Why Holding Feels Right - Understanding the Psychology underlying this

Understanding the subtle but strong psychological impediments against selling

At a most obvious level, making profit represents pleasure, while suffering a loss equates to feeling pain.

Let us attempt to understand the deeper layer of forces that dispose us to certain attitudes and behaviours springing from our subconscious pain-avoidance and comfort-seeking tendencies.

When we own a particular stock, inaction (holding) keeps us in or certainly closer to a place of comfort than does taking action to change our circumstances (selling).  Holding onto a friend keeps us close to our past, to memories and feelings we cherish.  Many continue to hold stock in companies whose fortunes peaked years or even decades ago.  Logic alone cannot seem to explain why they resist selling despite obviously dim prospects for recovery or gain. 

• Maybe grandfather worked for the company, or we reside in a town where it supported many families or sponsored the softball team. 
• Perhaps ages ago we made a profit, or at least had a good paper profit for a while in this stock. 
• Or our parents always spoke well of the company or
• confided they had made a decent sum in its shares at one time. 

Thus, nostalgic positive feelings surround it and we find it very difficult to end our association.

Our positive associations with a particular stock create a bonded feeling. 

• We have made a good profit on an overall basis and while the annualised return may be unspectacular, a gain is surely better than a loss and the total dollar or point profit feels pleasant.  So this stock is our friend. 
• Held for a number of years now, it has been virtually adopted as a family member.  Thus, our primary inclination is to not severe such ties by terminating this comfortable relationship. 

Why end this thing, we think at an unconscious and perhaps also at a conscious level.  Living with, rather than without, that stock represents staying in a comfort zone.

Even though the company's fortunes may now have faltered, choosing to sell its stock represents adopting a 180-degree opposite stance.  Issuing that order to liquidate means that we once thought was correct now is no longer so in our minds. 

• This company is no longer under priced, or its prospects or management quality are not what we earlier imagined or expected. 
• Or perhaps we have given up on its price/earnings ratio growing as we had earlier envisioned.

To say sell means that either

• what we once thought was right is no longer so and/or
• that maybe we have already been on the wrong side of the market for some time and are now admitting a change in opinion is warranted. 

Either way, selling represents admitting we now believe what we earlier thought is no longer true.  Most of us have great difficulty acknowledging that we were wrong. 

If you place a very strong value on reputation or esteem in life, the reversal of position inherent in selling is likely to be an especially difficult battle zone for your ego and your comfort.  This can be a special problem for professionals such as doctors, attorneys, and others looked up to.  Reversing a position is made even more difficult if we have publicly or strongly espoused it.  This is a very important reason for keeping our investment holdings secret:  reversing ourselves and selling then at least involves no loss of face with others who knew our prior opinion.

Breakdown of Risk

Actions/risk
that affect only
------One firm-----Few firms---------Many firms---All investments--
                                
Firm-specific=1====2===3==========4=======5===Marketwide


1.  Projects may do better or worse than expected.
2.  Competition may be stronger or weaker than anticipated.
3.  Entire sector may be affected by action.
4.  Exchange rates and political risks affect many stocks.
5.  Interest rates, inflation, and news about economy affect all stocks.

The most prudent practice is never waiting to hear sell advice

A recommendation by an analyst to buy can be presented to every client interested in income.

A sale advice by an analyst applies only to those clients who already own the stock (and to that tiny minority oriented to short selling). 

A sale recommendation has a much smaller business-generating potential.  Reseach analysts are employed and compensated on the basis of the accuracy of judgement and on the amount of business their reports generate.  So analysts have a buy bias too.

Individual brokers face yet another dilemma when making a sale recommendation.  The investor tends to blame poor results more on a sale than on a buy.  That tendency can get brokers into trouble with their clients (and analysts into trouble with a firm's brokers).  Another way for a broker to get into even more trouble is to suggest redeploying the funds in another stock that goes down.

In summary, there are five ways a sale advice can backfire on a broker:

1.  It can offend the client who is emotionally attached to this stock.

2.  Selling can close out a painful transaction (a loss).
3.  The sale can be followed by a price rally, which would have provided greater profit or a reduced loss if the stock had been held.
4.  Funds liberated by the sale might be reinvested unprofitably, making the sale a double troublemaker.
5.  Unless the sale price proves nearly perfect, the broker is resented for generating a commission by suggesting the action.

It is also worth noting that penny-stock houses never recommend a sell unless it is to generate funds to buy something else.  The major reason is that they themselves must buy what investors sell because they, virtually alone, make the market in the stock. 

The most prudent practice is never waiting to hear sell advice.  Assume it will not be heard, and plan to make your personal selling-versus-holding decisions based on your own rules.

Euphemisms

Other words for sell, however, commonly do appear.  Brokerage firms have devised a variety of ways to describte a corporate situation that indicates a sale is the best option. 

• One of them is to write a report covering a corporate finance client, which is labelled a follow-up to the underwriting and carries no opinion or recommendation.  Follow-ups need to be read closely. 
• Even if the official policy is to give no recommendation, the tone of the report needs to be evaluated carefully.  If it is less glowing, suspect that the research analyst is not impressed with this stock and, while constrained from saying so, really thinks it should be sold. 
• Another way, short of uttering the Sell-word, is for the firm to drop analyst coverage of a company altogether.  Such silence is not golden.
• Another diplomatic approach is to give a recommendation other than buy that is kinder and gentler than the Sell-word itself.  The best euphemism for sell, ironically, is its operative opposite: hold.  When an analyst does not want to say buy and is not allowed to say sell, the only option remaining is hold.  Consider hold almost always as a danger sign.  In fact, hold really should generally be interpreted as meaning, do not hold.

Common brokerage euphemisms for sell:

• hold
• accumulate
• long-term buy
• market performer
• market weight
• perform in line
• under perform
• underweight

Another coded way of saying sell is a carefully worded message such as:  The stock is probably a worthwhile long-term holding despite some near-term uncertainties.  That is translated by teh cynic as:  If you hold for quite a while, maybe you will not lose.  All such euphemisms should be taken as signals to cash in.

On the other hand, don't place too much hope on an analyst's postings titled: "Why I like stock XXX a lot?"  Remember the analyst's buy bias and always to do your own homework.

Investors buy stocks in order to sell them at a profit in the future

Investors buy stocks for a number of reasons, many of which are ill-advised. 

From purely an investment perspective, there are only 2 reasons to buy common stocks.

1.  True equities investing consist of identifying those companies with stocks undervalued in terms of future earning power and buying them now because the projected earnings per share (EPS) stream is expected to produce dividends.  So the first objective is dividend income. 

2.  The second objective is capital appreciation.  Growth in price tends to occur over time

• if the fortunes (fundamentals) of the underlying company improve,
• if interest rates do not move sharply higher (squeezing price/earnings ratio [P/Es], and
• if market psychology moves from negative to neutral or positive.

To be successful a transaction requires both buying and selling, since both are required before a transaction's final result is established. 

Many published books dealing with stock market investing in any form focus overwhelmingly on the buying transaction only and neglect the sell side of the equation almost completely. 

Selling may not be exciting, and assuredly it is a narrower topic, but it is absolutely necessary and has its own very interesting twists and curiosities.

Actual reversal to upside price action requires intervention by interested buyers.

Big and persistent buyers must overpower sellers to push stock's price higher

In any speculative market, a snowball that starts going downhill tends to keep going.

Prices swing emotionally from overvaluation to undervaluation. The extent of overshooting on each side is impossible to predict because it is driven by volatile emotions.

So an investor's first job is to become smart enough to realise that the market gyrates and then to get out of the way before the pendulum swings adversely.

