Evaluating Investment Results of Yourself and Your Fund Managers

The decision to employ an investment professional should only be made after a thorough analysis of the past investment performance of the individual or organization under consideration. Some questions are obvious:

• How long a track record is there? 
• Was it achieved over one or more market and economic cycles? 
• Was it achieved by the same person who will manage your money, and does it represent the complete results of this manager's entire investment career or only the results achieved during some favorable period? (Everyone, of course, will be able to extract some period of good performance even from a lengthy record of mediocrity.) 
• Did this manager invest conservatively in down markets, or did clients lose money? 
• Were the results fairly steady overtime, or were they volatile? 
• Was the record the result of one or two spectacular successes or of numerous moderate winners? 
• If this manager's record turns mediocre after one or two spectacular successes are excluded, is there a sound reason to expect more home runs in the future? 
• Is this manager still following the same strategy that was employed to achieve his or her past successes?

Obviously a manager who has achieved dismal long-term results is not someone to hire to manage your money. Nevertheless, you would not necessarily hire the best-performing manager for a recent period either. 

Returns must always be examined in the context of risk. 

• Consider asking whether the manager was fully invested at all times or even more than 100 percent invested through the use of borrowed money. (Leverage is neither necessary nor appropriate for most investors.)
• Contrariwise, if the manager achieved good results despite having held substantial amounts of cash and cash equivalents, this could indicate a low-risk approach. 
• Were the investments in the underlying portfolio themselves particularly risky, such as the shares of highly leveraged companies? 
• Conversely, did the manager reduce portfolio risk through diversification or hedging or by investing in senior securities?

When you get right down to it, it is simple to compare managers by their investment returns. It is far more difficult - impossible except in retrospect - to evaluate the risks that manger incurred to achieve their results.

Investment returns for a brief period are, of course, affected by luck.  

• The laws of probability tell us that almost anyone can achieve phenomena l success over any given measurement period.  
• It is the task of those evaluating a money manager to ascertain how much of their past success is due to luck and how much to skill. 

Many investors mistakenly choose their money managers the same way they pick horses at the race track. They see who has performed well lately and bet on them.

It is helpful to recognize that there are cycles of investment fashion, different investment approaches go into and out of favor, coincident with recent fluctuations in the results obtained by practitioners.

• If a manager with a good long-term record has a poor recent one, he or she may be specializing in an area that is temporarily out of favor.  
• If so, the returns achieved could regress to their long-term mean as the cycle turns over time, several poor years could certainly be followed by several strong ones.

Finally, one of the most important matters for an investor to consider is personal compatibility with a manager.  

• If personal rapport with a financial professional is lacking, the relationship will not last.  
• Similarly, if there is not a level of comfort with the particular investment approach, the choice of manager is a poor one.  
• A conservative investor may not feel comfortable with a professional short-seller no matter how favorable the results, by contrast, an aggressive investor may not be compatible with a manager who buys securities and holds them.

Once a money manager has been hired, clients must monitor his or her behavior and results on an ongoing basis.  The issues that were addressed in hiring manger are the same ones to consider after you have hired one.

5-Year Closing Price. Can this be predicted?

Be rational in facing market uncertainties.

Many good quality growth stocks have a price pattern quite similar to the above chart.  Many have even rebounded to reach their old highs or new highs.

Valuation of KNM and Sustainable Growth Companies

In the absence of clarity in future earnings, very low NTA and significant debt, how does one value KNM?

? 10 sen / share

A quick look at KNM
http://spreadsheets.google.com/pub?key=tnYPvXKu8my2Fsri8qR60oA&output=html


A related story:

One-time events that help grow companies for a short period usually affect prices significantly, but such changes are often temporary.

In the mid-1970s, again in the mid-1990s, and once again in the mid-2000s when oil prices went up quickly, many companies supplying oil-drilling services became high-growth companies.  However, they could not sustain their growth.

For example, Global Marine, an otherwise well-managed company, was trading at around $35 per share in late 1997, but oil prices went down in 1998, and Global Marine's stock price quickly retreated to less than $8 per share.  

A careful investor looking for an outstanding long-term growth company would have avoided Global Marine because the growth was from a one-time event.

It was and can be difficult to know which companies would have sustainable growth.

