The 10-year Treasury note yield just broke below 1%.

The 10-year Treasury note yield TMUBMUSD10Y, -1.71% tumbled 12.4 basis points to 0.967%, carving out a record intraday low of 0.914% in Tuesday trading, according to Tradeweb data.


The direction of the benchmark maturity’s yield is important for economists, households and central bankers as it serves as a benchmark for all kinds of loans including long-term mortgages. The long-dated bond also serves as a broader barometer of how easy it is to borrow money, and an indication of how investors perceive the U.S. economy’s prospects.




Analysts say the Fed’s move to ease monetary policy ahead of its scheduled policy meeting in two weeks suggests the central bank wanted to demonstrate its willingness to act, in line with research by Fed officials suggesting that early and aggressive rate cuts are more effective when interest rates are near zero.


https://www.marketwatch.com/story/the-10-year-treasury-note-yield-just-broke-below-1-heres-how-it-happened-2020-03-03

The U.S. bond-market’s benchmark yield plunged below 1% on Tuesday, a possibility that few analysts and investors contemplated at the beginning of the year.

Investors have attributed the slide in U.S. Treasury yields to a combination of factors including 

• slower global economic growth, 
• the attraction of a positive return when negative-yielding debt is the alternative in Europe and Japan abroad, and 
• the absence of any inflation threat.

But in the end, the spark for the furious rally in Treasurys on Tuesday came from a less abstract source: 

• a surprise 50 basis point interest rate cut from the Federal Reserve to counteract worries that the spread of the COVID-19 epidemic would deliver a painful blow to consumer and market confidence.

Here’s the real reason Warren Buffett is sitting on a record $128 billion in cash, according to one strategist

Published: Mar 2, 2020 1:31 p.m. ET

Warren Buffett, ever the beacon of market optimism, appears to be positively bullish about where stocks are headed from here.

The Berkshire Hathaway BRK.A, -3.26% boss made that clear in his annual letter to shareholders in which he wrote of the “American Tailwind” and made the case for staying invested in stocks.

“If something close to current rates should prevail over the coming decades and if corporate tax rates also remain near the low level businesses now enjoy, it is almost certain that equities will over time perform far better than long-term, fixed-rate debt instruments,” Buffett said in the letter.

But this chart of Buffett’s record cash pile, courtesy of RIA Advisors strategist Lance Roberts, seems to tell a different story — one in which what Buffett is saying looks a whole lot different from what Buffett is actually doing:




“As the old saying goes: ‘Follow the money,’” Roberts wrote in a post on his Real Investment Advice blog. “If he thinks stocks will outperform bonds why is holding $128 billion in short-term bonds?”

While the obvious take is that Buffett is just waiting for a good deal to come along so he can snap it up, another is that he’s not as optimistic as he lets on. Maybe, as Roberts suggests, the answer actually lies in a pair of charts.


This one takes a look at the Shiller price-to-earnings ratio, which is currently around 30x, to project 10-year total returns using history as a guide:



As you can see, a lot of red ink has spilled in the years following valuations like the one we’re currently seeing in the stock market.

Here’s another way to look at it, using the “Buffett Indicator”:




Just look at what happened the last few times Buffett’s favorite valuation measure was elevated. Again, forward return expectations, as several indicators clearly show, are markedly lower over the following 10 years.

Roberts says investors might want to exercise some caution before they follow Buffett’s “do as I say, not as I do” advice and buy and hold index funds.

“Buffett did not amass his fortune by following the herd but by leading it,” Roberts wrote. “He is sitting on a $128 billion in cash for a reason. Buffett is fully aware of the gains he has forgone, yet still continues his ways. Buffet is not dumb!”

Sitting on cash, for the first time in awhile, was not the place to be in Monday’s session as the Dow DJIA, -2.94% , S&P SPX, -2.81% and Nasdaq COMP, -2.99% were all staging strong rebounds.


https://www.marketwatch.com/story/heres-the-real-reason-warren-buffett-is-sitting-on-a-record-128-billion-in-cash-according-to-one-strategist-2020-03-02?fbclid=IwAR1WhwQ03BmZ49y4Uw1qDww03MApd5mz4anVVLCYOG35X7vdHcL-nduryls

How a 27-year-old millionaire in the Seattle area spends his money

27-year-old millionaire who saves 80% of his income refuses to spend on 2 things

Mar 2 2020
Kathleen Elkins
@KATHLEEN_ELK



Todd Baldwin’s net worth crossed $1 million when he was 25.

Today, at 27, he brings in $615,000 annually ($305,000 after business expenses) thanks to a mix of

• income from rental properties, 
• his day job working in commercial insurance sales and 
• the extra cash he makes as a secret shopper.

The majority of his revenue comes from the six rental properties that he owns with his wife, Angela: They earn $460,000 per year in rent. After expenses, including mortgage payments, taxes, insurance and utilities, they keep about $150,000 of that per year.

“Although our net worth is seven figures, we don’t do a lot of the typical things that most people envision millionaires doing. We are super frugal,” says Baldwin, who wears a $12 rubber wedding band and shares a 2009 Ford Focus with his wife. Because he keeps his expenses so low, he’s able to save more than 80% of his take-home pay.


The millennial millionaire refuses to spend money on a couple of things, he tells CNBC Make It: For starters, he won’t pay for entertainment, like restaurants and the movies, “but only because I know how to get paid for that.”

Baldwin is a “secret shopper” and gets paid for dining out, going grocery shopping, seeing movies and even visiting hotels and casinos.

“There are a lot of businesses out there that want to know how their employees are doing and how the market is responding to their products,” he explains. “So those companies will hire mystery shopping firms to find independent contractors like me to go pose at their establishment as a regular customer, buy the product or service and then report on it.”

He’s made about $30,000 since he started mystery shopping years ago in college. The surveys he fills out after the experience aren’t too time consuming, and for that reason, he has a hard time justifying spending money at bars and restaurants. “If a buddy wants to go to a bar or someone wants to go see a movie, I usually try to wait until I can get a mystery shop,” he says, “because if you’re going to go there anyway, you might as well get it for free and get paid on the top.”

Thanks to secret shopping, he and his wife spend just about $25 a month on food.



“Another thing that I’ll never spend money on is unnecessary bank account fees or credit card fees,” says Baldwin. That’s not to say he doesn’t use credit cards — he has 13 of them — but he never racks up a balance and makes payments on time to avoid late fees.

