Can You Stomach Another 40% Drop?
By Dan Caplinger
February 20, 2009
After seeing the stock market lose half its value and head down toward six-year lows, you may feel like you've suffered more than you'd ever expected with your stock portfolio. Yet as another dour earnings season comes to a close, many see the potential for a much larger drop right around the corner.
The valuation conundrum
As dramatic as the drop in stocks has been since last summer, some market observers who focus on relative valuation wonder how the market has held up even as well as it has. If you focus on recent earnings numbers, the collapse in corporate profits among S&P 500 stocks paints an even bleaker picture of where the stock market ought to be trading.
According to The Wall Street Journal, trailing 12-month earnings for the S&P as a whole are likely to drop below $30, thanks to the recession. At least one pundit has applied an average earnings multiple of 15 to that number and come up with a projected value for the S&P 500 index below 450 -- more than 40% below its close at around 780 on Thursday.
Fair value, or foul?
The obvious counterargument to that dire prediction is that the recession has temporarily depressed earnings. After all, earnings for the S&P 500 a year ago were closer to $80, which works out to a P/E below 10 at current levels. If earnings eventually recover to their 2007 levels, then stocks look exceedingly cheap at this point.
But there's no guarantee that earnings will recover anytime soon. Leaving the length of the recession aside, many of the businesses that drove growth over the past several years won't get back to their previous levels of profitability. Even among financial firms that seem likely to survive the crisis, such as Goldman Sachs (NYSE: GS) and JPMorgan Chase (NYSE: JPM), the business model and market conditions that allowed Wall Street to maintain strong profit growth for years no longer exist.
Put another way, even if earnings for the S&P 500 recover fairly strongly -- say 50% from their recession lows -- that still only gets them up to $45. And with the specter of inflation, huge budget deficits, and potentially higher interest rates on the horizon, a P/E ratio of 17 based on that $45 figure sounds fairly pricey.
Protecting against market risk
So with that gloomy prediction, what can you do to cover yourself no matter which way the market moves? One possibility is finding stocks that don't move in lockstep with the market -- and one way to find such stocks is by looking at their betas. Here are some examples of low-beta stocks, which you can see have held up pretty well in the recent bear market:
Stock
Beta (Past 3 Years)
1-Year Return
5-Year Average Return
Altria (NYSE: MO)
0
(25.8%)
9.3%
Aqua America (NYSE: WTR)
(0.05)
(0.5%)
5.6%
Genentech (NYSE: DNA)
0.11
17.1%
12.2%
Strayer Education (Nasdaq: STRA)
0.01
9.2%
12.4%
Fairfax Financial (NYSE: FFH)
0.05
0%
15. 7%
Source: Yahoo! Finance.
The concept of beta is often misunderstood. Many rely on beta as a pure measure of volatility, counting on high-beta stocks to be more volatile than stocks with low beta values. But that's only true to the extent that a stock's returns are correlated with the overall market. A stock that moves independently, however, might well show a low beta, but its overall price movements might be fairly volatile.
So while low-beta stocks may provide some protection against a crash, they're no guarantee of positive performance. And of course, if the market rebounds, you'd do better in high-beta stocks that take greater advantage of bull markets.
Be ready
No matter what you do to protect your money, you need to be prepared mentally for what you'll do if stocks crash again. As unfair as it might seem to have to consider further losses after what you've already been through, counting on this being the worst of it is just too dangerous. As cheap as many stocks are right now, they could get cheaper -- and if you're on the edge of panicking already, you need to steel yourself for whatever comes next.
http://www.fool.com/retirement/general/2009/02/20/can-you-stomach-another-40-drop.aspx
For more on investing in tough times, read about:
Companies that will get better in a recession.
How you can profit when the recovery comes.
Stocks that could cause permanent losses.
Thursday 25 June 2009
How We Tripled Our Money in a Year
How We Tripled Our Money in a Year
By Tim Hanson
June 24, 2009
This past year was an exciting one to be an investor. At one point in March, stocks were down well more than 50% from their 2008 highs. Yet amid this chaos, we at Motley Fool Global Gains identified a promising small company with a strong and growing core business that was selling for a dirt cheap 4.5 times earnings.
Since we recommended that stock to our members in October 2008, it's returned more than 200%. During that time, it has also listed on a major exchange and vastly expanded its production and distribution capacity. Thus, even though it's not quite the deal we got back in October, the stock remains on our Best Buys list.
But before I get to the stock, I want to tell you how we found it and provide a few points that can help you identify similar things for yourself.
You find what you're looking for
You may have heard (sometime, somewhere) that the market is efficient. That means that at any moment, all of the available information on a stock has been incorporated into its price. While I believe that's generally true, I don't believe it's true all the time. What's more, it's less true in certain market segments than others.
For example, take a popular U.S. megacap like Apple (Nasdaq: AAPL). It's tracked by 45 sell-side analysts, has earned a rabid following of fans and detractors, and everything from its products to the health of its CEO are reported on every day in the media. This, in other words, is a stock whose price is largely efficient. If you choose to buy or sell Apple stock, you're likely not doing so with any kind of informational advantage over your counterparty.
That, however, is less likely to be the case if you're buying and selling stocks that most other market participants aren't even paying attention to. Specifically, that's small stocks, foreign stocks, and especially small and foreign stocks.
Which brings me back to my story
The stock we discovered at Global Gains that's more than tripled in less than one year is a small Chinese fertilizer company called China Green Agriculture (AMEX: CGA). In hindsight, at less than 5 times earnings last October, it looked like a clear winner. The company's organic fertilizers were coming into favor as the government encouraged farmers to increase food production without a destructive environmental impact. Further, government efforts to aid rural farmers were giving those farmers -- China Green's customers -- increased purchasing power. Finally, there was a clear catalyst in the new 40,000-metric-ton manufacturing facility that the company planned to open with the capital it raised in a private placement.
Yet the market either wasn't paying attention here, or it was far too focused on the perceived risks of investing in China Green Agriculture. Those included a very short track record as a public company, an over-the-counter stock listing, and no permanent CFO.
How, then, were we able to get comfortable with recommending China Green's stock?
Elementary, my dear Watson
The simple fact is that we traveled to Xi'an, China, last June, and spent two days visiting with the company and touring its R&D and production facilities. We talked extensively with management about their plans for the future and their perceived market opportunities. And we got answers to every question we had about the company.
This doesn't mean we walked away 100% confident. After all, a company visit, while an important part of our research process at Global Gains, will never reveal the full story. But the visit enabled us to get comfortable enough to recommend that our members buy shares at less than 5 times earnings within the context of a diversified portfolio.
And the result speaks for itself. Not only is it up more than 200%, but it's outperformed other well-known China plays, such as PetroChina (NYSE: PTR), Baidu (Nasdaq: BIDU), and China Mobile (NYSE: CHL), as well as other well-known fertilizer plays, such as PotashCorp (NYSE: POT) and Mosaic (NYSE: MOS).
Your takeaway
Now, you may not have the resources to travel to China to check up on all of the small, cheap, and fast-growing companies there that you may be interested in owning. But short of that, the lesson is that the only way you're going to be able to take advantage of the inefficiencies that exist in the stock market is by doing an extraordinary level of due diligence. That means going through the filings with a fine-toothed comb, checking up on a company's auditor to make sure it has a good reputation, and doing extensive analysis of the numbers to make sure they're good, but not too good to be true.
Yet if you can make company visits a part of your research process, I encourage you to do so. We travel to China each and every year with Motley Fool Global Gains and have found that it's the best way to identify both the most promising ideas as well as potential disasters.
In fact, we're headed back to China in July to meet with more than a dozen promising names in cities such as Shanghai, Xi'an, and Harbin. While we may not find another company that will triple our money in less than a year, we do believe our intelligence from the ground gives us -- and can give you -- an advantage in the market.
Tim Hanson is co-advisor of Motley Fool Global Gains. He does not own shares of any company mentioned. China Green Agriculture is a Global Gains recommendation. Apple is a Stock Advisor pick. Baidu is a Rule Breakers selection. The Fool's disclosure policy is Zen.
http://www.fool.com/investing/international/2009/06/24/how-we-tripled-our-money-in-a-year.aspx
By Tim Hanson
June 24, 2009
This past year was an exciting one to be an investor. At one point in March, stocks were down well more than 50% from their 2008 highs. Yet amid this chaos, we at Motley Fool Global Gains identified a promising small company with a strong and growing core business that was selling for a dirt cheap 4.5 times earnings.
Since we recommended that stock to our members in October 2008, it's returned more than 200%. During that time, it has also listed on a major exchange and vastly expanded its production and distribution capacity. Thus, even though it's not quite the deal we got back in October, the stock remains on our Best Buys list.
But before I get to the stock, I want to tell you how we found it and provide a few points that can help you identify similar things for yourself.
You find what you're looking for
You may have heard (sometime, somewhere) that the market is efficient. That means that at any moment, all of the available information on a stock has been incorporated into its price. While I believe that's generally true, I don't believe it's true all the time. What's more, it's less true in certain market segments than others.
For example, take a popular U.S. megacap like Apple (Nasdaq: AAPL). It's tracked by 45 sell-side analysts, has earned a rabid following of fans and detractors, and everything from its products to the health of its CEO are reported on every day in the media. This, in other words, is a stock whose price is largely efficient. If you choose to buy or sell Apple stock, you're likely not doing so with any kind of informational advantage over your counterparty.
That, however, is less likely to be the case if you're buying and selling stocks that most other market participants aren't even paying attention to. Specifically, that's small stocks, foreign stocks, and especially small and foreign stocks.
Which brings me back to my story
The stock we discovered at Global Gains that's more than tripled in less than one year is a small Chinese fertilizer company called China Green Agriculture (AMEX: CGA). In hindsight, at less than 5 times earnings last October, it looked like a clear winner. The company's organic fertilizers were coming into favor as the government encouraged farmers to increase food production without a destructive environmental impact. Further, government efforts to aid rural farmers were giving those farmers -- China Green's customers -- increased purchasing power. Finally, there was a clear catalyst in the new 40,000-metric-ton manufacturing facility that the company planned to open with the capital it raised in a private placement.
Yet the market either wasn't paying attention here, or it was far too focused on the perceived risks of investing in China Green Agriculture. Those included a very short track record as a public company, an over-the-counter stock listing, and no permanent CFO.
How, then, were we able to get comfortable with recommending China Green's stock?
Elementary, my dear Watson
The simple fact is that we traveled to Xi'an, China, last June, and spent two days visiting with the company and touring its R&D and production facilities. We talked extensively with management about their plans for the future and their perceived market opportunities. And we got answers to every question we had about the company.
This doesn't mean we walked away 100% confident. After all, a company visit, while an important part of our research process at Global Gains, will never reveal the full story. But the visit enabled us to get comfortable enough to recommend that our members buy shares at less than 5 times earnings within the context of a diversified portfolio.
And the result speaks for itself. Not only is it up more than 200%, but it's outperformed other well-known China plays, such as PetroChina (NYSE: PTR), Baidu (Nasdaq: BIDU), and China Mobile (NYSE: CHL), as well as other well-known fertilizer plays, such as PotashCorp (NYSE: POT) and Mosaic (NYSE: MOS).
Your takeaway
Now, you may not have the resources to travel to China to check up on all of the small, cheap, and fast-growing companies there that you may be interested in owning. But short of that, the lesson is that the only way you're going to be able to take advantage of the inefficiencies that exist in the stock market is by doing an extraordinary level of due diligence. That means going through the filings with a fine-toothed comb, checking up on a company's auditor to make sure it has a good reputation, and doing extensive analysis of the numbers to make sure they're good, but not too good to be true.
Yet if you can make company visits a part of your research process, I encourage you to do so. We travel to China each and every year with Motley Fool Global Gains and have found that it's the best way to identify both the most promising ideas as well as potential disasters.
In fact, we're headed back to China in July to meet with more than a dozen promising names in cities such as Shanghai, Xi'an, and Harbin. While we may not find another company that will triple our money in less than a year, we do believe our intelligence from the ground gives us -- and can give you -- an advantage in the market.
