Cash Is Looking Better As Investment

INVESTING
OCTOBER 8, 2008, 4:18 P.M. ET

Cash Is Looking Better As Investment
As the market pushes investors beyond their comfort zones, cash and cash-equivalent investments -- traditionally stodgy options for advisors -- are gaining appeal.

By SUZANNE BARLYN

Cash and cash-equivalent investments - traditionally stodgy options for advisors - are gaining appeal as extreme market volatility pushes many clients beyond their comfort zones.
Advisors typically suggest that clients limit cash exposure to between 5% and 10% of their portfolios, or maintain a reserve that is equivalent to between 18 and 24 months of living expenses, in the event of a bear market. But some advisors are increasing their clients' cash holdings and exposure to other "cashlike" short-term investments, particularly to U.S. Treasurys, a safe haven in a brutal market.
"Cash is looking better for a few different reasons," says Donald B. Cummings Jr., an investment advisor with Blue Haven Capital in Geneva, Ill. Cummings says he was concerned that some municipal money-market funds would potentially "break the buck" - or fall below $1 per share. He preemptively moved client funds into plain-vanilla U.S. Treasury money-market funds. Cummings recognizes that Treasury yields are low. For example, the current seven-day yield for the Dreyfus 100% U.S. Treasury Money Market Fund (DUSXX) is 0.51%. However, the strategy is more tolerable for the short term, he says.
"People expect volatility, but no one wants to lose three and four percent on their money-market funds," says Cummings. He's not entirely sold on the Treasury Department's temporary guarantee program for money-market funds, he says, which protects certain shareholders of money-market mutual funds from losses if their funds are unable to maintain a $1 net asset value. The program offers protection for money-market holdings valued as of Sept. 19. Cummings says he's concerned about jeopardizing funds deposited after that time. "We're telling everyone to hold tight for a few months and see how this plays out," he says.
Advisors are also being judicious about investing new cash from clients since the bear market onset in October 2007. Cathy Curtis, a financial planner based on Oakland, Calif., says she's been particularly cautious with several new clients she took on last October, when the market started its decline, whose accounts average about $500,000. Curtis says she invested about 50% of their money at the time and left the rest in cash, including the Schwab Value Advantage Money Fund (SWBXX). "I have been investing it slowly - even over the last month," she says - about $2,500 at a time.
Cummings is stretching cash that he'd normally invest within about a month across a four- to five-month span. He stashes funds that he plans to invest at a later time in pre-refunded municipal bonds - a high-quality municipal bond in which the income and principal is typically insured by an irrevocable trust of U.S. securities. Cummings says that tax-free yields are between 1.5% to 2.5% - significantly better than U.S. Treasurys. A three-month T-bill, for example, currently yields 0.75%. "There are places to hide on the short end of the curve that make a lot of financial sense," he says.
Some advisors are also considering their clients' sense of well-being. "It's important that people feel safe and that they're going to have some liquidity," says Pran Tiku, a wealth manager for Peak Financial Management Inc. in Waltham, Mass. He's raising cash by selling off lower-quality, higher-yielding bonds, which are typically viewed unfavorably by bond-rating agencies. "If the credit crunch is as ominous as it seems and does not have a resolution, then cash becomes a very important investment to hold," he says.
Tiku has been investing the cash in short-term bonds, such as short-term Treasurys and government instruments, as well as money-market funds. A 5% minimum of clients' balanced portfolios is typically held in cash and cashlike investments. But Tiku has increased the allocation to about 30%. He's decreased bond allocations to 7% from about 30%.
For Doug DeGroote, managing director of United Wealth Management in Westlake Village, Calif., increasing his cash allocation serves another purpose. "We're sitting in a more liquid stance and looking for [buying] opportunities. It's being prepared for a chance to move money back into the market," he says.
DeGroote says he converted low-yielding short-term bonds to cash in preparation to snag good deals. DeGroote's firm typically allocates between 5% and 10% of client portfolios in cash, However, the figure is presently closer to 20%, he says.
Not all advisors are completely sold, however. Mark Colgan, president of Colgan Capital in Pittsford, N.Y., says he modifies his plan only after a client calls on three occasions and expresses extreme anxiety - indicating a client's lack of risk tolerance. If the client is a retiree, Colgan will then build a small cash position of between 12 and 24 months' worth of withdrawals to ride out the bear market. But he urges younger clients to stay the course. "For me, it is more about aligning the client with the proper portfolio - not reacting to the markets," he says.
Laura Mattia, an advisor with Baron Financial Group in Fair Lawn, N.J., says the firm adopts an "all-weather strategy" with clients early on and doesn't waver. Mattia and her colleagues typically limit cash exposure to 18 months of a client's personal expenses. "All of these assets will come back. They are going to rebound," she says. "The day when the stock market goes up 800 points is when people are going to be sitting there in cash saying I should have, would have could have."
Write to Suzanne Barlyn at suzanne.barlyn@wsj.com

http://online.wsj.com/article/SB122349648494716461.html

Welcome to a buyer's market without buyers

Joe Investor, the Markets Are All Yours Now
By JASON ZWEIG
Article
Video

The tables have turned.
For the past couple of decades, the markets have been dominated by institutional investors who devoured bargains so fast and in such bulk that individual investors were usually left, at best, with a few scraps.
But pension funds, hedge funds, mutual funds and other institutions are under siege as their portfolios implode and investors redeem their shares, forcing the fund managers to raise cash.

Advantage Goes to the Individual Investor

Personal Finance columnist Jason Zweig explains why individuals have a big advantage over institutional investors in the market right now. (Nov. 14)

Virtually every investment that carries any risk is on sale. Stocks and bonds, at home and abroad, have had their prices slashed by up to 45% this year. Yet at the very moment when bargains abound, many of the giants who normally would buy can do nothing but sell.

Welcome to a buyer's market without buyers.

This is a huge change for the little guys. Rob Arnott, who oversees $35 billion at Research Affiliates LLC in Newport Beach, Calif., puts it this way: "The question that hardly anyone ever thinks about is: Who's on the other side of my trade, and why are they willing to be losers if I'm going to be a winner?" Ever since the 1970s, the person on the other side of your trade has almost always been someone who manages billions of dollars and has millions of dollars to spend on gathering more information than most individuals ever could. Now, however, as Mr. Arnott says, "You can -- and probably do -- have a counterparty on the other side of your trade who absolutely has to sell, perhaps at any price."
You would be very wise to give these distressed sellers a little bit of your cash, which they overvalue, in exchange for some of the stocks and bonds that they are undervaluing. Sooner rather than later, institutions will no longer need to beg for cash, they will regain the upper hand over individuals, and the tables will turn again.
While blue-chip stocks are still cheap, as I've said many times lately, there are some areas where the liquidity drought borders on desperation.

Corporate bonds.

A year ago, corporate bonds outyielded Treasurys by 1.6 percentage points; now, the spread is more than five. Top-quality corporate debt is yielding 7% and up. Consider cheap, well-run funds like Harbor Bond, Loomis Sayles Bond or . Convertible bonds are yielding 12% and more; here, the easiest choice is Vanguard Convertible Securities.

Municipal bonds.

The tax-free securities issued by state and local governments have gotten so cheap that in many cases you would have to earn 7% or 8% before tax to match their yield. Vanguard, T. Rowe Price and Fidelity offer a wide range of muni funds at low cost.

Emerging markets.

Stocks and bonds in the developing world have been decimated. Emerging-market stocks have fallen nearly 60% in 2008. The bonds have dropped about 20%, producing the highest yields in about a decade. For stocks, Vanguard Emerging Markets ETF is a good choice; T. Rowe Price Emerging Markets Bond fund is a solid way to play the debt.

TIPS.

Larry Swedroe of Buckingham Asset Management in St. Louis recently bought 8-year Treasury Inflation-Protected Securities with a yield of 3.7%. "That is crazy," he marvels, since the same day the 5-year TIPS yielded 2.6% and the 10-year yielded 2.7%. Such fat yields in excess of inflation on a risk-free investment are a rare opportunity. Put TIPS in a tax-free retirement account; learn more at www.treasurydirect.gov.