On the other side, note that at the time of going public, even Microsoft was not an outstanding growth stock because it was not clear that the company could sustain its growth.  However, over time, it became clear that Microsoft's products were immensely successful.  Microsoft was a near monopoly, and the number of customers for those products would increase for many years to come.  At that point, it was a good growth stock worth investing in.

Sustainable Growth

Sustainable Growth



Good growth continues over time. It has a sustainable trajectory. You are NOT looking for a quick spike upward in revenues, caused by cutting prices or by throwing substantial resources against a one-shot opportunity. The goal is to have the growth continue year after year.



For example, the growth of Southwest Airlines has been based on a consitent set of actions. New routes are carefully vetted - the goal is to have them be profitable in less than a year - and turnaround times (the period from when a plane pulls into a gate until it pushes back on another flight) are substantially faster than the industry average, allowing Southwest planes to fly more trips a day than its competitors.



If you look at one of the suppliers to the airline industry, you can see another example of sustainable growth. In this case, the move toward sustainability was prompted out of necessity.



When the airline industry declined in the early 1990s, it led to a decerease in the revenues of firms that sold aircraft engines. GE Aircraft Engines redefined the needs of its airline customers to include not just the engines themselves but also servicing them on a regular basis. Up to that point, a major airline would use the service shop of one company in, say, Chicago and that of completely different companies in its other locations around the world. Some also did the service themselves in their own shops.



GE's new value proposition was to provide total service around the globe. Through innovation, use of information technology, and managerial ability to provide better maintenance, the result would be less downtime for the airlines and lower costs.



For example, doing a major overhaul on its own might have required an airline to fly its plane back empty to its service facility. With service operations around the world, GE can do the work wherever a plane is, which gets the plane back in the air, generating revenues sooner. And because it specialises, GE can do the necessary service work faster, increasing productivity for the airlines once again. Scores of airlines took advantage of the chance to outsource the maintenance part of their business to a single supplier.



Before its chief competitor, Pratt & Whitney, woke up, GE Aircraft Engines captured 70% of the airplane-service market. And, of course, the service contracts tied customers more closely to GE, giving it a leg up in selling the core product -engines - and developing a sustained trajectory of growth by having a built-in-revenue stream, the money that comes in month in and month out from the service contracts.



In this case, the "single" and "double" of adding a service coponent to a product created a platform that is a home run in terms of a sustained, decades-long trajectory of growth. The recurring revenues from the service work are extremely reliable. Not only has GE Aircraft Engines otgrown the competition - its model of adding service to products became a best practice for other GE businesses, which are now adding high-margin service work into their product mix.



It is also an example of building both scale and scope and then learning how to leverage for growth. GE Aircraft's number-one position in the marketplace, combined with organic growth and simultaneous productivity, gave it the leverage to make acquisitions in the service area.



But the only way this growth is going to occur is if everyone in the organization believes it to be possible. It is up to the organization's leadership to create the right mind-set.

Sustainability of business performance

Sustainability of business performance

Charlie Munger once said:
Frequently, you'll look at a business having fabulous results, and the question is: ' How long can this continue?' Well, there's only one way I know to answer that, and that's to think about why the results are occurring now - and then to figure out the forces that could cause those results to stop occurring.

We have learnt that there is no mystery to measuring business performance. The numbers will tell you whether the business is good, fair or bad. Neither is there any point in hopng that things will change.

Buffett makes the point with some humour: Think of it in terms of marrying some gal that's the girl of your dreams, and having another one and saying, 'If I send her to the psychotherapist for five years and hve some plastic surgery, well maybe it will work'.

A business may have a fabulous track record of performance, and the value based on it may make the price look cheap. However, the price will only be cheap if the performance criteria used to determine the value are sustainable. We must, as Charlie suggests, 'think about why the results are occurring now - and figure out the forces that could cause those results to stop occurring'.

When researching a company, the positive glare of the highlights tends to obscure the dim glow of the negatives. We must be aware not only of the positive manner in which a company's history and prospects are protrayed by management, but also our inherent desire to encourage optimistic expectations by placing excessive weight on positives.

Conversely, one should not become paranoid about negatives. For instance, if you were looking at two great businesses such as McDonald's and The Coca-Cola Company, you might be deterred by all the publicity about how fast food and carbonated drinks are major contributors to obesity and heart problems. These are not new concerns, so examination of the accounts will tell you whether they have had any effect on revenue.

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