While stocks do not always accelerate in decline as an easy telltale signal of having bnttomed, it is universally true that an actual reversal to upside price action requires intervention by interested buyers.

Such buyers must be big and persistent enough first to stop the price decline and then to stabilize the price against any trickle of further selling that results from boredom.

Finally, they must overpower sellers on an ongoing basis to push the stock's price higher.

With literally thousands of stocks available to buy, once a company becomes troubled in the collective opinion of the market, it will take considerable time and probably some notable events for improved prices to hold.

RHB Research upgrades KNM to outperform

RHB Research upgrades KNM to outperform

Written by RHB Research Institute
Thursday, 21 January 2010 09:19


KUALA LUMPUR: RHB Research Institute has upgraded KNM to outperform from underperform on potential stronger orderbook in FY10-11.

“We have raised our fair value to 91 sen a share (from 65 sen a share previously) which is now based on 13 times FY10 PER (vs 11x FY10 PER previously).

“Given potential upside of 17% to our new fair value, we have upgraded the stock to Outperform (from Underperform previously),” it said on Thursday, Jan 21.

RHB Research said KNM management expects FY10-11 orderbook to rise from RM2.8 billion given stronger demand for process equipment arising from new oil sands investments as well as increase in petrochemical plants and refineries.

Stockwatch

In today's The Edge Financial Daily


RHB Research upgrades KNM to outperform
Thursday, 21 January 2010 RHB Research Institute

RHB Research maintains overweight on motor
Thursday, 21 January 2010 RHB Research Institute

Maybank Research maintain Buy on Tenaga, TP 12.10
Thursday, 21 January 2010 Maybank Investment Research

Maybank Research maintains Hold on Public Bank
Thursday, 21 January 2010 Maybank Investment Research

OSK Research: Tenaga fair value RM9.38
Thursday, 21 January 2010 OSK Investment Research

Selling is often a harder decision than buying

"If you have bought a good quality stock at bargain or reasonable price, you can often hold forever." 

Investing is fun.  For every rule, there is always an exception. 

The main reasons for selling a stock are:

 1.  When the fundamental has deteriorated permanently,  (Sell urgently)

2.  When it is overpriced, whereby the upside gain will be unlikely or very small and the downside loss will be big or certain.

 We shall examine reason No. 2 through the property market.  The property market is also cyclical.  There were periods of booms and dooms. 

If you have a good piece of property that is always 100% tenanted and which gives you good consistent return (let's say 2x or 3x risk free FD rates), would you not hold this property forever?  The answer is probably yes.

Then, when would you sell this property?

 Note that the valuation of property, as with stocks, is both objective and subjective.

Would you sell when someone offered to buy at 500% above your perceived market price?  Probably yes, as this is obviously overpriced.  You could cash out and probably easily re-employ the money to earn better returns in another property (or properties) or other assets. 

Would you sell when someone offered to buy at 50% above your perceived market price? Maybe yes or maybe no.  You can offer your many reasons.  However, all these will be based on the perceived future returns you can hope to get from this property in the future.  This is both objective based on past returns obtained and subjective and speculative on future returns.

However, unlike reason No.1 when you would need to sell urgently to another buyer to prevent sustaining a permanent loss, you need not sell just because someone offered to buy the property at high price. (However, there are also those who "flip properties" for their earnings; they will sell quickly for a quick profit.)  You will not suffer a loss but only a diminished return at worse.  You can take your time to work out the mathematics.  You maybe surprised that you may still achieve a return higher at a time in the near future by rejecting the present immediate gain based on the present high price offered.  Also, you would need to price in the lost opportunity cost when the property is sold at this price, even though it is 50% above the perceived normal market price.  Could you buy a similar quality property with the same sustainable increasing income or return by offering the same price?

Similarly, the same line of thinking can be applied to your selling of shares.  When should you sell your shares?  Yes, definitely when the fundamentals have deteoriorated permanently.  The business has suffered for various reasons and going forward, the earnings will be permanently impaired and deteriorating.  Yes, when the price is very very overpriced.  However, you need not sell your shares in good quality companies that you bought at fair or bargain price.  As long as the fundamentals are strong and the business is adding value, selling now at a higher price may mean losing the return that you could have obtained in the future years from owning this stock and the opportunity cost of reinvesting the cash into another stock of similar quality and returns.  Once again, the importance of sound reasoning and doing the mathematics in making a decision whether to sell or not.

Additional notes: Other reasons for selling a stock (or property) are:

• To raise cash to reinvest into another asset with better return.
• A certain stock (or property sector) may be over-represented in your portfolio due to recent rapid price rises and you need to reduce its weightage to reduce your risk of over-exposure in this single stock (or property sector).

Footnote: This is a true story. A rich man was approached by a buyer to sell his property. A few neighbouring lots were sold for $1.6 m the last 2 years. What offer will ensure that you sell your property to me?  Please let me know. The unwilling owner replied, "$5 million". There is a lesson here too.

Buying when the price is right.

When you have a good idea, make sure you bet big.  At other times, don't bother.  Enjoy the things you like, stay inactive if you must.

Just thinking of an analogous situation.  You have been eyeing the house in a neighbourhood.  The house is up for sale, priced at $800,000.  It has been in the market for some time.  The other houses in the neighbourhood had previously been transacted for any price between $600,000 and $800,000.

You have inspected the house and you estimated the fair price for the house based on your assessment to be  $650,000.

Suddenly the economy turned bad.  More houses were up for sale in the neighbourhood.  The prices started to fall.  A house was priced $700,000.  Two months later, another house was in the market for  $730,000.  Then another for $750,000.   The sellers were not keen to lower the prices by much from the quoted price. 

More hardships hit the economy and the community.  No new houses were up for sale, but the buyers literally were not visible.  The prices quoted previously came down, but not by much, except one.  This one house was priced at $600,000 for a quick sale.  The seller was making an urgent sale to obtain cash for various reasons. 

And what did you do?  You waited hoping that the price would drop further.  Perhaps, the seller might sell at $570,000.  You waited for the seller to agree.  You waited. 

Then the news came, the house was sold to another for $600,000.  And how did you feel?  You felt you have missed out on a good deal.  For the next 5 years, the houses in the region never reached this price.  All the houses were priced or transacted around $700,000.

It is difficult, perhaps, close to impossible to buy at the bottom.  There are bargains when the market is on the way down and also on the way up.  The ability to value an asset is important.  As long as the price is below the "intrinsic value" and given an appropriate margin of safety for the risks appropriate for the particular asset, you can buy with conviction. 

Isn't this scenario applicable to buying shares? 

Don't wait for the best price on the way down (Will you ever know when or what will be the lowest price, other than retrospectively?)  or  only pick buy stocks after the prices have swung up from an obvious bottom (Can you predict the short-term volatilties?  The possibilities of the prices swinging up and down over a short period cannot be predicted?  Did you buy when the market swung up from the bottom of March 09, or did you wait thinking that the rally may not be sustainable and the market might go down further?)

Often the shrewd investors wish to buy good quality stocks cheap?  When the prices dropped, some waited hoping for a bigger bargain.  Then the price swung upwards, and that momentary opportunity was lost.  Of course, the consolation is that there will always be another bargain the next time around.

Keeping a proportion of your wealth in cash is always a good thing.  When the opportunities to buy bargains present (and this is always a certainty in the stock market, though perhaps, only about less than 5 times a year), you can then take a big bet.  And here is the point:  Buy when the price is already at a significant bargain to your "fair or intrinsic value".  Once that price is there, buy and buy and buy.  You have all the reasons to buy as you are already buying with a margin of safety to the "intrinsic value."   Of course, if the price dropped further, you can buy more. 