Baldwin, who was raised by a single mom and started working when he was 12, gets a thrill out of saving. “It’s actually really fun being able to buy something and then choosing not to,” he says.

He thinks through all of his purchases, especially the big ones: “My wife and I want to start a family in the next couple of years, and I was thinking we might get an SUV. I was looking at ones that were about $60,000.” After running the numbers, though, they decided to redirect that money elsewhere. “We took the 60 grand and bought another rental property — and now that property cash flow is $4,000 per month.”

Eventually, the rental income “could pay for four of those SUVs that I liked,” he adds.

The only time Baldwin likes to splurge is if it’s something for his wife — if he’s allowed to, that is. “My wife is more frugal than I am!” he says. “A couple years ago, I bought her a designer purse for like 500 bucks. But when I surprised her with it, she immediately took it back, exchanged it for a $60 purse at Macy’s and then we invested the difference.”

“So we don’t normally splurge.”

https://www.cnbc.com/2020/03/01/millennial-millionaire-shares-what-he-refuses-to-spend-money-on.html

John Maynard Keynes - Courage is the Key to Investing

From 1922 through 1946, Keynes’ stock portfolio outperformed the U.K. stock market by an average of nearly six percentage points annually — over a period covering the worst market crash, the worst economic depression and the worst war in modern history.


Keynes didn’t look like a great investor all the time. 

As a value investor, focused on buying stocks at bargain prices, he got left behind in the torrid bull market of the 1920s. Keynes didn’t see the Great Depression coming; he went into the Crash of 1929 with roughly 90% of the college’s funds in stocks even though, at the time, most other endowments overwhelmingly preferred bonds.

By late 1929 Keynes had cumulatively underperformed the British stock market by 40 percentage points over the preceding five years.

But he was already turning his performance around.


How Keynes mustered the courage to invest heavily in U.S. stocks devastated by the crash and the ensuing depression.

Keynes had almost entirely ignored U.S. stocks in the college’s endowment until September 1930. What a time to get interested!

The U.S. stock market had fallen 38.4% over the preceding 12 months. But Keynes was so excited by the bargains he saw opening up in the U.S. that he worked with a small New York brokerage, Case Pomeroy & Co., to research the market and his own stock ideas.

In 1931, when U.S. stocks fell a bloodcurdling 47.1%, and again in 1934, when they dropped another 5.9%, Keynes traveled to the U.S., spending much of his time meeting people on Wall Street, in government and in business who could help him research his investment ideas.


He bought U.S. stocks throughout the depression. 

When they fell another 38.6% in 1937, Keynes, undaunted, bought still more.

By 1939, he had put half his main portfolio for the college in U.S. companies, favoring

• high-dividend-paying preferred stocks, 
• investment trusts (diversified stock portfolios similar to today’s mutual funds) and, later on, 
• public utilities. 

He focused on a small number of stocks trading at low multiples of their value as businesses, often hanging on for eight years or more until their stock prices finally rose to reflect those asset values.


Buy when blood was running in the streets

Keynes’  words still ring with the resolve it must have taken to buy when blood was running in the streets:

“The spectacle of modern investment markets has sometimes moved me towards the conclusion that to make the purchase of an investment permanent and indissoluble, like marriage, except by reason of death or other grave cause, might be a useful remedy for our contemporary evils. For this would force the investor to direct his mind to the long-term prospects and to those only.”



Bear markets are unpredictable, reliably sidestepping them is nearly impossible

Keynes understood, as did his contemporary, the American value investor Benjamin Graham, that bear markets are so unpredictable that reliably sidestepping them is nearly impossible — and that the pain of losing money is nearly unbearable.


Buying into bear markets is the way to prevail

Still, Keynes knew, barging into bear markets to buy, rather than trying to sidestep them, is the way to prevail. Since, over the long run, stocks tend to go up more than they go down, one of the greatest advantages an investor can have is the gumption to buy stocks aggressively in falling markets.


That requires both cash and courage.

With stocks still not far from their record highs today, sitting on some cash is a better idea than ever.

And — unless you’re in or near retirement, in which case you should probably be scaling back on stocks already — steel your courage. Write a binding contract with yourself, witnessed by a friend or family member, committing you to buy more stocks when they fall 25%, 50% or more. Years from now, you’ll be glad you did.



Source: The Wall Street Journal

http://blogs.wsj.com/moneybeat/2016/10/14/john-maynard-keynes-courage-is-the-key-to-investing/

Independent Thinking

"You are neither right or wrong
because the crowd disagrees with
you. You are right because your
data and reasoning are right."
-Benjamin Graham


"The most difficult thing in business
is first getting yourself to thinking and
then getting others to thinking."
-Harvey Firestone


"Apply logic to help avoid fooling
yourself. Charlie will not accept
anything I say just because I say it,
although most of the world will."
-Warren Buffett


"Never fool yourself, and remember
that you are the easiest person to fool."
- Richard P. Feynman

Warren and Charlie on "Moats"

Buffett: "So we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary criterion of a great business. And we tell our managers we want the moat widened every year. That doesn't necessarily mean the profit will be more this year than it was last year because it won't be sometimes. However, if the moat is widened every year, the business will do very well. When we see a moat that's tenuous in any way - it's just too risky. We don't know how to evaluate that. And, therefore, we leave it alone.  We think that all of our businesses - or virtually all of our businesses - have pretty darned good moats. And we think the managers are widening them.
Charlie?"

Munger:  "How could you say it better?"
Buffen:  "Sure. Have some peanut brittle on that one."


- From the 2000 Berkshire Hathaway annual meeting

Philip Fisherr, author of Common Stocks and Uncommon Profits

Philip Fisher (1907-2004), author of Common Stocks and Uncommon Profits, among many other books, began his investment career in 1931.

Like Ben Graham, he achieved impressive results over his lifetime, but Fisher did it with a markedly different approach.

Unlike Graham, who typically invested in statistically cheap "cigar-butts" (with the notable exception of GEICO), Fisher preferred to buy and hold the stocks of high-quality companies that could, "grow and grow and grow."

Evaluating Investment Results of Your Money Manager

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

Some questions are obvious:

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

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

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

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

Investment returns for a brief period are, of course, affected by luck. The laws of probability tell us that almost anyone can achieve phenomenal success over any given measurement period. It is the task of those evaluating a money manager to ascertain how much of their past success is due to luck and how much to skill. 

