Vietnam is a clever way to play Asia

Vietnam is a clever way to play Asia

Imagine the amount of money you would have made if you had started investing in China 10 years before the hot money started to flow. Your profits would have been absolutely phenomenal – even after the correction over the last two years.

By Garry White
Published: 5:41PM BST 12 Sep 2009

VinaCapital Vietnam Opportunities Fund

$1.71 +0.01

Questor says BUY

For investors keen on getting in ahead of the crowd, Vietnam could offer you a similar opportunity today.

For the 10 years before the credit crunch hit, Vietnam was Asia's second-fastest growing economy after China. The country tabled an average growth in GDP of 7.5pc a year. This year's government target is 5pc.

The country was hit hard by the financial crisis, but it has now started to recover – and a return to stellar growth in the next few years is very likely. Questor urges investors to buy into Vietnam now, while it is still cheap.

The country certainly has a lot going for it. It has one of the highest literacy rates in Asia, at 90pc, and the workforce is young, hard-working and optimistic.

Almost two-thirds of Vietnam's 85m people are under the age of 35 – and this should support economic growth over the medium term. A young population implies significant population growth in the future, which should stimulate demand further.

Significantly, labour in the country is even cheaper than in China, which should underpin investment in areas such as manufacturing.

A good example of the attractiveness of Vietnam was seen last week when Coca-Cola said it planned to double its investment in the country to $400m over the next three years. The company did not didn't send a minor representative to make this announcement; Muhtar Kent, Coke's chairman and chief executive, went to the country personally.

Arguably, Vietnam is now in the same position as China was a decade ago, but there are limited ways that a UK investor can invest in this fledgling economy.

The Vietnam Opportunity Fund (LSE: VOF), which is managed by country specialist VinaCapital, is one of the easiest ways for UK investors to play growth in the Asian nation.

The shares peaked at $4.78 in 2007, but the sharp risk aversion that gripped the markets means the shares have plunged significantly. They hit a low of 65 cents in December last year, but have since more than doubled to the current level.

The fund's mandate is to invest at least 70pc of its cash in Vietnam, with the remaining 30pc in China, Cambodia and Laos.

Its managers target medium to long-term capital gains with some recurring income and short-term profit taking – which appears to be a sensible strategy. The fund will invest in private companies, not just listed entities, as well as taking part in any privatisations the government proposes.

The largest portfolio constituent of this open-ended investment trust, at 7.6pc, is financial group Eximbank. It also has major holdings in HPG, a steel manufacturer, dairy group VNM, real estate group DI and fertiliser group DPM.

As of August 31, Vietnam Opportunity Fund's net asset value per share was $2.44 – up 12.2pc in just one month.

The shares can be bought as normal through your broker and the investment trust is priced in dollars. For investors seeking substantial long-term capital growth, Questor recommends an investment in this Asian market, as it is not fully recovered from the recent plunge and should return to significant growth soon. Shares in the Vietnam Opportunity Fund are a buy.


Catlin

332.8p +2.60

Questor says BUY

Lloyd's of London insurers had a good first half of the year and Catlin, the largest syndicate in the market, was no exception. The group posted a record half-year profit of $240m (£143m) as investment returns more than tripled.

In February, Questor recommended buying the shares, despite the insurer falling into the red. The group was one of many that needed a rights issue – and £200m was raised at a hefty 47pc discount. The cash call was sensible, as the company could invest in its business.

Insurance premiums had started to rise, as underwriters tried to rebuild their balance sheets following an active hurricane season in 2008 and heavy investment losses.

Since this time, market conditions have continued to improve and insurers including Amlin, Chaucer and Hiscox have benefited as returns from hedge funds and equities begin to improve. With a market capitalisation of more than £1bn, Catlin was always going to be well positioned to seize these fertile market conditions.

The company now covers about 30 different types of risks and has an international network in 17 countries across five continents.

Although short-term risks hang over the Lloyd's market – including the onset of the Atlantic hurricane season – Questor believes Catlin shares are worth buying for their impressive yield, despite the shares being 10pc below their recommendation price.

The shares are currently yielding 7.2pc and the stance remains buy.


Cisco Systems

$23.12 +0.03

Questor says TAKE PROFITS

Shares in networking group Cisco were recommended in January at $16.91. Questor argued that the group's earnings would be supported by the US stimulus package, which aimed to connect many US schools to the internet.

The recent market rally means that the shares have risen by 36pc since that time. Questor thinks that the shares are now looking fully valued and are likely to mark time from here.

After this year's recovery, they are trading on a July 2010 earnings multiple of 17.5 times which, given the fragility of the recovery, looks like a fair rating.

Although global stock markets have rallied significantly, unemployment remains a major problem in Western economies. This means that the recovery could easily be derailed.

Indeed, the gold price crossed the $1,000 barrier last week, which is potentially a warning sign of a return of risk aversion, although it could just be a function of the weakening dollar.

Nevertheless, gold tends to outperform at times of crisis, so the latest popularity of the metal is a sign of investor concern that the market has risen too far too fast.

Investors do not go broke taking profits and, with worries over dollar weakness starting to gather pace, Questor thinks now is a good time to take profits in Cisco and sell.


http://www.telegraph.co.uk/finance/markets/questor/6179041/Vietnam-is-a-clever-way-to-play-Asia.html

8600% gains with a buy and hold strategy

Maximising gains with a buy and hold strategy

Buffett is so confident in his stock-picking ability that he is incline to continue holding an investment perpetually. Rather than lull himself into believing he can win by continually darting in and out of the market.

Buffett believes he can earn and retain more money picking a few choice companies and letting them grow over time.

"All you do is buy shares in a great business for less than the business is intrinsically worth, with managers of the highest integrity and ability. Then you hold those shares forever," he told a Forbes reporter in 1990.

To make the point, Buffett's porfolio is concentrated in a small number of companies he has owned for years.

• - He began accumulating stock in The Washington Post in the mid-1970s until he owned 1,869,000 shares. In 1985, he sold about 10% of his holdings but has kept the remaining 1.727,765 to this day.

• - He continues to hold all 96,000,000 million shares of Gillette bought in 1989. He originally bought a preferred stock that converted into 12,000,000 shares; there have been three splits since.

• - He vows never to sell his 200,000,000 shares of Coca-Cola despite the recent slump in revenues and earnings.

• - Buffett began studying and buying shares of GEICO at the age of 21. He reportedly made a nearly 50 % gain on his first GEICO investment in a single year. Later, when Wall Street belived GEICO was on the verge of bankruptcy, Buffett began accumulating large stakes in the insurer. By 1983, he owned 6.8 million shares, which turned into more than 34 million shares - 51% of the company - by virtue of a 5 for 1 split. In August 1995, he announced he would buy the remaining 49% of GEICO and bring the company under Berkshire's umbrella.

Such patience has paid off.

• - His $45 million investment in GEICO in the 1970s became worth $2.4 billion (a 54-fold increase in 20 years) when Buffett announced he was buying the rest of the company.

• - He has held shares in The Washington Post for 27 years, over which time his $10.6 million investment grew to $930 million by the end of 1999, an 86-fold increase. During a period in which Wall Street's brokerages alternately told investors numerous times to buy and sell The Washington Post, Buffett held on for the maximum gain. Buffett has not paid a dime of capital gains taxes on The Washington Post since he sold a portion of his position in 1985.

Few investors can brag of attaining an 8,600 percent return on one investment because so few will hold a stock long enough to maximise the stock's potential.

Even thought the past few years has provided several stocks that surged 8,000 percent within a few years, such as Dell Computer, Qualcom, or America Online, it's doubtful that many investors reaped the full gain.

These stocks rallied so prodigiously because investors flipped them so rapidly. Turnover caused most of the gains. The majority fo investors tripped themselves up playing the market's short-term lottery.

Understanding Buffett's frugal convictions

Warren Buffett once joked that he spent 6% of his net worth buying his wife Susie an engagement ring, thus depriving himself of immeasurable millions in future gains.