However, be prepared to see the price going further downwards - market prices often overshoot on the way down (and up).  Have conviction in your valuation (assuming you have done the homeworks).  Be patient.  Be very patient.  Be prepared to hold the stock for 2, 3 or 5 years  to realise this objective.  Short term price changes can be volatile and unpredictable.  Provided that you bought only good quality stocks at reasonable or bargain prices, you should, given time and patience, eventually realise a prospective gain.

The importance of only buying good quality stocks cannot be overemphasized.  These are the stocks with good businesses that will over time build value.  These values will eventually be reflected in their share prices.  Even if the prices were to drop below your buying price, given time, the business will generate value pushing the price back to your buying price.

As Benjamin Graham taught, it is not easy to profit consistently by timing the buying. However, one can have high probability of profiting by buying good quality stocks based on price - always buying below the intrinsic value with a margin of safety.

Footnote:

Warren Buffett called the bottom of the market only a few occasions in his long investing career.

• On one occasion, the market continued to go down further for 3 years after his call.
• In the recent severe bear market, he called to buy in October 2008. The market continued its downtrend to bottom in March 2009. Those who bought in October 2008 would have to hold on to losses soon after they bought. However, when the market rebounded from the lows of March 2009, and assuming they have held onto their investments to now, they would have made substantial gains to-date.

The 3 key variables in any investing plan

Why You Shouldn't Give Up on Stocks
By Dan Caplinger
January 20, 2010

You'd think that with all the good news investors have gotten lately, all the doomsayers would be laying low. Yet even after the stock market's big rally from last year's lows, some pundits still question whether investing is a hopeless cause.

Keeping your head above water
An article in The Wall Street Journal earlier this week took a close look at the unrealistic expectations that many investors have about the returns they can generate from their portfolios. After a decade during which the broad stock market has laid a big fat goose egg in the return column, a survey showed that investors expect average annual returns of nearly 14% over the next 10 years.

Yet that isn't the most sobering fact about the misconceptions people have about the financial markets. When asked how much they could expect to keep in terms of purchasing power, after accounting for the impact of taxes, investing costs, and inflation, a group of financial advisers estimated a return of between 6% and 9% annually.

Should you hope for returns that are that good? You bet. But should you count on earning them? No way. Fortunately, if you're smart about how you structure your investment plan, you don't have to earn that high a return from your portfolio.

Keep it real
It's easy to understand how people mislead themselves about how much they can earn from investing in stocks. The secret comes down to success stories: We hear the most about winning stocks, while the much larger group of mediocre performers tends to get lost in the shuffle. Take this group of stellar stocks, for instance:

Stock
20-Year Average Annual Return

Dell (Nasdaq: DELL)
32.9%

Oracle (Nasdaq: ORCL)
21.7%

Altria Group (NYSE: MO)
15.4%

United Technologies (NYSE: UTX)
15.2%

Hewlett-Packard (NYSE: HPQ)
14.5%

Source: Yahoo! Finance. As of Jan. 19.

Combine the bull market of the 1990s with the lost decade since 2000, and you'll see that these stocks have greatly outperformed the overall market. Yet when you take away a few percentage points for inflation, a few more for taxes, and another point or so for trading costs, you'll notice that only the best performers manage to stay in double-digit territory.

More importantly, recall that these are the big winners. For every stock like this, there are several like Dow Chemical (NYSE: DOW) and Citigroup (NYSE: C) that have languished with much smaller gains -- and others, such as General Motors, that have contributed substantial losses to the overall picture.

Stay on target
But don't let the sobering reality of the investing world convince you that it's impossible to reach your financial goals. There are three key variables in any investing plan:

• how much you can save,
• how much you earn on your investments, and
• how much you need to spend.

Investors tend to focus almost solely on their portfolios' earning potential and think a lot less about the other keys to financial success.

If you're not making the most of your financial situation to save as much as you can, then you're making a huge mistake with your money. By saving less than you could afford to save, you'll take bigger risks than you need to. Sometimes, those risks will go sour, costing you what would have been an easily attainable financial goal. Just as millions of investors learned too late that their portfolios included more high-risk investments than they really needed, you could be making big bets that you don't need to make in order to have a safe, secure retirement.

You'll get there
What you do need to do, though, is have realistic expectations. If you're more conservative about the return assumptions you make, you'll have to find more savings to reach a certain target value for your portfolio. But you'll also have more options to help you get there, rather than relying on finding tomorrow's top performers at all cost.

If you can do that, then you won't be fooling yourself about your investing. As hard as it is to rein in expectations during a roaring rally, doing so will leave you in a better condition to make rational decisions about your portfolio -- decisions that are likely to lead to exactly the returns you need to reach your goals.

Many people are nervous about 2010's prospects.

http://www.fool.com/retirement/general/2010/01/20/why-you-shouldnt-give-up-on-stocks.aspx

We Are Due for a Pullback!

Stocks have made an epic run but it won't last. "The economy isn't strong enough" to support a new bull market reports The Wall Street Journal. We are overdue for a big pullback.

You have a choice: Stay the course and suffer big losses or go on the offense!

The Four Essentials of Successful Investing

In brief, here are the four rules:

Start early in life to invest.


Invest in common stocks.


Be thrifty.


Pick the right investment.

The Best Reason for Buying Low

"Buying low makes it a lot easier to sell high."

Some rights issues are good, others can be very bad

Some rights issues are good, others can be very bad

Like most things in investment, rights issues are not simple matters.

Rights are not automatically "good things" from the shareholders' point of view. Some of the rights are good, others can be very bad.

Investors have to be careful and they should not rush in every time there is an annoucement of rights. They should classify the rights issue they are considering in accordance with the three categories indicated below:

 (1) The case of the improperly managed companies

(2) The case of moving into new business area
(3) The case of the very fast growing company

 They should purchase only those of the last category.

Many will protest that they have neither the time nor the knowledge to carry out a detailed analysis of the company which announces the rights.

It is not possible for each and every one to carry out a careful analysis but there is an easier way out for the small timers. The dividend yield approach to stock valuation can be readily used to value a rights issue.

Why Companies Have to Make Rights Issue?

To put it bluntly, a company only needs to make a rights issue when it is short of money.

A business, any business, requires investment in various forms of assets in order to carry out its operations. A company is usually required to continually buy new assets in order to carry on its business either because its old assets have to be replaced or its expanding business requires more assets. To buy new assets, it will need new capital.

A company can obtain necessary money to purchase its assets from any one of three sources or a combination of all three.

• It can borrow the money,
• retain part or all of its profit or
• it can sell new shares.

 Under the normal circumstances, a company should be able to finance its additional purchase of assets from either retained earnings or new borrowing or a combination of the two. There are many examples of very fast growing businesses in Malaysia that have prospered without recourse to issuing rights (for examples: Nestle and BAT )

 But, companies may have to raise new capital by making rights issues under three types of abnormal circumstances. These three cases are:

(1) The company is improperly managed such that it is either not very profitable (or even losing a lot of money) such that the incoming cash is not adequate to support the need to purchase more assets. Or owing to poor management of its assets, it now requires a lot more assets to support its operations.

 (2) The company is moving into another line of business which is large relative to its current size and it requires a great deal of additional capital to start up the new venture.

(3) The company is in a very fast growing business. In fact, it is so fast growing that retained earnings and new borrowing alone are insufficient to sustain the growth.

 In order to be a prudent investor, we must analyse the situation of the company which has announced a rights issue carefully to see which category it falls into in the first place.

 Depending on which category of rights it is issuing, we can then carry out a further analysis to decide whether the rights issue is a good or a bad one.