Tim Hanson is co-advisor of Motley Fool Global Gains. He does not own shares of any company mentioned. China Green Agriculture is a Global Gains recommendation. Apple is a Stock Advisor pick. Baidu is a Rule Breakers selection. The Fool's disclosure policy is Zen.
http://www.fool.com/investing/international/2009/06/24/how-we-tripled-our-money-in-a-year.aspx
Don't Rely on This Stock Measure
Don't Rely on This Stock Measure
By Selena Maranjian
June 24, 2009
Should you care about a stock's beta? I recently learned that it might be even less of a meaningful sign of a great stock than I'd originally thought.
But let's back up a bit and review what it is. Beta is a measure of a stock's volatility. A beta of 1.0 means that a stock rises and falls in sync with the overall market. A beta greater than 1.0 suggests wider swings, while a beta less than 1.0 indicates a sleepier stock.
Imagine that the stock of Meteorite Insurance (ticker: HEDSUP) has a beta of 1.2. If in the past, the market as a whole advanced 10% in a given period, Meteorite Insurance tended to advance 12%. If the market fell 20%, Meteorite Insurance typically fell around 24%. Conversely, if Acme Explosives Co. (ticker: KABOOM) has a beta of 0.50, it is roughly half as volatile as the market. With a market drop of 8%, we'd expect Acme to slump about 4%. With a market surge of 10%, we'd expect Acme to rise about 5%. Got it?
Beta in real life
Below are the recent betas for some of the Dow's components, just to give you a sense of how some major companies' volatilities compare. I'll also include their star rating from our Motley Fool CAPS community to give you an idea of how bullish on them our thousands of members are:
Company
CAPS rating (out of five)
Beta
Wal-Mart (NYSE: WMT)
***
0.23
ExxonMobil (NYSE: XOM)
****
0.41
McDonald's (NYSE: MCD)
****
0.67
Microsoft (Nasdaq: MSFT)
***
1.06
Cisco Systems (Nasdaq: CSCO)
****
1.18
American Express (NYSE: AXP)
***
2.17
Bank of America (NYSE: BAC)
***
2.66
Data: Motley Fool CAPS, Yahoo! Finance.
As a long-term investor, I haven't paid too much attention to beta. Obviously, if I think the market's going to rise over time, I'd love to have a high-beta stock that outpaces the market's return. But as the examples above show, high-beta stocks during downturns are dangerous to your portfolio.
More importantly, when I buy stock in a company, I usually hope and plan to hang on for a long time. I also expect the stock to rise over that time, ideally substantially. So, to the extent that beta measures volatility, I don't care so much about it. As long as the stock grows over time, I'm not too concerned with how volatile it is as it advances. Many stocks that have proven to be wonderful long-term investments have been very volatile.
What's new?
Here's what I just learned, though: According to an article by researchers Pablo Fernandez and Vicente Bermejo from last month, beta measures vary widely from data provider to data provider. (They mentioned a range of 0.13 to 0.71 for Wal-Mart, for example.) One reason is that the number relies greatly on the time period involved. If one data provider calculates beta based on the past three years and another based on the past five or 10, their results will probably be quite different.
In addition, the researchers concluded that comparing betas of different stocks can be misleading, as even with a given set of data and method of calculation, beta values can differ, making it impossible to be sure that one stock's beta is actually higher than another's.
Lastly, the researchers found that returns of the vast majority of Dow stocks didn't correlate well with their calculated beta values. The researchers found stronger return correlations just by plugging in a fixed beta value of 1. That reduces its usefulness for many investing strategies.
So, even though beta can be interesting as a measure of volatility, don't give the measure more importance than it has. Even if past results suggest a stock will move in a certain direction, always keep in mind that future performance may take a completely different path
http://www.fool.com/investing/value/2009/06/24/dont-rely-on-this-stock-measure.aspx
Learn more:
Can You Stomach Another 40% Drop?
Early Signs of Winning Stocks
The 10 Hottest Stocks of 2008
By Selena Maranjian
June 24, 2009
Should you care about a stock's beta? I recently learned that it might be even less of a meaningful sign of a great stock than I'd originally thought.
But let's back up a bit and review what it is. Beta is a measure of a stock's volatility. A beta of 1.0 means that a stock rises and falls in sync with the overall market. A beta greater than 1.0 suggests wider swings, while a beta less than 1.0 indicates a sleepier stock.
Imagine that the stock of Meteorite Insurance (ticker: HEDSUP) has a beta of 1.2. If in the past, the market as a whole advanced 10% in a given period, Meteorite Insurance tended to advance 12%. If the market fell 20%, Meteorite Insurance typically fell around 24%. Conversely, if Acme Explosives Co. (ticker: KABOOM) has a beta of 0.50, it is roughly half as volatile as the market. With a market drop of 8%, we'd expect Acme to slump about 4%. With a market surge of 10%, we'd expect Acme to rise about 5%. Got it?
Beta in real life
Below are the recent betas for some of the Dow's components, just to give you a sense of how some major companies' volatilities compare. I'll also include their star rating from our Motley Fool CAPS community to give you an idea of how bullish on them our thousands of members are:
Company
CAPS rating (out of five)
Beta
Wal-Mart (NYSE: WMT)
***
0.23
ExxonMobil (NYSE: XOM)
****
0.41
McDonald's (NYSE: MCD)
****
0.67
Microsoft (Nasdaq: MSFT)
***
1.06
Cisco Systems (Nasdaq: CSCO)
****
1.18
American Express (NYSE: AXP)
***
2.17
Bank of America (NYSE: BAC)
***
2.66
Data: Motley Fool CAPS, Yahoo! Finance.
As a long-term investor, I haven't paid too much attention to beta. Obviously, if I think the market's going to rise over time, I'd love to have a high-beta stock that outpaces the market's return. But as the examples above show, high-beta stocks during downturns are dangerous to your portfolio.
More importantly, when I buy stock in a company, I usually hope and plan to hang on for a long time. I also expect the stock to rise over that time, ideally substantially. So, to the extent that beta measures volatility, I don't care so much about it. As long as the stock grows over time, I'm not too concerned with how volatile it is as it advances. Many stocks that have proven to be wonderful long-term investments have been very volatile.
What's new?
Here's what I just learned, though: According to an article by researchers Pablo Fernandez and Vicente Bermejo from last month, beta measures vary widely from data provider to data provider. (They mentioned a range of 0.13 to 0.71 for Wal-Mart, for example.) One reason is that the number relies greatly on the time period involved. If one data provider calculates beta based on the past three years and another based on the past five or 10, their results will probably be quite different.
In addition, the researchers concluded that comparing betas of different stocks can be misleading, as even with a given set of data and method of calculation, beta values can differ, making it impossible to be sure that one stock's beta is actually higher than another's.
Lastly, the researchers found that returns of the vast majority of Dow stocks didn't correlate well with their calculated beta values. The researchers found stronger return correlations just by plugging in a fixed beta value of 1. That reduces its usefulness for many investing strategies.
So, even though beta can be interesting as a measure of volatility, don't give the measure more importance than it has. Even if past results suggest a stock will move in a certain direction, always keep in mind that future performance may take a completely different path
http://www.fool.com/investing/value/2009/06/24/dont-rely-on-this-stock-measure.aspx
Learn more:
Can You Stomach Another 40% Drop?
Early Signs of Winning Stocks
The 10 Hottest Stocks of 2008
3 Ways to Beat Lower Stock Returns
3 Ways to Beat Lower Stock Returns
By Dan Caplinger
June 24, 2009
When 18 months of losses recently gave way to a nice three-month rally, many investors started to see a glimmer of hope that maybe, just maybe, the stock market was starting to get back to normal. Unfortunately, though, the "new normal" may not give you the kinds of results you got used to before the bear market.
For decades, investors have counted on rules of thumb, such as the 10% long-term average annual return on stocks, to guide their investing decisions. Nearly every financial plan has assumed that while investors would still see bumps in the road, you'd eventually get back to that 10% trajectory.
Getting used to less
Now, though, top investors have started to question that basic assumption. As Foolish fund expert Amanda Kish discusses in the brand-new issue of the Fool's Champion Funds newsletter -- which is available today at 4 p.m. ET -- the recent Morningstar Investment Conference featured two well-known investors, both of whom warned against excessive optimism about any potential recovery.
Both bond guru Bill Gross and index fund pioneer Jack Bogle spoke about the future of the world economy and where the U.S. will fit into it. Gross believes that as a more mature economy, the U.S. can't expect to sustain its past economic growth rates, and so the era of high stock returns is over. As Gross sees it, investors will be better served finding stable sources of income, along with a greater emphasis on overseas investing.
Bogle comes at the problem from a slightly different tack, but he comes to much the same conclusions. With his projections of an 8% average return on stocks and a much smaller payoff from bonds, the conservative allocations he recommends aren't going to get you anywhere near the 10% returns to which many people have grown accustomed.
How to meet the challenge
The toughest thing about lower returns is the impact they have on compounding. Over a typical 35-year career, you can expect to see the money you first invest grow to more than 28 times its original value if you earn 10%. If you assume you'll only earn 7% on your money, though -- not unreasonable if Gross and Bogle's projections are anywhere close -- then the same money will grow less than 11-fold. That will leave you with less than half of what you would have earned with higher returns.
So, what's the right solution? The Champion Funds article recommends three ways to get the most from your portfolio, along with smart fund choices to go with all three methods:
Demand dividends.
While Amanda likes the idea of getting income from your portfolio, she prefers not to rely entirely on bonds. She recommends a fund that invests in ExxonMobil (NYSE: XOM), Hershey (NYSE: HSY), and Home Depot (NYSE: HD) -- strong dividend-paying stocks with yields that can supplement the current low rates that bonds pay now.
Go global.
The premise here is that if the U.S. economy stays slow, then you may get better results from companies with greater overseas exposure. The newsletter's fund recommendation here will help you load up on shares of global giants like Sanofi-Aventis (NYSE: SNY) and Nokia (NYSE: NOK).
Seek out strong growth.
Even in the depths of the recession, some countries are still seeing their economies grow, albeit at a somewhat slower pace. If you prefer the strong growth of emerging markets over developed countries like Japan and Germany, then Amanda has the fund for you, offering an easy way to own parts of America Movil (NYSE: AMX), Petroleo Brasileiro (NYSE: PBR), and other powerhouses of the emerging world.
Weaker returns from your investments can make your life more challenging. The right mix of investments, however, can help you make the most of whatever market environment you face in the years and decades to come.
http://www.fool.com/investing/mutual-funds/2009/06/24/3-ways-to-beat-lower-stock-returns.aspx
By Dan Caplinger
June 24, 2009
When 18 months of losses recently gave way to a nice three-month rally, many investors started to see a glimmer of hope that maybe, just maybe, the stock market was starting to get back to normal. Unfortunately, though, the "new normal" may not give you the kinds of results you got used to before the bear market.
For decades, investors have counted on rules of thumb, such as the 10% long-term average annual return on stocks, to guide their investing decisions. Nearly every financial plan has assumed that while investors would still see bumps in the road, you'd eventually get back to that 10% trajectory.
Getting used to less
Now, though, top investors have started to question that basic assumption. As Foolish fund expert Amanda Kish discusses in the brand-new issue of the Fool's Champion Funds newsletter -- which is available today at 4 p.m. ET -- the recent Morningstar Investment Conference featured two well-known investors, both of whom warned against excessive optimism about any potential recovery.
Both bond guru Bill Gross and index fund pioneer Jack Bogle spoke about the future of the world economy and where the U.S. will fit into it. Gross believes that as a more mature economy, the U.S. can't expect to sustain its past economic growth rates, and so the era of high stock returns is over. As Gross sees it, investors will be better served finding stable sources of income, along with a greater emphasis on overseas investing.
Bogle comes at the problem from a slightly different tack, but he comes to much the same conclusions. With his projections of an 8% average return on stocks and a much smaller payoff from bonds, the conservative allocations he recommends aren't going to get you anywhere near the 10% returns to which many people have grown accustomed.