Indeed, Buffett once was seen picking up a penny on an elevator on his way to the office and remarked to the stunned witnesses, "the beginning of the next billion."

To Warren, a $100 bill lying on a sidewalk should not be valued on its present-day worth or on the present-day efforts needed to accumulate it, but on the future value of the greenback. Suppose, for example, that Buffett could compound $100 at 25% annual rates. In 10 years, his $100 discovery would be worth $931. After 30 years, it would be worth $80,779, unadjusted for inflation.

To understand Buffett's frugal convictions, one must view them from the point of view of mathematics and by using the types of calculation just shown. To Buffett, every dollar not accumulated now or spent needlessly could have productively been turned into numerous dollars later.

Thus, everything you buy or do not buy has the potential to greatly increase or decrease your net worth, depending on the rate of return you can obtain on investments. This principle applies whether you spend money on a poorly chosen investment or on an unnecessary personal expense or luxury item.

Buffett has to make such choices because of his high opportunity costs. In contrast, a household that has no opportunity costs, that is, it doesn't invest or derives no returns from investments, may be just as well off making the various types of purchases.

A household with zero oppoortunity costs can be a net consumer with no detrimental impact to its long-term fortune, but, to Buffett, money saved is money compounded. He has been known buy 50 12-packs of Coca-Cola at once from the grocery store to get a volume discount. Each year, the money he saves buying cases of pop will ultimately increase his net worth by thousands of dollars.

Opportunity costs of our investments

Every dollar spent on a single item is a dollar unavailable for other items. That dollar must provide a suitable return - measured against what you could have earned on tha dollar somewhere else.

Investors should look at their investments similarly.

Because the market tempts us with thousands of potential investments each day, we tend to screen our stock choices until we find those that meet our risk and return characteristics. Likewise, we've learned to benchmark our investments by comparing their performance against the S&P 500 index or some other proxy.

If your portfolio rose just 8% in a year in which the S&P 500 index rose 20%, the opportunity cost on your money was great - you lost the chance at an extra 12 percent a year because the investments you chose did poorly.

Look at all spending decisions as opportunities - won or lost

Most individuals these days are astute enough to understand the power of time and understand the need to fund their own retirement rather than to rely on government programs whose long-term viability don't seem guaranteed anymore.

However, compounding works two ways.

An investment that compounds at, say, 20% annual rates, will swell into a tremendous amount after 30 years.

Conversely, a missed opportunity that could have compounded at 20% a year has the opposite effect on your portfolio. A poorly chosen stock tha rises just 5% a year ultimately costs you tens of thousands of dollars in lost opportunities.

Money that is misspent today and not invested can have the same injurious effect on your future net worth.

At any given moment, you have tens of thousands of investment opportunities worldwide from which to choose. You may decide to put your available cash into shares of Intel or into a home remodeliing project. You may decide to spend $50 at a restaurant, or on a new pair of slacks, or on a new golf putter. You may be faced with the choice of buying a new automobile or funding a college account for a chld. No matter how you choose, every possible use of your money must bring a return - tangible or intangible - or else you should not spend the money. When making the choice of buying, say, shares of Intel or new carpeting, you must think about the opportunity costs of the money spent.

As an investor, you must also look at all spending decisions as opportunities - won or lost. Every dollar spent on a single item is a dollar unavailable for other items. That dollar must provide a suitable return - measured against what you could have earned on that dollar somewhere else.

Virtually anyone can evolve into a millionaire

Mathematics also shows us that virtually anyone can evolve into a millionaire through patient, diligent investing.

An individual who socks away a few thousand dollars every year starting at the age of 21 can easily amass $1 million by retirement. The power of time and the power of compounding ensure that any individual who can save money consistently can attain a decent degree of wealth by the age of 65 or 70.
If that same individual can manage to save an extra few thousand dollars more each year, the pile of assets attained at retirement would be much larger.

If that individual manages to earn a few extra percentage points of gain each year, either through good stock-picking or wise account management, the amount of money earned at the end is many times greater.

Columbus's four voyages to the Caribbean

The Joys of Compounding

In Buffett's annual report to partners for the year ending in 1962, he broke cadence from his routine review of the market to discuss "The Joys of Compounding." Anyone reading this passage, even four decades after Buffett penned it, could see the raw-boned logic behind the 32-year-old Buffett's stubborn frugality. As he saw it, every dollar put to productive use magnifies the benefit to society by virtue of compounding. Wasting that dollar had serious long-term ramifications - for him, his partners, even for society at large. What if, Buffett mused in his letter, Spain had decided not to finance Christopher Columbus? The results would be staggering.

In financial terms, Columbus's four voyages to the Caribbean yielded very little for the crown, except to pave the way for generations of future navigators. Think how that $30,000 (cost of the voyage Isabella originally underwrote for Columbus), if spent more judiciously by Spain in the late 15th century, could have greatly increased the wealth of the Spanish people. By 1999, 37 years after Buffett made the analogy, Isabella's $30,000 expenditure could have compounded into more than $8 trillion, nearly the total annual economic output of the United States. Spain would be a world economic powerhouse today.

On this topic, Buffett is behaving as any rational CEO would. If a company generates a high return on its assets, it should withhold dividends to investors and plow as much money as it can each year back into the business. Only when it can no longer generate a strong internal return should a company think about returning money to shareholders.

It's very doubtful that recipients of his wealth could have compounded their largesse at the rate Buffett did. Isn't it better, Buffett believes, to forego conspicuous consumption today if it means leaving even larger amounts for society tomorrow?

"My money represents an enormous number of claims checks on society. It's like I have these little pieces of paper that I can turn into consumption," Buffett told Esquire magazine in 1988. "If I wanted to, I could hire 10,000 people to do nothing but paint my picture every day for the rest of my life. And the (Gross Domestic Product) would go up. But the utility of the product would be zilch, and I would be keeping those 10,000 people from doing AIDS research, or teaching or nursing."

Letting money compound productively creates an enormous economic benefit.

Postulating the value of assets into the future holds meaning for investors who, if they're fortunate, can live many decades. Letting money compound productively creates an enormous economic benefit, not only to investors but also to their benefactors and to society at large.

Buffett is occasionally criticized for not donating more of his wealth to foundations and charities, as many other tycoons have. Buffett's reasoning, however, is perfectly consistent with his investing philosophy. As long as he can continue to compound money at great rates, society would be better off if he didn't give away money now.

He told Ted Koppel in a 1999 Nighline interview, for example, that if he had donated most of his money 20 years ago, society would have been $100 million richer. Because he chose not to donate, society will one day receive more than $30 billion.

Had he given away $100 million in the 1970s, it's very doubtful that recipients could ahve produced $30 billion in economic benefits for society becasue few people alive can compound money as Buffett can.

One day, the value of Buffett's foundation grants will certainly surpass $100 billion and then $200 billion, which would make Buffett's fortune the largest ever donated to charity.

Let time work to your advantage

Choosing good companies at fair prices seldom has produced losses for investors willing to wait patiently for the stock price to track the growth of the company.

"Time is the friend of the good business, the enemy of the poor," Buffett has said many times.

Strong enterprises see their intrinsic value rise consistently, lifting the stock every step of the way. Over a period of 5 years or more, there should be a very close correlation between the change in the value of the company and the change in the stock. Watching great companies increase their sales and earnings consistently is a dream come true for an investor.

The power of compounding begins working its magic as the years progress and allows your net worth to gather momentum and increase (in dollar value) by greater and greater amounts.

What happens to money that is allowed to sit and grow at different rates? Two principles should be readily apparent:

1. Time has a tremendous effect on terminal wealth. The longer that money can compound, the larger the sum will be.

2. The rate of return attained acts as a lever that magnifies or minimises your ultimate wealth. Adding just a few extra percentage points a year to your overall returns can have unfathomable consequences to your wealth. An investor who compounds $1 at 6 percent annual rates has $5.74 in his pocket at the end of 30 years. The same investor who can find ways to obtain higher returns (the purpose of posting all these materials here :-) ) walks away with much more. If you can obtain a 10 percent annual return, your $1 compounds into $17.45 in 30 years. Compounding $1 at 20 percent annual rates compounds into $237.