Closed-end funds.

These neglected fund/stock hybrids are at their cheapest in years. Closed-ends often trade at a discount to the market value of their holdings. In many cases, you now can get $1 in assets for 85 cents. That augments the yield on funds that hold corporate or municipal bonds. A handy starting point for research is www.closed-endfunds.com. Be sure the fund is "unleveraged," meaning that it does not borrow money, and avoid any fund with annual expenses over 1%.

Real estate.

REITs, or real-estate investment trusts, have been gutted in the housing crisis, losing more than 40% so far this year after an 18% drop in 2007. Many REITs are now priced as if people and businesses will never again want roofs over their heads. The safest choice: a basket holding dozens of real-estate bundles, like Vanguard REIT Index fund.

Finally, if you have cash and courage, consider a vacation property or second home. Nearly two-thirds of the condominiums built in and around Myrtle Beach, S.C. during the boom remain unsold as of June, says the National Association of Home Builders. A similar supply glut has clogged markets in other getaways like Tampa, Fla., and San Diego. With due diligence, you could get both a high financial and a high psychic return.
Email: intelligentinvestor@wsj.com.

Is Your AIG Insurance Policy Safe?

Is Your AIG Insurance Policy Safe?
Will the struggling insurer be able to meet its financial obligations? Here's what you need to know.
By BRETT ARENDS

People are in a panic about AIG. In the last 24 hours I have been swamped with emails from anxious readers around America who want to know: Is my mom's retirement annuity safe? Is grandma's long-term care insurance policy safe? Is my car or homeowner's policy OK?
Here's what you need to know.

There are three separate barriers between your policy and the AIG crisis that you're hearing about on TV.
1. The AIG that's in crisis and the one that wrote your insurance policy are to a large degree separate companies. The AIG on Wall Street is an umbrella company that owns the stock in a lot of smaller insurance subsidiaries. But your policy is held with the subsidiary in your state. They are tightly regulated, they are required to hold conservative assets to back up your policy, and those assets are walled off from the troubles at the parent company. It is perfectly possible for AIG to file for chapter 11 and your policy to be OK.
2. Even if your local AIG subsidiary got into financial difficulties, there's a second level of protection for policyholders. Your state insurance commissioner would step in and take over the company and run it in the interests of policyholders. Under the law, policyholders should get back 100 cents on the dollar before the company's other creditors can get a penny.
3. And even if those first two steps didn't cover you completely, there's a third protection: your local state guaranty funds. These are pools of money put together by insurance companies to provide a backstop. As a general rule of thumb, you're covered to at least $100,000 on most policies and $300,000 on life insurance death benefits. The levels may be even higher in your state.
No system is perfect. It is understandable that people are nervous. Anything shaking their insurance provider is going to rattle their confidence. But at least insurance customers have some protections to help them.
There may be one more protection as well. AIG is simply too big to be allowed to fail. If the worst came to the worst, the federal government could let the stock and bondholders lose their money. But it would be a monumental blunder of the first order to let the policyholders lose. These are people on Main Street, not Wall Street. There are hundreds of thousands of them, perhaps millions. Oh yes -- and they vote.
Write to Brett Arends at brett.arends@wsj.com

http://online.wsj.com/article/SB122159859013744663.html

Giving Your Stock Portfolio a Year-End Face Lift

Giving Your Stock Portfolio a Year-End Face Lift
By JASON ZWEIG

'Tis the season to dump last year's folly.
The market meltdown of 2008 gives you the rare opportunity for a triple whammy: You can transform your losers into winners, remain fully invested and cut your tax bill to boot.
Plus, you earn the satisfaction of taking action when so much of your investing destiny otherwise seems to be out of your hands. Yet these actions, unlike such drastic steps as dumping all your stocks, are very likely to leave you better off in the long run.
That makes this month the ideal time to beautify even the most battered portfolio.
Of course, it is hard to make peace with your losses. Selling a loser forces you to admit a mistake; it also forces you to make what might be a second mistake. What if you move the money into something that does even worse? Hamlet was right: We would "rather bear those ills we have than fly to others that we know not of."
To ease the pain of selling a loser, replace it with something that feels similar. Say you bought 100 shares of Exxon Mobil in October 2007 at $95. Your $9,500 investment is now worth less than $7,700. Sell Exxon Mobil and immediately buy another energy stock. A recent study by investment strategist James Montier of Société Générale in London finds that Chevron, ConocoPhillips, Marathon Oil, Tesoro and Valero Energy all meet several of the standards for investment value set years ago by the great analyst Benjamin Graham.
Better yet, sell Exxon Mobil and put the proceeds into a basket of oil stocks like Energy Select Sector SPDR or Vanguard Energy ETF. This way, you decrease your risk by increasing your diversification, yet you maintain 100% of your exposure to energy stocks while they are on sale.
In each case, you can use the $1,800 loss to reduce your tax bill by offsetting capital gains you may have elsewhere now or in the future. That would become even more valuable if the Obama administration raises the tax rates on capital gains.
There are other ways to clean up by cleaning up. Say you own an index fund that holds all the companies in the Standard & Poor's 500. Sell at a loss, buy a total stock market index fund that holds everything in the Dow Jones Wilshire 5000 index, and voilà: less risk, more diversification, equal exposure to stocks and a lower tax bill.
Just be sure the new fund isn't what the IRS regards as "substantially identical" to the old one; so long as it tracks a different index you should be fine, says James A. Seidel of the tax and accounting business at Thomson Reuters.
Next, consider cleaning up your individual retirement account. If your adjusted gross income won't exceed $100,000 this year (and you don't file a separate married return), you can convert a traditional IRA to a Roth IRA.
The bear market has shriveled not just the value of your old IRA but also the tax liability you will incur on the conversion. "Converting makes more sense now than it has at any point in history," says Gary Schatsky, a financial planner in New York. An IRA that was worth $50,000 a year ago may be worth only $30,000 today; switch to a Roth now, and you cut your conversion taxes roughly 40% below what they would have been in 2007.
That smaller hit today means much bigger savings tomorrow. In general, once you convert to a Roth, all future withdrawals from the account are tax-free to you -- and to your heirs.
Finally, if you already converted a traditional IRA to a Roth earlier this year thinking the market had bottomed, don't just lick your wounds; call a do-over. Remarkably, you can transform your Roth back to a traditional IRA. Instruct the trustee of your account (your bank, broker or fund company) to "recharacterize" the IRA. That erases your original conversion and the taxes you would have owed on it.
Then wait 30 days after the recharacterization date and convert again to a Roth. Chances are, the market will be in the dumps next month, too, enabling you to convert at an even more opportune price this time.
For more guidance on tax swaps and Roth moves, see IRS Publications 550 and 590 (www.irs.gov/publications); be sure to walk through the requirements with your tax adviser to confirm that you qualify. You wouldn't want to miss out on the chance to clean up by year's end, but you wouldn't want to mess it up, either.
Write to Jason Zweig at intelligentinvestor@wsj.com