How to meet the challenge
The toughest thing about lower returns is the impact they have on compounding. Over a typical 35-year career, you can expect to see the money you first invest grow to more than 28 times its original value if you earn 10%. If you assume you'll only earn 7% on your money, though -- not unreasonable if Gross and Bogle's projections are anywhere close -- then the same money will grow less than 11-fold. That will leave you with less than half of what you would have earned with higher returns.
So, what's the right solution? The Champion Funds article recommends three ways to get the most from your portfolio, along with smart fund choices to go with all three methods:
Demand dividends.
While Amanda likes the idea of getting income from your portfolio, she prefers not to rely entirely on bonds. She recommends a fund that invests in ExxonMobil (NYSE: XOM), Hershey (NYSE: HSY), and Home Depot (NYSE: HD) -- strong dividend-paying stocks with yields that can supplement the current low rates that bonds pay now.
Go global.
The premise here is that if the U.S. economy stays slow, then you may get better results from companies with greater overseas exposure. The newsletter's fund recommendation here will help you load up on shares of global giants like Sanofi-Aventis (NYSE: SNY) and Nokia (NYSE: NOK).
Seek out strong growth.
Even in the depths of the recession, some countries are still seeing their economies grow, albeit at a somewhat slower pace. If you prefer the strong growth of emerging markets over developed countries like Japan and Germany, then Amanda has the fund for you, offering an easy way to own parts of America Movil (NYSE: AMX), Petroleo Brasileiro (NYSE: PBR), and other powerhouses of the emerging world.
Weaker returns from your investments can make your life more challenging. The right mix of investments, however, can help you make the most of whatever market environment you face in the years and decades to come.
http://www.fool.com/investing/mutual-funds/2009/06/24/3-ways-to-beat-lower-stock-returns.aspx
5 Traits of Great Stocks
5 Traits of Great Stocks
By Jeff Fischer
June 15, 2009
A recent study revealed that three of four stocks on the U.S. markets lost value between 1980 and 2008, despite the S&P 500 returning 10.4% annualized. What this means is the winning stocks won big, thereby compensating for the overwhelming number of losing stocks. However, if you hope to be invested in the winners, you need to choose carefully.
More than two decades of investing experience has helped us at Motley Fool Pro zero in on what makes for a winning business. Here are five of the key traits we seek in each stock before we buy it.
1. Sustainable competitive advantage
Healthy profits in a business attract competition -- everyone wants a piece of the profit pie. The only way a company can maintain profit margins and grow is to have a sustainable competitive advantage that serves as a protective moat around the business. You hear this quality talked about often, from Warren Buffett on down, but many investors still fail to buy companies that sustainably meet the bill. That's because it's the rare company that truly has lasting advantages -- but they are out there.
They're usually midsized or larger, have a long history of steady growth, and own assets or market share that provide enduring advantages over all others. Think Cameco (NYSE: CCJ), the largest uranium owner on the planet (the world isn't producing more uranium anytime soon); or Intel (Nasdaq: INTC), which enjoys 80% market share in computer CPUs. eBay (Nasdaq: EBAY) has sustainable competitive advantages, but it hasn't evolved quickly enough to keep all of its customers happy. However, network effects and market share -- competitive advantages -- are buying it time to right the ship.
2. Diverse customer base
A competitive advantage isn't worth much if the business is dependent on only a few customers. We like our businesses to have widely diverse and growing customer bases. This way, when some customers are lost, the business is not in peril and will continue to grow. We shy away from buying companies where just one or two customers account for 10% -- or more -- of annual sales.
3. Pricing power
With a lasting competitive edge and a broad customer base, a company usually enjoys some degree of pricing power. When costs rise, the company can pass them on to customers rather than suffering them itself. The strongest companies can implement modest price increases every few years without losing or alienating customers. Pricing power gives a company one more important arrow in its quiver as it hunts for long-term annualized growth.
4. Significant recurring revenue
If a business enjoys our first three criteria and also has significant recurring revenue, we become even more interested. By recurring revenue, we mean sales that repeat all but automatically, often with the same customers again and again, and usually without the company needing to spend more on marketing or reinventing itself or its products.
Revenue at the largest electronic exchange in the world, Nasdaq OMX (Nasdaq: NDAQ), recurs whenever someone makes a stock or option trade on its exchanges. Elsewhere, insurance companies enjoy recurring revenue every time a policy is auto-renewed, which happens more than 80% of the time at the best providers. Software companies have also gotten wise and sell annual subscriptions to their wares.
As General Motors collapsed in the first major recession in years, we're reminded that automakers are an example of anything but easy recurring revenue. They need to advertise continually to drive each sale, making for an expensive business that's vulnerable when the economy stumbles.
Easily or "naturally" recurring revenue results in more predictable and more profitable results, and helps maintain a business even during recessions. Some of the stocks we buy in Pro won't have naturally recurring revenue, but when it drives at least 30% of annual sales, the company gets a close second look from us.
5. Expanding free cash flow
The qualities we've mentioned so far will usually lead to strong free cash flow, which is the lifeblood of any company. By definition, free cash flow is cash from operations minus capital expenditures and any other nonoperational cash income, such as tax benefits from stock options. Much more reliable than mere earnings per share numbers, we're looking for free cash flow that's growing at least 8% to 10% annualized over the long term.
No company grows in a straight line, but over time we want expanding free cash flow to drive the value of the businesses we own. Strong free cash flow growers over recent years include software provider Oracle (Nasdaq: ORCL) and credit card giant MasterCard (NYSE: MA). Meanwhile, a rebound in free cash flow can revitalize a company, as has happened with BMC Software (NYSE: BMC) since 2004, more than doubling its share price. All three companies, incidentally, also enjoy all of the four traits above.
http://www.fool.com/investing/general/2009/06/15/five-traits-of-great-stocks.aspx
By Jeff Fischer
June 15, 2009
A recent study revealed that three of four stocks on the U.S. markets lost value between 1980 and 2008, despite the S&P 500 returning 10.4% annualized. What this means is the winning stocks won big, thereby compensating for the overwhelming number of losing stocks. However, if you hope to be invested in the winners, you need to choose carefully.
More than two decades of investing experience has helped us at Motley Fool Pro zero in on what makes for a winning business. Here are five of the key traits we seek in each stock before we buy it.
1. Sustainable competitive advantage
Healthy profits in a business attract competition -- everyone wants a piece of the profit pie. The only way a company can maintain profit margins and grow is to have a sustainable competitive advantage that serves as a protective moat around the business. You hear this quality talked about often, from Warren Buffett on down, but many investors still fail to buy companies that sustainably meet the bill. That's because it's the rare company that truly has lasting advantages -- but they are out there.
They're usually midsized or larger, have a long history of steady growth, and own assets or market share that provide enduring advantages over all others. Think Cameco (NYSE: CCJ), the largest uranium owner on the planet (the world isn't producing more uranium anytime soon); or Intel (Nasdaq: INTC), which enjoys 80% market share in computer CPUs. eBay (Nasdaq: EBAY) has sustainable competitive advantages, but it hasn't evolved quickly enough to keep all of its customers happy. However, network effects and market share -- competitive advantages -- are buying it time to right the ship.
2. Diverse customer base
A competitive advantage isn't worth much if the business is dependent on only a few customers. We like our businesses to have widely diverse and growing customer bases. This way, when some customers are lost, the business is not in peril and will continue to grow. We shy away from buying companies where just one or two customers account for 10% -- or more -- of annual sales.
3. Pricing power
With a lasting competitive edge and a broad customer base, a company usually enjoys some degree of pricing power. When costs rise, the company can pass them on to customers rather than suffering them itself. The strongest companies can implement modest price increases every few years without losing or alienating customers. Pricing power gives a company one more important arrow in its quiver as it hunts for long-term annualized growth.
4. Significant recurring revenue
If a business enjoys our first three criteria and also has significant recurring revenue, we become even more interested. By recurring revenue, we mean sales that repeat all but automatically, often with the same customers again and again, and usually without the company needing to spend more on marketing or reinventing itself or its products.
Revenue at the largest electronic exchange in the world, Nasdaq OMX (Nasdaq: NDAQ), recurs whenever someone makes a stock or option trade on its exchanges. Elsewhere, insurance companies enjoy recurring revenue every time a policy is auto-renewed, which happens more than 80% of the time at the best providers. Software companies have also gotten wise and sell annual subscriptions to their wares.
As General Motors collapsed in the first major recession in years, we're reminded that automakers are an example of anything but easy recurring revenue. They need to advertise continually to drive each sale, making for an expensive business that's vulnerable when the economy stumbles.
Easily or "naturally" recurring revenue results in more predictable and more profitable results, and helps maintain a business even during recessions. Some of the stocks we buy in Pro won't have naturally recurring revenue, but when it drives at least 30% of annual sales, the company gets a close second look from us.
5. Expanding free cash flow
The qualities we've mentioned so far will usually lead to strong free cash flow, which is the lifeblood of any company. By definition, free cash flow is cash from operations minus capital expenditures and any other nonoperational cash income, such as tax benefits from stock options. Much more reliable than mere earnings per share numbers, we're looking for free cash flow that's growing at least 8% to 10% annualized over the long term.
No company grows in a straight line, but over time we want expanding free cash flow to drive the value of the businesses we own. Strong free cash flow growers over recent years include software provider Oracle (Nasdaq: ORCL) and credit card giant MasterCard (NYSE: MA). Meanwhile, a rebound in free cash flow can revitalize a company, as has happened with BMC Software (NYSE: BMC) since 2004, more than doubling its share price. All three companies, incidentally, also enjoy all of the four traits above.
http://www.fool.com/investing/general/2009/06/15/five-traits-of-great-stocks.aspx
Wednesday 24 June 2009
How to value this stock?
Wednesday June 24, 2009
John Master’s ‘retirement’ an eye-opener
Comment by Jagdev Singh Sidhu
THE circumstances in which a company proposes to sell its assets, distribute all the cash to shareholders and eventually remove itself from the stock exchange are usually done when conditions are dire.
It’s either that the company is financially haemorrhaging or affected by some cataclysmic event that has destroyed its balance sheet.
Rarely would that scenario be pictured of a still healthy albeit marginally profitable listed company that has basically decided to call it a day on the stock exchange.
When John Master Industries Bhd (JMI) said it wanted to “retire” as a listed company, the motive itself was a little perplexing. In its latest annual report, John Master did not sound like it was preparing to throw in the towel. Nor did it indicate such a desire in its latest quarterly announcement.
Yes, low trading volumes are an indication of investor interest and JMI said its average trading volume of just 7,300 shares a day over the past 12 months shows how illiquid and thinly traded its stock is.
Meagre volumes might be a reflection of investor interest but is that sufficient reason to exit the exchange? Based on yesterday’s trading on Bursa Malaysia, there were 317 companies on the stock exchange with fewer shares traded.
Financially, JMI has hinted that it was treading on water. It says its financial future is uncertain and the prospects for the industry it operates in are tough.
Competition in this business is fierce and there will always be places where it’s cheaper to produce a piece of garment than Malaysia. Economics and profitability will rule and the directors might feel that the company is fighting a losing battle on that front.
It argues those conditions make any future dividend payments doubtful. Even though business conditions are tough and outlook uncertain, there is an offer to bid for the assets of JMI from three directors of the company related to the founder of the company who retired in May last year.
Nobody knows whether shareholders would get full value of the company’s net tangible assets which was RM1.07. The company’s last traded share price was 49 sen a share.
The company is relatively debt free with only RM5.5mil in short-term borrowings. It has RM43mil in cash, or a cash backing of 35 sen a share.
Most of its assets are in the form of inventories (RM67mil) and receivables (RM39.7mil). Plant and machinery carries a value of RM2.8mil on the balance sheet and land for development is another RM2.4mil.
The company, however, has promised that its assets would be sold via an open tender and under the watchful eye of Ferrier Hodgson MH Sdn Bhd.