The mathematics of compounding excited Buffett in his earliest years, and stories abound of how he memorised compounding and annuity tables to help him calculate an investment's merit and to keep his personal portfolio on a straight upward track.

If the Indians wanted to buy back Manhattan

There's the story that, if the Indians wanted to buy back Manhattan, they would have had to pay more than $2.5 trillion by January 1, 2000. That's what the $24 sale price in 1626 would have compounded into at 7 percent annual rates. And the clock keeps ticking.

Next year, Manhattan's theoretical value jumps by $175 billion (7 percent of $2.5 trillion). The following year, another $187 billion is added. The year after that, $200 billion, and so on.

Letting wealth accumulate and compound unfettered and, if possible, untaxed is a potent formula individuals should use to increase their standard of living.

It goes without saying that to an investor, the power of compounding is paramount.

The Power of Compounding

No force exerts more influence on your portfolio than time. Time takes a bigger toll on your terminal wealth than do taxes, inflation and poor stock-picking combined. Time magnifies the effects of these critical issues.

A poorly chosen stock may cost you only $2,000 in losses today, but over time that one suspect decision could cost $50,000 in lost opportunities.

Trading frequently for short-term gains may net you strong gains periodically, but the overall result, validated by time, is to create an enormous tax burden that could have been avoided.

Likewise, persistent inflation exacts a weighty toll on your portfolio becasue it destroys value at increasing rates.

Means and end should not be confused. Buffett once wrote to his partners, "The end is to come away with the largest after-tax rate of compound."

Lost Opportunities

A poorly chosen stock may cost you only $2,000 in losses today, but over time that one suspect decision could cost $50,000 in lost opportunities.

The margin of safety related to the Upside-Downside Ratio

Building in Room for Error
Related to the Upside-Downside Ratio

by Michael Maiello
12.3.2008


The margin of safety is one of Benjamin Graham and David Dodd’s most enduring contributions to the world of investing. The two coined the term in Security Analysis in 1934, and Graham expanded on the concept in The Intelligent Investor in 1949. The gist of it is that no matter how careful an analyst is, so many variables are involved in calculating a company’s intrinsic value and future sales and earnings that mistakes are inevitable. So buy a stock worth $12 at $10 instead of $11.50, because the wider the gap between the stock’s price and its intrinsic value, the bigger the margin of safety.


How much safety is warranted depends on the company’s quality. A speculative com-pany that’s losing money, carrying a lot of debt or operating in a shrinking industry reasonably demands a larger margin of safety than a profitable company that leads a growing industry and has a solid balance sheet. Graham and Dodd typically looked for a 50-percent margin of safety on speculative companies but would require a margin of only 10 percent for a high-quality issue.

All investors employ the margin of safety differently, since it’s tied both to intrinsic value analysis and an individual’s risk tolerance. BetterInvesting expresses the risk-reward tradeoff as the upside-downside ratio. The goal here is to evaluate the risk and reward potential of a stock over five years, assuming one boom and one recession. This analysis says nothing about the probability of a stock reaching any particular price. Instead, it expresses what a stock’s potential is. BetterInvesting recommends buying a stock only when the upside is at least three times that of the downside.

In calculating the ratio, you first find the extreme upside. For a company with growing earnings, estimate the stock’s highest price-earnings ratio over the next five years. This will represent “as good as it gets.” Then determine the company’s highest earnings per share over this period. Multiply them and that’s your extreme high.

Now do the same on the low end. Multiplying your estimated low P/E by the expected low earnings is a common way to do this. If the stock is already trading below your low forecast, you’ll want to revisit your assumptions.

Finally, take the forecast high and subtract the current price. Then divide that by the current price minus the forecast low. The result is the upside-downside ratio. Anything above 3:1 offers a reasonable margin of safety for growth stocks.

Some investors also like a margin of safety for selling stocks. The upside-downside ratio for existing holdings should be updated to see whether price appreciation has outpaced potential.

The analysts at Morningstar do something similar. They give a “fair value” estimate for every stock. For Wachovia, it’s currently $53. The stock recently traded at $34.60. Morningstar says to consider buying it at any price below $39.80, which is 75 percent of what Morningstar thinks the stock is worth.

If you buy the stock, Morningstar says not to consider selling it until it reaches $68.90. In other words, Morningstar believes Wachovia’s stock could increase by 30 percent beyond what it now considers the stock’s fair value. The answer to the selling conundrum in this case is that if Wachovia reaches its fair value, the investor has to analyze the stock again to see whether there’s room left for the stock to run.

BetterInvesting’s Online Tools

The Stock Selection Guide, the primary stock study tool of BetterInvesting members, helps you identify stocks that are reasonably priced. Our new online tool will walk you through evaluating a company using the SSG. Click on the Online Tools & Software link under the Tools & Resources menu on the BetterInvesting homepage. Your membership may already include access to the tool; if not, you can upgrade your membership to use it.



Michael Maiello, who wrote "Fly With the Fundamentals" for the January 2006 issue, is the author of Buy the Rumor, Sell the Fact (McGraw-Hill, 2004).


http://www.betterinvesting.org/Public/StartLearning/BI+Mag/Articles+Archives/0408fundamentalpublic.htm

The Perils of High-P/E Stocks

The Perils of High-P/E Stocks
The Higher They Are, the Harder They Fall

by Michael Maiello
30.7.2008


Financial journalist Jason Zweig has a well-known interest in behavioral finance, the study of how investors’ minds work — sometimes against their best interests. In his latest book, Your Money & Your Brain, he deals with the “story stock,” the must-have equity of the moment that only investors with the strongest convictions can avoid.



Think Krispy Kreme, which went public in 2000 after the market crash and climbed from $23 to over $100 a share. Yes, a doughnut company had a price-earnings ratio above 80. A doughnut company.

Krispy Kreme is losing money now and trades for just over $3 a share. But at the time it had exactly what investors craved — a simple business model, a good (some would say addictive) product, room to grow from a regional to a national chain and the attention of both the media and Wall Street analysts.

These are the types of stocks that play well in the human mind, Zweig says. Investors are naturally risk-averse and wary of potential surprises. High-profile companies that get a lot of attention and are mentioned on the nightly news and on financial websites seem less likely to surprise us. They seem safer.

There’s also a perceived safety in numbers. No matter how often we’re told that 50,000 people can indeed be wrong, we’re afraid to be seen as out of step with our neighbors. To be wrong while acting as part of a group is understandable. To be wrong on your own is just plain embarrassing.

The result of this, writes Zweig, is that a stock might do well for the wrong reasons in the short run. But eventually the fundamentals will catch up with it.

Remember, it’s negative surprises that send most investors fleeing, and when they seek safety, they wind up buying stocks that today are telling happy stories of high growth. This means the effects of any negative news about these stocks are amplified. And when the story turns ugly, it turns in a hurry.

Zweig calculates that if a growth company misses its earnings forecast by as little as 3 cents a share, its stock will drop two to three times faster compared with a value stock reporting the same bad news. When a high-growth company misses earnings, it can cause a crisis of confidence. Many analysts, for example, believe there’s no such thing as one bad quarter; when a high-growth company stumbles, investors fear more bad news is on the way.

But over time, less-popular, lower-P/E stocks do outperform. In his updated edition of Stocks for the Long Run, Wharton professor Jeremy Siegel measured the performances of low-P/E and high-P/E stock portfolios between 1957 and the end of 2006. The portfolio with $1,000 invested in stocks with the lowest P/E ratios was worth $700,000, for a 14.3 percent annual return. The portfolio with $1,000 invested in the highest-P/E stocks was worth $65,000, for a return of 8.9 percent a year.

What’s more, during the first 10 years the high- and low-P/E portfolios traded places a few times, depending on market conditions. But once the experiment passed the decade mark, returns on the low-P/E stocks were always higher.

Of course, it’s important to put P/Es in context. You should compare a stock’s P/E with that of its peers and to the rest of the market and remember that some stocks deserve a higher valuation.