Dividends Without Debt

Dividends Without Debt

By JACK HOUGH
An 18% dividend yield is usually a warning sign. It might mean investors have little confidence in a company's ability to preserve its share price and keep making payments. Often, debt adds to the anxiety. Newspaper publisher Gannett pays 18%, but has sinking sales and profits and carries long-term debt of nearly double its stock-market value. Capstead Mortgage pays 21%. Its business of borrowing cheap-to-hold government-sponsored mortgage debt isn't as risky as it sounds, unless financing dries up -- something investors are clearly worried about.
Biovail yields 18% and owes nothing. It, too, has warts. But maybe the stock has gotten cheap enough to make up for them.
Ontario-based Biovail, Canada's largest traded drug company, has focused since the mid-1990s on making alternative versions of existing drugs. But the thinning development pipelines of big drug makers have given Biovail less to work with.
Its biggest hit, Wellbutrin XL, has faced generic competition since late 2006. Ultram ER, a once-daily pain pill released in 2006, hasn't caught on as quickly as hoped. Demand for Zovirax, a herpes cream, and Cardizem LA, a pill for high blood pressure, is cooling, too. Companywide sales are on pace to shrink to $748 million this year and $695 million next year. Shares, which multiplied in price from 50 cents in 1994 to more than $50 in 2001, have since fallen below $9.
Biovail is plowing money into purchasing and developing a new roster of drugs, an effort analysts say won't reverse sales declines for at least two years. The company is still plenty profitable. A drop of 50 cents per share in profit this year and another foreseen for next year of 24 cents will leave 2009 profit of $1.13 a share. That puts the stock at less than eight times earnings. But investors have their pick of low-P/E stocks about now.
If they can rely on pocketing 18% for a few years, though, shares are certainly cheap enough. The company can afford the payments. Even with dwindling drug sales, it will clear enough free cash. What's unknown is whether management will fund its new drug efforts with a dividend trim or with already-budgeted research dollars. Shareholders surely hope for the latter. Few investments reward investors as richly at the moment as cash in the pocket.
For more debt-free companies with big dividends, if not quite double-digit ones, have a look at the list below.

Click on the image to get the full version.

Coping With the Inevitable: The Losers in Your Portfolio

Coping With the Inevitable: The Losers in Your Portfolio

By JAMES B. STEWART
However unnerving, there's this to be said about stock-market crashes and bear markets: They generate losses, which in turn lower your taxes. One of the few positive things I can say about the tech-stock collapse of 2000-02 is that I didn't pay capital-gains taxes for years.

If you've been avoiding looking at your account statements recently -- a state of denial I can well understand -- it's time to take a deep breath and tally your unrealized losses. (Most online accounts have a feature that displays that information, as do many paper reporting statements.) I did this recently, and though the results came as something of a shock, I was actually surprised at how many positions still showed gains or only minor declines. Of course, many of these positions were 10 years old or more.
It seems to help, at least psychologically, that for these purposes, the bigger the losses the better. If you have capital gains this year, as I do (the result of selling some of my energy positions last spring) you can use these losses to offset the gains. Most investors can deduct up to $3,000 in net losses against ordinary income ($1,500 if you're married and filing separately), provisions everyone should be sure to take advantage of. And excess losses can be carried forward to that happy day when once again you need to shield gains.
Obviously, you need to sell something to realize a loss. What should you sell? I simply start with the biggest losers. This year, two of those positions were General Electric and Valero Energy, not the financial stocks I'd begun buying this year and which I expected to show the biggest losses.
I had no trouble dispensing with both. GE has pretty much been a disappointment ever since Jack Welch stepped down. I don't blame his successor, Jeffrey Immelt; after all, Mr. Welch was the architect who added NBC (now NBC/Universal) to GE's portfolio and beefed up GE Capital. Media and financial are two sectors that have been crushed in the recent sell-off. While I believe GE Capital will weather the storm, I'm no longer interested in owning a television network or a Hollywood studio.
Part of my goal while selling is to maintain my overall exposure to the market; I'm not trying to time the market. I also want to avoid a common syndrome, which is to sell the biggest losers, then chase the best performing stocks. So I put the GE proceeds into shares of United Technologies, which is a genuine industrial cyclical compared to the hybrid GE. UTX is down over 35% this year, better than GE has fared, but still a steep decline. Not only are cyclicals out of favor in the midst of depression fears, but I believe they could benefit from proposed global infrastructure spending.
For Valero, I substituted Devon Energy and Chevron, two oil producers I've previously recommended for their exposure to Brazil's big offshore oil discovery. A closer alternative would have been another refiner, like Tesoro. But the refiners have shown a perverse ability to suffer from both low and high oil prices. I suppose there exists a golden mean where they manage to make money, but I've given up waiting for it. The refining business is just too competitive, which is great for consumers, but not shareholders. By buying Devon and Chevron, I'm gradually increasing my exposure to the energy sector now that oil prices are below $50 a barrel.
I find making these kinds of changes to be healthy, forcing you to concentrate on the investment rationale for your holdings. By moving from one stock to another in the same sector, you also avoid the problem of violating the "wash sale" rule. A wash sale typically occurs when you sell stock at a loss and buy the same thing within 30 days of the sale. Violate this rule, and you can't deduct the loss.
Of course you have to make these moves before Dec. 31 to reduce your 2008 taxes. I'm planning to continue realizing losses gradually over the remaining month. Supposedly there's a burst of this kind of selling right before the end of the year, depressing stocks, followed by the "January effect" rise once the selling is over. That seems plausible, but I've never seen any data to support it. Last year there certainly was no January effect. In any event, by maintaining your overall market position, you don't need to worry.
James B. Stewart, a columnist for SmartMoney magazine and SmartMoney.com, writes weekly about his personal investing strategy. Unlike Dow Jones reporters, he may have positions in the stocks he writes about. For his past columns, see: www.smartmoney.com/commonsense.

http://online.wsj.com/article/SB122826218146374041.html

Recent tulmultuous events provided great opportunity

How to keep your head when people all around you are losing theirs...

Morningstar FundInvestor:
Your roadmap to the best funds to buy, sell, and watch.

Dear Investor,

It's no secret that this is a frightening market. Watching the devastating effects of the financial meltdown and widespread panic scare me, too. But I also think the tumultuous events have provided savvy investors with a great opportunity.

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I'll guide you to the best managers--those who invest more than one million dollars in the fund they manage--and steer you away from the over hyped managers. I will also provide insights into companies that are a good steward of your funds and name names of those that are not.

So tune out the panicky doomsayers on television and invest in some of the best funds around. Don't throw up your hands and give up on investing. With the downturn in the market, there are more funds available than ever before.

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Morningstar FundInvestor

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Liquidating Value of Assets

Liquidating Value of Assets

Percentage of Liquidating Value to Book Value
(Normal Range & Rough Average)

Type of Asset

Current assets: cash assets (including securities at market)
Normal Range: 100%
Rough Average: 100%

Current assets: receivables (less usual reserves)*
Normal Range: 75%-90%
Rough Average: 80%

Current assets: inventories (at lower of cost or market)
Normal Range: 50%-75%
Rough Average: 66% (2/3)

Fixed and miscellaneous assets: real estate, buildings, machinery, equipment, nonmarketable investments, intangibles
Normal Range: 1%-50%
Rough Average: 15% (approx.)


*Retail instalment accounts must be valued for liquidation at a lower rate. The range is about 30%-60%; the average, about 50%

Source: Security Analysis (New York: McGraw Hill, 1940), p.579

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Liquidating Value

When looking at the current asset value, we’re getting down to a notion that few investors care to ponder – the liquidating value.

Following the Great Depression the share price of public companies fell so low that many investors bought in just to sell off the companies’ assets and close their operations.

Liquidating a company is not a pleasant prospect, since workers lose their jobs, communities lose their income base, and society in general suffers.

The liquidating value is not only the end of the line; it can be seen as the absolute bottom line. There is no question that the ultimate intrinsic value is revealed when liquidation occurs.

The net current asset value (working capital) per share described by Graham also is a rough index of liquidating value. The liquidating value of a company is never a hard number. It can only be estimated, until a company actually is sold off. This is attributed to a fact we sometimes called Graham and Dodd’s first rule of liquidating value: “The liabilities are real but the value of the assets must be questioned.”

Fortunately, advise Graham and Dodd, it is enough to get a rough idea of the liquidating value for most purposes, accepting the fact that you won’t get, nor will you actually need, an exact figure.

A share price below liquidating value seldom is good news. Temporary conditions – a big stock market drop, a sudden reaction to shocking bad news – may impact a company to that extent. Very quickly, however, the share price should recover. When a stock persistently sells below its liquidating value, it indicates an error in judgment by someone – management, shareholders, or the stock market in general.