Cashing out of JMI would give shareholders of the company the financial flexibility to decide on what to do with their money. It’s also an avenue for shareholders to maybe realise the value of their current investment in a thinly traded counter with over 122 million shares.
The entire exercise might be a quasi privatisation process of JMI but whatever it is, the entire exercise would be a test case for other companies on Bursa.
It’s for the directors, who act as custodians of a company, to advice and recommend the best course of action to be taken by a company. And in this case, they have decided that the latest proposal is in the best interest of the listed company.
Ultimately it will be a decision for the company’s shareholders to make.
JMI : [Stock Watch] [News]
http://biz.thestar.com.my/news/story.asp?file=/2009/6/24/business/4182449&sec=business
Ref: Asset valuation approach in liquidation
Company Name: JOHN MASTER INDUSTRIES BERHAD
Stock Name: JMI
Date Announced: 29/05/2009
Financial Year End: 31/03/2009
Quarter: 4
Announce - 0309(Ann).xls
Announce - 0309 (Ann).doc
When valuing a business for liquidation, most assets are marked down and the liabilities treated at face value.
- Cash and securities are taken at face value.
- Receivables require a small discount (perhaps 15 percent to 25 percent off).
- Inventory a larger discount (perhaps 50 percent to 75 percent off).
- Fixed assets at least as much as inventory.
- Any goodwill should probably be ignored.
- Most intangible assets and prepaid expenses should be ignored.
Applying the following to the latest balance sheet of JMI:
- a 50% discount to fixed assets and inventories,
- 25% discount to receivables, and
- all liabilities are at face value,
I deduced a liquidation NTA value of $ 0.70 per share (equivalent to net worth for the whole company of $ 110.5 m).
http://spreadsheets.google.com/pub?key=rMg4CdEMPdLx-jOwZM-ecKA&output=html
This contrast with the reported NTA of $ 1.0754 per share in its latest quarterly report.
Today, the market price per share of JMI is $ 0.60 giving a market capitalization of $ 73.70 m. Therefore there is little potential upside here.
Always buy, hold or sell based on fundamentals.
To summarise:
We should buy, hold or sell based on fundamentals.
The basic premise behind our "buy" strategy - over the long term, investors gravitate toward stocks with strong fundamentals because those are the strongest companies, and that causes those stocks' prices to rise over time.
If you're buying stocks based on the above basic premise, that is, they have strong fundamentals, and over the long term, stocks with strong fundamentals tend to rise, you should hold on to a stock as long as it continues to meet the fundamental criteria you used to select it.
It's time to sell and replace the stock with another stock that does meet your criteria (and one that thereby has better prospects of rising in value), if the stock's fundamentals have slipped, so that it no longer meets the criteria you used to buy it. Also consider selling, if the stock is grossly overpriced, not justifiable even by the good fundamentals of the company.
Price should always be related to the fundamentals.
We should NOT buy, hold or sell based solely on the price is low or high or rising or falling
Related posts:
Why we buy? Because of the fundamentals
Why we hold? Because of the fundamentals
Why we sell? Because of the fundamentals
Always buy, hold or sell based on fundamentals.
Because the goal is always:
Also read:
To guide you on holding or selling a stock in your portfolio.
To guide you in re-balancing and re-weighting of your portfolio.
Weathering a Panic
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)
We should buy, hold or sell based on fundamentals.
The basic premise behind our "buy" strategy - over the long term, investors gravitate toward stocks with strong fundamentals because those are the strongest companies, and that causes those stocks' prices to rise over time.
If you're buying stocks based on the above basic premise, that is, they have strong fundamentals, and over the long term, stocks with strong fundamentals tend to rise, you should hold on to a stock as long as it continues to meet the fundamental criteria you used to select it.
It's time to sell and replace the stock with another stock that does meet your criteria (and one that thereby has better prospects of rising in value), if the stock's fundamentals have slipped, so that it no longer meets the criteria you used to buy it. Also consider selling, if the stock is grossly overpriced, not justifiable even by the good fundamentals of the company.
Price should always be related to the fundamentals.
We should NOT buy, hold or sell based solely on the price is low or high or rising or falling
Related posts:
Why we buy? Because of the fundamentals
Why we hold? Because of the fundamentals
Why we sell? Because of the fundamentals
Always buy, hold or sell based on fundamentals.
Because the goal is always:
- look closely at what to hold and what to sell now
- to maximize return on capital and
- to take advantage of the time value of money,
Also read:
To guide you on holding or selling a stock in your portfolio.
To guide you in re-balancing and re-weighting of your portfolio.
Weathering a Panic
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)
Why we sell? Because of the fundamentals
When you're building your portfolio, then, you want to pick the stocks that have the best fundamentals - because (sorry again) over the long run, investors gravitate toward stocks with strong fundamentals because they are the strongest companies.
If the stock's fundamentals have slipped, however, so that it no longer meets the criteria you used to buy it, it's time to sell and replace it with another stock that does meet your criteria(and one that thereby has better prospects of rising in value).
Your selling is based on ongoing re-evaluation of portfolio at regular intervals
The selling assessment is thus an ongoing re-evaluation of where a stock stands right now. You must continually reassess what the stock's prospects are going forward - not what they were a month ago, six months ago, or whenever you bought it.
On average, using monthly rebalancing period produce the highest raw return.
The important point here, whether you use a one-month rebalancing or a different time frame that works for you, is this - you need to re-examine your portfolio at set intervals, to assess how your holdings stand relative to the reasons you bought them. If they no longer meet the criteria you used to pick them, you should consider replacing them with new stocks that do make the grade.
By sticking to a firm rebalancing and reweighting plan, you keep emotion and hype from impacting your selling decisions. You sell at regular intervals, and you sell based on fundamentals. Just as with buying stocks, there's no place for hunch-playing or knee-jerk reactions here.
Price matters in how it is related to fundamentals
Whether the stock price has dropped sharply since you bought it or whether it has skyrocketed is no matter; what matters is where the stock's fundamentals stand right now.
Price - just as with buying - matters only in terms of how it relates to the fundamentals (what the stock's PE or P/S ratios are, for example).
Many investors will sell a stock:
Making good sell decisions is another reason for better returns in your investment portfolio.
Related posts:
Why we buy? Because of the fundamentals
Why we hold? Because of the fundamentals
Why we sell? Because of the fundamentals
Always buy, hold or sell based on fundamentals.
If the stock's fundamentals have slipped, however, so that it no longer meets the criteria you used to buy it, it's time to sell and replace it with another stock that does meet your criteria(and one that thereby has better prospects of rising in value).
Your selling is based on ongoing re-evaluation of portfolio at regular intervals
The selling assessment is thus an ongoing re-evaluation of where a stock stands right now. You must continually reassess what the stock's prospects are going forward - not what they were a month ago, six months ago, or whenever you bought it.
On average, using monthly rebalancing period produce the highest raw return.
The important point here, whether you use a one-month rebalancing or a different time frame that works for you, is this - you need to re-examine your portfolio at set intervals, to assess how your holdings stand relative to the reasons you bought them. If they no longer meet the criteria you used to pick them, you should consider replacing them with new stocks that do make the grade.
By sticking to a firm rebalancing and reweighting plan, you keep emotion and hype from impacting your selling decisions. You sell at regular intervals, and you sell based on fundamentals. Just as with buying stocks, there's no place for hunch-playing or knee-jerk reactions here.
Price matters in how it is related to fundamentals
Whether the stock price has dropped sharply since you bought it or whether it has skyrocketed is no matter; what matters is where the stock's fundamentals stand right now.
Price - just as with buying - matters only in terms of how it relates to the fundamentals (what the stock's PE or P/S ratios are, for example).
Many investors will sell a stock:
- because its price has fallen and they think they need to cut their losses, or
- because the price has risen and they think the "smart" thing to do is to take the profits rather than risk the stock coming back down.
But those are arbitrary, emotional decisions.
When stock should be sold immediately
There are a couple rare occasions, however, when you should sell a stock without waiting for the rebalancing date to arrive.
- If a firm is involved or allegedly involved in a major accounting or earnings scandal, you should sell the stock immediately, because you can no longer trust its publicly disclosed financial data.
- In addition, if a firm has become a serious bankruptcy risk since the last rebalancing, you should also sell its stock immediately.
Making good sell decisions is another reason for better returns in your investment portfolio.
Related posts:
Why we buy? Because of the fundamentals
Why we hold? Because of the fundamentals
Why we sell? Because of the fundamentals
Always buy, hold or sell based on fundamentals.
Why we hold? Because of the fundamentals
When you're building your portfolio, then, you want to pick the stocks that have the best fundamentals - because (sorry to repeat) over the long run, investors gravitate toward stocks with strong fundamentals because they are the strongest companies.
If you're buying stocks because they have strong fundamentals, and (everyone now), over the long term, stocks with strong fundamentals tend to rise, you should hold on to a stock as long as it continues to meet the fundamental criteria you used to select it.
Whether the stock price has dropped sharply since you bought it or whether it has skyrocketed is no matter; what matters is where the stock's fundamentals stand right now.
Price - just as with buying - matters only in terms of how it relates to the fundamentals (what the stock's PE or P/S ratios are, for example). Many invetors will sell a stock because its price has fallen and they think they need to cut their losses, or because the price has risen and they think the "smart" thing to do is to take the profits rather than risk the stock coming back down. But those are arbitrary, emotional decisions.
Remember, you bought the stock because its strong fundamentals made it a good bet to gain value; if its fundamentals are still strong, why wouldn't it still be a good bet to gain more value?
Related posts:
Why we buy? Because of the fundamentals
Why we hold? Because of the fundamentals
Why we sell? Because of the fundamentals
Always buy, hold or sell based on fundamentals.
If you're buying stocks because they have strong fundamentals, and (everyone now), over the long term, stocks with strong fundamentals tend to rise, you should hold on to a stock as long as it continues to meet the fundamental criteria you used to select it.
Whether the stock price has dropped sharply since you bought it or whether it has skyrocketed is no matter; what matters is where the stock's fundamentals stand right now.
Price - just as with buying - matters only in terms of how it relates to the fundamentals (what the stock's PE or P/S ratios are, for example). Many invetors will sell a stock because its price has fallen and they think they need to cut their losses, or because the price has risen and they think the "smart" thing to do is to take the profits rather than risk the stock coming back down. But those are arbitrary, emotional decisions.
Remember, you bought the stock because its strong fundamentals made it a good bet to gain value; if its fundamentals are still strong, why wouldn't it still be a good bet to gain more value?
Related posts:
Why we buy? Because of the fundamentals
Why we hold? Because of the fundamentals
Why we sell? Because of the fundamentals
Always buy, hold or sell based on fundamentals.
Why we buy? Because of the fundamentals
Let us examine the basic premise behind our "buy" strategy - over the long term, investors gravitate toward stocks with strong fundamentals because those are the strongest companies, and that causes those stocks' prices to rise over time.
We buy because of the fundamentals - not just because the price is high or low or rising or falling.
Remember, the only way price comes into the decision to buy is in how it relates to the stock's fundamentals - that is, in the form of such variables as the price-sales ratio or price-earnings ratio.
When you're building your portfolio, then, you want to pick the stocks that have the best fundamentals - because (sorry to repeat) over the long run, investors gravitate toward stocks with strong fundamentals because they are the strongest companies.
Related posts:
Why we buy? Because of the fundamentals
Why we hold? Because of the fundamentals
Why we sell? Because of the fundamentals
Always buy, hold or sell based on fundamentals.
We buy because of the fundamentals - not just because the price is high or low or rising or falling.
Remember, the only way price comes into the decision to buy is in how it relates to the stock's fundamentals - that is, in the form of such variables as the price-sales ratio or price-earnings ratio.
When you're building your portfolio, then, you want to pick the stocks that have the best fundamentals - because (sorry to repeat) over the long run, investors gravitate toward stocks with strong fundamentals because they are the strongest companies.
Related posts:
Why we buy? Because of the fundamentals
Why we hold? Because of the fundamentals
Why we sell? Because of the fundamentals
Always buy, hold or sell based on fundamentals.