Growth and value also go in and out of favor; cycles usually last five years to seven years. But investors with time on their side would do well to be wary of trendy story stocks because they can turn in an instant.




Michael Maiello, who wrote "Fly With the Fundamentals" for the January 2006 issue, is the author of Buy the Rumor, Sell the Fact (McGraw-Hill, 2004).

http://www.betterinvesting.org/Public/StartLearning/BI+Mag/Articles+Archives/0808fundamentalspublic.htm

Use Binaries to Choose Among Options

The Forks in the Road to Investing Success
Use Binaries to Choose Among Options

by Angele McQuade



I’m sure you’ve heard the chestnut that the hardest choice isn’t the one between right and wrong but the one between two rights. When you’re faced with a decision between two potentially profitable investment strategies, how do you find the clarity that will leave you content with your selection? Although I can’t help you work through all your weighty life choices, I can channel a little investing guidance from Clark Winter, author of The Either/Or Investor: How to Succeed in Global Investing, One Decision at a Time.



As director of portfolio strategy and managing director of Goldman Sachs, Winter has surely faced a fair number of challenging choices. He believes binaries simplify the decision-making process: If you can whittle your options to two, you can begin to gather the necessary information and assess that data. “I realized that smart people approach problems as dichotomies — either/or decisions,” he explains in the preface. “If this, then not that. If yes, if no, then what?”

Great investing is really about understanding how to evaluate facts, Winter continues — “how to make reasonable suppositions about the things you don’t know, how to account for the uncertainties that impede decision-making, and finally how to do all that rapidly enough so that you can gain an advantage over competitors and thus the market.” At 27 pages the introduction might be longer than many book chapters, but it’s more illuminating than many, too. I found it very compelling reading and one of my favorite parts of the book.

Winter didn’t want to write yet another tome about investing but instead one about sound decision-making, with investing as the object, not the subject. Winter’s purpose is to “link the two skill sets, investing and decision-making.” Though he assesses markets using hundreds of binaries, he focuses here on the 21 he says can explain just about all investment thinking.

Most chapters in The Either/Or Investor are based on these dichotomies, with their titles identifying the decision-making lesson you’ll discover: “Here Versus There,” “The Developed World Versus the Developing World,” “Preservation Versus Growth,” “Fad Versus Trend,” “Conventional Wisdom Versus Anomalies” — you get the idea.

“In investing, the first and most important binary is fear or greed,” Winter says, and sure enough you can learn why by reading Chapter 7, called — of course — “Fear Versus Greed.” You might read his chapters hoping for universal right or wrong answers, but Winter wants you to learn to ask what the available information tells you to do. And although he can’t answer that question, he does give a firm enough push in the direction of information gathering and analysis to help you build some momentum in your process.

The Either/Or Investor disputes the popular belief that all the average inves-tor needs to achieve the returns of a spectacularly successful investor is to follow that master’s strategy. Winter even takes on books that model famous investors’ methods (ones you’ve probably read about right here, in fact). His beef isn’t so much with these experts but with what he considers the misapplication of perfect math (assuming, for example, the reader will achieve an average annual return of 11 percent) and readers’ inability to accept the idea that they won’t ever match the very best money managers’ returns. Winter is determined to promote this daring, provocative position even though it’s a hard reality for most investors — not to mention the publishers of all those investment books — to acknowledge.

The subprime mortgage crisis hit full force after Winter submitted The Either/Or Investor to Random House but before the book was published. He seized the opportunity to update his manuscript and address more directly the problems of easy credit. This revision makes the book feel even more relevant, especially for investors concerned about today’s economic uncertainties.

Can you endure a few final binaries? Plausible vs. forgettable: My answer? Highly plausible — quite convincing, too. Read it vs. skip it: Read it, definitely.

Here’s one more piece of information, if it will help your assessment: The Either/Or Investor is high on my list of the most thought-provoking, assumption-challenging, instructive books of 2008. And that’s one determination I didn’t have a bit of trouble making.

Have a question about this month’s book? Want to share your own recent financial favorites? Write to Angele at angemc
quade@betterinvesting.net.



Angele McQuade is the author of two books, including Investment Clubs for Dummies. You can find her online at angelemcquade.com.

http://www.betterinvesting.org/Public/StartLearning/BI+Mag/Articles+Archives/1008publicbv.htm

Defining Value: Are You an Investor or a Speculator?

Defining Value
Are You an Investor or a Speculator?


Value, like beauty, is in the eye of the beholder. As “a beggar’s dime is worth more than a king’s gold,” seeking value in the stock market is often subjective. Some investors think that a value stock should be a mature company; some think it has to trade at a low price-earnings ratio; and some believe that a high dividend yield is key.


by Ronald W. Chan and Brian C. Lui
29.10.08

In our first article on the subject, we’ll define value investing and how it’s applied. Before we begin, however, we must ask ourselves who we are when we purchase a stock — investors or speculators?



Investing and gambling traditionally have been viewed as being at the opposite ends of the spectrum, with speculating in between. An investor, through fine calculation, gains profit and earns dividends; the less reputable speculator or gambler, by skill or luck, gains only profit.

Benjamin Graham, the father of value investing, distinguished between investment and speculation: “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”

Graham disciple Warren Buffett believes investing intrinsically encompasses the notion of value. In a letter to shareholders, he wrote: “The very term ‘value investing’ is redundant. What is ‘investing’ if it is not the act of seeking value at least sufficient to justify the amount paid? Consciously paying more for a stock than its calculated value — in the hope that it can soon be sold for a still-higher price — should be labeled speculation.”

A low earnings multiple and high dividend yield aren’t necessarily the determining factors of a value stock, Buffett said. A stock with a high P/E can also be cheap as long as its value is higher than its stock price.

People often separate value investing from growth investing as if they’re opposing practices. This distorts the true nature of what value investors do. “The whole concept of dividing it up into ‘value’ and ‘growth’ strikes me as twaddle,” says Charlie Munger, Buffett’s business partner. “It’s convenient for a bunch of pension fund consultants to get fees prattling about and a way for one adviser to distinguish himself from another. But to me, all intelligent investing is value investing.”

Buffett spoke of value and growth in a softer tone and united the two strategies: “The two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.”

Simply put, value investing means buying a stock when it’s trading at less than its fair value. In practice, investors must bear in mind that a stock certificate means part ownership of a company. Therefore, to be a good investor, one needs to think like a good businessman.

Imagine that an investor wants to buy out an entire business. He obviously doesn’t want to overpay, so the company’s fair value is crucial. Stock investors should apply the same mentality.

In value investing terms, determining the fair value — commonly known as intrinsic value — is the first step to successful investing. A stock’s intrinsic value is calculated from the economic value of its underlying business. Thus, a value investor needs to delve into a company’s financial statements and analyze its competitive position, considering both tangible and intangible attributes.

Although there are many different models for deriving intrinsic value, the most common method involves the concept of discounted cash flow. This model measures the cash that can be taken out of a business during the remainder of its life and discounts the cash flow at an appropriate interest rate.

Intrinsic value calculations can vary widely depending on the growth and interest rates assumed. So value investors should treat intrinsic value more as a rough estimate than as a precise figure. In our next article, we’ll explore intrinsic value’s technical aspects. After all, value investing is half art and half science; therefore, a true investor needs to be prepared mentally and mathematically.

That said, Albert Einstein put it well: “Try not to be a person of success, but rather, a person of value!”

Ronald Chan and Brian Lui operate Chartwell Capital Limited, an asset management firm based in Hong Kong.

http://www.betterinvesting.org/Public/StartLearning/BI+Mag/Articles+Archives/1008public1.htm

The Oracle of Omaha Exhorts Investors to Buy

Buffett’s Advice Always Fit to Print
The Oracle of Omaha Exhorts Investors to Buy

by Kenneth S. Janke
7.1.2009



Most of the time, I preferred to read the college newspaper, keeping track of our football and cross country teams as they both went on to win national championships that fall. The one big disappointment I had with the Times was that there were no comic strips. How in the world could a newspaper not have comic strips and devote the sports section to the Yankees and Giants, seldom mentioning games in the Midwest?