****My Investment Philosophy, Strategy and various Valuation Methods

Investment Philosophy and Strategy
Investment, speculation and gambling
My strategies for buying and selling (KISS version)
Investment Policies (Based on Benjamin Graham)
Thriving In Every Market
The Estimate of Future Earning Power

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Risks, Rewards, Probabilities and Consequences
Consequences must dominate Probabilities
The risk is not in our stocks, but in ourselves
Behavioural Finance
Strategies for Overcoming Psychological Biases

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The Power of Compounding
**Understanding the Power of Compounding
http://www.horizon.my/2008/11/the-story-of-anne-scheiber/
Be like Grace: 5 Lessons From an Unlikely Millionaire
Slow consistent accumulation through the power of compounding
The Master: Warren Buffett 1
What is your optimum Return on Investment?

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Strategies: For Buying, Holding and Selling & Portfolio Management
Stock Selling Guide - Gain/Loss Worksheet (Part 1 of 5)
Stock Sale Considerations (Part 2 of 5)
Evaluating Changing Fundamentals (Part 3 of 5)
To Sell or to Hold Checklist (Part 4 of 5)
Selling and Holding mistakes Checklist (Part 5 of 5)
Portfolio Management - Defensive & Offensive strategies
Detail version of To Sell or to Hold & Portfolio Management
My strategies for buying and selling (KISS version)

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Strategies: Good Quality Companies with Durable Competitive Advantage
**Exploring Durable Competitive Advantage
Company with Durable Competitive Advantage 1
Selling a unique product 2
Selling a unique service 3
Low-cost buyer and seller of a product or service 4...
Warren's durable competitive advantage companies 5...
Buffett versus Graham 6
Durability is the Ticket to Riches 7
Financial Statement: Where the Gold is Hidden 8
Durable Competititve Advantage - Conclusion 9

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Strategies: Asset Allocation & Market PE
Preparing Your Portfolio Is the Most Important Action You Can Take
**A Seven-Step Process for investing in New Assets
**Why Stocks Are Dirt Cheap
20.11.2008 - KLSE MARKET PE

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Valuation: Based on Equity per Share
Stock Valuation
Variable values of a dollar of earnings
Assumptions used to calculate value
Stock valuation
Stock valuation 2
Stock Valuation 3
Stock Valuation 4
Stock valuation 5
Stock Valuation 6
Stock valuation 7

Stock Val's@ valuation formula:{[(APC/RR) x Reinvestment + Dividends]/RR} x Equity per share = VALUE

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Valuation: Based on Buffett's Equity Bond Concept
Warren Buffett’s Concept of Equity Bond in Action
Warren Buffett's concept of Equity Bond

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Valuation: Based on Ben Graham's checklist
Ben Graham Checklist for Finding Undervalued Stocks

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Valuation: Discount Cash Flow models (using various types of cash flows)
http://www.capital-flow-analysis.com/investment-theory/stock-valuation.html

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*****Long term investing based on Buy and Hold works for Selected Stocks

Why Stocks That Raise Dividends Trounce the Market

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Also read:
Market Strategies Review Notes I (January 2009)

Intrinsic value, impossible to pinpoint but essential to estimate

Graham did not invent the term intrinsic value, though he did endow it with greater meaning than it had before he began teaching and writing.

The phrase is known to have been used in relation to the stock market as early as 1848. William Armstrong, an investment writer, described it as the principal determinant in setting the market prices of securities, though not the only factor.

Further groundwork for the intrinsic value concept was laid when Charles H. Dow was the editor and a columnist for The Wall Street Journal. Though Dow is most famous for his study of stock market movements, he repeatedly explained to his turn-of-the century audience that stock prices rise and fall because of investors' perception of the future profitability of a company - in other words, on the stock's intrinsic value.

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In the 1940 edition of Security Analysis, Graham and Dodd used a now historic company as an example of one way intrinsic value is determined.

Graham: In 1992, prior to the boom in aviation securities, Wright Aeronautical Corporation stock was selling on the New York Stock Exchange at only $8, although it was paying a dividend of $1, had for some time been earning over $2 a share, and showed more than $8 per share in cash assets in the treasury. In this case analysis would readily have established that the intrinsic value of the issue was substantially above the market price.

Graham looked at Wright Aeronautical again in 1928. By then the company was selling at $280 per share. It was paying a $2 dividend, and earning $8 per share, and the net asset value was $50 per share. Wright was still a sound company, but future prospects in no way justified its market price. The company was, by Graham's reckoning, selling substantially above its intrinsic value.

-----
An Artful Science

In his 1994 Berkshire Hathaway annual report, Warren Buffett spent several pages explaining how he arrives at intrinsic value. Buffett regularly reports per share book value for Berkshire Hathaway, as most investors expect.

"Just as regularly we tell you that what counts is intrinsic value, a number that is impossible to pinpoint but essential to estimate." However, he continues, "we define intrinsic value as the discounted value of the cash that can be taken out of a business during the remaining life." Though Buffett says this is a subjective number that changes as estimates of future cashflow are revised and as interest rates change, it still has enormous meaning.

Warren Buffett used his 1986 Scott Fetzer purchase to illustrate the point.

When it was acquired by Berkshire Hathaway, Scott Fetzer had $172.6 million in book value. Berkshire paid $315.2 million for the company, a premium of $142.6 million. Between 1986 and 1994, Scott Fetzer paid $634 million in dividends to Berkshire. Dividends were higher than earnings because the company held excess cash, or retained earnings, which it turned over to its owner - Berkshire.

As a result, Berkshire (of which Buffett himslef owns more than 60 percent) tripled its investment in 3 years. Berkshire still owned Scott Fetzer, which had virtually the same book value that it did when Buffett bought it. Yet since purchasing the company, Berkshire has earned double the accquistion price in dividends. (1996)

-----

So, what is intrinsic value?

• Some analysts consider net current asset value to be a measure of intrinsic value.
• Others focus on price-earnings ratio or other, more fluid factors.
• Buffet defines intrinsic value as the "discounted value of the cash that can be taken out of a business during the remaining life."

Whatever device investors may use, the goal is to find an estimate of a company's present and future worth."

Almost by definition, a really good business generates far more money (at least after its early years) than it can use internally," explains Buffett. That money can be reinvested to increase the value of the company or paid out to shareholders in dividends. One way or another this additional money will eventually work its way back to the shareholders.

Also read:
http://articles.wallstraits.net/articles/315
"Warren Buffett used the Scott Fetzer acquisition to explain Berkshire’s investing strategy in his 1985 letter to shareholders: Scott Fetzer is a prototype, understandable, large, well-managed, a good earner. The Scott Fetzer purchase illustrates our somewhat haphazard approach to acquisitions. We have no master strategy, no corporate planners delivering us insights about socioeconomic trends, and no staff to investigate a multitude of ideas presented by promoters and intermediaries. Instead, we simply hope that something sensible comes along-- and, when it does, we act.

Buffett went on to outline six acquisition criteria that are still published annually in his famed letters to shareholders:

• large purchases,
• consistent earnings,
• little debt,
• ongoing management,
• simple businesses, and
• an offering price

.....At Berkshire, in contrast, Ralph ran Scott Fetzer for 15 years until his retirement. Under his leadership, the company distributed US$1.03 billion to Berkshire against our net purchase price of $230 million. We used these funds, in turn, to purchase other businesses. All told, Ralph’s contributions to Berkshire’s present value extend well into the billions of dollars.

Value Investing and Intrinsic Value

Value investing is a search for sound securities that sell at or below their "intrinsic value."

These investments are then held until there is strong incentive to sell them. For example,

• the stock's price may have risen;


• an asset value may have declined; or


• a government security may no longer deliver the kind of return the investor could earn on competing securities.

The most profitable path in any case is to sell the security and move the money to another investment that is intrinsically undervalued.