Tuesday 23 June 2009
Determining When to Sell
While a lot of strategies out there tell you how to buy stocks that will make nice gains, there are few that address the second half of the stock investing equation: when to sell.
Why are investors struggling with selling?
A few phenomena make selling - and sticking to a selling plan - a difficult task.
- There's the 'fear of regret."
When we make an error of judgment, we feel badly; which is never pleasant. This is certainly true when we take a loss on a stock. Hindsight is always 20/20, and we end up thinking that we could have easily avoided what turned out to be a bad move.
- Another common mistake many investors make is holding on to winners too long.
Growth fund managers often do just that "because they are encouraged to do so by all the good news regarding companies prospects."
To try to avoid some of these problems, some people will set price targets for stocks they buy.
- For many investors, deciding when to sell is a harder decision than deciding what to buy.
- Cabot Research, a behavioural finance consulting firm, has found that even top-performing mutual fund managers may be missing out on 100 to 200 basis points per year because of poor sell decisions.
- Seeing as how amateur investors tend to do much worse than the professionals, it is likely that the average, nonprofessional investor suffers even greater losses because of poor sell decisions.
Why are investors struggling with selling?
- Advice on this topic is somewhat lacking in the investment world. A survey found that more than 70% of professionals investors used a selling approach that was not highly disciplined or driven by research and objective criteria. So it seems most of the pros aren't offering a whole lot of guidance here.
- Just as our brains tell us to avoid unpopular stocks and jump on hot stocks when we're buying, they also cause havoc when we're trying to figure out when we should sell a stock.
A few phenomena make selling - and sticking to a selling plan - a difficult task.
- There's the 'fear of regret."
When we make an error of judgment, we feel badly; which is never pleasant. This is certainly true when we take a loss on a stock. Hindsight is always 20/20, and we end up thinking that we could have easily avoided what turned out to be a bad move.
- Because of the unpleasantness of those feelings, the investor avoid selling stocks that have lost value, instinctively wanting to postpone those feelings of pain and regret - even if those stocks now have little prospect of rebounding.
- Loss aversion refers "to the observed tendency for decision makers to weigh losses more heavily than gains; losses hurt roughly twice as much as gains feel good."
- As locking in losses hurts a lot, investors avoid selling stocks for a loss even after they no longer have good prospects, to delay that hurt.
- Another common mistake many investors make is holding on to winners too long.
Growth fund managers often do just that "because they are encouraged to do so by all the good news regarding companies prospects."
- A perfect example would seem to be the tech stock boom of the late 1990s.
- Many investors - professional and amateur, made a fortune as the Internet bubble grew. The problem was that the bubble kept growing, long, long after these stocks had risen above reasonable values.
- Still the buzzs was that the "Internet Era" had arrived, and would fundamentally change the stock market; when it came to the World Wide Web, the theory went, there were limitless possibilities - and thus limitless returns.
- Blinded by the hype, most of those people who had made huge sums of money ignored logic and held on to their stocks too long, only to see them come crashing down.
To try to avoid some of these problems, some people will set price targets for stocks they buy.
- They'll determine ahead of time that, if the stock gains, say 30%, they will sell it and take the profits. This sounds good on the surface, but really it's just another problem.
- All gaining stocks were not created equal; one stock may gain 30% and then drops, but another may gain 30% and then gain another 200%.
- Setting arbitrary selling targets like this can hurt just as much as they help, if not more.
The most difficult decision - when to sell
The most difficult decision for an investor isn't deciding which stock to buy, but deciding when to sell.
"You can be right about a stock's potential, but if you hold on too long, you may end up with nothing."
Many experts give detailed advice on how to buy stocks, few give advice about when to sell, despite the importance of that decision.
Discipline plays a key role in any selling strategy.
- One problem investors run into is that they fall in love with a winning stock and hold onto it too long.
- Many investors also fear that they will sell winners too soon and miss out on even greater gains.
There are two main reasons to sell stocks:
One of the most important things an investor can do is stick to a firm selling strategy - whatever the details of that strategy may be.
"You can be right about a stock's potential, but if you hold on too long, you may end up with nothing."
Many experts give detailed advice on how to buy stocks, few give advice about when to sell, despite the importance of that decision.
Discipline plays a key role in any selling strategy.
- One problem investors run into is that they fall in love with a winning stock and hold onto it too long.
- Many investors also fear that they will sell winners too soon and miss out on even greater gains.
- "Instead of groping for the last dollar, you should gladly leave some upside on the table. Catching market tops is not your game. This is preferable to getting caught in a subsequent downdraft."
There are two main reasons to sell stocks:
- deterioration in the stock's fundamentals (particular in its earnings estimates or five-year growth rates), or
- the stock's price approached the firm's expectations. You can devel0p these price expectations for each stock you own, using earnings estimates, and the projected expansion of the stock's PE ratio. These targets should also be adjsuted based on market climate.
One of the most important things an investor can do is stick to a firm selling strategy - whatever the details of that strategy may be.
Low Price-Earnings Investor
What does PE ratio signifies?
1. One of the common explanations of the PE ratio is that it tells you how much investors are willing to pay for every dollar in earnings that a company is generating.
2. However, PE ratio is also a measure of what kind of growth, investors are expecting from a company in the future.
- For example, take two stocks, one with a PE of 50 and the other with a PE of 10. Earnings drive stock prices, so if investors are willing to pay 5 x as much for one company's dollar of current earnings as they are for the other company's dollar in current earnings, they must be expecting that the first company will grow earnings much more rapidly than the second.
This idea of expectation was key.
- High-flying growth stocks with high PEs had so much expectation built into them that they often fell at the slightest sign of disappointment.
- Low PE stocks, however, have little anticipation or expectation built into their price. Therefore, any improvement in performance is likely to boost the attention they get, while they suffer little if their results don't meet the Market's already low expectation.
Low PE Investing
John Neff wrote, "Indifferent financial performance by low PE companies seldom exacts a penalty. Hints of improved prospects trigger fresh interest. If you buy stocks when they are out of favour and unloved, and sell them into strength when other investors recognize their merits, you'll often go home with handsome gains."
Neff continuously searched the newspapers for companies with low PE ratios (i.e. the least popular stocks in the market), also keeping tabs on those that had just posted new lows or were getting hammered in the press. From these shunned firms, he used a series of quantitative measures to identify those that were good bets to rebound.
He explained, "Swept up by flavours of the moment, prevailing wisdom frequently undervalues good companies. Many - but not all - that languish out of favour deserve better treatment. Despite their solid earnings, they are rejected and ignored by investors caught in the clutch of groupthink."
The challenge of course, is separating the stocks that are unfairly being beaten down because of overreaction from those that deserve their low prices.
What is 'low' PE ratio?
"You should look for stocks with a low PE ratio." What is 'low'?
Depending on your point of view, low PE ratios could mean:
Depending on your point of view, low PE ratios could mean:
- PE of 5 or below
- PE of 15 or below
- anything less than the median PE of the S&P 500 industrials
- PE in the bottom 20% of the market
- PE that is less than the annual EPS growth rate of the company (PE/EPSGR ratio less than 1)
Why the P/E Ratio Is Dangerous
Why the P/E Ratio Is Dangerous
By Rex Moore
June 19, 2009
I have no doubt that the most widely used valuation tool by individual investors is the price-to-earnings ratio (P/E). Unfortunately, it may also be the most dangerous tool, because it's so misunderstood. Today, I'll talk (well, type) a little about what the P/E's problems are and how you can overcome them.
What it is
On the surface, this is a very simple and informative ratio -- a company's stock price divided by its last 12 months of earnings per share. So we can look and see that Monsanto earned $4.10 per share over the past year. At today's price around $81.30, its P/E ratio is $81.30 / $4.10 = 20. You might also hear the hip Wall Street crowd say "Monsanto has a multiple of 20" -- because it sounds so cool.
Because you obviously want more earnings for every dollar you invest, a lower P/E is considered more attractive. After all, you'd rather be paying $40.65 per share for Monsanto's $4.10 in earnings (P/E = 10) than $81.30 (P/E = 20), right?
Yes, absolutely -- why wouldn't you want to pay less for the exact same earnings stream? The same principle also applies when comparing different businesses, as long as they are equal in all other respects.
What it isn't
Of course, things are never equal in the investing world (you didn't need me to tell you that), and this is where problems creep in. It's also why the P/E ratio should never be the only tool you use to value a business, for several reasons. Let's look at three of them.
1. Forward to the future
A glance at most any financial data provider tells us that Cisco Systems (Nasdaq: CSCO) is trading at a P/E of 16. Juniper Networks (Nasdaq: JNPR) has a multiple of 31. So Cisco must be a better value, right?
Well … maybe. It's rare to find two businesses that are exactly alike, and these two certainly have their differences. Also, analysts estimate Juniper will grow earnings about 18% annually over the next five years, while Cisco is only projected to grow at around 10% per year. So there you run into a big problem with the P/E -- it's a short-sighted, usually backward-looking tool. If one company is able to double its earnings in a few short years while another remains stagnant, the former could be a much better value despite a higher multiple. Yet you wouldn't know it from the single-snapshot picture the P/E provides.
The "forward P/E" published by some sources is a better tool, because it uses the next year's estimated earnings for the "E" part of the equation, instead of the previous year's earnings. But that still provides only a very limited snapshot. This chart illustrates just how tough it is to get a handle on this simple ratio.
Company
Estimated 2-Year Growth Rate
Trailing P/E
Forward P/E*
Apollo Group (Nasdaq: APOL)
69%
16
15
USEC (NYSE: USU)
91%
17
15
Visa (NYSE: V)
49%
41
20
Baidu.com (Nasdaq: BIDU)
77%
65
44
Data provided by Capital IQ, a division of Standard & Poor's. *Using next 12 months' earnings estimate.
The first two companies look like bargains compared to their growth rates, but you should question just how likely they are to achieve this future growth. The second two appear expensive looking backward, but much more reasonable looking forward. But how much growth will there be after the next couple of years? So many variables!
2. Focus on fundamentals
As the previous example shows, the P/E becomes more useful if you can get a grasp on just how much in earnings a company will be able to achieve over the coming years. But in order to do this, you'll need to study the underlying business and understand its margins, scalability, competitive position within the industry, etc. This fundamental analysis goes a long way toward putting the P/E in its proper perspective.
3. The fiction of accounting
Another problem comes in defining "earnings," the denominator in our equation. Like Donald Trump's hair color, it isn't always what it seems. In fact, unlike Donald's hair, it's so easy to massage and manipulate the earnings number that it's a wonder the Street still hangs on every penny. While one company may report a largely honest number, its competitor may be padding the EPS in order to "meet estimates." In the end, stuff like that usually catches up to these companies -- and, in turn, their shareholders.
My story
The best way to think about the P/E ratio reinforces what Motley Fool co-founders Tom and David Gardner tell members of their Stock Advisor investing service: You must understand that you're buying a business when you buy a stock. I'd heard that often enough, but it took a real-life example to drive the point home.
Several years ago, a friend and I considered buying a sporting goods store. It was a family-run business, with virtually no debt -- or cash -- on the balance sheet. The owner wanted $100,000 for it.
What's the most important thing you'd want to know if you'd been in our situation? Right: how much money we could reasonably expect to earn over the next few years. We didn't care about the fiction of accounting earnings (point No. 3 above) -- we wanted to know how much in real cash profits the business could pull in.
If it were $10,000 per year, we'd be getting the company at a P/E of 10 ($100,000 / $10,000 = 10). If it were $5,000, that's a much less attractive multiple of 20.
We dived into the fundamental analysis to figure out the real earning power of the company (point No. 2). The short story is, we thought we could make the business much more efficient (improving the margins), but future revenue and earnings growth (point No. 1) seemed very limited due to several well-financed competitors in the area.
In assessing whether this was a smart purchase, we used the three points to come up with our decision. In the end, we passed on the purchase because the P/E we calculated was over 20. Using that number hand-in-hand with our analysis, we knew it would have taken too long for us to even recoup our original investment. But the exercise itself was a lesson I'll never forget.