A few years ago, I succumbed again and subscribed to the Sunday edition. But I soon realized that I read only the financial section and was turned off by the rest of the reporting. There still weren’t any comic strips, but I unsuccessfully attempted to complete the crossword puzzle and developed a dislike for the puzzle editor. I had stopped reading any part of the Times until Warren Buffett’s opinion piece published on Oct. 16. (As of early December the article, “Buy American. I Am,” was still available for free at the newspaper’s website. Use the site’s search function for quick access to it.)

Since I’ve always enjoyed reading Buffett’s remarks in the Berkshire Hathaway annual reports and listening to him talk about his approach to investing, I read the article carefully. Now, keep in mind that this was written a full month before the heavy gyrations (mostly down) in the stock market through the first three weeks of November. During that span it wasn’t unusual to see daily moves in the Dow Jones industrial average of 300 points and more. Although you wouldn’t call him bullish, he explained his analytical outlook and said he was buying American stocks in his personal account.

The reason he was buying was covered in a couple of paragraphs:

“A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

“Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.”

We already know he’s an investing genius, but Mr. Buffett also has an extraordinary talent to succinctly state in a few words his approach to investing. It’s commonsense advice we should follow. Oh, by the way, The New York Times still doesn’t have any comic strips.



Kenneth S. Janke, Sr., is a chairman emeritus of the NAIC/BetterInvesting board of directors and a member of the magazine’s Editorial Advisory and Securities Review Committee.

http://www.betterinvesting.org/NR/exeres/AD099AF4-F179-403D-9B30-8DBB0FD9DB29.htm

Risk Tolerance: Mood, Recent Events Can Change Your Point of View

What’s Your Tolerance for Risk?
Mood, Recent Events Can Change Your Point of View

by Alexandra Armstrong CFP, CCPS and Karen Preysnar CFP
8.4.2009


The dictionary defines risk as “the possibility of suffering harm or loss; danger.” But many people think of risk as the possibility of making money more than the potential of losing it. Or at least they did before experiencing the market of 2008. We’re willing to bet that you’d answer the question of how much risk you’re willing to take differently today than you would have in December 2007 when the current recession started.


The losses we saw in the stock market in 2008 as measured by the Standard & Poor’s 500 index1 surpassed previous annual losses since 1825 with the exception of 1931, reports Value Square Asset Management and Yale University. Last year’s losses weren’t confined to stocks, since corporate bonds lost value as well. Recently a money manager told us that in October, if you wanted to sell a bond position, it was difficult to find a buyer at any price. If you were invested during the last quarter of 2008, there was no place to hide — except in cash or U.S. Treasury securities.

The whole issue of risk is a difficult one to discuss. Unlike measuring height or weight, there’s no unit of measurement for risk tolerance. Your risk tolerance can be measured only relative to others on a constructed scale in much the same way an IQ is measured. Even the meaning of the word risk can depend on the situation. When individuals talk about risk as they experience it in their financial affairs, they aren’t talking about the same thing as investment researchers discussing the risk of a particular kind of investment.

As we mentioned in our November 2008 article, we provide our clients with a risk tolerance questionnaire with 20 questions. But this only gives us an idea of what degree of risk people are willing to take at the time they’re completing the questionnaire.

We have to recognize that your risk tolerance changes and can be easily influenced by recent information and even your moods. It’s easy to rate yourself as an aggressive risk-taker when you think home values and stock prices can only go up. When they come crashing down again, though, people tend to become very conservative very fast.

We think there are two basic ways of looking at risk-taking. The first is to assess the amount of financial risk you can afford to take. The second is to assess the amount of emotional risk you’re willing to take.

When assessing the level of financial risk you can afford to take, consider your age as well as the amount of assets you have. For instance, if you’re relatively young and part of a two-earner couple who don’t spend all your income, you should be able to afford to take more risk with your investments because you have time on your side. Even if your investments don’t work out as you hoped, you can make other investments in the future.

Those who are retired and need to live on the income from their investments, however, can’t afford to take as much risk. With retirees living longer than they did in previous generations, this has become more of an issue, particularly for those who don’t have a pension providing them with regular income.

The size of your total assets influences your attitude toward risk as well. People who have more assets than needed to maintain their lifestyle usually are willing to take more risk with at least some of their investments.

During the tech debacle of 2000-2002, values of homes were increasing. Assuming you hadn’t invested all your portfolio in tech stocks, even though the stock market was down as measured by the major indexes, you didn’t feel as poor because your house was worth more. Thus, you could tolerate riding out the down market of 2000-2002.

Between 2003 and 2007, your patience was rewarded, and hopefully you saw your investments grow in value. At the same time, the value of your home continued to go up. In some cases, during this period some retirees became complacent and withdrew more than the recommended 5 percent from their portfolios because they could do so. After all, they reassured themselves that their principal was intact. This past year’s market decline has changed all that. Now investors realize that markets really do go down as well as up and their investments can decline in value.

Once you’ve figured out how much financial risk you can afford to take, you need to measure your emotional attitude toward risk-taking. If your parents or grandparents lost all their money in 1929, or if your father wasn’t good at managing money, you may have difficulty taking risk with your own money. This is a very human reaction. It’s important to realize that these negative family experiences can have a lasting negative effect on your attitudes.

In addition, your attitude toward taking risk can vary over time based on your most recent experiences (either positive or negative) when you took risks. For example, some new clients will say they’re highly risk-averse, but when we examine their portfolios, they own some speculative investments. When we ask about this apparent inconsistency, they usually reply that they used to be risk-takers, but these investments didn’t work out well, so now they’re less willing to take risk. Obviously, the reverse can be true. If your experiences with taking risks were rewarded in the past, you’ll probably be more willing to take chances in the future.

After you’ve assessed how much risk you can afford to take and how much risk you’re comfortable taking, you should focus on risk reduction techniques. It’s important to start with the basic premise that it’s virtually impossible to avoid risk altogether. For instance, when you cross the street, you run the risk of being hit by a car. But there are ways you can reduce your risk. If you cross the street at a marked intersection when the light clearly indicates it’s safe for you to walk, you’ve greatly lessened your risk of being hit. If instead you’re jaywalking, you’re taking more risk.

When investing, the first way to control the negative impact of risk-taking to some extent is by doing your homework. There’s a difference between taking educated risks and speculating. Speculating is equivalent to racetrack betting if you put all your money on one horse with the name you like or the color of silks you prefer.

As a BetterInvesting member, you’re familiar with this concept of educating yourself. A company might have a wonderful product, but you need to check out its competition, the amount of debt the company has, its record of earnings and the relationship of earnings to the stock’s current price before deciding to invest in it.

We believe you can also reduce the risk you take with investments by diversifying your portfolio among different kinds of investments (international/U.S. stocks, bonds, cash) and within asset categories (small-cap, large-cap and so on). If you diversify, one investment might not work out as well as expected, but others may do well so that overall your total portfolio is worth more than the amount you invested.

For example, let’s compare two investors. Mary invests $100,000 that earns 8 percent annually. At the end of 20 years, her portfolio is worth $466,096. On the other hand, Jane invests her $100,000 among five different investments — $20,000 each. After 20 years she assesses her situation. The first investment is a total loss, while she gets her money back with the second. With the third investment, she received an average annual return of 5 percent; the fourth, 10 percent; and the fifth, 15 percent. At the end of 20 years, she would have $534,947 — almost $100,000 more than Mary does (see table, below).



Another way you can control your risk is to work with an experienced financial adviser. Although this isn’t necessarily a panacea, the adviser can show you different investment alternatives and explain both the risk and return potential of each choice. That way you can construct a portfolio that matches your risk tolerance.

We explain to clients that there’s no right or wrong attitude toward risk. What’s important is that you’re honest with both yourself and your adviser about your risk tolerance and construct your investment portfolio accordingly.