Many investors mistakenly choose their money managers the same way they pick horses at the race track. They see who has performed well lately and bet on them. It is helpful to recognize that there are cycles of investment fashion; different investment approaches go into and out of favor, coincident with recent fluctuations in the results obtained by practitioners. If a manager with a good long-term record has a poor recent one, he or she may be specializing in an area that is temporarily out of favor. If so, the returns achieved could regress to their long-term mean as the cycle turns over time; several poor years could certainly be followed by several strong ones.

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

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

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

Evaluating Discretionary Stockbrokers and Money Managers

Some stockbrokers function as money managers, having discretionary investment authority over some or all of their clients' funds. Practices such as these may entail serious conflicts of interest since compensation is made on the basis of trading commissions rather than investment results. Nevertheless, you would select a discretionary stockbroker just as you would choose a money manager. The questions to be asked are virtually identical. In both cases, while there are large pools of people from whom to choose, selecting someone to handle your money with prudence and fiduciary responsibility is never easy. 

The ultimate challenge in selecting a stockbroker or money manager is

• understanding precisely what they do, 
• evaluating the validity of their investment approaches (do they make sense?) and 
• their integrity (do they do what is promised, and is it in your best interest?). 

How do you begin to evaluate stockbrokers and money managers? 

There are several important areas of inquiry, and one or more personal interviews are absolutely essential.

There is no better place to begin one's investigation than with personal ethics.

• Do they "eat home cooking"- managing their own money in parallel with their clients'? 
• I can think of no more important test of the integrity of a manager and the likelihood of investment success than his or her own confidence in the approach pursued on behalf of clients. 
• It is interesting to note that few, if any, junk-bond managers invested their own money in junk bonds. In other words, they ate out. 

Another area of inquiry concerns the fair treatment of clients.

• Are all clients treated equally? If not, why not, and in what ways? 
• Are transactions performed for all clients contemporaneously? If not, what method is used to ensure fairness? 

A third area of interest concerns the likelihood of achieving good investment results.

• Specifically, does the broker or money manager oversee a reasonably sized portfolio, or have the assets under management grown exceedingly large? 
• One way to judge is to examine the manager's track record since the assets under his or her control reached approximately the current level. Investors can also examine the records of other managers to determine in general how increased size affects performance. 
• From experience, large increases in assets under management adversely affect returns. The precise amount that can be managed successfully depends on the specific investment strategy employed as well as the skills of the manager under consideration. 

A fourth area of inquiry concerns the investment philosophy of the manager.

• Does the broker or money manager have an intelligent strategy that is likely to result in long-term investment success? (Obviously, a value-investment strategy would be optimal.) 
• Does he or she worry about absolute returns, about what can go wrong, or is he or she caught up in the relative-performance game? 
• Are arbitrary constraints and silly rules, such as remaining fully invested at all times, absent?

Mutual Funds

Mutual funds are, in theory, an attractive alternative for the individual investor, combining

• professional management, 
• low transaction costs, 
• immediate liquidity, and 
• reasonable diversification. 

In practice, they mostly do a mediocre job of managing money. There are, however, a few exceptions to this rule. 

For one thing, investors should certainly prefer no-load over load funds; the latter charge a sizable up-front fee, which is used to pay commissions to salespeople. Unlike closed-end funds, which have a fixed number of shares that fluctuate in price according to supply and demand, open-end funds issue new shares and redeem shares in response to investor interest. The share price of open-end funds is always equal to net asset value, which is based on the current market prices of the underlying holdings. Because of the redemption feature that ensures both liquidity and the ability to realize current net asset value, open-end funds are generally more attractive for investors than closed-end funds.' 

Unfortunately for their shareholders, because open-end mutual funds attract and lose assets in accordance with recent results, many fund managers are participants in the short-term relative-performance derby. Like other institutional investors, mutual fund organizations profit from management fees charged as a percentage of the assets under management; their fees are not based directly on results. Consequently, the fear of asset outflows resulting from poor relative performance generates considerable pressure to go along with the investment crowd. 

Another problem is that open-end mutual funds have in recent years attracted (and even encouraged) "hot" money from speculators looking to earn quick profits without the risk or bother of direct stock ownership. Many highly specialized mutual funds (e.g., biotechnology, environmental, Third World) have been established in order to exploit investors' interests in the latest market fad. Mutual-fund-marketing organizations have gone out of their way to encourage and even incite investor enthusiasm, setting up retail mutual fund stores, providing hourly fund pricing, and authorizing switching among their funds by telephone. They do not discourage the mutual fund newsletters and switching services that have sprouted up to accommodate the "needs" of hot-money investors.

Some open-end mutual funds do have a long-term value investment orientation. These funds have a large base of loyal, long-term-oriented shareholders, which reduces the risk of substantial redemptions that could precipitate the forced liquidation of undervalued positions into a depressed market. The Mutual Series Funds and the Sequoia Fund, Inc., are among some favorites; the Sequoia Fund, Inc., has been completely closed to new investors in recent years, while some of the Mutual Series Funds periodically open to accommodate new investors.

Investment Alternatives for the Individual Investor

The unfortunate fact is that the individual investor has few, if any, attractive investment alternatives.

Investing, it should be clear by now, is a full-time job. 

Given the vast amount of information available for review and analysis and the complexity of the investment task, a part-time or sporadic effort by an individual investor has little chance of achieving long-term success. 

It is not necessary, or even desirable, to be a professional investor, but a significant, ongoing commitment of time is a prerequisite. 

Individuals who cannot devote substantial time to their own investment activities have three alternatives:

• mutual funds, 
• discretionary stockbrokers, or 
• money managers. 

Good Portfolio Management and Trading are of maximum value when used with an Appropriate Investment Philosophy

Here are a number of issues that investors should consider in managing their portfolios.

While individual personalities and goals can influence one's trading and portfolio management techniques to some degree, sound buying and selling strategies, appropriate diversification, and prudent hedging are of importance to all investors.

Of course, good portfolio management and trading are of no use when pursuing an inappropriate investment philosophy; they are of maximum value when employed in conjunction with a value investment approach.

Use a Broker to Whom You Are Important

Whether buying or selling, there are distinct advantages to finding and doing business with long-term-oriented stockbrokers who recognize that it is in their interest to build and maintain mutually beneficial relationships with clients. 