Don't Make These Three Investment Mistakes

Don't Make These Three Investment Mistakes
Christopher Davis
Tuesday December 9, 2008, 7:00 am EST


In the world of traditional economists and finance professors, though, that's not supposed to happen. If investors are rational decision-makers, then emotion-driven bubbles shouldn't be possible. Yet human weaknesses can limit our ability to think clearly. Many studies of investor behavior have shown that investors are:

• too willing to extrapolate recent trends far into the future,


• too confident in their abilities, and


• too quick (or not quick enough) to react to new information.

These tendencies often lead investors to make decisions that run counter to their own best interests.


The idea that investor psychology can result in poor investment decisions is a key insight of an increasingly influential field of study called behavioral finance. Behavioral-finance theorists blend finance and psychology to identify deep-seated human traits that get in the way of investment success. Behavioral finance isn't just an interesting academic diversion, however. Its findings can help you identify--and correct--behaviors that cost you money.


What commonplace mistakes should investors avoid? Here are a few key behavioral-finance lessons worth heeding.


Don't Read Too Much into the Recent Past



When faced with lots of information, most people come up with easy rules of thumb to help them cope. While useful in some situations, these shortcuts can lead to biases that cause investors to make bad decisions. One example is "extrapolation bias," the overreliance on the past to assess the future. Instead of doing all the necessary and possibly tedious homework in researching a potential investment, investors instead "anchor" their expectations for the future in the recent past.


The problem, of course, is that yesterday doesn't always tell you what tomorrow will bring. If you don't believe us, just ask investors who swarmed red-hot technology- and Internet-focused stocks in 1999 and 2000 expecting the good times to continue. They didn't, and most folks ended up suffering huge losses. Those who dove into real estate or natural-resources funds in more recent years are learning the same lesson now.


It's also worth pointing out that you can make the same mistake in the other direction. It's been a horrible year for the markets, but that won't last forever either. Just as it's a mistake to assume the good times will never end, it's also foolish to think in bad times that they'll never end.


Realize That You Don't Know As Much As You Think



In a 1981 study asking Swedish drivers to assess their own driving abilities, 90% rated themselves as above average. Statistically speaking, that's just not possible. But most of us are just like the Swedes: We think that we're more capable and smarter than we really are. As an investor, you should check your excessive optimism at the door. You might believe you're more likely than the next guy to spot the next Microsoft (NasdaqGS:MSFT - News), but the odds are you're not.


According to several studies, overconfident investors trade more rapidly because they think that they know more than the person on the other side of the trade. And all that trading can be hazardous to your wealth, as University of California, Berkeley professors Brad Barber and Terrance Odean put it in their 2000 study of investor trading behavior. The study looked at approximately 66,000 households using a discount broker between 1991 and 1996 and found that individuals who trade frequently (with monthly turnover above 8.8%) earned a net annualized return of 11.4% over that time, while inactive accounts netted 18.5%. Investors who traded most often paid the most in brokerage commissions, taking a huge bite out of returns.


All that trading might've been worthwhile if investors replaced the stocks they sold with something better. But interestingly, the study found that, excluding trading costs, newly acquired stocks actually slightly underperformed the stocks that were sold. That means that rapid traders' returns suffered whether or not fees were taken into account. Some researchers have come to a similar conclusion studying fund manager trading--standing pat is often the best strategy.


Keep Your Winners Longer and Dump Your Losers Sooner



Investors in Odean and Barber's study were much more likely to sell winners than losers. That's exactly what behavioral-finance theorists would predict. They've noticed that investors would rather accept smaller but certain gains than take their chances to make more money. On the flip side, investors are reluctant to admit defeat and sell stocks that are underwater in hopes of a rebound. As a result, investors tend to sell their winners too early and hang on to their losers for too long.


One way that investors can avoid leaving too much money on the table is to rebalance their portfolios less often. Rebalancing involves regularly trimming winners in favor of laggards. That's a prudent investing strategy because it keeps a portfolio diversified and reduces risk. But rebalancing too frequently could limit your upside. Instead, rebalance only when your portfolio is out of whack with your target allocations. Minor divergences from your targets aren't a big deal, but when your current allocations grow to more than 5 percentage points beyond your original plan, it's time to cut back. To learn more about rebalancing your portfolio, click here.


You also shouldn't be afraid to sell a loser because it will turn a paper loss into a real one. Hanging on to a dog in hopes of breaking even is a bad idea because you may be forgoing a better opportunity. The trick is knowing when it's time to cut bait. That's why it pays to have clear reasons in mind for your purchase of any investment right from the get-go. If your expectations don't pan out, then it's time to sell.

It's All about Discipline

Fortunately, you don't have to be a genius to be a successful investor. As Berkshire Hathaway chief and investor extraordinaire Warren Buffett said in a 1999 interview with Business Week, "Success in investing doesn't correlate with IQ once you're above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing." It's true that not everyone is gifted with Buffett's calm, cool demeanor. But challenging yourself to avoid your own worst instincts will help you reach your financial goals.


Christopher Davis does not own shares in any of the securities mentioned above.



http://finance.yahoo.com/news/Dont-Make-These-Three-ms-13780451.html

Whose recession is this, anyway?

Whose recession is this, anyway?
For some people, bargain prices and new workplace advantages make the economic downturn a time to profit.
By Catherine Holahan, MSN Money

Stephen Lasher reads all the dire economic forecasts declaring this recession the most worrisome since the Great Depression. But life doesn't seem so bad to Lasher. In fact, his horizons have never looked brighter.

Last year, the 33-year-old Columbia Business School grad landed a great job at media company NBC Universal. Now his spending money stretches further than before, thanks to retail store sales. Last month, he closed on his first home: a one-bedroom waterfront condo in a complex with a gym, pool and doorman.

"I am feeling good," Lasher says. "The housing prices were out of control before. . . . Now I was not only able to get a good price, but I was also able to get a mortgage interest rate well below what I thought would have been possible."

Lasher's neighbor James Tortorella agrees that the recession has afforded him some opportunities. He bought his condo in November. "I found a great deal," says Tortorella.

Scoring a bargain condo

So the economic crisis isn't hurting all Americans.

True, the combination of plummeting home prices, steep stock declines and rising unemployment has proved disastrous for many, particularly those new to the job market or nearing retirement. Nationwide, unemployment reached 6.7% in November, according to a Dec. 5 report from the U.S. Bureau of Labor Statistics. The rate jumps to more than 11% when the bureau adds workers who have ceased looking for employment and former full-time employees forced to reduce their hours.

No jobs for grads?

But the same weakness in the economy has helped others, providing many young and midcareer professionals with new purchasing power and giving some a boost up the corporate ladder.
"Middle-career people have the opportunity to do things they were never given exposure to before," says Kathleen Downs, a recruiting manager at Robert Half International, one of the world's largest business staffing and consulting firms. As companies trim their staffs, she explains, midcareer people get an earlier shot at jobs once held by more-expensive, more-experienced workers.

"It's a good time to be positioning themselves," she says of the younger workers.
For people with relatively secure jobs and cash in the bank, it's also a good time to shop. The Consumer Price Index, a measure of the average price of common household goods purchased by urban consumers, fell 4.4% in the past three months, according to the Bureau of Labor Statistics. In that period, transportation costs fell more than 26% because of steep fuel price declines. Apparel dropped prices 2.4%. Year over year, the S&P/Case-Schiller home price index is down 16.6%, according to data released Nov. 25.

Lasher -- and doubtless many like him -- see the price declines as a welcome dose of reality, placing homeownership, vehicle purchases and even blue-chip company stock within reach of a new generation.

"I personally was waiting for a market correction," he says.

Price drop puts homes within reach

Welcome, indeed. A year ago, Lasher was ready to give up on the idea of owning a home near his New York City job. The going rate for one-bedroom condominiums near the city was simply too high.

"I thought I was going to have to move farther away from New York City," Lasher says.
But as the housing market got worse, things got better for Lasher. In recent months, condominiums on the New Jersey side of the river, once prohibitively expensive, began to look affordable. Lasher watched as prices fell about 25% from their peak.