The lesson
Using P/E as a standalone valuation tool could cost you big-time. Isolating on any single metric, for that matter, is a recipe for disaster.
When David recommended Amazon.com (Nasdaq: AMZN) in September 2002, he acknowledged that its P/E of 75 carried risks. But his fundamental analysis convinced him the company deserved that multiple, and the stock is up more than 400% since.
Rex Moore is a Fool analyst who's been cleared to operate heavy machinery. He owns no companies mentioned in this article. Amazon.com is a Motley Fool Stock Advisor selection. Baidu is a Rule Breakers pick. The Fool has a disclosure policy.
http://www.fool.com/investing/general/2009/06/19/why-the-pe-ratio-is-dangerous.aspx
By Rex Moore
June 19, 2009
I have no doubt that the most widely used valuation tool by individual investors is the price-to-earnings ratio (P/E). Unfortunately, it may also be the most dangerous tool, because it's so misunderstood. Today, I'll talk (well, type) a little about what the P/E's problems are and how you can overcome them.
What it is
On the surface, this is a very simple and informative ratio -- a company's stock price divided by its last 12 months of earnings per share. So we can look and see that Monsanto earned $4.10 per share over the past year. At today's price around $81.30, its P/E ratio is $81.30 / $4.10 = 20. You might also hear the hip Wall Street crowd say "Monsanto has a multiple of 20" -- because it sounds so cool.
Because you obviously want more earnings for every dollar you invest, a lower P/E is considered more attractive. After all, you'd rather be paying $40.65 per share for Monsanto's $4.10 in earnings (P/E = 10) than $81.30 (P/E = 20), right?
Yes, absolutely -- why wouldn't you want to pay less for the exact same earnings stream? The same principle also applies when comparing different businesses, as long as they are equal in all other respects.
What it isn't
Of course, things are never equal in the investing world (you didn't need me to tell you that), and this is where problems creep in. It's also why the P/E ratio should never be the only tool you use to value a business, for several reasons. Let's look at three of them.
1. Forward to the future
A glance at most any financial data provider tells us that Cisco Systems (Nasdaq: CSCO) is trading at a P/E of 16. Juniper Networks (Nasdaq: JNPR) has a multiple of 31. So Cisco must be a better value, right?
Well … maybe. It's rare to find two businesses that are exactly alike, and these two certainly have their differences. Also, analysts estimate Juniper will grow earnings about 18% annually over the next five years, while Cisco is only projected to grow at around 10% per year. So there you run into a big problem with the P/E -- it's a short-sighted, usually backward-looking tool. If one company is able to double its earnings in a few short years while another remains stagnant, the former could be a much better value despite a higher multiple. Yet you wouldn't know it from the single-snapshot picture the P/E provides.
The "forward P/E" published by some sources is a better tool, because it uses the next year's estimated earnings for the "E" part of the equation, instead of the previous year's earnings. But that still provides only a very limited snapshot. This chart illustrates just how tough it is to get a handle on this simple ratio.
Company
Estimated 2-Year Growth Rate
Trailing P/E
Forward P/E*
Apollo Group (Nasdaq: APOL)
69%
16
15
USEC (NYSE: USU)
91%
17
15
Visa (NYSE: V)
49%
41
20
Baidu.com (Nasdaq: BIDU)
77%
65
44
Data provided by Capital IQ, a division of Standard & Poor's. *Using next 12 months' earnings estimate.
The first two companies look like bargains compared to their growth rates, but you should question just how likely they are to achieve this future growth. The second two appear expensive looking backward, but much more reasonable looking forward. But how much growth will there be after the next couple of years? So many variables!
2. Focus on fundamentals
As the previous example shows, the P/E becomes more useful if you can get a grasp on just how much in earnings a company will be able to achieve over the coming years. But in order to do this, you'll need to study the underlying business and understand its margins, scalability, competitive position within the industry, etc. This fundamental analysis goes a long way toward putting the P/E in its proper perspective.
3. The fiction of accounting
Another problem comes in defining "earnings," the denominator in our equation. Like Donald Trump's hair color, it isn't always what it seems. In fact, unlike Donald's hair, it's so easy to massage and manipulate the earnings number that it's a wonder the Street still hangs on every penny. While one company may report a largely honest number, its competitor may be padding the EPS in order to "meet estimates." In the end, stuff like that usually catches up to these companies -- and, in turn, their shareholders.
My story
The best way to think about the P/E ratio reinforces what Motley Fool co-founders Tom and David Gardner tell members of their Stock Advisor investing service: You must understand that you're buying a business when you buy a stock. I'd heard that often enough, but it took a real-life example to drive the point home.
Several years ago, a friend and I considered buying a sporting goods store. It was a family-run business, with virtually no debt -- or cash -- on the balance sheet. The owner wanted $100,000 for it.
What's the most important thing you'd want to know if you'd been in our situation? Right: how much money we could reasonably expect to earn over the next few years. We didn't care about the fiction of accounting earnings (point No. 3 above) -- we wanted to know how much in real cash profits the business could pull in.
If it were $10,000 per year, we'd be getting the company at a P/E of 10 ($100,000 / $10,000 = 10). If it were $5,000, that's a much less attractive multiple of 20.
We dived into the fundamental analysis to figure out the real earning power of the company (point No. 2). The short story is, we thought we could make the business much more efficient (improving the margins), but future revenue and earnings growth (point No. 1) seemed very limited due to several well-financed competitors in the area.
In assessing whether this was a smart purchase, we used the three points to come up with our decision. In the end, we passed on the purchase because the P/E we calculated was over 20. Using that number hand-in-hand with our analysis, we knew it would have taken too long for us to even recoup our original investment. But the exercise itself was a lesson I'll never forget.
The lesson
Using P/E as a standalone valuation tool could cost you big-time. Isolating on any single metric, for that matter, is a recipe for disaster.
When David recommended Amazon.com (Nasdaq: AMZN) in September 2002, he acknowledged that its P/E of 75 carried risks. But his fundamental analysis convinced him the company deserved that multiple, and the stock is up more than 400% since.
Rex Moore is a Fool analyst who's been cleared to operate heavy machinery. He owns no companies mentioned in this article. Amazon.com is a Motley Fool Stock Advisor selection. Baidu is a Rule Breakers pick. The Fool has a disclosure policy.
http://www.fool.com/investing/general/2009/06/19/why-the-pe-ratio-is-dangerous.aspx
Valuing a business using PE
The best way to think about the P/E ratio: You must understand that you're buying a business when you buy a stock. Here is a real-life example to drive the point home.
Several years ago, a friend and I considered buying a sporting goods store. It was a family-run business, with virtually no debt -- or cash -- on the balance sheet. The owner wanted $100,000 for it.
What's the most important thing you'd want to know if you'd been in our situation? Right: how much money we could reasonably expect to earn over the next few years. We didn't care about the fiction of accounting earnings (point No. 1) -- we wanted to know how much in real cash profits the business could pull in.
If it were $10,000 per year, we'd be getting the company at a P/E of 10 ($100,000 / $10,000 = 10). If it were $5,000, that's a much less attractive multiple of 20.
We dived into the fundamental analysis to figure out the real earning power of the company (point No. 2). The short story is, we thought we could make the business much more efficient (improving the margins), but future revenue and earnings growth (point No. 3) seemed very limited due to several well-financed competitors in the area.
In assessing whether this was a smart purchase, we used the three points to come up with our decision. In the end, we passed on the purchase because the P/E we calculated was over 20. Using that number hand-in-hand with our analysis, we knew it would have taken too long for us to even recoup our original investment. But the exercise itself was a lesson I'll never forget.
http://www.fool.com/investing/general/2009/06/19/why-the-pe-ratio-is-dangerous.aspx
To recap:
When buying a small business:
Point 1: Past accounting earnings are a guide, but can be manipulated. More importantly is to conservatively assess the real earning power or cash profits of this company over the next few years.
Point 2: Can you increase this real earning power through improving its efficiency - the profit margins?
Point 3: Assess its future revenue growth and earnings growth. Are these sustainable?
Having assessed the quality of the business and its management, the other decisions one has to make are:
Point 4: Would you like to own or run the business of this company?
- If the answer is no, walk away.
- If the answer is yes, proceed on to next step.
Point 5: Is the seller's price attractive for you to own this company? Given your target of a certain return on your investment, what is the 'maximum' price (akin to intrinsic value) you are willing to pay to own this company?
Point 6: Can you buy this company at a discount to your price? Ask for a discount from the seller? Maybe 'wait' for a discount from the seller? Also remember, it is also alright to buy at a fair price, especially if it is a good business with good fundamentals, up for sale for various reasons.
Essentially, this is not dissimilar to our use of QVM method in assessing which companys' stocks to invest in. (Q=Quality, V=Value, M=Management)
Market turns down again
We need to prepare ourselves to “fish” good quality stocks at reasonable price levels if the market turns down again.
Monday 22 June 2009
An Interesting Comeback Calculator
http://www.nytimes.com/interactive/2009/01/06/business/20090106-comeback-graphic.html
Calculate Your Financial Comeback
Has your portfolio plummeted? So has ours. Use our Comeback CalculatorSM to calculate when your investments could return to their peak levels.
--------------------------------------------------------------------------------
June 20, 2009
Your Money
For Older Investors, Old Rules May Not Apply
By TARA SIEGEL BERNARD
The stock market’s damage has already been done. And if you’re one of those people near or already in retirement, you already know you’re going to have to work longer, save more or spend less.
But what should you do right now with the money you have left? Should you wade back into the stock market, if you bailed out when the market was plunging? Or if you watched your investments drop and then recover a little in the last few months, should you just hold on? What happens if the market doesn’t fully recover for a long time? (That happened in Japan in the ’90s.)
This economic downturn has been steep enough and frightening enough to undermine the idea that the stock market, over time, will always deliver. So a lot of investors have retreated to a more conservative stance.
The wisdom of that move is debatable. The investment industry warns that becoming too defensive is costly in the long run. Its argument goes something like this: People are living longer, retirement may last 25 or 30 years and stocks are supposed to protect you from the ravages of inflation. And since stocks tend to outpace most investments over long periods of time, the industry says, your savings will do all right in the end.
But some people are no longer comfortable with that logic. There’s even a new study that contends holding stocks over long periods of time may be riskier than previously thought. Robert F. Stambaugh, a finance professor at the Wharton School at the University of Pennsylvania and a co-author of the report, said most investment research only accounted for the risk of short-term market swings around the stock market’s average gain over time. It doesn’t factor in the fact, he said, that the average itself is subject to change.
So what should retirees and pre-retirees make of all of this?
“If another decline in the market is going to bankrupt you or put you out of business or destroy your retirement account, you should not go back into the stock market,” said John C. Bogle, the founder of Vanguard and viewed by many as the father of index investing. “It’s not complicated. The stock market can go up and down a lot and nobody really knows how much and when.”
What’s worked for Mr. Bogle may not work for you, but his method isn’t a bad place to start. “I have this threadbare rule that has worked very well for me,” he said in an interview this week. “Your bond position should equal your age.” Mr. Bogle, by the way, is 80 years old.
That’s a rather conservative recommendation, by many financial planners’ standards. In fact, Vanguard itself offers products that are more aggressive. Its target-date funds — whose investment mix grows more conservative as retirement nears — recommend that people retiring in 2010 (generally, people who are 65) should split their savings evenly between stock and bonds.
Charles Schwab, by contrast, has recently reduced the risk for its target-date funds. The company’s 2010 fund will allocate about 40 percent to stock funds next year, down from 50 percent in the past. “It’s a reflection that our clients’ appetite for risk has changed,” said Peter Crawford, a senior vice president at Charles Schwab Investment Management.
But you shouldn’t simply view your investments through the lens of how much you allocate to different investments (though you will need to come up with a plan). Instead, you should work your way backward. First, consider how much you will need to live when you’re retired and then figure out how you’ll pay for it.