• If customers feel that their best interests are being served and that brokerage commissions are a secondary consideration, long-term relationships are likely to ensue. 
• By contrast, brokers who charge exorbitant commissions or routinely recommend trades designed more to generate commissions than investment profits will eventually lose customers. 

The challenge is to find one or more brokers with whom you feel comfortable. 

• An appropriate broker will possess a balance of experience and desire, a commitment to the investment business, and a willingness to sacrifice immediate commissions for the sake of  long-term relationships. 
• You want a broker with sufficient clout within his or her firm to provide you with access to analysts and traders, one with experience to handle your account properly and to know when to call you and when not to waste your time. 
• You don't want a totally inexperienced broker who is learning at your expense, a complacent broker satisfied with mediocre results, or one so successful that your account is relatively unimportant. 

Michael Price and Bill Ruane would have no problem capturing the undivided attention of any broker; they would be very important clients for anyone.

• Other investors must work harder to find one or more brokers to whom they will be important clients. 
• One possibility is to develop a relationship with a fairly young but capable broker to whom your account is currently very important and one who will gain importance and clout within the firm over time.

Comments:

I may have to look for a few more brokers to find out more.  :-)

Selling: The Hardest Decision of All

Many investors are able to spot a bargain but have a harder time knowing when to sell. 

• One reason is the difficulty of knowing precisely what an investment is worth. 
• An investor buys with a range of value in mind at a price that provides a considerable margin of safety. 
• As the market price appreciates, however, that safety margin decreases; the potential return diminishes and the downside risk increases. 
• Not knowing the exact value of the investment, it is understandable that an investor cannot be as confident in the sell decision as he or she was in the purchase decision. 

To deal with the difficulty of knowing when to sell, some investors create rules for selling based on specific price-to-book value or price-to-earnings multiples. Others have rules based on percentage gain thresholds; once they have made X percent, they sell. Still others set sale price targets at the time of purchase, as if nothing that took place in the interim could influence the decision to sell. None of these rules makes good sense. Indeed, there is only one valid rule for selling: all investments are for sale at the right price. 




Decisions to Sell

Decisions to sell, like decisions to buy, must be based upon underlying business value.' Exactly when to sell-or buy depends on the alternative opportunities that are available.

• Should you hold for partial or complete value realization, for example? 
• It would be foolish to hold out for an extra fraction of a point of gain in a stock selling just below underlying value when the market offers many bargains. 
• By contrast, you would not want to sell a stock at a gain (and pay taxes on it) if it were still significantly undervalued and if there were no better bargains available. 

Some investors place stop-loss orders to sell securities at specific prices, usually marginally below their cost. If prices rise, the orders are not executed. If the prices decline a bit, presumably on the way to a steeper fall, the stop-loss orders are executed. Although this strategy may seem an effective way to limit downside risk, it is, in fact, crazy. Instead of taking advantage of market dips to increase one's holdings, a user of this technique acts as if the market knows the merits of a particular investment better than he or she does.

Liquidity considerations are also important in the decision to sell.

• For many securities the depth of the market as well as the quoted price is an important consideration. 
• You cannot sell, after all, in the absence of a willing buyer; the likely presence of a buyer must therefore be a factor in the decision to sell. 
• As the president of a small firm specializing in trading illiquid over the-counter (pink-sheet) stocks once told me: "You have to feed the birdies when they are hungry." 

If selling still seems difficult for investors who follow a value investment philosophy, I offer the following rhetorical questions: If you haven't bought based upon underlying value, how do you decide when to sell?

• If you are speculating in securities trading above underlying value, when do you take a profit or cut your losses? 
• Do you have any guide other than "how they are acting," which is really no guide at all?

Buying: Leave Room to Average Down

The single most crucial factor in trading is developing the appropriate reaction to price fluctuations.

Investors must learn to resist 

• fear, the tendency to panic when prices are falling, and 
• greed, the tendency to become overly enthusiastic when prices are rising. 

One half of trading involves learning how to buy. 

• In my view, investors should usually refrain from purchasing a "full position" (the maximum dollar commitment they intend to make) in a given security all at once. Those who fail to heed this advice may be compelled to watch a subsequent price decline helplessly, with no buying power in reserve. 
• Buying a partial position leaves reserves that permit investors to "average down," lowering their average cost per share, if prices decline. 

Evaluating your own willingness to average down can help you distinguish prospective investments from speculations. 

• If the security you are considering is truly a good investment, not a speculation, you would certainly want to own more at lower prices. 
• If, prior to purchase, you realize that you are unwilling to average down, then you probably should not make the purchase in the first place. 

Potential investments in companies that are

• poorly managed, 
• highly leveraged, 
• in unattractive businesses, or 
• beyond understanding 

may be identified and rejected.

Stay in Touch with the Market: Opportunities and Dangers

Some investors buy and hold for the long term, stashing their securities in the proverbial vault for years. While such a strategy may have made sense at some time in the past, it seems misguided today. This is because the financial markets are prolific creators of investment opportunities. 

• Investors who are out of touch with the markets will find it difficult to be in touch with buying and selling opportunities regularly created by the markets. 
• Today with so many market participants having little or no fundamental knowledge of the businesses their investments represent, opportunities to buy and sell seem to present themselves at a rapid pace. 
• Given the geopolitical and macroeconomic uncertainties we face in the early 1990s and are likely to continue to face in the future, why would abstaining from trading be better than periodically reviewing one's holdings? 

Being in touch with the market does pose dangers, however.

• Investors can become obsessed, for example, with every market uptick and downtick and eventually succumb to short-term-oriented trading. 
• There is a tendency to be swayed by recent market action, going with the herd rather than against it. 
• Investors unable to resist such impulses should probably not stay in close touch with the market; they would be well advised to turn their investable assets over to a financial professionaL 

Another hazard of proximity to the market is exposure to stockbrokers.

• Brokers can be a source of market information, trading ideas, and even useful investment research. 
• Many, however, are in business primarily for the next trade. 
• Investors may choose to listen to the advice of brokers but should certainly confirm everything that they say. 
• Never base a portfolio decision solely on a broker's advice, and always feel free to say no.

The Importance of Trading: Since transacting at the right price is critical, trading is central to value-investment success.

There is nothing inherent in a security or business that alone makes it an attractive investment.