He had been renting an apartment near the New Jersey commuter ferry on the Hudson River, but in November, he pounced on a one-bedroom condo at The Hudson Club, a waterfront complex overlooking Manhattan and just a short walk to the ferry. He locked in a fixed-rate mortgage at 5.875% interest. Lasher isn't discussing precisely what he paid, but here's an idea: a two-bedroom condo in the same complex is now listed for sale at $569,000.

"I don't expect 20, 30 or 40% increases," Lasher says of the condo's value. But he is confident that the purchase price makes his unit a good investment for the future.

Lasher knows he and his peers are not immune to the effects of recession. Some business school buddies who went into the banking business have been laid off.

The national statistics confirm that midcareer professionals have not escaped the downturn unscathed. Unemployment for people ages 25 to 34 rose to a 10-year high of 6.9% in November. That's up from 4.7% a year earlier. Employees ages 35 to 44 also saw record, albeit lower, unemployment rates: 5.4% in November, compared with a 3.5.% rate 12 months earlier. Those figures don't include the more than 33,000 additional job cuts announced this December.

As companies lay off more-senior employees, many midcareer workers are forced to assume additional management responsibilities without receiving pay increases.

"What we are not seeing is the pay increases that would often come in a very strong economy," says Robert Half's Downs.

It may be quite a while before those pay increases return. Consumer spending rose just 2.6% in 2007 from the previous year, according to Bureau of Labor Statistics figures released Nov. 25. Though spending kept pace with inflation, growth was significantly weaker than the 4.3% seen a year earlier. And consumer confidence is still near record lows, though it has risen slightly from its worst levels, according to The Conference Board. A majority of consumers still rate business conditions as "bad" and jobs as "hard to get."

Hard to gain entry at this level

That's how Andy Fisher sees the situation. Fisher is a New York University senior majoring in journalism and history. He thinks his future employment prospects are far less certain thanks to the downturn. Entry-level journalism and publishing jobs seem scarce, he says.

"I am currently in an internship, and, if anything, they are firing, not hiring," Fisher says. "The chances of getting a job at the publishing houses I had hoped to work for seem pretty slim."
In terms of unemployment rates, the recession is hitting recent and soon-to-be college grads hardest. Nearly 11% of 20- to 24-year-olds were unemployed in November, according to the statistics bureau. That's up from 8% a year ago. The increase is due to hiring freezes at major companies and slowdowns at large employers such as Google. It doesn't help to have a glut of older, more-experienced workers in the marketplace willing to downsize careers in return for a steady income.

"It is pretty safe to say that all levels of hiring have slowed," says Michael Erwin, a senior career adviser for online job site CareerBuilder.com.

The recent grads who do land jobs find the process is taking longer. On average, recent college grads are searching an additional six weeks before securing a job, compared with last year, according to a recent CareerBuilder study. Erwin recommends that students set to graduate in the spring begin looking for jobs now. He suggests graduates be prepared to accept positions in fields other than their preferred field, for less pay than they may have targeted previously.
Fisher is weighing whether he should switch to a different career.

"It's pretty troubling," he says. "I basically just have to hope that somebody will pay me for something and keep myself marketable to as many different fields as possible."

'Experienced' translates as 'expensive'

One bright side for younger workers who obtain jobs is they are less likely targets for layoffs. The same can't be said of older workers. In this recession, businesses facing cuts are more likely to buy out or fire expensive, experienced workers whose total compensation, including salaries and health care costs, is more material for the bottom line.

"One way that people try to trim down their work force is by buyouts -- it is usually a first resort for companies trying to shed workers," says Andrew Eschtruth, the communications director at Boston College's Center for Retirement Research.

Buyout offers can present tough decisions for older workers whose retirement savings have been depleted. Many older workers now think they have no choice but to remain on the job and try to rebuild their resources, says Steve Sass, the associate director at the Center for Retirement Research and a co-author of "Working Longer: A Solution to the Retirement Income Challenge."
Sass suggests that even conservative investors -- those who had only 30% of their nest egg in the stock market -- are now contemplating losses of 10% to 15%.

"If you had to save to cover that loss, it is enormous, and it is pretty onerous," Sass says. "If you had to work to overcome that, you're talking another year and a half to two years."

The unemployment rate for workers ages 55 to 64 rose to 4.6% in November. That may sound OK compared with the rates affecting younger workers, but it's a 70% increase for that group from a year ago.

"Previous recessions tended to hit younger workers hard and not so much for older workers," says Richard Johnson, a principal research associate for retirement issues at the Urban Institute, a nonprofit think tank in Washington, D.C. "But what we're seeing this fall is a rather steep increase in the unemployment rate for those 55 and older and those 65 and older."
Employment professionals are all about opportunity, so they try to put a positive spin on all this. They suggest that, for now, employers are in the driver's seat, able to lay off workers and keep salaries down. But their leverage will vanish when the economy turns around, and the leverage will pass to employees who have added responsibility during the downtown with no significant increase in salary. When that happens, it's time to ask for a fat raise, they say.

"There is some light at the end of the tunnel," CareerBuilder's Erwin says.

Produced by Darragh Worland
Published Dec. 5, 2008

http://articles.moneycentral.msn.com/Investing/StockInvestingTrading/Whose-recession-is-this-anyway-msnmoney.aspx?page=all

Under 50? Do This, or You'll Regret It!

Under 50? Do This, or You'll Regret It!
By John Rosevear December 8, 2008 Comments (1)

I know, I know -- the stock market is crazy and unpredictable right now.

I know that sitting in cash or doing nothing until things settle down seems like a sensible course of action.

But I also know this: 10 or 15 years from now, the market will be up. Way up from here, in all likelihood.

If you're under 50, and you're trying to figure out what to do with the wreckage of your retirement portfolio, there's only one good answer: Buy great stocks.

Here's why.

When the game is rigged, bet with the house No, the stock market isn't "rigged" in the sense of being manipulated. It is, however, inherent in the market's nature to go up over the long term, scary bear markets notwithstanding.

Check out these 15-year returns, which assume purchase on Dec. 8, 1993 and include reinvested dividends for those stocks that have them:

Stock-----15-Year Gain

McDonald's (NYSE: MCD)
430%

Apple (Nasdaq: AAPL)
1,110%

Southern Company (NYSE: SO)
804%

Nokia (NYSE: NOK)
541%*

Qualcomm (Nasdaq: QCOM)
1,945%

Johnson & Johnson (NYSE: JNJ)
573%

Target (NYSE: TGT)
612%

Source: Yahoo! Finance.
Figures as of market close on Dec. 5, 2008. *Nokia return since Apr. 25, 1995.

Those returns are despite the dot-com bubble bursting and despite the recent market crisis. As Richard Ferri, an investment manager and author of several books on asset allocation and indexed investing, argues in this month's issue of Rule Your Retirement, there are strong reasons to believe that the market is naturally prone to going up over time -- and that average annual returns near 10% over the next 15 years are extremely likely.

His methodology and reasoning are a little too elaborate to lay out here -- check out the complete article for specifics -- but his recommendations for those under 50 are crystal-clear:

• Your portfolio should be 100% in stocks.
  
• Continue to add to your retirement accounts, and use that money to buy stocks.
  
• Be aggressive -- as aggressive as you can stand.
  
• Ignore performance. Don't look at your statements.
  

That last one might seem weird -- how will you know how you're doing if you don't look at your statements? -- but Ferri has a point. He argues that they're "completely irrelevant" -- following short-term price movements just doesn't give you any useful information. In fact, it's more likely to give you something to worry about, needlessly.

I'd add this caveat: This only works if you have very long-term investments! Not all portfolios are built to run 15 years or longer with no more maintenance than the occasional trade or rebalance -- in fact, most aren't.

How do you do that?

Construct a long-haul portfolio

Ferri is a proponent of indexing -- of using index funds and ETFs in your retirement portfolio. That’s one way to build a long-term investment strategy. Another way, one likely to yield far greater returns if done right, is to buy great stocks -- the blue-chip dividend monsters and future giants that will keep delivering rewards year after year. (Can you guess which method I favor?)