Nearing Retirement
Ideally, you should have started to slowly shrink your stock position over your working career. But some financial planners have become more conservative about that. Before the market’s sharp downturn, Warren McIntyre, a financial planner in Troy, Mich., typically reduced his clients’ stock allocations by about 1 percent each year. Now, for older investors, he ratchets down their stocks by 2 percent each year once they reach 60. So a 65-year-old’s investments would be evenly split between stocks and bonds.
Other planners are taking even more defensive positions. “We are still very concerned about the status of the economic recovery and remain quite defensive as a result,” said Chip Addis, a financial planner in Wayne, Pa., who invests his clients’ portfolios in only 40 percent stocks.
Of course, there’s no one formula. Milo Benningfield, a fee-only planner in San Francisco, for instance, said he put a 61-year-old client in a portfolio with 60 percent in diversified stocks and alternatives (like real estate) and 40 percent in fixed-income (largely split among high-quality, short-term and intermediate-term bonds and cash). But this client can afford to take that risk — the client owns a house, rental property and has other holdings outside the portfolio.
The picture may change for pre-retirees who are 61 and close to meeting their savings goals, but can’t afford to lose any money. “We would ask ourselves to what degree, if any, can you afford equities,” Mr. Benningfield said. If inflation was their only concern, he might invest their money across a ladder of Treasury Inflation-Protected Securities, or TIPS, which are backed by the government and keep pace with inflation.
But since retirees generally spend money on entertainment, health care and food — whose costs often exceed the general rate of inflation — he said he might invest 40 to 50 percent of their money in a portfolio of diversified stock funds (with at least 30 percent of that in international stock funds). But, he added, “Cash is risky, stocks and bonds are risky, life is risky.”
As to those investors who got out of stocks, Mr. Bogle said it might be time for some of them to get back in. “But I would take two years to do it,” he said. “Maybe average in over eight quarters, and do an eighth each quarter. I am just not in favor of doing things in a hurry or emotionally.”
And then? “Don’t touch it,” he said, emphatically. “One of my rules is don’t do something. Just stand there.”
Retirement
Several planners recommended different variations on a similar strategy for retirees. Set aside anywhere from eight to 15 years of your expected expenses — that includes food, utilities, housing, insurance — in bonds and cash. That way, you’ll never have to tap your stock holdings at the worst possible moment.
“Once you have that in place, you feel like you can weather any economic storm,” said Chip Simon, a financial planner in Poughkeepsie, N.Y.
When you have figured out how much it costs to live each year, the next step is to see how much Social Security will cover. Whatever is left needs to be financed by your retirement portfolio. And the general rule of thumb is that you shouldn’t withdraw more than 4 percent of your portfolio (adjusted for inflation) each year.
There are different ways to invest your cash and bond holdings.
Rick Rodgers, a financial planner in Lancaster, Pa., invests 10 years of annual expenses in a bond ladder, with an equal amount coming due every six months. The ladder can include high-quality corporate bonds, Treasury notes, certificates of deposit or municipal bonds, depending on the retiree’s tax bracket. Mr. Simon takes a similar approach using a 15-year ladder of zero-coupon bonds. He says that investors can start building the ladder in their 50s, with the first rung coming due the year they retire.
Some advisers also say you can guarantee you’ll be able to cover your basic expenses by purchasing an immediate annuity from an insurance company. The annuity pays you a stream of income until you die. “You can buy four small ones from four insurers if you are worried about insolvency risk,” said Dallas L. Salisbury, president of the Employee Benefit Research Institute. “And if you are just worried about inflation protection, you can do TIPS.”
But you should probably delay any annuity purchases because payouts rise with interest rates. With current rates so low, and the possibility of inflation later, advisers said it’s best to wait a few years. You can also research inflation-adjusted annuities, but you’ll receive lower payouts in the beginning, Mr. Benningfield said, adding: “Less than most people can stomach.”
Calculate Your Financial Comeback
Has your portfolio plummeted? So has ours. Use our Comeback CalculatorSM to calculate when your investments could return to their peak levels.
--------------------------------------------------------------------------------
June 20, 2009
Your Money
For Older Investors, Old Rules May Not Apply
By TARA SIEGEL BERNARD
The stock market’s damage has already been done. And if you’re one of those people near or already in retirement, you already know you’re going to have to work longer, save more or spend less.
But what should you do right now with the money you have left? Should you wade back into the stock market, if you bailed out when the market was plunging? Or if you watched your investments drop and then recover a little in the last few months, should you just hold on? What happens if the market doesn’t fully recover for a long time? (That happened in Japan in the ’90s.)
This economic downturn has been steep enough and frightening enough to undermine the idea that the stock market, over time, will always deliver. So a lot of investors have retreated to a more conservative stance.
The wisdom of that move is debatable. The investment industry warns that becoming too defensive is costly in the long run. Its argument goes something like this: People are living longer, retirement may last 25 or 30 years and stocks are supposed to protect you from the ravages of inflation. And since stocks tend to outpace most investments over long periods of time, the industry says, your savings will do all right in the end.
But some people are no longer comfortable with that logic. There’s even a new study that contends holding stocks over long periods of time may be riskier than previously thought. Robert F. Stambaugh, a finance professor at the Wharton School at the University of Pennsylvania and a co-author of the report, said most investment research only accounted for the risk of short-term market swings around the stock market’s average gain over time. It doesn’t factor in the fact, he said, that the average itself is subject to change.
So what should retirees and pre-retirees make of all of this?
“If another decline in the market is going to bankrupt you or put you out of business or destroy your retirement account, you should not go back into the stock market,” said John C. Bogle, the founder of Vanguard and viewed by many as the father of index investing. “It’s not complicated. The stock market can go up and down a lot and nobody really knows how much and when.”
What’s worked for Mr. Bogle may not work for you, but his method isn’t a bad place to start. “I have this threadbare rule that has worked very well for me,” he said in an interview this week. “Your bond position should equal your age.” Mr. Bogle, by the way, is 80 years old.
That’s a rather conservative recommendation, by many financial planners’ standards. In fact, Vanguard itself offers products that are more aggressive. Its target-date funds — whose investment mix grows more conservative as retirement nears — recommend that people retiring in 2010 (generally, people who are 65) should split their savings evenly between stock and bonds.
Charles Schwab, by contrast, has recently reduced the risk for its target-date funds. The company’s 2010 fund will allocate about 40 percent to stock funds next year, down from 50 percent in the past. “It’s a reflection that our clients’ appetite for risk has changed,” said Peter Crawford, a senior vice president at Charles Schwab Investment Management.
But you shouldn’t simply view your investments through the lens of how much you allocate to different investments (though you will need to come up with a plan). Instead, you should work your way backward. First, consider how much you will need to live when you’re retired and then figure out how you’ll pay for it.
Nearing Retirement
Ideally, you should have started to slowly shrink your stock position over your working career. But some financial planners have become more conservative about that. Before the market’s sharp downturn, Warren McIntyre, a financial planner in Troy, Mich., typically reduced his clients’ stock allocations by about 1 percent each year. Now, for older investors, he ratchets down their stocks by 2 percent each year once they reach 60. So a 65-year-old’s investments would be evenly split between stocks and bonds.
Other planners are taking even more defensive positions. “We are still very concerned about the status of the economic recovery and remain quite defensive as a result,” said Chip Addis, a financial planner in Wayne, Pa., who invests his clients’ portfolios in only 40 percent stocks.
Of course, there’s no one formula. Milo Benningfield, a fee-only planner in San Francisco, for instance, said he put a 61-year-old client in a portfolio with 60 percent in diversified stocks and alternatives (like real estate) and 40 percent in fixed-income (largely split among high-quality, short-term and intermediate-term bonds and cash). But this client can afford to take that risk — the client owns a house, rental property and has other holdings outside the portfolio.
The picture may change for pre-retirees who are 61 and close to meeting their savings goals, but can’t afford to lose any money. “We would ask ourselves to what degree, if any, can you afford equities,” Mr. Benningfield said. If inflation was their only concern, he might invest their money across a ladder of Treasury Inflation-Protected Securities, or TIPS, which are backed by the government and keep pace with inflation.
But since retirees generally spend money on entertainment, health care and food — whose costs often exceed the general rate of inflation — he said he might invest 40 to 50 percent of their money in a portfolio of diversified stock funds (with at least 30 percent of that in international stock funds). But, he added, “Cash is risky, stocks and bonds are risky, life is risky.”
As to those investors who got out of stocks, Mr. Bogle said it might be time for some of them to get back in. “But I would take two years to do it,” he said. “Maybe average in over eight quarters, and do an eighth each quarter. I am just not in favor of doing things in a hurry or emotionally.”
And then? “Don’t touch it,” he said, emphatically. “One of my rules is don’t do something. Just stand there.”
Retirement
Several planners recommended different variations on a similar strategy for retirees. Set aside anywhere from eight to 15 years of your expected expenses — that includes food, utilities, housing, insurance — in bonds and cash. That way, you’ll never have to tap your stock holdings at the worst possible moment.
“Once you have that in place, you feel like you can weather any economic storm,” said Chip Simon, a financial planner in Poughkeepsie, N.Y.
When you have figured out how much it costs to live each year, the next step is to see how much Social Security will cover. Whatever is left needs to be financed by your retirement portfolio. And the general rule of thumb is that you shouldn’t withdraw more than 4 percent of your portfolio (adjusted for inflation) each year.
There are different ways to invest your cash and bond holdings.
Rick Rodgers, a financial planner in Lancaster, Pa., invests 10 years of annual expenses in a bond ladder, with an equal amount coming due every six months. The ladder can include high-quality corporate bonds, Treasury notes, certificates of deposit or municipal bonds, depending on the retiree’s tax bracket. Mr. Simon takes a similar approach using a 15-year ladder of zero-coupon bonds. He says that investors can start building the ladder in their 50s, with the first rung coming due the year they retire.
Some advisers also say you can guarantee you’ll be able to cover your basic expenses by purchasing an immediate annuity from an insurance company. The annuity pays you a stream of income until you die. “You can buy four small ones from four insurers if you are worried about insolvency risk,” said Dallas L. Salisbury, president of the Employee Benefit Research Institute. “And if you are just worried about inflation protection, you can do TIPS.”
But you should probably delay any annuity purchases because payouts rise with interest rates. With current rates so low, and the possibility of inflation later, advisers said it’s best to wait a few years. You can also research inflation-adjusted annuities, but you’ll receive lower payouts in the beginning, Mr. Benningfield said, adding: “Less than most people can stomach.”
Learn from the Worst: Summary
We have learned that we have a lot going against us when it comes to investing in the stock market -
Therefore, it is important to have good philosophy and strategy on how to stay in the market and avoid these pitfalls.
Summary
While the stock market is unpredictable in the short term, it becomes predictable - and predictably good - over the long term. In fact, it has proven to be far and away the best long-term investment vehicle of all-time, especially when inflation is factored in.
Despite that fact, the vast majority of individual investors, mutual fund managers, and stock recommendation newsletters fail to beat the market over the long run, often underperforming by wide margins.
The reason for most underperformance is that investors' emotions lead them astray, causing them to react to short-term price movements and the interpretation of those movements by experts featured in the media. This leads to selling low and buying high.
Much of the stock market's gains come on a limited number of days - and no one knows exactly when those big days will occur; if you jump in and out of the market, you risk missing them.
In order to make money by timing the market, you need to be right on about 75% of your market calls - and research shows that most investors, even so-called experts don't come closee to that success rate.
- our brains,
- our emotions,
- timing, and even,
- the mutual fund industry itself.
Therefore, it is important to have good philosophy and strategy on how to stay in the market and avoid these pitfalls.
Summary
While the stock market is unpredictable in the short term, it becomes predictable - and predictably good - over the long term. In fact, it has proven to be far and away the best long-term investment vehicle of all-time, especially when inflation is factored in.
Despite that fact, the vast majority of individual investors, mutual fund managers, and stock recommendation newsletters fail to beat the market over the long run, often underperforming by wide margins.
The reason for most underperformance is that investors' emotions lead them astray, causing them to react to short-term price movements and the interpretation of those movements by experts featured in the media. This leads to selling low and buying high.