Through examining each type of rights issue, an intelligent investor can tell the wolves from the sheep.

Pricing the rights also requires proper evaluation.

 http://myinvestingnotes.blogspot.com/2009/09/why-companies-have-to-make-rights-issue.html

Also read:
So Many Cash Calls In OuR Market!
http://whereiszemoola.blogspot.com/2010/01/so-many-cash-calls-in-our-market.html

How Buffett avoided mistakes by staying within his circle of competence

Understanding Your Circle of Competence

If Buffett cannot understand a company's business, then it lies beyond his circle of competence, and he won't attempt to value it.

Although it might seem obvious that investors should stick to what they know, the temptation to step outside one's circle of competence can be strong.

Buffett has written that he isn't bothered when he misses out on big returns in areas he doesn't understand, because investors can do very well (as he has) by simply avoiding big mistakes.

Buffett is simply a better investor than just about any other in the world. Brilliant, consistently rational, and blessed with a superb mind for business, he has managed to avoid the mistakes that have crushed so many portfolios. Let's look at two examples.

• In early 2000, Berkshire Hathaway's portfolio had underperformed funds that enjoyed spectacular returns by loading up on stocks of technology companies and Internet startups. Buffett avoided all tech stocks. He told his investors that he refused to invest in any company whose business he did not fully understand - and he didn't claim to understand the complicated, fast-changing technology business - or where he could not figure out how the business model would sustain a growing stream of earnings. Some said he was an old fuddy-duddy. Buffett had the last laugh when Internet-related stocks came crashing back to earth.
• In 2005 and 2006, Buffett largely avoided the mortgage-backed securities and derivatives that found their way into many investment portfolios. Again, his view was that they were too complex and opaque. He called them "financial weapons of mass destruction." When they brought down many a financial institution (and ravaged our entire financial system), Berkshire Hathaway avoided the worst of the meltdown.

http://bursabulltrader.blogspot.com/2010/01/6-biggest-investing-mistakes.html

Burton G. Malkiel, Princeton economics professor and author of 'A Random Walk Down Wall Street,' and Charles D. Ellis, author of 'Winning the Loser's Game,' have teamed up to write 'The Elements of Investing.' He commented: 

"We're both in our seventies. So is Warren Buffett. The main difference between his spectacular results at Berkshire Hathaway and our good results is not the economy and not the market, but the man from Omaha. "

Will this rally continue?

Will This Rally Continue?
By Rich Greifner
January 19, 2010

 

Will the recent rally continue? Or is the stock market overheated after a 65% surge?

 

I have no idea -- and frankly, I don't care.

 

Here's why you shouldn't care, either

 

http://www.fool.com/investing/general/2010/01/19/will-this-rally-continue.aspx

 

 

Here's why you shouldn't care, either
Of course it would be wonderful to be able to forecast stock gyrations, deftly jumping in and out as the market ebbs and flows. But unfortunately, it simply isn't possible to accomplish such a feat on a consistent basis, and investors' attempts to anticipate the market's short-term movements only cost them money in the long run.

 

According to a study from Dalbar Inc., the S&P 500 produced an 8.35% annual return from 1988 through 2008. However, the average equity investor realized an annual return of just 1.87% over the same period thanks to the adverse effects of market timing.

• That means an investment of $10,000 in 1988 would have grown to $49,725 over the past two decades if left untouched.
• But investors who panicked at market bottoms and chased returns as the market rose would have only $14,485 today.

 

This problem has become so widespread that in 2006, Morningstar introduced an "investor return" measure to illustrate the impact of investors' timing their purchases and sales.

• Not surprisingly, a recent Morningstar study found that investor returns trailed fund returns over the past five years in each of the 14 mutual fund categories that Morningstar tracks.

 

Still not convinced that trying to time the market is a bad idea? One final example should drive the point home.

• Thanks to big bets on Goldman Sachs (NYSE: GS), Mosaic (NYSE: MOS), and PotashCorp (NYSE: POT), Ken Heebner's CGM Focus Fund was the best-performing equity mutual fund of the past decade.
• But while CGM Focus posted an 18% annual gain over the past 10 years, the average investor in the fund lost 11% a year!

 

So rather than obsess over which way the stock market is headed next, heed these wise words from investing legend Peter Lynch: "Market timing is speculating and it rarely, if ever, pays off."

 

What does pay off?
"I don't believe in predicting markets," Lynch wrote in his classic One Up On Wall Street. "I believe in buying great companies -- especially companies that are undervalued and/or underappreciated. … Pick the right stocks and the market will take care of itself."

 

That strategy worked pretty well for Lynch, who posted 29% annual returns during his 13 years at the helm of Fidelity's Magellan Fund (sadly, most Magellan investors realized much lower returns during Lynch's tenure due to their attempts to time the market).

 

But Lynch famously focused on consumer-facing companies whose products he enjoyed, like Taco Bell (now owned by Yum! Brands (NYSE: YUM), Hanes (NYSE: HBI), and Chrysler (now owned by the U.S. government). With unemployment at a 26-year high and the U.S. consumer on the ropes, where should investors look to find the right stocks today?

 

The right stocks
That's the question I posed to Jeff Fischer, lead advisor for Motley Fool Pro. Like Lynch, Jeff and his team don't get swept up in trying to forecast short-term market movements. Instead, they seek out companies with

• sustainable competitive advantages,
• significant recurring revenue,
• diverse customer bases,
• strong free cash flow, and
• healthy balance sheets.

Here are two picks that Jeff believes will serve investors well whether the stock market heads up, down, or sideways:

 

 

 

 

5 Dumb Investing Mistakes to Avoid

5 Dumb Investing Mistakes to Avoid
by Gary Belsky | Jan 19, 2010

In his newly revised book, Why Smart People Make Big Money Mistakes and How to Correct Them, co-author Gary Belsky says irrational behavior often leads us to make dumb and costly financial decisions. In this excerpt, Belsky reveals the investing secrets that will help you avoid such goofs.

We all commit financial follies that cost us hundreds or thousands of dollars each year. Worse, we’re often blissfully ignorant of the causes of our monetary missteps and clueless about how to correct them. But by knowing these five big investing mistakes, you can change your behavior to put more money in your pocket.

1. Letting Losses Hurt More Than Gains Please You
People generally are “loss averse.” The pain felt from losing $100 is much greater than the pleasure from gaining the same amount. That’s why people behave inconsistently when it comes to taking investment risks. You might act conservatively to protect gains (by selling your winners to guarantee the profits) but act recklessly to avoid losses (by holding onto losers, hoping they’ll bounce back). Loss aversion causes some investors to sell all their holdings during periods of market turmoil, but trying to time the market doesn’t work in the long run.

2. Placing Too Much Emphasis on Unusual Events
Many people still recall the stock market crash of 2008 with anxiety, forgetting that stocks have offered the most consistent investment gains over time. As MoneyWatch blogger Nathan Hale has written, investors often pour money into mutual funds that performed well recently on the mistaken belief that the funds’ success is the result of something other than dumb luck.

3. Being Paralyzed by Investment Choices
You can’t let yourself get so overwhelmed by a surfeit of options that you penalize your finances through inaction. Some people won’t move money out of ultra-conservative, low-yielding retirement funds because they can’t bear having to select a better alternative. So limit your choices. Find “trusted screeners” whose judgment you admire to pare down your choices or even make them for you.


4. Ignoring the ‘Small’ Numbers
People have a tendency to ignore what they think are insignificant numbers, such as mutual fund expenses. But doing so can have a deleterious effect of surprising magnitude on your investment returns over time. On a $10,000 investment, an expense ratio of 0.5 percent might cost you about $180 over three years, but a 1.5 percent expense tab could nick you by $500 or so. Over 15 years, a low-expense fund might eat up less than 7 percent of your potential investment return, while a high-expense fund could devour almost 20 percent.