Of course, "buy stocks" isn't a complete to-do list. To maximize your gains over the long haul, you need a solid asset-allocation plan -- one that gives you exposure to all the key corners of the stock market. Your 401(k) provider can probably help you come up with a decent one -- though as a rule, those computer-generated templates tend to be more conservative than is appropriate for most young investors.

A far better set of asset allocation roadmaps for retirement investors -- one of the best I've seen, and one that works well whether you're using mutual funds in a 401(k) or stocks in an IRA, or a combination of the two -- are the ones maintained by the team at Rule Your Retirement. They're available to members by clicking on "Model Portfolios" under the Resources tab after you log in.

What do the unfolding financial crisis and ongoing market volatility mean for your money? The Fool's here with answers. Fool contributor John Rosevear owns share of Apple. Southern Company and Johnson & Johnson are Motley Fool Income Investor selections. Nokia is a Motley Fool Inside Value pick. Apple is a Motley Fool Stock Advisor recommendation.

http://www.fool.com/personal-finance/retirement/2008/12/08/under-50-do-this-or-youll-regret-it.aspx

Value Investing: A Philosophy More Than a Formula

Value investing is based more on philosophy. Those who studied directly under Graham are careful to explain that Graham and Dodd's Security Analysis and Graham's The Intelligent Investor are not cookbooks for the investment professional. There is no step one, step two, and step three. Graham's purporse was to make his students use the deductive process to think for themselves.

Despite continual examination, questioning, probing, and tweaking of the Graham and Dodd concepts, the very basics - the fundamentals - remain intact.

Three Key Concepts

When Warren Buffett talks about his training under Graham, he says that the two most important things he learned at Columbia University were:

• The right attitude
• The importance of margin of safety

By listening to Buffett speak and by reading Berkshire Hathaway's annual reports, a third key Graham concept surfaces repeatedly, that of

• Intrinsic value.

Market Manipulation

Charles Dow wrote in 1901: "The manipulator is all-powerful for a time. He can move market prices up or down. He can mislead investors, inducing them to buy when he wishes to sell, and sell when he wishes to buy; but manipulation in a stock cannot be permanent, and, in the end, the investor learns the approximate truth. His decision to keep his stock or sell it then makes a price independent of speculation and, in a large sense, indicative of true value."

In the current regulatory situation, manipulation, though it does crop up, is less common.

Also read:
Stock Market Manipulations
25 Nov 2008 BURSA MALAYSIA SECURITIES BERHAD REPRIMANDS, FINES AND STRIKES OFF PNEH TEE EONG, A COMMISSIONED DEALER'S REPRESENTATIVE OF M&A SECURITIES SDN BHD FROM THE REGISTER FOR VIOLATION OF RULES 404.3(1)(a) & (b) AND 401.1(2) & (3) OF THE RULES OF BURSA SECURITIES

Five tips for buying stocks in bad times

WEEKEND INVESTOR
How to outsmart a not-so-average bear
Five tips for buying stocks in bad times

By Jonathan Burton, MarketWatch
Last update: 7:01 p.m. EDT Oct. 17, 2008

SAN FRANCISCO (MarketWatch) -- You survived the stock-market crash of 2008. Congratulations. Now comes the hard part: Buying stocks and mutual funds that can survive -- and even thrive -- in the bear market.

Buying in a bear market? That's what Warren Buffett is doing. The famed investor was blunt about why: "Be fearful when others are greedy, and be greedy when others are fearful," he wrote in an opinion piece Friday in The New York Times. "Bad news is an investor's best friend," he added. "It lets you buy a slice of America's future at a marked-down price." Read Buffett's editorial.

The key, as always, is what you buy and how patient you are. Buffett isn't banking on a quick turnaround; he knows that patience is rewarded. You can average in to stocks over time -- there's no reason to back up the truck. Markets are bracing for another shock: the specter of the first consumer-led recession in almost two decades.

"This volatility is signaling the end of an era," said Rich Bernstein, chief investment strategist at Merrill Lynch. "If you're picking stocks or looking for a fund, the characteristics you want are the ability to continue to enhance shareholder value. Think of it in terms of companies that are self-funding. Look for companies that have excess cash flow."

Let that be your bear-market investing guide. You want an investment portfolio of high-quality stocks and mutual funds that not only can weather this economic storm but come through it stronger.

That naturally steers you to traditionally defensive consumer staples and health-care companies, but don't limit yourself. There will be opportunities in other sectors, but the new leaders, regardless of their business, will demonstrate the financial strength and self-sufficiency to flourish in what will be an increasingly Darwinian market.

So think like an acquirer; think like Buffett. Keep the following five criteria uppermost in mind when you evaluate a stock or the companies in a fund's portfolio:

1. Free cash flow
Free cash flow is essentially a company's budget surplus. Excess cash -- not earnings -- is for many investors the true measure of a company's flexibility because unlike earnings, cash flow is tough to fudge with accounting tricks.

"Look for strong and growing free cash flow," said Rob McIver, co-manager of Jensen Portfolio (JENSX ) . "Cash flow is harder to manipulate than earnings per share."

To calculate free cash flow, take net income plus amortization and depreciation, minus changes in working capital and capital expenditures. Companies with excess cash have options. They can invest in the business or make acquisitions, and give investors a boost by increasing dividend payments and buying back shares.

Many of the 28 stocks in the Jensen fund are large-cap consumer goods and health care companies fitting this bill. Top holdings as of Sept. 30 included medical-device giant Stryker Corp. (SYK) , pharmaceutical leader Abbott Laboratories (ABT) and consumer products titan Procter & Gamble Co. (PG) . The fund also has a newer position in software developer Cognizant Technology Solutions (CTSH) .

Said McIver: "There's a place in everyone's portfolio for high-quality companies where predictability and sustainability of earnings is valued."

2. Little or no debt

The most profitable areas for much of this decade -- real estate, energy, financials, commodities, emerging markets -- all benefited from cheap and easy credit. Now credit is not readily available and not so cheap. Accordingly, credit-sensitive sectors are underperforming.

"Companies that are levered or need to tap the capital markets are going to struggle in terms of being able to get financing at a reasonable price -- or at all," said John Buckingham, editor of The Prudent Speculator newsletter and manager of the Al Frank Fund (VALUX) .

Concentrate on companies that can finance their own growth and have low debt as a percentage of total capital. Organic growth, as opposed to growth through acquisition, is also crucial.
"Focus on balance sheet strength," Buckingham said. "We like Microsoft (MSFT) because it doesn't need to tap the capital markets." Big blue-chip technology companies such as Cisco Systems Inc. (CSCO) and Oracle Corp. (ORCL) "are excellent places for investors," he added.

In a market where cash is king and earnings predictability is paramount, Buckingham is also bullish on big pharmaceutical companies including GlaxoSmithKline Plc (GSK ) and Merck & Co. (MRK) and health insurers Aetna Inc. (AET) and Humana Inc. (HUM)

"The important thing," Buckingham said, "is does the company have the ability to navigate the difficult environment we're in or does it have to go to the markets for capital, and the markets are not exactly friendly right now."

3. Strong market share

Companies involved in basic businesses with a national or global footprint, or that help other companies be more productive have a competitive advantage in a miserly market. Marshall Kaplan, senior equity strategist with Smith Barney Private Client Investment Strategy, uses the example of oil service companies that can charge a premium for extracting oil and gas, or technology companies that make it easier to process data.

"Ask yourself, is it a viable franchise?" Kaplan said "Are you talking about products and services that are going to be needed not for brief periods but over the long term? Is the quality of earnings there? You've got to make sure you're in a situation where the business can be maintained at levels that are conducive to growth."

Stocks on Smith Barney's recommended list that meet this criteria include Apple Inc. (AAPL) , ConAgra Foods Inc. (CAG) , Johnson & Johnson (JNJ) , Kimberly-Clark Corp. (KMB) and National Oilwell Varco Inc. (NOV)

"It's tough for the individual investor to keep his or her head about them in a market like this," Kaplan said. "These types of names create a stronger level of support. The days of buy-and-hold, one-decision stocks are gone, but you could have a longer holding period in the names with these characteristics."