Much of the stock market's gains come on a limited number of days - and no one knows exactly when those big days will occur; if you jump in and out of the market, you risk missing them.
In order to make money by timing the market, you need to be right on about 75% of your market calls - and research shows that most investors, even so-called experts don't come closee to that success rate.
Learn from the Worst: The Best Way Not to Miss the Boat - Don't Get Off in the First Place
Many investors, however, either don't expect or just plain cannot tolerate the short-term discomfort of the stock market, and they'll do just about anything to try to avoid it.
Some will ignore stocks altogether, not wanting to deal with the short-term risk involved. Instead, they will put their money into bonds, Treasury bills, or even just keep it in a CD or savings account. After all, while those options don't have nearly the upside of stocks, you can't lose money with them. Or can you?
There are flaws in this logic. The reason: inflation. If, for example, all of your money is in a savings account that is earninng 2% interest per year but inflation is at 3% per year, the relative worth of your money isn't increasing by 2% annually; it's actually declining.
Since, World War II, the threat of infaltion to fixed-income investments has been very real. In his book Contrarian Investment Strategies, Dreman notes that:
Some will ignore stocks altogether, not wanting to deal with the short-term risk involved. Instead, they will put their money into bonds, Treasury bills, or even just keep it in a CD or savings account. After all, while those options don't have nearly the upside of stocks, you can't lose money with them. Or can you?
There are flaws in this logic. The reason: inflation. If, for example, all of your money is in a savings account that is earninng 2% interest per year but inflation is at 3% per year, the relative worth of your money isn't increasing by 2% annually; it's actually declining.
Since, World War II, the threat of infaltion to fixed-income investments has been very real. In his book Contrarian Investment Strategies, Dreman notes that:
- when adjusted for inflation, stocks returned an average of 7.5% from 1946 to 1996;
- when also adjusted for inflation, however, bonds had an average annual return of just 0.86%, gold actually declined by 0.13% per year, and T-bills returned just 0.42% annually.
Looked at another way, the average annual T-bill return before inflation was 4.8% during that period, about 2.5 x less than what stocks returned before inflation - not great, but not bad considering that T-bills are essentially risk-free; after inflation is factored in, however, stocks returned about 18x as much as T-bills per year.
Based on information like that, Dreman concluded that inflation was a far greater risk to long-term investors than short-term stock market volatility.
While some will try to avoid short-term market discomfort by avoiding stocks altogether, others, of course, believe they can skirt the stock market's short-term anxiety and still reap the long-term rewards. But much more often than not, they will end up with all the short-term discomfort and none of the long-term gains.
Part of the reason is that, most investors who try to time the market end up buying high and selling low. But there's also another important reason that is critical to understand - the nature of when and how the stock market makes its gains. In a 2007 article for CNNMoney, Jeanne Sahadi touched on this concept.
Citing data from Ibbotson Associates, Sahadi said tha if you had invested $100 in the S&P 500 in 1926, you would have had $307,700 in 2006 - a pretty staggering gain. But if you had been out of the market for the best-performing 40 months of that lengthy 972-month period, you would have had just $1,923 in 2006. That means that 99% of the gains over that 81-year period came in just 4 percent of the months.
The principle holds over shorter periods, as well. If you invested $100 in 1987, you'd have had $931 by the end of 2006, Sahadi noted. But if you were out of the market for the 17 best trading months of that 240-month period, you'd have ended up with just $232. In this case, 84% of the gains came in 7% of the months.
The bottom line: While the market rises substantially over time, much of its increases come on a relatively small portion of trading days - and no one knows for sure when they're going to come. If you jump in and out of the market based on short-term fluctuations you're bound to miss some of those big days - and you can't get them back.
Another point to note. In a market where the vast majority of gains come on a small number of days, you don't just have to be right more than you're wrong if you want to make money timing the market - you have to be right a whole lot more than you're wrong. That's what the research of William Sharpe shows. Sharpe found that in order to make money with a market-timing approach, you need to be right in your timing decisions at least 74% of the time - not just 51% , as many assume. Consider that statistic showed that the most accurate human forecasters were right about 20% of the time - and you see that most market timers won't even come close to succeeding.
Learn from the Worst: Our Emotions - Need for an Emotional Rescue
If we don't succeed at it, why do we keep trying to time the market? Given the short-term unpredictability of the stock market, it's pretty much inevitable that we'll fail if we try to time our participation in stocks, yet we always think we can learn to do it.
- "Man, it was so obvious that I should have done last time; now that I've learned my lesson, I'll be able to time things right next time." We tell ourseleves, even though it wasn't obvious what we should have done last time, and it won't be obvious whenit comes to future market-timing decisions (hindsight bias).
- "And time and time again, when one of our stocks starts declining, we jump off of it and onto the latest "hot" stock, only to watch our old stock rise and our new, flashy stock fall."
Our emotions
We are emotional creatures, and in many cases throughout life, that's a good thing. When we are in danger, for example, we feel fear, and our brains interpret this feeling as a signal to flee for safety's sake.
In the stock market, however, emotion is one of our greatest enemies. Our intstincts tell us to flee when we see danger, and danger is what we see when our investments start losing value -
- danger of losing our money,
- danger of not being able to afford to send our children to college,
- danger of not being able to afford to retire when we want to retire.
And, just as with other dangers we perceive, our first reaction is to flee - or, in this case, sell.
Now, when it comes to being attacked by an animal or a mugger who is trying to hurt you, fleeing from harm is a good instinct to have. But in the stock market, fleeing can, in fact, lead to great harm. That's because the danger we often sense in the stock market is false danger.
Perfectly good stocks fluctuate over the short-term (there's typically a 40 to 50% difference between a stock's high and the low for the previous 12 months), and sometimes it's due to factors that have nothing to do with their real value. (Think of the example in which one company is negatively impacted when another company in its industry posts a bad earnings report.) Because of the array of factors that go into its day-to-day movements, we just can't predict what the market's or an individual stock's short-term fluctuations will be with any degree of accuracy.
Nevertheless, we still act on them, and a big reason is emotion.
Peter Lynch once explained this phenomenon in an interview.
- "As the market starts going down, you say, 'Oh, it'll be fine."
- Then "it starts going down more and people get laid off, a friend of yours loses their job or a company has 10,000 employees and they lay off 200. The other 9.800 people start to worry, or somebody says their house price just went down. These are little thoughts that start to creep to the front of your brain."
- People even start thinking about past financial disasters, bringing thoughts of such calamities as the Great Depression to the front of their minds, even if the current situation is nowhere near as bad.
In today's world of nonstop media hype and sensational headlines, it's very difficult to keep those thoughts from entering our minds. And the more they do, the more likely we are to make bad investment decisions.
Dallbar's study of investor behaviour shows that the percentage of investors who correctly predict the direction of the market is much lower during down markets than it is during rising markets.
During falling markets, when people have already been losing money, the fear of losing even more can cause many to cash out, even if the downturn is just one of Wall Street's periodic short-term hiccups. (Behavioural finance referes to this a myopic loss aversion.) Often, investors are then slow to jump back in when the market turns around, so they miss out on the bounce-back gains.
And it's important to remember that the market does bounce back, even when your fears and worries are telling you that "this time is different, this time the market won't recover." In fact, over time, the market climbs higher than any other investment vehicles.
According to reserach performed by Roger Ibbotson, Rex Sinquefield, and Ibbotson Associates, in the 20-year period that ended at the end of 2006, the S&P averaged an 11.8% annual compound return, beating long-term corporate bonds (8.6%), long-term government bonds (8.6%), and Treasury bills (4.5%).
While unpredictable in the short term, the performance of the stock market becomes quite predictable - and predictably good - when looked at over the long term.
Imagine, for a moment, that the market is a helium-filled balloon that you set loose outside on a gusty day. From moment to moment, it's hard to tell where the balloon is headed. It gets pushed around from side to side by the wind - that is, earnings reports, economic data, analysts' ratings, pundits' predictions - and sometimes even gets knocked downward. From moment to moment, you'd be foolish to bet someone exactly which way the balloon will go, since there's no way predict which way the wind will blow. But it's almost a sure bet that, over a longer period of time, it will end up a lot higher than it started.
In his book Stocks for the Long Run, Jeremy Seigel states that the market has averaged an annual compound return of 11.2% in the period 1946 to 2006. Siegel also examines those returns for their standard deviations. This is a statistical measure to show the rangee of returns in a "normal" year during a particular period.
If a stock has returned an average of 10% annually over a particular period with a standard deviation of 5%, for example, that means that about 2/3 rds of the time, its returns have been between 5% (the average return minus the standard deviation) and 15% (the average plus the standard deviation).
According to Siegel, the annual standard deviation of the market has been about 17% in the 1946 - 2006 period, which means that about 2/3rds of the time during the 60-year time frame, returns were between -5.8% and 28.2% , a huge potential year-to-year difference. (And that's the range returns fell into about 2/3 rd of the time; in other years they were even further from the average.)
The fact that such major year-to-year fluctuations can - and many times do - occur in the stock market makes for a lot of anxious times in the short term, but that anxiety is simply the price you pay for the excellent long-term returns that the stock market gives you. If stocks earned 10 or 12 % per year and were a smooth ride, why would anyone ever invest in anything else? This concept is known as the equity risk premium.
The bottom line: There are no free lunches in the stock market. If you want the long-term benefits of stocks, you've got to pay the price of short-term discomfort.
Ref: The Guru Investor by John P. Reese
Learn from the Worst: Market Timing - The Most Dangerous Game
Every day, millions of investors, try to discern where the market will head tomorrow, next week, or next month.
Market timing occurs when people move in and out of the stock market with the intent of taking advantage of anticipated short-term price movements.
Market timing can be
Market timing occurs when people move in and out of the stock market with the intent of taking advantage of anticipated short-term price movements.
Market timing can be
- as simple as you want it - maybe you've heard from a friend that the market is about to take off, so you invest in stocks - or
- as complex as you want it - perhaps you've developed an elaborate model that uses various economic indicators to predict which way the market will go in the next month.
Whatever way you go about it, though, it's not likely to end well, because the market is simply too complex and irrational in the short-term for anyone to correctly and reliably predict its movements.
Want proof that market timing doesn't work?
1. Research performed by Dalbar, Inc (in its 2007 Quantitative Analysis of Investor Behaviour): The firm notes that the S&P has grown an average of 11.8% per year from 1987 through 2006, an impressive gain. During this period, however, the average equity investor averaged a return of just 4.3%.
- The reason? As markets rise, the data shows that investors "pour cash" into mutual funds, and when a decline starts, a "selling frenzy" begins.
- In other words, the research shows that investors tend to do the opposite of the old stock market adage, "Buy low, sell high."
2. A few years ago, the investment research company Morningstar began tracking mutual fund performance in a new way. Normally, mutual fund returns are reported as though an investor remained invested in the fund throughout the full reporting period. A fund's three-year return, for example, is reported as the percentage increase or decrease an investor would have seen if he had been invested in the fund for the entire three previous years.
In a methodology paper ('Morningstar Investor Return'), Morningstar says it found that this "total return" percentage doesn't accurately portray how well investors in a particular fund really fare.
- The reason: While the "total return" percentage measures how a fund does over a specific period, people often don't stick with the fund for that entire period; instead, they jump in and out of it.
- And, according to Morningstar, the returns that the typical investor in a particular fund actually realizes (the "investor returns") tend to be lower than the fund's total return - implying that people pick the wrong times to jump in and out of the fund (or the market).
3. While investors themselves deserve some of the blame for this, mutual funds sometimes don't help. In its investor returns methodology paper, Morningstar states that if firms encourage short-term trading and trendy funds, or if they advertise short-term returns and promote high-risk funds, they may not be looking out for their investors' long-term interests.
- Their investors' actual returns will likely be lower than the fund's total return.
- (The fees mutual funds charge also don't help, something Bogle stresses; those costs make it so that the fund manager has to beat the market just for his client to net market-matching returns.)
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