5. Failing to Understand the Odds against Beating the Market
Most investors will fare best by sticking primarily with index funds mirroring the averages. You won’t just keep up with the typical investor this way; you’ll likely do better than all those brave souls who think they can beat the law of averages. High transaction and management expenses, faulty psychology, and the law of averages often burden actively managed portfolios. Index funds take much of the emotion out of investing. And the most successful investors are the ones who don’t let emotions affect their decisions.

From Why Smart People Make Big Money Mistakes and How to Correct Them by Gary Belsky & Thomas Gilovich. Copyright 1999, 2009, by Gary Belsky and Thomas Gilovich. Reprinted by permission of Simon & Schuster, Inc.

http://moneywatch.bnet.com/investing/article/investing-5-dumb-mistakes-to-avoid/384546/

The recipe for truly high growth

The recipe for truly high growth has a handful of necessary ingredients. They are:

• A small company
• A wide market opportunity
• Meaningful macroeconomic tailwinds.  

Think, for example, of Amazon.com (Nasdaq: AMZN) when it launched in 1995. It was a tiny company, one of the first e-tailers, and it had the rising tide of the Internet -- merely the greatest development of the past 25 years -- helping it along. Now ask yourself: Do any of the companies or industry opportunities in your surveillance fit that profile at all?

This Mistake Could Cost You a Fortune

This Mistake Could Cost You a Fortune
By Austin Edwards
January 17, 2010

 

Granted, it's not like I made a big bet on DryShips (Nasdaq: DRYS) at the beginning of last year -- right before it dropped more than 75% (although I know people who did). And I certainly didn’t listen to any of the doom-and-gloom pundits who suggested you short “zombie banks” like JPMorgan Chase (NYSE: JPM) and Morgan Stanley (NYSE: MS) just before their epic rebounds.

 

But I did move back to Big 12 country just in time to see my beloved Oklahoma Sooners lose game after game after game -- not to mention lose their Heisman-winning quarterback, Sam Bradford, to a season-ending shoulder injury mere minutes into their opener.

 

You see, my grandfather played football for Oklahoma, and I've been rooting for them since I was old enough to walk, so 2009 was a pretty painful year for me. But don't worry, I'll always be a Sooners fan -- no matter how bad things get. In sports, that's a virtue.

 

Wall Street, though, is a different ball game
For proof, just ask any longtime "fan" of:

 

Stock
10-Year Return

 

Merck (NYSE: MRK)
(22%)

 

Corning (NYSE: GLW)
(46%)

 

Home Depot (NYSE: HD)
(47%)

 

Sun Microsystems (Nasdaq: JAVA)
(94%)

 

 

Data provided by Yahoo! Finance.

 

 

Or ask my fellow Fools Rich Greifner or Adam Wiederman. Or even ask Jim Cramer. In his book Real Money, Cramer reminds investors, "This is not a sporting event; this is money. We have no room for rooting or hoping."

 

Yet it happens all the time -- and time after time, investors ride stocks right into the ground because they're emotionally attached to a company's story, products, or management.

 

I, for one, am sitting on a major loss in Clearwire. And if we're being honest, the only reason I bought shares in the first place was because I liked that it was backed by Google, Comcast, and a handful of other tech heavyweights.

 

Ditch that loser!
One of the "20 Rules for Investment Success" from Investor's Business Daily is to "cut every loss when it's 8% below your cost. Make no exceptions so you'll avoid any possible huge, damaging losses."

 

To a sports fan, that might seem cruel and unusual, but is it good investment advice?

 

To find out, I dug through David and Tom Gardner's Motley Fool Stock Advisor picks. You see, they often re-recommend a stock even after a big run-up -- or a sharp fall.

 

As it turns out, I found three examples when breaking IBD's rule actually paid off big-time:

 

Stock Advisor Pick
Decline After Recommendation
Gain After Re-Recommendation

 

Netflix
23%
294%

 

Quality Systems
14%
1,189%

 

Dolby Labs
10%
163%

 

 

These weren't flukes, either
In his re-recommendation write-up for Netflix, David Gardner admitted, "We're currently sitting on a 23% loss." But he went on to say, "I think this is one cheap stock at $11, backed by a great management team that's going to create value for us going forward."

 

And he had well-thought-out reasons for continuing to own the stock: "It remains first and best in a growing industry, creates convenience for millions of consumers, and is led by visionary management that markets aggressively." Netflix stock has risen 313% since then.

 

So when do you sell?
Many investors have hard-and-fast numerical rules. Others -- like the Gardners -- stick to a more analytical and intellectual approach to determine when to recommend that their Stock Advisor subscribers sell a stock. So when do David and Tom Gardner consider dumping a stock? Primarily when they encounter:

• Untrustworthy management.
•  Deteriorating financials.
•  Mergers, acquisitions, and spinoffs that could damage the business.

The debate rages on
Investors may never agree on when or why to sell a stock. But it is important to have an emotionless, well-thought-out strategy in place. If you don't, you may suffer major losses -- or miss out on massive gains.

 

For what it's worth, David and Tom Gardner rarely sell, and it works for them. In fact, Tom's average Stock Advisor pick is performing more than 35 percentage points better than a like amount invested in the S&P 500. Meanwhile, David's are performing 66 points better on average.

 

http://www.fool.com/investing/general/2010/01/17/this-mistake-could-cost-you-a-fortune.aspx?source=irasitlnk0000001&lidx=3

Charlie Munger is negative about the economy, but positive about stocks

The strategy sounds simple enough, but Mr Munger says few investors practise it.

“You can’t believe the way that conventional wisdom invests money,” he explains. “They tend to rush into whatever fad has worked lately. In my opinion, a lot of them are going to get creamed.”


17th May 2009: Today he's negative about the economy, but positive about stocks -- a bullish sign. In the late 1990s, Munger complained that he didn't see much to buy. The market quickly proved him right. But, at current market prices, Munger sees many long-term investment opportunities.

"I am willing to buy common stocks with long-term money at these prices," Munger said. "Is Coca-Cola worth what it's selling for? Yes. Is Wells Fargo? Yes." He owns both.

"If you wait until the economy is working properly to buy stocks, it's almost certainly too late," he said. "I have no feeling that just because there's more agony ahead for the economy you should wait to invest."

But you need to be selective.

Is Value Investing Dead?

Is Value Investing Dead?
By Jordan DiPietro
January 14, 2010

Every year thousands of people make the trip to Omaha for Berkshire Hathaway's annual shareholder meeting. They come in fanatical droves -- from as far away as South Africa and Singapore -- to see the man whose extraordinary success has been largely attributed to one strategy: value investing.

Unfortunately, the original value crusaders, Benjamin Graham and David Dodd, are long gone, while Warren Buffett has become a touchstone in an investing landscape riddled with leveraged corpses, speculative traders, and overzealous CEOs.

We've squeezed almost every gem of wisdom from his meetings and transcripts, and we've analyzed his moves from every conceivable angle. All of this ultimately raises one question: Once Warren is gone, will the end of an era also mark the end of value investing?

Old school values
When Graham and Dodd's seminal piece, Security Analysis, was written in 1934, it was much easier to be a value investor.

First, the time was right. Still reeling from the Great Depression and unemployment of up to 25%, the Dow had lost about 90% of its value in three years. The tenets of Graham and Dodd -- to buy stocks for prices significantly below their intrinsic values and even their book values -- were especially applicable because prices were distorted, and many stocks were significantly undervalued.