4. Solid management

Companies in top financial shape have management that's proactive and capable.

"Honorable," is how McIver, the Jensen fund manager, puts it.

"Understand what creates and what destroys shareholder value," he said. "You can't run a company from quarter to quarter to meet earnings targets. You have to make long-term decisions and capital expenditure decisions that will reap rewards."

The Jensen fund won't invest in a company until the managers visit executives on their home turf. Moreover, these corporate chieftains must have delivered return on equity -- net income divided by shareholders' equity -- of at least 15% annually on average for 10 consecutive years. One slip, and the stock is booted from the portfolio.

"By knowing the companies well, we can minimize business risk," he said.

5. Attractive valuation

Investors have tossed out stocks in panic, including those with strong fundamentals. Market sentiment is mired somewhere between despondency and ye of little faith.

But many professionals are taking a page from Buffett. "I'm looking for stocks that are already cheap," said Tom Forester, manager of Forester Value Fund (FVALX ) , which counts consumer goods leaders H.J. Heinz Co. (HNZ) , Kraft Foods Inc. (KFT) and Johnson & Johnson among its top holdings. "They tend to have a lot less downside, but they also have plenty of upside potential."

He's also finding bargains in technology. "I'll buy Microsoft at 12 times earnings," Forester said. "For a tech stock it's very cheap. I like the cash, the stock buybacks, and revenue streams are steady."

Buckingham's picks include General Electric (GE ) , United Technologies (UTX) and IBM (IBM) . "There's a lot of opportunity in large-cap stocks right now," he said, "and arguably you've got a greater margin of safety."

In this market, investors will need the margin of safety that a low price brings. The crash was just the end of the beginning. Now comes what could be many months of head-fakes and hopeful rallies that wind up in dead ends. You'll be Charlie Brown charging the football with head held high, only to land flat on your back.

While it won't make the challenges any easier, take to heart what veteran stock analyst Bob Farrell noted in his iconic 10 "Market Rules to Remember": Bear markets, he wrote, have three stages -- "sharp down, reflexive rebound, and a drawn-out fundamental downtrend." See related story.

Where it stops, nobody knows, but a portfolio with strong defensive stocks stands a fighting chance.

Jonathan Burton is an assistant personal finance editor for MarketWatch, based in San Francisco.

http://www.marketwatch.com/news/story/you-can-buy-bear-market/story.aspx?guid=%7b61CFDC64-F688-4C93-8C88-010A83AEECF0%7d&print=true&dist=printMidSection

50%-50% versus 80%-20% portfolio blend of stocks and bonds

It's all in the mix
How to invest well and sleep better, in good markets or bad

By Jonathan Burton, MarketWatch
Last update: 6:37 p.m. EST Nov. 18, 2008
Comments: 58

SAN FRANCISCO (MarketWatch) -- In this devastated market, "risk tolerance" is an oxymoron. Those little tests the online investing sites give you to assess how much risk you can handle in your investments don't do justice to the kind of crash we're living through.

Most of us can't stomach 40% free falls in our fortunes and we certainly can't -- or don't want to -- suffer a shellacking like the one we had in October and then watch what's left trickle away.


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You don't have to.

This may be too late for many investors who have already seen their stock-heavy nest eggs scrambled, but some research and simple number-crunching indicates you can keep less money invested in stocks than conventional wisdom would have you believe -- without giving up your retirement goals and with a lot less risk.

Indeed, a portfolio that mixes 50% stocks and 50% super-safe long-term Treasury bonds has performed almost as well over the past two decades as a portfolio that carries an 80%-20% blend of stocks and bonds. And if you're the guy holding the first portfolio, you're probably sleeping a lot better these days than the other fellow.

"If your goal is to be very confident about having a certain amount of money at a point in time, lower-risk portfolios are actually a cheaper way to get there than a higher-risk portfolio," says Christopher Jones, of Financial Engines, an investment advisory firm.

If you, like many investors, have bailed out of stocks this year, you have, unfortunately, sold into the collapsing market and locked in your losses. But who could blame you? Most people can't handle the pain this market is inflicting. And the losses are worse because people nearing retirement often end up with way too much of their portfolios in stocks as they try to goose growth in their twilight working years.

The typical investor's thinking goes something like this: Stocks over time outperform both bonds and cash. So without a high allocation to stocks, you'll fall short of your financial goal, inflation will ravage your portfolio and your golden years will be tarnished as your money runs out before you do.

Big problem: The 80% or 70% stock portfolio that served you well in your 20s or 30s bites back in your 50s and 60s, when a crash erases years of growth in just a few weeks or months.

Start with a balance

There has to be a better, more automatic way to build wealth without constantly refiguring your investment mix. There is. Forget the stock-heavy plan and start with an equal balance of stocks and bonds.

Let's look at what happens when you ratchet down stocks early to a less volatile level: We asked investment researcher Morningstar to calculate your investment results if at the end of October 1987 -- a really frightening moment, right after the big crash that year -- you had put 50% of your money in a low-cost fund that mimicked the Dow Jones Industrial Average ($INDU:
Dow Jones Industrial Average) and 50% in a vehicle that mirrored long-term Treasurys.
Nowadays that could be accomplished at a low cost using the Dow "Diamonds" exchange-traded fund (DIA: Dow Diamonds ETF) and iShares Lehman 20+ Year Treasury Bond ETF (TLT:
iShares:Lehm 20+ Trs) . Over the decades, you would keep the allocation constant through annual rebalancing and would reinvest all stock dividends and bond income.

'Good enough' returns

The plan is to smooth your investment performance, accepting lesser short-term gains in exchange for milder, and less worrisome, short-term declines.

In this most recent 21-year example, by October of this year a 50%-50% portfolio would have averaged a 10% annual return and you would have insulated yourself from a significant portion of the market's day-to-day risk. Your best quarterly performance? A 13.8% gain in the value of your portfolio. Your worst? A 9.1% loss.

By comparison, a portfolio of 80% stocks and 20% Treasurys would have been exposed to considerably more market risk, but your return would average just a slightly better 10.3% a year. Your best quarterly performance would have been an increase of 17.6% in your portfolio while your worst would have been a 14.2% loss.

In the current bear market, the 50%-50% portfolio would be down about 14.6% from the October 2007 market peak through the end of last month, while the 80%-20% portfolio would be down 24.8%.

Over the 21-year period, the 50%-50% portfolio would have achieved 95% of the total dollar return of the 80%-20% mix, with substantially lower risk, a steadier performance and, for you, many fewer sleepless nights.

Not much difference

Make no mistake. The 50%-50% portfolio will leave you poorer than the riskier blend. But the difference isn't that substantial.

Had you put $25,000 into the 80%-20% split in 1987 and never invested another dime, the money would have grown to about $196,000. That same amount in the 50%-50% blend would be worth around $185,000.

The strategy holds up if you dollar-cost average, too, and invest a little at a time over the years. Add $100 a month, and $25,000 grows to $261,621 in the 80%-20% portfolio and $251,732 in the 50%-50% mix.

And even if you eliminate the market's horrendous decline over the past year from the calculations, the conservative plan still performs admirably. At the market's peak in October 2007, the 80%-20% portfolio would have been worth $261,109, while the 50%-50% split would have grown over that 20-year period to $217,222, capturing 83% of the more aggressive approach's return, but with far fewer bumps.

Of course in bull markets, you won't make as much with a 50%-50% portfolio. You'll give up bragging rights. But you also won't feel the raw fear that others do during the inevitable downturns. That should be worth a few thousand dollars right there.

Jonathan Burton is an assistant personal finance editor for MarketWatch, based in San Francisco.

http://www.marketwatch.com/news/story/how-invest-well-sleep-better/story.aspx?guid=%7BA27C214B%2DE1CE%2D4990%2D907C%2D67D1338851AC%7D#comments