Investment opportunity is a function of price, which is established in the marketplace.

• Whereas some investors are company- or concept-driven, anxious to invest in a particular industry, technology, or fad without special concern for price, a value investor is purposefully driven by price. 
• A value investor does not get up in the morning knowing his or her buy and sell orders for the day; these will be determined in the context of the prevailing prices and an ongoing assessment of underlying values. 

Since transacting at the right price is critical, trading is central to value-investment success. 

• This does not mean that trading in and of itself is important; trading for its own sake is at best a distraction and at worst a costly digression from an intelligent and disciplined investment program. 
• Investors must recognize that while over the long run investing is generally a positive sum activity, on a day-to-day basis most transactions have zero sum consequences. If a buyer receives a bargain, it is because the seller sold for too low a price. If a buyer overpays for a security, the beneficiary is the seller, who received a price greater than underlying business value. 

The best investment opportunities arise when other investors act unwisely thereby creating rewards for those who act intelligently. 

• When others are willing to overpay for a security, they allow value investors to sell at premium prices or sell short at overvalued levels. 
• When others panic and sell at prices far below underlying business value, they create buying opportunities for value investors. 
• When their actions are dictated by arbitrary rules or constraints, they will overlook outstanding opportunities or perhaps inadvertently create some for others. 

Trading is the process of taking advantage of such mispricings.

Reducing Portfolio Risk

The challenge of successfully managing an investment portfolio goes beyond making a series of good individual investment decisions.

Portfolio management requires paying attention to the portfolio as a whole, taking into account 

• diversification, 
• possible hedging strategies, and 
• the management of portfolio cash flow. 

In effect, while individual investment decisions should take risk into account, portfolio management is a further means of risk reduction for investors. 



1.  Appropriate Diversification 

Even relatively safe investments entail some probability, however small, of downside risk.

• The deleterious effects of such improbable events can best be mitigated through prudent diversification. 
• The number of securities that should be owned to reduce portfolio risk to an acceptable level is not great; as few as ten to fifteen different holdings usually suffice. 

Diversification for its own sake is not sensible. This is the index fund mentality: if you can't beat the market, be the market.

• Advocates of extreme diversification - which I think of as overdiversification - live in fear of company-specific risks; their view is that if no single position is large, losses from unanticipated events cannot be great. 
• My view is that an investor is better off knowing a lot about a few investments than knowing only a little about each of a great many holdings. 
• One's very best ideas are likely to generate higher returns for a given level of risk than one's hundredth or thousandth best idea. 

Diversification is potentially a Trojan horse. 

• Junk-bond-market experts have argued vociferously that a diversified portfolio of junk bonds carries little risk. Investors who believed them substituted diversity for analysis and, what's worse, for judgment. 
• The fact is that a diverse portfolio of overpriced, subordinated securities, about each of which the investor knows relatively little, is highly risky. 
• Diversification of junk-bond holdings among several industries did not protect investors from a broad economic downturn or credit contraction. 
• Diversification, after all, is not how many different things you own, but how different the things you do own are in the risks they entail. 

2.  Hedging 

Market risk - the risk that the overall stock market could decline - cannot be reduced through diversification but can be limited by hedging. An investor's choice among many possible hedging strategies depends on the nature of his or her underlying holdings.


A diversified portfolio of large capitalization stocks, for example, could be effectively hedged through the sale of an appropriate quantity of Standard & Poor's 500 index futures. 

• This strategy would effectively eliminate both profits and losses due to broad-based stock market fluctuations. 
• If a portfolio were hedged through the sale of index futures, investment success would thereafter depend on the performance of one's holdings compared with the market as a whole. 

A portfolio of interest-rate-sensitive stocks could be hedged by selling interest rate futures or purchasing or selling appropriate interest rate options.

A gold-mining stock portfolio could be hedged against fluctuations in the price of gold by selling  gold futures.

A portfolio of import- or export-sensitive stocks could be partially hedged through appropriate transactions in the foreign exchange markets. 



It is not always smart to hedge. 

• When the available return is sufficient, for example, investors should be willing to incur risk and remain unhedged. 
• Hedges can be expensive to buy and time-consuming to maintain, and overpaying for a hedge is as poor an idea as overpaying for an investment. 
• When the cost is reasonable, however, a hedging strategy may allow investors to take advantage of an opportunity that otherwise would be excessively risky. 
• In the best of all worlds, an investment that has valuable hedging properties may also be an attractive investment on its own merits. 

By way of example, from mid-1988 to early 1990 the Japanese stock market rose repeatedly to record high levels. The market's valuation appeared excessive by U.S. valuation criteria, but in Japan the view that the stock market was indirectly controlled by the government and would not necessarily be constrained by underlying fundamentals was widely held.

• Japanese financial institutions, which had become accustomed to receiving large and growing annual inflows of funds for investment, were so confident that the market would continue to rise that they were willing to sell Japanese stock market puts (options to sell) at very low prices. 
• To them sale of the puts generated immediate income; since in their view the market was almost certainly headed higher, the puts they sold would expire worthless. 
• If the market should temporarily dip, they were confident that the shares being put back to them would easily be paid for out of the massive cash inflows they had come to expect. 

Wall Street brokerage firms acted as intermediaries, originating these put options in Japan and selling them in private transactions to U.S. investors.' These inexpensive puts were in theory an attractive, if imprecise, hedge for any stock portfolio.

• Since the Japanese stock market was considerably overvalued compared with the U.S. market, investors in U.S. equities could hedge the risk of a decline in their domestic holdings through the purchase of Japanese stock market puts. 
• These puts were much less expensive than puts on the U.S. market, while offering considerably more upside potential if the Japanese market declined to historic valuation levels. 

As it turned out, by mid-1990 the Japanese stock market had plunged 40 percent in value from the levels it had reached only a few months earlier.

• Holders of Japanese stock market put options, depending on the specific terms of their contracts, earned many times their original investment. 
• Ironically, these Japanese puts did not prove to be a necessary hedge; the Japanese stock market decline was not accompanied by a material drop in U.S. share prices. 
• These puts were simply a good investment that might have served as a hedge under other circumstances.

The Importance of Liquidity in Managing an Investment Portfolio

Since no investor is infallible and no investment is perfect, there is considerable merit in being able to change one's mind.

