OAKVX).

“After a low-quality recovery last year, now quality matters, and it's time for serious stock selection,” he said.

Mr. Coats has been part of the fund's management team since it was launched in 1993 by Oak Value Capital Management Inc.

As a portfolio manager, he describes himself as an “opportunistic buyer of advantaged businesses.” The strategy goes beyond the “implicit biases” of a traditional value investing approach, he said.

“By concentrating on price-to-earnings and price-to-book ratios, money managers are spending all their time looking at the cheapest stocks, but they're missing some valuable opportunities,” he said. “When we look at all the companies in the S&P 500, we start by looking at the businesses themselves, not the valuations.”

The highly concentrated portfolio of just 27 names has an average operating profit margin of 25%, which is about 10 percentage points higher than the S&P 500.

The fund's 30% average return on equity is almost double that of the index.

Mr. Coats said by focusing on a company's balance sheet, he has been able to build a portfolio of truly profitable businesses that aren't hampered by excess leverage.

The fund, which has a four-star rating from Morningstar Inc. and has $76 million in assets, is categorized as large-cap blend.

Mr. Coats admitted that the strategy could fit into a few different boxes.

“Some people would argue that what we’re doing is [growth at a reasonable price], but in our mind, it’s value with a quality bias, or growth with a pricing discipline” he said. “Our discipline is blend, and our portfolio is built with a growth bent.”

The strategy got high marks from Morningstar analyst Greg Wolper for the way it beat its benchmark during both the 2008 market decline and the rebound last year. The fund gained 33% last year, while the S&P 500 returned 26%. And during the meltdown of 2008, the fund lost 33%, while the index fell by 38%.

The average annual turnover of around 37% is reflective of a strategy that is based on an extremely deliberate research process. “We identify the best companies from the index, follow them, research them and then wait for the right time to buy them,” Mr. Coats said.

One stock added to the portfolio late last year is Intuit Inc. (INTU), a company best known for its TurboTax software. But Mr. Coats said the stock price was pushed down by investor concerns that an economic slowdown would hurt Intuit's broader software sales to smaller businesses.

“The stock got cheap because people were concerned about a slowdown in new business starts,” he said.

Through Tuesday's market close, Intuit shares were up 3.7% this year, which compares with a 1.8% decline by the S&P 500 over the same period.

Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. For more information, please visit InvestmentNews.com/pmperspectives .