Second, with most of the Dow 30 comprised of metal, oil, or manufacturers, balance sheets were pretty straightforward. Valuing stocks wasn't necessarily easy, but there were some pretty common elements to look for: book value, tangible assets, etc.

Third, if you look at all the value crusaders, they all share one unique attribute: tenacity. They had the doggedness to perform painstakingly tedious work, laboring over worksheets, completing arithmetic by hand. They just seemed to work, well, the hardest.

New school values
Seventy years have come and gone, and value investing has come under increasing criticism. In fact, I've seen money managers tell their clients that if their time horizon is less than two decades away, value investing is not for them.

Why? Take a look at the comparative performance of value versus growth over the last five years.

Indices
Top Holdings
2009 Return
3-Year Return
5-Year Return

Russell 1000 Value Index (IWD)
JPMorgan Chase (NYSE: JPM), General Electric (NYSE: GE)
19.2%
(7.9%)
(1%)

Russell 1000 Growth Index (IWF)
Cisco Systems (Nasdaq: CSCO), Wal-Mart (NYSE: WMT)
36.7%
(2.1%)
2.5%


What gives? Well, business is much more complex than it used to be. With intellectual property rights, patents, and licensing fees, studying balance sheets is a bit murky. Companies like Qualcomm (Nasdaq: QCOM), Pfizer (NYSE: PFE), and Merck (NYSE: MRK) are all wrapped up in intangibles, and its simply harder to predict future earnings.

In addition, the days of sweating over spreadsheets are over. Computer programs and stock screeners make it simple to find a company that fits a certain mold -- even the laymen can whittle down enormous loads of data and draw conclusions. The advantage of having the fortitude to do the "hard work" is gone, lost in a sea of statistics and a market inundated with information.

And finally, being a value investor requires a temperament few have -- especially given the above considerations. Asset manager Jean-Marie Eveillard said, in response to the question of why there aren't more value investors, given Buffett's success, "If you are a value investor, every now and then you lag, or experience what consultants call tracking error. It can be very painful. To be a value investor, you have to be willing to suffer pain."

So does this mean value investing is dead?

WWWD?
Value investing isn't dead -- but it's not going to look the same in the 21st century as it did in the 20th.

We just have to look at Buffett, who, like always, adapts to the times. As the market collapsed around us and blue chips fell by the wayside, he scooped up some $3 billion worth of General Electric, and recently invested in ExxonMobil and Nestle. He lent Goldman Sachs $5 billion and locked in 10% annual gains -- and of course negotiated an option that has already netted him close to $2.4 billion.

Deliberate, prudent, unyielding -- classic Buffett.

Today's market offers something unique to the 21st century -- a plethora of booms and busts. There have been more financial crashes in the last 30 years than in any other time period -- and that means there are price distortions that investors can take advantage of, just like Buffett has done lately. Value investing isn't dead, nor is it immaterial.

Don't get distracted by puzzling trading strategies or speculate on leveraged financials (thank you, Citigroup). Understand a business and invest in your area of competence -- when it's cheap.

And remember as well that the last five years don't dictate the future. From 1927-2005 (78 years!), value investing has outperformed both small and large cap growth stocks by a substantial margin. From 1975-2005, value stocks outperformed growth stocks in 12 out of 13 developing countries. Clearly, in both the U.S. and abroad, value reigns supreme.

So don't let the naysayers get you down -- there are still plenty of tremendous value stocks out there! Our Motley Fool Inside Value team practices what Warren preaches and scours the market for the best deals each month. This has been a difficult few years for our analysts, but they're still managing to beat the S&P 500 by over seven percentage points -- that's pretty impressive considering the challenging environment.

If you believe like we do that value investing is here to stay, and you want to know the seven value stocks you should be buying right now, we're currently offering a 30-day free trial to Inside Value. Click here for more information.

Fool contributor Jordan DiPietro owns shares of General Electric. Berkshire Hathaway is a Motley Fool Stock Advisor recommendation. Berkshire Hathaway, Pfizer, and Wal-Mart Stores are Inside Value recommendations. The Fool owns shares of Berkshire Hathaway. The Fool's disclosure policy is always looking for a discount.

http://www.fool.com/investing/value/2010/01/14/is-value-investing-dead.aspx

4 Ways to Screw Up Your Portfolio

4 Ways to Screw Up Your Portfolio
By Selena Maranjian
January 19, 2010 | Comments (0)

 

Sometimes, it can be easy to make money in the stock market. Dumping the bulk of your nest egg into broad-market index funds can instantly make you a part-owner of such successful companies as Apple (Nasdaq: AAPL), General Electric (NYSE: GE), and UnitedHealth (NYSE: UNH). If you'd rather fly solo, finding the right individual stock can bring you massive gains -- witness Intuitive Surgical (Nasdaq: ISRG) and its 50% average annual returns over the past five years.

 

Sadly, though, it can be even easier to lose money when investing. Some losses just can't be foreseen; they happen even to good investors invested in seemingly solid companies. But other times, investors make a classic error -- and pay the price for it.

 

Here are four blunders you'd do well to avoid:

 

Too few metrics
If you focus only on a single aspect of a given company, such as its price-to-earnings ratio, you could miss out on the bigger picture. Check out the different ratings our CAPS community has assigned to stocks with similarly low P/Es:

 

Company
CAPS Stars (out of five)
P/E

 

Noble (NYSE: NE)
*****
7

 

Merck (NYSE: MRK)
****
10

 

Garmin
***
12

 

Qwest Communications (NYSE: Q)
**
10

 

Data: Motley Fool CAPS.

 

A closer look at these companies' other metrics would likely reveal varying debt and cash levels, growth rates, profit margins, and competitive advantages. It can be useful to seek out low-P/E stocks, since they may have been overly punished and due to rebound. But a low P/E can't and shouldn't be your sole criteria for making an investment.

 

Tax obliviousness
Forgetting about the IRS can lead to another needless error. If you net a $5,000 gain in Home Surgery Kits (Ticker: OUCHH), but sell it less than 365 days after you bought it, you'll be the one wishing you had some anaesthetic. Short-term gains -- stocks held for less than a year -- are taxed at your standard income rate; at 28%, you'd pay $1,400 in tax on that $5,000 profit. Long-term gains -- held for more than a year -- get dinged for a much smaller 15%, or just $750 in our example.

 

Looking the other way
Failing to follow your investments closely enough can be another major mistake. You might buy into a biotechnology or pharmaceutical company, for example, because you're enthusiastic about the exciting drugs in its pipeline. But if one or more of those candidates fail to win FDA approval, or report poor results in clinical trials, the company's future could suddenly become less bright.

 

Wandering too far
Finally, we often stray beyond our circle of competence.

• Do you really understand biotechnology? Or the energy industry? Or telecommunications?
• If you don't have a firm grasp of a company's industry and its position in it, you're at a great disadvantage as an investor.
• You need to be aware of developments in and threats to a given industry, and have a clear sense of its winners and losers, before you start investing there.

 

As you invest, focus not only on all the things you do right, or the amazing companies you come across, but also on mistakes you may be making. The more blunders you eliminate from your repertoire, the better the performance you can expect from your portfolio.

 

http://www.fool.com/investing/value/2010/01/19/4-ways-to-screw-up-your-portfolio.aspx

Relying on a single metric misses out on the bigger picture

Too few metrics

 

If you focus only on a single aspect of a given company, such as its price-to-earnings ratio, you could miss out on the bigger picture. Check out the different ratings our CAPS community has assigned to stocks with similarly low P/Es:

 

Company
CAPS Stars (out of five)
P/E

 

Noble (NYSE: NE)
*****
7

 

Merck (NYSE: MRK)
****
10

 

Garmin
***
12

 

Qwest Communications (NYSE: Q)
**
10

 

 

Data: Motley Fool CAPS.