• If an investor purchases a liquid stock such as IBM because he thinks that a new product will be successful or because he expects the next quarter's results to be strong, he can change his mind by selling the stock at any time before the anticipated event, probably with minor financial consequences. 
• An investor who buys a nontransferable limited partnership interest or stock in a nonpublic company, by contrast, is unable to change his mind at any price; he is effectively locked in. 
• When investors do not demand compensation for bearing illiquidity, they almost always come to regret it. 

Most of the time liquidity is not of great importance in managing a long-term-oriented investment portfolio. 

• Few investors require a completely liquid portfolio that could be turned rapidly into cash. 
• However, unexpected liquidity needs do occur. 
• Because the opportunity cost of illiquidity is high, no investment portfolio should be completely illiquid either. 
• Most portfolios should maintain a balance, opting for greater illiquidity when the market compensates investors well for bearing it. 

A mitigating factor in the trade-off between return and liquidity is duration. 

• While you must always be well paid to sacrifice liquidity, the required compensation depends on how long you will be illiquid. 
• Ten or twenty years of illiquidity is far riskier than one or two months; in effect, the short duration of an investment itself serves as a source of liquidity. 
• Investors making venture-capital investments, for example, must be exceptionally well compensated to offset the high probability of loss, the large proportion of the investment that is at risk (losses are often complete wipeouts), and the illiquidity experienced for the duration of the investment. 
• The cost of illiquidity is very high in such situations, rendering venture capitalists virtually unable to change their minds and making it difficult for them to cash in even when the businesses they invested in are successful. 

Liquidity can be illusory.

• As Louis Lowenstein has stated, "In the stock market, there is liquidity for the individual but not for the whole community. 
• ''''The distributable profits of a company are the only rewards for the community."! 
• In other words, while anyone investor can achieve liquidity by selling to another investor, all investors taken together can only be made liquid by generally unpredictable external events such as takeover bids and corporate-share repurchases. 
• Except for such extraordinary transactions, there must be a buyer for every seller of a security. 

In times of general market stability the liquidity of a security or class of securities can appear high. In truth liquidity is closely correlated with investment fashion. 

• During a market panic the liquidity that seemed miles wide in the course of an upswing may turn out only to have been inches deep. 
• Some securities that traded in high volume when they were in favor may hardly trade at all when they go out of vogue. 

When your portfolio is completely in cash, there is no risk of loss. There is also, however, no possibility of earning a high return. 

• The tension between earning a high return, on the one hand, and avoiding risk, on the other, can run high. 
• The appropriate balance between illiquidity and liquidity, between seeking return and limiting risk, is never easy to determine. 

Investing is in some ways an endless process of managing liquidity. 

• Typically an investor begins with liquidity, that is, with cash that he or she is looking to put to work. 
• This initial liquidity is converted into less liquid investments in order to earn an incremental return. 
• As investments come to fruition, liquidity is restored. Then the process begins anew. 

This portfolio liquidity cycle serves two important purposes. 

• First, portfolio cash flow - the cash flowing into a portfolio - can reduce an investor's opportunity costs. 
• Second, the periodic liquidation of parts of a portfolio has a cathartic effect. 
• For the many investors who prefer to remain fully invested at all times, it is easy to become complacent, sinking or swimming with current holdings. 
• "Dead wood" can accumulate and be neglected while losses build. 
• By contrast, when the securities in a portfolio frequently tum into cash, the investor is constantly challenged to put that cash to work, seeking out the best values available.

Portfolio Management and Trading

Investing would be complete without a discussion of trading and portfolio management.



Trading

Trading - the process of buying and selling securities - can have a significant impact on one's investment results.  Good trading decisions can

• sometimes add to an investment's profitability and 
• other times can mean the difference between executing a transaction and failing to do so. 

Portfolio Management

Portfolio management encompasses

• trading activity 
• as well as the regular review of one's holdings. 

In addition, an investor's portfolio management responsibilities include

• maintaining appropriate diversification, 
• making hedging decisions, and 
• managing portfolio cash flow and liquidity. 

All investors must come to terms with the relentless continuity of the investment process. 

Although specific investments have a beginning and an end, portfolio management goes on forever. 




Investors in marketable securities will not have predictable annual results

Unlike many areas of endeavor, there is no near-annuity of profitable business, no backlog of upcoming investment returns. 

Heinz ketchup will have a reasonably predictable volume of sales year in and year out. In a sense, its profits of tomorrow were partially earned yesterday when its franchise was established.

Investors in marketable securities will not have predictable annual results, however, even if they possess shares representing fractional ownership of the same company. 

Moreover, attractive returns earned by Heinz may not correlate with the returns achieved by investors in Heinz; the price paid for the stock, and not just business results, determines their return.

JOHN MAYNARD KEYNES: COURAGE IS THE KEY TO INVESTING

Posted by jasonzweig on Oct 17, 2016 in Articles & Advice, Blog, Columns, Featured, Radio & Podcasts |

Image Credit: “Maynard Keynes,” Duncan Grant (1917-18), The Charleston Trust

 

By Jason Zweig |  Oct. 14, 2016 11:21 am ET

The next time the stock market crashes, we will all step forward and buy stocks boldly — at least in our imaginations.

But buying stocks when the market collapses is far harder to do than to imagine. New research looks at how the great economist  — and equally great investor — John Maynard Keynes waded into the wake of the Great Crash of 1929, when U.S. stocks fell by more than 80% from peak to trough. His experience should teach all investors the importance of preparation, courage and patience.

Between the early 1920s and his death in 1946, Keynes wrote several books, revolutionized economic policy and helped devise the modern global monetary system. In his spare time, he managed the endowment of King’s College at the University of Cambridge. From 1922 through 1946, Keynes’ stock portfolio outperformed the U.K. stock market by an average of nearly six percentage points annually — over a period covering the worst market crash, the worst economic depression and the worst war in modern history.

Keynes didn’t look like a great investor all the time. As what we today call a value investor, focused on buying stocks at bargain prices, he got left behind in the torrid bull market of the 1920s. Keynes didn’t see the Great Depression coming; he went into the Crash of 1929 with roughly 90% of the college’s funds in stocks even though, at the time, most other endowments overwhelmingly preferred bonds.

By late 1929 Keynes had cumulatively underperformed the British stock market by 40 percentage points over the preceding five years.

But he was already turning his performance around.