Rank your own risk temperament on a scale of 1 (risk-averse) to 10 (willing to take a high degree of risk) and then make sure you communicate this information to your adviser. If you’re married, are you more or less of a risk-taker than your spouse? We’ve often seen instances in which one spouse is willing to take a lot of risk and the other is willing to take few risks. This can lead to family conflict. You need to discuss this issue with each other, and some compromises may have to be made. For instance, the spouse who’s more willing to take risk might invest part of her portfolio in more aggressive investments than her partner.

After experiencing the 2008 stock market, many investors are shellshocked and may vow to avoid investing altogether, thus trying to avoid taking any risk. We don’t think this is a wise decision. Although this past year’s experience has been very difficult for everyone, it may have some good long-term results. Perhaps people will realize that you can’t make fortunes overnight, that you should avoid being heavily in debt, that you shouldn’t spend all your income, that it’s important to accumulate a cash reserve for a rainy day and that you really need to investigate before you invest. In other words, they may start believing all those maxims that financial planners have been preaching for years!

Although taking some risk is essential to making money, it has been our experience that you don’t have to be a speculator to build wealth successfully. We advocate controlling the amount of risk you take through self-education, portfolio diversification and consultation with a good adviser.

Having been in the investment business for over 40 years, we really believe that ultimately the pendulum will turn and selecting and holding good-quality investments will reward patient investors. We encourage you to take a deep breath, take educated risks and make sound decisions that aren’t based on emotions.

Keep in mind the tortoise and hare race. We believe the slow, steady, consistent approach works every time.

1 The S&P 500 index is an unmanaged index comprising widely held securities considered to be representative of the stock market in general. Performances of the indexes are not indicative of any particular investment. Individuals cannot invest directly in any index. Past performance is no guarantee of future results.

2 Diversification doesn’t guarantee against loss. It’s a method used to manage risk.



Alexandra Armstrong is co-author of the fourth edition of On Your Own: A Widow’s Passage to Emotional and Financial Well-Being. She is a Certified Financial Planner practitioner and chairman of Armstrong, Fleming & Moore, Inc., a registered investment advisory firm in Washington, D.C. Securities are offered through Common-wealth Financial Network, member FINRA/SIPC. Investment advisory services are offered through Armstrong, Fleming & Moore, Inc., an SEC-registered investment adviser not affiliated with Commonwealth Financial Network.

Karen Preysnar, Certified Financial Plan-ner practitioner, co-author of this article, is vice president in charge of financial planning at Armstrong, Fleming & Moore, Inc., and a registered representative with Common-wealth Financial Network.

Individuals should contact a financial planner, tax adviser or attorney when considering these issues. Commonwealth Financial Network does not give tax or legal advice. Consult your personal adviser before making any decisions. The authors cannot answer individual inquiries, but they welcome suggestions for article topics.


http://www.betterinvesting.org/Public/StartLearning/BI+Mag/Articles+Archives/0509fppublic.htm

Inflation and Your Portfolio

Inflation’s Deflating Effect on Stocks
No Free Lunch With Looser Credit, Increased Government Spending

by Virginia B. Morris
13.5.2009


As unemployment increases and retail sales falter, the threat of inflation isn’t getting much attention. Instead, the government is focused on trying to stimulate spending as a way to end the recession. Using the primary tool at its disposal, the Federal Reserve has kept the federal funds rate between 0 percent and 0.25 percent since the end of 2008. By comparison, the rate was 5.25 percent in summer 2007, before the meltdown in the subprime mortgage market and the subsequent credit crisis.


Perhaps the most immediate effect of the Fed’s decision is the reduced rates on conventional mortgages available to borrowers with high credit scores. In many areas of the country, those rates are lower than they’ve been since 1965, according to Freddie Mac. Car dealers are offering even lower rates — though sometimes with strings attached — to get moribund vehicle sales moving.

But even with the added liquidity that low rates provide, there’s been relatively little economic growth. One reason is that people concerned about losing their jobs are reluctant to make major financial commitments, including
discretionary or large purchases. Similarly, businesses that may be able to borrow more cheaply, or hire talented workers more easily, than they could six months ago
may be reluctant to expand when the timeline for an economic recovery is uncertain.

Meanwhile, if the Fed’s looser credit policy works — and we have to hope it does — the downside is that it could kick off a new inflationary spiral.

The spiral typically works like this: On the consumer front, increasing demand for a range of products would drive prices up because months of production cuts have reduced supply. On the business side, the increased costs of adding new employees and new equipment to meet demand would result in higher prices for new products. More problematic, an expanding economy typically increases demand for energy, which can ratchet up costs across the board.

Inflation and Your Portfolio

As if paying more for almost everything weren’t enough, rising inflation can also create problems for your stock portfolio. An old rule of thumb is that when inflation threatens, stock prices suffer.

One explanation for falling stock prices in an inflationary period is that interest rates also often inflate as the Fed tightens the money supply to rein in borrowing. When the rate investors can earn on insured bank CDs is high enough, they tend to move out of stocks and into CDs. The thinking is that there’s no reason to risk losing principal when you can realize a higher return with no risk.

In addition, investors may be concerned that the higher earnings companies report in inflationary periods may result from artificially high prices rather than productivity gains. In that case, investors may be unwilling to pay the current price for the stock or, if they own it already, decide it’s time to sell. Similarly, if they sense that inflation is getting out of hand, they may anticipate that the Fed will reverse course and tighten its credit policy. In that case, companies that have become too dependent on easy credit are likely to lose traction as borrowing becomes more expensive. As their expectations falter, their stock prices are likely to fall.

The Deficit and Stock Prices

Another, more serious threat to stock prices may be the increased federal deficits that result from the programs designed to jump-start the economy and put more money into circulation. To meet its obligations, if the Treasury needs to raise rates on its issues to attract investors, those higher rates will attract money that might otherwise have gone into stocks, pushing equity prices lower.

At the same time, if unemployment remains high, the country could witness a replay of the stagflation — high inflation in a stagnant economy — that plagued the United States in the 1970s and early 1980s. In 1980, for example, the inflation rate topped 13 percent — more than 10 percentage points above the historical annual average of 3 percent.

Yet as concerned as stock investors may be about prospective inflation, it pays to remember that the early 1980s were followed by the longest bull market in U.S. history. Although this isn’t a prediction of what may happen over the next few years, history may provide some assurance that stocks have the potential to rebound even from the toughest times.



Virginia B. Morris is the Editorial Director for Lightbulb Press.

http://www.betterinvesting.org/Public/StartLearning/BI+Mag/Articles+Archives/060709abpublic.htm

Six Defensive Moves in a Down Market

Six Defensive Moves in a Down Market
A Great Time for Regular Investing

by CraneAmyButtell
24.12.2008



Market volatility is enough to give any investor heartburn these days. Although there have been some notable gains — the Dow Jones industrial average’s 889.4 point gain on Oct. 28 being one of the most impressive ever — most of the volatility has been on the downside.


With the media delivering one grim story after another about the economy, most observers aren’t expecting to see the market stabilize soon. Unemployment is up, banks aren’t lending, big corporations are teetering on the brink of bankruptcy and banks are failing at a rapid clip, news that doesn’t exactly inspire confidence.

Still, with so much riding on your investments, including your retirement and your kids’ college savings, you might feel it’s time to position yourself somewhat defensively given how long this downturn might last. You don’t want to stop investing, because there’s no way to know when the market will rebound; you have too much to lose by being out of the market at the wrong time. But here are some steps you can take to lessen the pain and position yourself as best you can.

Dollar-Cost-Average Your Contributions

You’re most likely already doing a lot of dollar-cost averaging — investing a set amount regularly — if you’re contributing to a 401(k) or college savings plan. This is a good strategy no matter what the market is doing because when you dollar-cost average, you buy more shares when prices are lower and fewer shares when prices are higher, keeping your overall cost basis down.

If you can employ this technique with your other investment accounts, do so. By dollar-cost averaging in a volatile market, you keep your cost basis down. If prices fall farther, you’ll benefit more by spreading your purchases out over a longer period than if you just invested a lump sum all at once.