 

 

A closer look at these companies' other metrics would likely reveal

• varying debt and cash levels,
• growth rates,
• profit margins, and
• competitive advantages.

It can be useful to seek out low-P/E stocks, since they may have been overly punished and due to rebound. But a low P/E can't and shouldn't be your sole criteria for making an investment.

 

http://www.fool.com/investing/value/2010/01/19/4-ways-to-screw-up-your-portfolio.aspx

 

3 Ways to Prepare for the Next Big Drop

3 Ways to Prepare for the Next Big Drop
By Dan Caplinger
January 19, 2010 | Comments (0)

This time last year, even a dart-throwing monkey could have made money in the stock market -- all you needed was the courage to buy at one of the scariest times in history. Now, though, financial markets of all sorts have risen sharply, and there's a lot more to making a winning investment than picking a stock ticker at random and buying shares.

It's a whole new ball game
If you're like many people, you've probably done your best to repress your memories of early 2009. Back then, the stock market was falling apart, after a failed attempt to put together a rally off the lows set during 2008's panic. Everyone was convinced that companies like MGM Mirage (NYSE: MGM) and Bank of America (NYSE: BAC) were just a few steps from bankruptcy, and even the prospects for healthier companies seemed grim.

Now, though, fear has given way to greed. Many of the stocks that seemed most likely to fail instead topped the performance charts for 2009. Stock markets around the world saw huge gains, with the U.S. market's rise relatively small in comparison to jumps in emerging markets like Brazil and China. Moreover, after a terrible end in 2008, commodities also regained much of their lost luster, as gold jumped to new highs and energy prices made a sharp recovery from their huge drop to $30 from nearly $150.

If those big gains make you nervous, you're not alone. If you think it's time for these roller-coaster markets to start another downswing and don't want to go along for the ride, then here are three things to think about for various parts of your portfolio.

1. With stocks, think quality
Amid all the big gains of last year, many stocks have gotten left behind, at least compared to the overall market. Johnson & Johnson (NYSE: JNJ), Procter & Gamble (NYSE: PG), and AT&T (NYSE: T) are among the big-name companies that haven't seen anything close to the gains of even the S&P 500, let alone the multibagger performance that dozens of stocks produced last year.

But there are two reasons to look for lagging sectors. First, as bull markets evolve, they tend to go through sector rotation, in which stocks that haven't performed as well catch up with the top performers. So if this is the beginning of a longer-term bull market, then you can expect large caps that have thus far been left behind to see some gains.

On the other hand, the stocks that have risen the most also have the furthest to fall. If the stock market's rally reverses itself soon, then you can expect stocks that are still value-priced to hold up better than highfliers without the fundamentals to back up their lofty valuations.

2. With bonds, think duration
Everyone's stretching for yield right now, as interest rates have remained low. When you need income from your portfolio to survive, times like these can lead you to take desperate measures.

But you need to resist the urge to buy longer-term bonds just to get higher yields. Rates show signs of rising soon, and if they do, falling prices could wipe out the higher interest you'll receive on long bonds. In contrast, short-term bonds won't pay as much income up front, but they also won't lose as much value per percentage-point move in a rising-rate environment.

Finally, just as speculative stocks may have gotten ahead of themselves, lower-quality corporate bonds have also jumped in front of Treasuries. Consider rebalancing your portfolio to get its risk profile back where you want it.

3. With alternative investments, be wary
Commodities and real estate are becoming more mainstream investments than ever. But while having some exposure can help your portfolio, now isn't the time to make huge bets on them.

Whether you use stocks like Freeport-McMoRan Copper & Gold (NYSE: FCX) and Precision Drilling Trust (NYSE: PDS) as proxies for metals and energy or invest in specialized ETFs with direct exposure to commodities, prices have jumped a lot over the past year. Hedging your holdings, either by selling some of those investments or with other strategies such as writing covered calls or buying puts, can take some risk off the table.

Watch your greed
Most investors are in much better shape now than they were this time last year. But you don't want to lose those hard-fought gains. By taking steps to secure your portfolio, you'll help to keep yourself from enduring the same trials you suffered through during the financial crisis.

With so many stocks seeing big gains, focusing on value stocks might seem hopelessly outdated. Jordan DiPietro takes a closer look at whether value investing is dead.

http://www.fool.com/retirement/general/2010/01/19/3-ways-to-prepare-for-the-next-big-drop.aspx

How investors are rebelling against professional money managers

By Edmund Conway Economics Last updated: January 18th, 2010

14 Comments Comment on this article

It is hardly headline news to say we’ve all lost rather a lot of our faith in the financial Masters of the Universe during this crisis. We all know they proved just how little they knew or understood the risks they were taking, and as we can see from the recent bonus rows, their standing has diminished considerably as a result.

What I hadn’t realised is that many of people are already putting their money where their mouth is on this one. According to analysts at Goldman Sachs, over the past year or so, people have been pulling their money out of funds managed by professional investors and fund managers, and choosing instead to invest it themselves, whether in simple shares or in exchange traded funds.

The story, according to Goldman’s chief US equity strategist, David Kostin, and as told by the chart above, is that despite the 25pc increase in the stock market over the past year or so, not one dollar went into US equity funds (in fact, there was a net outflow) – and yet over the first nine months of the year there was about $225bn of direct purchases of common shares.

It represents, according to Kostin, a “repudiation of the professional investor class by individuals, who are investing in ETFs and direct purchases of stocks.”

He prefers to frame this phenomenon (which reflects the US, but may well be mirrored over here in the UK) as a sign that people are becoming more independent when it comes to their finances, plus that they are aware that there are tax advantages of investing through exchange traded funds (which can track indices and commodities, but without having to pay a fund manager to do the legwork). However, one could just as easily see it as a sign of revulsion in professional asset managers. And for good reason.

Throughout this crisis, much of the criticism over what happened has been levelled at the banks, but far less at bank investors. And while bankers are not blameless for having done far too much in the way of slicing and dicing assets, creating toxic debt and pushing sub-prime mortgages, a semi-legitimate excuse on their part is that there was demand for these toxic assets. Which indeed there was: professional investors have been given far too easy a ride for investing in some of the dross that contributed to the crisis. They have also been given too easy a ride for not monitoring the banks fiercely enough in previous years. After all, if a few more bank shareholders (and I’m talking big pension funds and asset managers here) had scrutinised the banks (which they own), they might have realised that capital and liquidity were at paper-thin levels, leaving the banks at risk of insolvency.

Against this backdrop, and given how much wealth was lost as a result, it is hardly surprising that people are steering clear of the fund managers for the time being. That sounds like a pretty functional market reaction to me.

http://blogs.telegraph.co.uk/finance/files/2010/01/goldman.jpg

Investment students need only two well-taught courses

"In our view, though, investment students need only two well-taught courses -

• How to Value a Business, and
• How to Think About Market Prices."

- Warren Buffett

****Constructing a Portfolio

Now that you have learned to analyse companies and pick stocks, it is time to focus on putting groups of stocks together to construct your stock portfolio.

No one answer is right for everyone when it comes to portfolio construction. It is more art than science. And perhaps that's why many believe portfolio management may be the difference that separates a great investor from an average mutual fund manager.

Famed international stock-picker John Templeton has often said that he's right about his stock picks only about 60% of the time. Nevertheless, he has accumulated one of the best track records in the business. That's because great managers have a tendency to have more money invested in their big winners and less in their losers.