In a new research paper in Business History Review, an academic journal, finance professor David Chambers of Cambridge’s Judge Business School and economist Ali Kabiri of the University of Buckingham analyze how Keynes mustered the courage to invest heavily in U.S. stocks devastated by the crash and the ensuing depression.

Keynes had almost entirely ignored U.S. stocks in the college’s endowment until September 1930. What a time to get interested! The U.S. stock market had fallen 38.4% over the preceding 12 months. But Keynes was so excited by the bargains he saw opening up in the U.S. that he worked with a small New York brokerage, Case Pomeroy & Co., to research the market and his own stock ideas. In 1931, when U.S. stocks fell a bloodcurdling 47.1%, and again in 1934, when they dropped another 5.9%, Keynes traveled to the U.S., spending much of his time meeting people on Wall Street, in government and in business who could help him research his investment ideas.

He bought U.S. stocks throughout the depression. When they fell another 38.6% in 1937, Keynes, undaunted, bought still more. By 1939, he had put half his main portfolio for the college in U.S. companies, favoring high-dividend-paying preferred stocks, investment trusts (diversified stock portfolios similar to today’s mutual funds) and, later on, public utilities. He focused on a small number of stocks trading at low multiples of their value as businesses, often hanging on for eight years or more until their stock prices finally rose to reflect those asset values.

Chapter 12 of Keynes’ book “The General Theory of Employment, Interest and Money,” which he wrote 80 years ago, remains one of the most concentrated bursts of brilliance anyone has ever brought to bear on investing. His words still ring with the resolve it must have taken to buy when blood was running in the streets:

“The spectacle of modern investment markets has sometimes moved me towards the conclusion that to make the purchase of an investment permanent and indissoluble, like marriage, except by reason of death or other grave cause, might be a useful remedy for our contemporary evils. For this would force the investor to direct his mind to the long-term prospects and to those only.”

Keynes understood, as did his contemporary, the American value investor Benjamin Graham, that bear markets are so unpredictable that reliably sidestepping them is nearly impossible — and that the pain of losing money is nearly unbearable.

Still, Keynes knew, barging into bear markets to buy, rather than trying to sidestep them, is the way to prevail. Since, over the long run, stocks tend to go up more than they go down, one of the greatest advantages an investor can have is the gumption to buy stocks aggressively in falling markets.

That requires both cash and courage.

With stocks still not far from their record highs today, sitting on some cash is a better idea than ever.

And — unless you’re in or near retirement, in which case you should probably be scaling back on stocks already — steel your courage. Write a binding contract with yourself, witnessed by a friend or family member, committing you to buy more stocks when they fall 25%, 50% or more. Years from now, you’ll be glad you did.

Source: The Wall Street Journal

http://blogs.wsj.com/moneybeat/2016/10/14/john-maynard-keynes-courage-is-the-key-to-investing/

Your financial well-being is definitely not something to trifle with.

Once you choose to venture beyond U.S. Treasury bills, whatever you do with your money carries some risk.

Don't think you can avoid making a choice; inertia is also a decision.

It took a long time to accumulate whatever wealth you have; your financial well-being is definitely not something to trifle with. 

For this reason, I recommend that you adopt a value-investment philosophy and

• either find an investment professional with a record of value-investment success 
• or commit the requisite time and attention to investing on your own.

Investing in Financially Distressed and Bankrupt Securities: Issuer Responses to Financial Distress

There are three principal alternatives for an issuer of debt securities that encounters financial distress:

• continue to pay principal and interest when due, 
• offer to exchange new securities for securities currently outstanding, or 
• default and file for bankruptcy. 

A potential investor in distressed securities must consider each of these three possible scenarios before committing capital.

Financially troubled companies can try to survive outside bankruptcy by resorting to

• cost cutting, 
• asset sales, or 
• an infusion of outside capital. 

Such efforts can be successful, depending on the precise cause of the debtor's woes.  Short-term palliatives, however, can contribute to the erosion of long-term business value.

Efforts to conserve cash by cutting back inventory, stretching out accounts payable, or reducing salaries, for example, can get a business through a short-term crisis, but in the long run some of these measures may hurt relationships with customers, suppliers, and employees and result in a diminution of business value. 

A second option for a company is to make an exchange offer to replace outstanding debt and, where relevant, preferred stock with new securities. The possibility of an exchange offer adds a strategic dimension to investing in financially distressed securities absent from most passive investments. An exchange offer is an attempt by a financially distressed issuer to stave off bankruptcy by offering new, less-onerous securities in exchange for some or all of those outstanding.

An exchange offer can serve as an out-of-court plan of reorganization. Sometimes an offer is made to exchange for only one security; perhaps the issuer needs only to extend an upcoming maturity. Other times most or all outstanding debt securities and, where relevant, preferred stock are offered the opportunity to exchange.

Exchange offers are difficult to complete. Typically they involve persuading debt holders (and preferred stockholders, if any) to accept less than one dollar's worth of new securities for each current dollar of claim against the debtor. The greatest difficulty in consummating an exchange offer is that, unlike stockholders, bondholders cannot be compelled to do anything. Depending on state law, a vote of 50 percent or 67 percent of the stockholders of a company is sufficient to approve a merger; the minority is compelled to go along. However, the majority of a class of bondholders cannot force the minority to accept an exchange offer. This results in a free-rider problem since the value of "holding out" is typically greater than the value of going along with a restructuring.

Suppose Company X needs to cut its debt from $100 million to $75 million and offers bondholders an opportunity to exchange their bonds, currently trading at fifty cents on the dollar, for new bonds of equal seniority valued at seventy-five. This offer may be acceptable to each holder; individually they would be willing to forego the full value of their claims in order to avoid the uncertainty and the delay of bankruptcy proceedings as well as the loss of the time-value of their money. They may be concerned, however, that if they agree to exchange while others do not, they will have sacrificed 25 percent of the value owed them when others have held out for full value. Moreover, if they make the sacrifice and others do not, the debtor may not be sufficiently benefitted and could fail anyway. In that event those who exchanged would be rendered worse off than those who did not because, by holding a lower face amount of securities, they would have a smaller claim in bankruptcy.

An exchange offer is somewhat like the Prisoner's Dilemma. In this paradigm two prisoners, held incommunicado, are asked to confess to a crime. If neither confesses, they both go free. If both confess, they incur a severe punishment but not a lethal one. If one confesses and the other holds out, however, the holdout will be executed. If they could collude, both prisoners would hold out and go free; held in isolation, each fears that the other might confess.