For example, if you have an individual retirement account and plan to invest the maximum allowable of $5,000 annually, you could arrange to have $416.66 transferred from your bank account to your IRA every month and have that invested in the stock, mutual fund or bond of your choice. Or you could invest the money all at once in your IRA at the beginning of the year, then dollar-cost average it out yourself over a year.



Consider Stop-Losses?

Stop-losses aren’t a good idea for most investors in most long-term investing situations. But if you absolutely cannot afford to lose more than a certain amount of money in your investment accounts, this strategy is worth considering.

You might fall into this category if you’re a retiree on a fixed income with only a certain amount of assets in your retirement account besides your Social Security. To implement this strategy, you either call your broker or go into your online investment account and set a floor on some of your investments. When the prices of the securities you select reach those floors, your brokerage will automatically sell them.

Keep in mind, however, that in falling markets the price can blow right by your stop-loss order and you may be sold out at a much lower price. This is why you should employ this strategy cautiously. (Editor’s note: Many investors don’t like stop-loss orders because of their automated nature and because they might cause you to sell high-quality stocks that drop for reasons unrelated to their fundamentals.)

Save More

In a difficult economy, it makes sense to hunker down and cut your expenses where you can. Unemployment is rising, and you never know when you or your spouse might be out of a job. If you do hang on to your job, later on you can invest some of your excess cash for your retirement, your children’s college education or any other long-term goals you have.

Below are the extra savings you can expect to generate for differing saving rates. The following assumes you’ll reap 8 percent annual compound interest, pay 25 percent in federal taxes and 6.5 percent in state taxes, and see an average inflation rate of 3 percent:

• by saving $50 a month for 30 years, you increase your savings by $25,970
• by saving $100 a month for 30 years, you increase your savings by $51,940
• by saving $200 a month for 30 years, you increase your savings by $103,880

Stretch Out the Long Term

Change your attitude on what constitutes the long term and remember that stocks historically have averaged an annual return of 10 percent or more. Think of the long term as 20 or 30 years, or even more, rather than five or 10 years.

Because stocks increased so much in the 1990s and in the 2000s after the end of the dot-com bust, the law of averages dictates that the market will then have a number of average or subpar return years at some point.

Large returns are nice, but there’s no guarantee they’ll continue in the short run. History shows that the stock market has produced many years of ugly returns, even consecutively, or returns that have gone essentially nowhere over a number of years. Think about the late 1920s and 1930s as well as the mid-to-late 1970s and early 1980s.

Surviving a negative or sideways market that lasts for years takes a lot of patience. In those circumstances, continue dollar-cost averaging, work on bolstering your cash cushion and save every dime you can get your hands on.

If you’re getting close to retirement age, consider staying on the job a few years longer to shore up your nest egg. If that isn’t a possible, consult or take on a part-time job.

Just about the worst thing you can do is start drawing your assets down when the market is tanking, as it will be difficult for your investments to recover sufficiently to fund the rest of your retirement, given lengthening life spans.

Check Your Asset Allocation

With stocks and below-investment-grade bonds taking substantial hits in the last few months, it’s likely that your target asset allocation is out of whack. Take a look at your investment accounts and determine what you need to do to get back to your target allocations.

Financial planners generally recommend that you reallocate assets periodically, with once a year being a good benchmark. At this annual reallocation, you should move investment funds from asset classes that have done well, or at least have not done as badly as others, and move them into those that have declined, such as stocks.

Given the uncertainty of the markets, it might make sense to reallocate gradually rather than all at once. For example, if your investment accounts total $100,000 and your target allocation is 60 percent stock, 20 percent bonds and 10 percent cash, you could move funds out of bonds and cash gradually to bolster your stock allocation up to the preferred target.

Such a gradual shift could work in several ways. For example, you could move money out of bonds into cash all at once, then gradually dollar-cost average into stocks over the next six months or year or so. (Editor’s note: Be careful with asset allocation so that you’re not trying to time the market, an often disappointing venture. Many investors believe that for a long-term portfolio, there’s little reason to own anything except stocks.)

Expand Your Cash Cushion

Cash is an important bulwark in a falling market and during what’s shaping up to be a potentially long recession. When you have enough cash to last out the ups and downs of the markets without having to sell any of your investments, you can respond to market developments rather than react to them.

Financial planners recommend that employed workers have six months of living expenses squirreled away. Retirees should have at least two years of cash, preferably more, so that they can ride out a bear market of several years without having to sell investments at fire-sale prices for living expenses.

If you’re still working, see where you can trim your expenses and direct those savings into a bank savings or money market account. Interest rates on these savings vehicles aren’t great, but the ease of access to these funds is the most important factor.

With an expanded cash cushion, there’s less danger that you’ll need to tap your investment accounts for funds, whether by liquidating taxable mutual funds, stocks or bonds or by arranging to borrow from your 401(k) account.

No Time to Cash Out

When positioning your portfolio, it makes sense to play both defense and offense. Just remember not to give in to your emotions and get out of the market altogether, no matter how dire the markets and the economy may seem today. The next upturn is impossible to predict.


http://www.betterinvesting.org/Public/StartLearning/BI+Mag/Articles+Archives/0109mfmpublic.htm

Explaining the Mark-to-Market Controversy

Fair Game for Asset Values
Explaining the Mark-to-Market Controversy

by Virginia B. Morris



If you want to know what a stock sells for, you look at its current market price. That price might be different from what it was yesterday or what it will be later today or tomorrow. But it’s what the stock is worth right now because it’s what you could sell it for. The value of an investment, in this sense, is determined by how interested other investors are in owning it at this moment.


The market price of a mutual fund share is also clear — although it’s determined by the value of its underlying investments and the number of outstanding shares in the fund, rather than by what people are willing to pay for fund shares. Once a day a fund, using a process known as mark-to-market, finds the closing prices of the securities in its portfolio. Then it calculates the fund’s net asset value, which is its per-share price for the next 24 hours.

Futures contracts, which tend to be significantly more volatile than either stocks or mutual funds, are also marked-to-market every day to make those markets more transparent.

The Fairness of a Fair Value Price

In effect, mark-to-market is a widely recognized method for determining the fair market value of an investment. If that’s the case, why do some people want regulators to suspend this established accounting practice amid the current financial uncertainty?

For starters, it helps to know about rule FAS 157, which U.S. government regulators introduced in 2007. This rule requires publicly traded financial companies to report the value of some, though not all, of their assets and liabilities by marking them to market. The controversy arises because the assets that must be marked-to-market are those that either trade infrequently or don’t trade at all, basically because nobody wants to buy them.

If you own something you can’t sell, what’s its value? Often, it isn’t worth what you paid for it. And if you borrowed money to buy the asset, it could be worth less than you owe. That’s the predicament many homeowners face as housing values have dropped and credit has dried up.

This problem of owning assets whose value has shrunk is magnified for financial companies, partly because so much money is at stake. In addition, these companies are required to keep a certain amount of capital on hand to meet their obligations.

If cash is running short — perhaps because clients pull their money out — these companies have to sell whatever assets they can, at whatever prices they can get, to have adequate funds on hand. These fire-sale prices become the new valuation for similar assets that the company retains and for comparable assets owned by other firms.

When these diminished values are reported on a company’s balance sheet, as they must be under the rules, the firm’s financial situation appears significantly less healthy than it would be if the assets’ purchase prices were being reported instead. And the less value a company’s balance sheet shows, the harder it is for that company to borrow, potentially threatening its ability to survive.

To Mark or Not to Mark

Would relaxing or eliminating the mark-to-market rules loosen up credit and help trigger an economic recovery? Advocates of this approach insist that in bad times, assets can be hard to value and harder to sell. Further, they argue that firms shouldn’t have to value long-term assets for what they could be sold for immediately, especially if the companies don’t want or need to sell them.

Opponents of relaxing the rule are equally adamant. They maintain that transparency is essential for a strong and healthy economy and that the current financial problems aren’t the result of mark-to-market rules. Rather, they point out, many of the companies at risk were eager for outsized profits, so they invested in innovative and perhaps fatally flawed products whose true value was never established.