The Fat-Pitch Approach

You should hold relatively few great companies, purchased at a large margin of safety, and that you shouldn't be afraid to hold cash when you can't find good stocks to buy. But why?

Most investors will discover only a few good ideas in any given year - maybe five or six, sometimes a few more. Investors who hold more than 20 stocks at a time are often buying shares of companies they don't know much about, and then diversifying away the risk by holding lots of different names. It is tough to stray very far from the average return when you hold that many stocks, unless you have wacky weightings like 10% of your portfolio in one stock and 2% in each of the other 45.

About 90% of the maximum benefit of diversification was derived from portfolios of 12 to 18 stocks. If you own about 12 to 18 stocks, you have obtained more than 90% of the benefits of diversification, assuming you own an equally weighted portfolio.

If you want to obtain a higher return than the markets, you increase your chances by being less diversified. At the same time, you also increase your risk.

If you own more than 18 stocks, you will have achieved almost full diversification, but now you will just have to keep track of more stocks in your portfolio for not much marginal benefit.

When you own too many companies, it becomes nearly impossible to know your companies really well. When you lose your focus and move outside your circle of competence, you lose your competitive advantage as an investor. Instead of playing with weak opponents for big stakes, you begin to become the weak opponent.

Non-Market Risk and a Concentrated Portfolio

Interestingly, holding a concentrated portfolio is not as risky as one may think. Just holding two stocks instead of one eliminates 46% of your unsystematic risk. Using a twist on the 80/20 rule of thumb, holding only eight stocks will eliminate about 81% of your diversifiable risk.

Unsystematic Risk and the Number of Stocks in a Portfolio

Number of Stocks   Non-Market Risk Eliminated (%)
1======== 0%
2 ========46%
4 ========72%
8 ========81%
16======= 93%
32======= 96%
500====== 99%
9,000==== 100%

What about range of returns?

Joel Greenblatt in his book You Can Be a Stock Market Genius explains that during one period that he examined,

• the average return of the stock market was about 10% and
• statistically, the one-year range of returns for a market portfolio (holding scores of stocks) in this period was between negative 8% and positive 28% about two-thirds of the time.
• That means that one-third of the time, the returns fell outside this 36-point range.

Greenblatt noted that if your portfolio is limited to only :

• 5 stocks, the expected return remains 10%, but your one-year range expands to between negative 11% and positive 31% about two-thirds of the time.
• 8 stocks, the range is between negative 10% and positive 30%.

In other words, it takes fewer stocks to diversify a portfolio than one might intuitively think.

Portfolio Weighting

In addition to knowing how many stocks to own in your portfolio and which stocks to buy, the percentage of your portfolio occupied by each stock is just as important.   Unfortunately, the science and academics behind this important topic are scarce, and therefore, portfolio weighting is, again, more art than science.

The great money managers have a knack for having a great percentage of their money in stocks that do well and a lesser amount in their bad picks.  So how do they do it?

Essentially, a portfolio should be weighted in direct proportion to how much confidence you have in each pick.  If you have a lot of confidence in the long-term outlook and the valuation of a stock, then it should be weighted more heavily than a stock you may be taking a flier on.

If a stock has

• a 10% weighting in your portfolio, then a 20% change in its price will move your overall portfolio 2%.
• a 3% weighting, a 20% change has only a 0.6% effect on your portfolio.

Weight your portfolio wisely.  Don't be afraid to have some big weightings, but be certain that the highest-weighted stocks are the ones you feel the most confident about.  And, of course, don't go off the deep end by having, for example, 50% of your portfolio in a single stock.



Portfolio Turnover

If you follow the fat-pitch method, you won't trade very often.  Wide-moat companies selling at a discount are rare, so when you find one, you should pounce.  Over the years, a wide-moat company will generate returns on capital higher than its cost of capital, creating value for shareholders.  This shareholder value translates into a higher stock price over time.

If you sell after making a small profit, you might not get another chance to buy the stock, or a similar high-quality stock, for a long time.  For this reason, it's irrational to quickly move in and out of wide-moat stocks and incur capital gains taxes and transaction costs.  Your results, after taxes and trading expenses, likely won't be any better and may be worse.  That's why many of the great long-term investors display low turnover in their portfolios.  They've learned to let their winners run and to think like owners, not traders.



Circle of Competence and Sector Concentration

If you are investing within your circle of competence, then your stock selections will gravitate toward certain sectors and investment styles. 

Maybe you:

• work in the medical field and thus are familiar with and own a number of pharmaceutical and biotechnology stocks, or,
• you've been educated in the Warren Buffett school of investing and cling to entrenched, easy-to-understand businesses such as Coca-Cola and Wrigley.

Following the fat-pitch strategy, you will naturally be overweight in some areas you know well and have found an abundance of good businesses.  Likewise, you may avoid other areas where you don't know much or find it difficult to locate good businesses.

However, if all your stocks are in one sector, you may want to think about the effects that could have on your portfolio.  For instance, you probably wouldn't want all of your investments to be in unattractive areas such as the airline or auto industry.



Adding Mututal Funds to a Stock Portfolio

In-the-know investors buy stocks.  Those less-in-the-know, or those who choose to know less, own mutual funds. 

But investing doesn't have to be a choice between investing directly in stocks or indirectly through mutual funds.  Investors can - and many should - do both.  The trick is determining how your portfolio can benefit most from each type of investment.  Figuring out your appropriate stock/fund mix is up to you.

Begin by looking for gaps in your portfolio and circle of competence. 

• Do you have any foreign exposure?
• Do your assets cluster in particualr sectors or style-box positions?

Consider investing in mutual funds to gain exposure to countries and sectors that your portfolio currently lacks.

Some funds invest in micro-caps, others invest around the globe, still others focus on markets, such as real estate.  Stock investors who turn over some of their dollars to an expert in these areas gain exposure to new opportunities without having to learn a whole new set of analytical skills.

Ultimately, your choice depends on your circle of competence and comfort level.  While many may feel comfortable with picking their own international stocks, others may prefer to own an international equity fund.



Our Objective

Modern Portfolio Theory has been built on the assumption that you can't beat the stock market. If you can't beat the market porfolio, then the best you can do is to match the market's performance. Therefore, academic theory revolves around how to build the most efficient portfolio to match the market.

We have taken a different approach.  Our objective is to outperform the market.  Therefore, we believe that our odds increase by holding (not actively trading) relatively concentrated portfolios of between 12 and 20 great companies purchased with a margin of safety.  The circle of competence will be unique to every person; therefore, your stock portfolio will naturally have sector, style, and country biases.  If lacking in any area, such as international stocks, a good mutual fund can be used to balance your overall portfolio.

PPB Group a 'buy', says Kim Eng

PPB Group a 'buy', says Kim Eng
Published: 2010/01/19


PPB Group Bhd, a Malaysian plantation and property group, was raised to “buy” from “hold” at Kim Eng Research Sdn Bhd, which said the stock is an “attractive proxy” for its palm oil trading affiliate, Wilmar International Ltd.

The share price estimate for PPB was raised to RM19.20 from RM14.68, Kim Eng said in a report today. -- Bloomberg

Public Bank rises to new record

Public Bank rises to new record
Published: 2010/01/19


Public Bank Bhd, Malaysia’s third largest lender, rose to a new record in Kuala Lumpur trading ahead of its fourth-quarter earnings report this week.

HWANG DBS Vickers Research Sdn Bhd yesterday said the bank’s 2009 earnings may exceed market projections.

The stock rose 1.5 per cent to RM12.02 at 9:17 am local time, its fourth straight day of gains. -- Bloomberg