The Prisoner's Dilemma is directly applicable to the bondholders in an exchange offer. Each might be willing to go along if he or she could be certain that other holders would also, but since no bondholder could be certain of others' cooperation, each has a financial incentive to hold out. Exchange offers often require a very high acceptance rate in order to mitigate this problem. If all bondholders could be brought together, there might be a chance to achieve voluntary cooperation. Historically, however, bondholders have been a disparate group, not always even identifiable by the debtor and hard to bring together for negotiations.

One way to overcome the free-rider problem is a technique known as a prepackaged bankruptcy, in which creditors agree to a plan of reorganization prior to the bankruptcy filing. Because negotiations have already been completed, a prepackaged bankruptcy is reasonably expected to be dispatched in months rather than years; the duration is not much greater than the time involved in completing an exchange offer. The advantage of a prepackaged bankruptcy over an exchange offer is that since a majority in number and two-thirds of the dollar amount of each creditor class must approve a bankruptcy plan, up to one-third of the dollar amount of a class can be compelled to go along with the other creditors, effectively eliminating the freerider problem. It seems likely that there will be increased use of the prepackaged bankruptcy in future efforts to restructure overleveraged companies in order to expedite the reorganization process, avoid the high administrative costs of a traditional Chapter 11 filing, and circumvent the free-rider problem.


If measures to keep the patient alive prove unsuccessful, the third option is to file for court protection under Chapter 11 of the federal bankruptcy code and attempt to reorganize the debtor with a more viable capital structure. This is typically a last resort, however, for there is still considerable stigma attached to bankruptcy.

Investing in Financially Distressed and Bankrupt Securities

Financially Distressed and Bankrupt Businesses 

Companies get into financial trouble for at least one of three reasons: 

• operating problems, 
• legal problems, and/or 
• financial problems. 

A serious business deterioration can cause continuing operating losses and ultimately financial distress. Unusually severe legal problems, such as those that plagued Johns Manville, Texaco, and A. H. Robins, caused tremendous financial uncertainty for these companies, leading them ultimately to seek bankruptcy court protection. Financial distress sometimes results almost entirely from the burdens of excessive debt; many of the junk-bond issuers of the 1980s shared this experience.



Financial distress is typically characterized by a shortfall of cash to meet operating needs and scheduled debt-service obligations.

• When a company runs short of cash, its near-term liabilities, such as commercial paper or bank debt, may not be refinanceable at maturity. 
• Suppliers, fearing that they may not be paid, curtail or cease shipments or demand cash on delivery, exacerbating the debtor's woes. 
• Customers dependent on an ongoing business relationship may stop buying. 
• Employees may abandon ship for more secure or less stressful jobs. 

Since the effect of financial distress on business results can vary from company to company, investors must exercise considerable caution in analyzing distressed securities.

• The operations of capital-intensive businesses are, over the long run, relatively immune from financial distress, while those that depend on public trust, like financial institutions, or on image, like retailers, may be damaged irreversibly. 
• For some businesses the decline in operating results is limited to the period of financial distress. 
• After a successful exchange offer, an injection of fresh capital, or a bankruptcy reorganization, these businesses recover to their historic levels of profitability. Others, however, remain shadows of their former selves. 

The capital structure of a business also affects the degree to which operations are impacted by financial distress.

• For debtors with most or all of their obligations at a holding company one or more levels removed from the company's primary assets, the impact of financial distress can be minimal. 
• Overleveraged holding companies, for example, can file for bankruptcy protection while their viable subsidiaries continue to operate unimpaired; Texaco entered bankruptcy while most of its subsidiaries did not file for court protection. 
• Companies that incur debt at the operating-subsidiary level may face greater dislocations. 

The popular media image of a bankrupt company is a rusting hulk of a factory viewed from beyond a padlocked gate.

• Although this is sometimes the unfortunate reality, far more often the bankrupt enterprise continues in business under court protection from its creditors. 
• Indeed, while there may be a need to rebuild damaged relationships, a company that files for bankruptcy has usually reached rock bottom and in many cases soon begins to recover. 
• As soon as new lenders can be assured of their senior creditor position, debtor-in-possession financing becomes available, providing cash to meet payroll, to restock depleted inventories, and to give confidence both to customers and suppliers. 
• Since postpetition suppliers to the debtor have a senior claim to unsecured prepetition creditors, most suppliers renew shipments. 
• As restocked inventories and increased confidence stimulate business and as deferred maintenance and delayed capital expenditures are undertaken, results may begin to improve. 
• Cash usually starts to build (for a number of reasons). 
• When necessary, new management can be attracted by the prospect of a stable and improving business situation and by the lure of low-priced stock or options in the reorganized company. 
• While Chapter 11 is not a panacea, bankruptcy can provide a sheltered opportunity for some troubled businesses to return to financial health.

The Value Investing Process: Investing in Financially Distressed and Bankrupt Securities

As we have learned from the history of the junk-bond market, investors have traditionally attached a stigma to the securities of financially distressed companies, perceiving them as highly risky and therefore imprudent. 

Financially distressed and bankrupt securities are analytically complex and often illiquid.

• The reorganization process is both tedious and highly uncertain. 
• Identifying attractive opportunities requires painstaking analysis; investors may evaluate dozens of situations to uncover a single worthwhile opportunity. 

Although the number of variables is high in any type of investing, the issues that must be considered when investing in the securities of financially distressed or bankrupt companies are greater in number and in complexity.

• In addition to comparing price to value as one would for any investment, investors in financially distressed securities must consider, among other things, the effect of financial distress on business results; the availability of cash to meet upcoming debt-service requirements; and likely restructuring alternatives, including a detailed understanding of the different classes of securities and financial claims outstanding and who owns them. 
• Similarly, investors in bankrupt securities must develop a thorough understanding of the reorganization process in general as well as the specifics of each situation being analyzed. 

Because most investors are unable to analyze these securities and unwilling to invest in them, the securities of financially distressed and bankrupt companies can provide attractive value investment opportunities. Unlike newly issued junk bonds, these securities sell considerably below par value where the risk/reward ratio can be attractive for knowledgeable and patient investors.

Areas of Opportunity for Value Investors

The theme: that attractive opportunities to purchase undervalued investments arise with some frequency in a number of areas and that these opportunities can be identified and exploited by value investors.