One of the first things you learn as an investor is that you should avoid securities you don’t understand and that a thinly traded product puts you at increased risk. So you may wonder why these investment basics seem to have escaped the notice of so many experienced financial professionals.



Virginia B. Morris is the Editorial Director for Lightbulb Press.

http://www.betterinvesting.org/Public/StartLearning/BI+Mag/Articles+Archives/0109abpublic.htm

Using Book Value in Making Investment Decisions

Going by the Book
Using Book Value in Making Investment Decisions

by Virginia B. Morris



Heading the list of questions investors sometimes struggle to answer is the perennial “What’s this stock worth?” The response is never simple, since there are several ways of assessing value. One of the most reliable ways is to use a combination of ratios, also called multiples. The BetterInvesting methodology employs the price-earnings ratio, which compares the stock’s price with its earnings per share.


Investors also measure a company’s stock price in relation to entries on its balance sheet. One of those ratios is price-to-book, or a stock’s market price divided by book value per share.

A stock’s book value, also called its net asset value and sometimes its shareholder equity, is key to figuring its price-to-book. Even if you don’t use price-to-book in your analysis, you should understand what book value is because it’s part of the calculation of return on equity, a key measure of management performance on the Stock Selection Guide.

Basically, book value is the company’s assets minus its liabilities, divided by the number of outstanding shares. The liabilities include the obligations the company has to its bondholders and preferred stockholders.

Some stock research companies report price-to-book over time, such as 10 years, as well as percentage growth in book value. You can also calculate book value on your own, using the company’s financial reports. You find net assets by subtracting the company’s short- and long-term liabilities from its assets. Then divide net assets by the number of outstanding shares to find the per-share results.

Two cautions: Check what’s being counted as assets. If intangibles such as goodwill or brand value are being included, those amounts should be subtracted to determine net assets. Also, as a related point, book value is more meaningful for companies that have actual physical assets that can be valued.

What P/B Tells You

Book value is important because it can help you determine whether a stock you may be interested in is underpriced and therefore potentially worth purchasing.

If the market price of a stock and its book value are the same, its price-to-book value is said to be 1. In that case, investors are paying exactly the value of the company’s reported assets. If the ratio is more than 1, they’re paying for past performance or what they anticipate the company’s future performance will be. That’s quite common, especially for companies with strong earnings.

Conversely, a ratio of less than 1 may indicate investors aren’t convinced that the assets the company is reporting are credible. It also may signal that the company’s performance has been disappointing or the stock is out of favor with investors for some other reason. Questionable valuation of assets, of course, is a reason to steer clear of the stock, while the latter instance, which is remediable, may be a reason to consider buying.

One for the Books

Both book value and price-to-book change constantly as a stock’s market value and the number of its outstanding shares continually fluctuate. As a result, these numbers are “snapshots” that report the present but can’t predict the future.

If you’re just beginning to investigate a stock, however, book value is a useful benchmark to watch as you track the issuing company over time. That’s especially true if you’re looking at a number of stocks in the same sector or industry, since the price-to-book value can be strikingly similar across companies of varying sizes in the same industry. One that’s out of sync may be a stock that merits closer attention.

As you study a stock, putting its price-to-book and percentage growth in book value in a historical context can be helpful in establishing a target price you’re o use this ratio want a sense of where the current price fits in relation to earlier highs and lows in helping them pinpoint a price range that would allow them to realize a satisfactory return.

Putting Value in Perspective

Book value and a price-to-book ratio, by themselves, should never be the single basis for making an investment decision, any more than the ROE, EPS or P/E should be. But each can be a valuable addition to your research toolbox, and used in combination they can provide a valid foundation for choice.



Virginia B. Morris is the Editorial Director for Lightbulb Press.


http://www.betterinvesting.org/Public/StartLearning/BI+Mag/Articles+Archives/0409abpublic.htm

The Quest for Sustainedable Earnings Growth

The Quest for Railroad-Track Growth
Often a Sign of Good Management, Sometimes Too Good to Be True

by Michael Maiello

Sustainable earnings growth is a Holy Grail sought by investors of all stripes. Value investing guru Benjamin Graham searched for it, choosing stocks based in part on a management team’s ability to generate an upward trend in earnings over many years. Graham was a bit accommodating with this requirement; he’d tolerate flat earnings for a year or two so long as it didn’t look as if earnings were about to break through the floor. He believed stock prices eventually would track growing earnings over time.

Growth investors expect more. BetterInvesting members look for companies that have a consistent history of producing better-than-average earnings growth. In innovation-based industries such as pharmaceuticals and technology, this can often mean double-digit earnings growth even as stocks in the broader market are buffeted by recession.

The managers of the U.S. Trust Focused Large-Cap Growth Fund explain the strategy this way: “Emphasis is placed on selecting high-quality companies having dominant industry positions, strong financials and consistently high earnings growth rates. Such companies tend to be brand name, globally dominant companies in open-ended growth industries such as devices/biotech/ genetics, information technology, global consumer brands and global financial companies.”

Consistent earnings growth implies that a company is in a position to maintain dominance and has the management team to do it. A good example is Johnson & Johnson. Its five-year earnings growth rate is 13.8 percent a year, creating enough steady increases to fund 14 percent growth in dividends over that time and more than 20 percent return on equity. J&J has a diversified product line across pharmaceuticals, home products and consumer goods. Its ability to distribute products around the world is difficult for competitors to match much less beat. This seems to be a company where the past growth is indicative of good management and a dominant market position. (Companies are mentioned in this article for educational purposes only. No investment recommendations are intended.)

Apple has grown earnings at well over 100 percent annually for the last five years, an amazing run as new products such as the iPod and iPhone were brought to market and then allowed to mature. These are widely acknowledged as the products of Steve Jobs’ genius, or at least of the culture of design he implemented and fostered during his tenure at the company. A lot of companies had MP3 players and smart phones before Apple, but only Apple made them cool.

But the Apple example brings us to the pitfall of this style of investing. Apple isn’t exactly like J&J. Apple has a good number of larger competitors (such as Sony and Microsoft) that can, and often do, undersell it. Also, fads change, so although Apple’s proven ability to remain in style is nice to know, investors can’t count on it. Look at what happened to The Gap, which was once a hot brand but hasn’t been in a decade.

Another concern is that consistent earnings growth is extremely hard to produce, so investors should try to learn more when seeing 15 percent growth year after year. Enron is among the most notorious examples of this principle. Between 1997 and 2000 the company’s management team somehow beat analysts’ earnings estimates more than three quarters of the time, an amazing feat we now know was made possible by accounting shenanigans that kept losses and liabilities out of the picture. Enron’s managers were also masters at inorganic growth — boosting earnings through acquisitions and asset sales rather than by improving fundamentals in its business.

Finally, watch out for “earnings smoothing,” the term academics and regulators use to describe cases in which company managers adhere strictly to the letter of generally accepted accounting principles, or GAAP, but not quite to the spirit of it. Some have charged that financial firms used loopholes and oversights in the complicated body of GAAP rules to consistently understate losses and potential losses they faced from subprime mortgage exposure early in the credit crisis. This explains why, as the crisis unfolded, there seemed to be so many new surprises from companies that had supposedly come clean.

One rule of thumb: If the earnings growth doesn’t have a simple explanation behind it, as in the case of, say, J&J, Wal-Mart or Apple, at the very least be skeptical.

BetterInvesting’s Online Tools

The Stock Selection Guide, the primary stock study tool of BetterInvesting members, helps you identify stocks with histories of sales and earnings growth. Our new online tool will walk you through evaluating a company using the SSG. Click on the Online Tools & Software link under the Tools & Resources menu on the BetterInvesting homepage. Your membership may already include access to the tool; if not, you can upgrade your membership to use it.



Michael Maiello, who wrote "Fly With the Fundamentals" for the January 2006 issue, is the author of Buy the Rumor, Sell the Fact (McGraw-Hill, 2004).

http://www.betterinvesting.org/Public/StartLearning/BI+Mag/Articles+Archives/0809fundamentalpublic.htm