Monday, 4 May 2020

Buffett admits a mistake with airline stocks

There's been a lot of speculation about the moves that Berkshire Hathaway has recently made with its airline stock holdings. In early April, Berkshire sold substantial amounts of its holdings in Delta Air Lines (NYSE:DAL) and Southwest Airlines (NYSE:LUV), with disclosures necessary because of Berkshire's having held more than 10% of the two airlines' outstanding shares. At the time, it seemed as though Buffett might simply be reducing its positions below 10% to avoid future complications.

However, Buffett reported selling a total of $6.5 billion in stock during April, far more than the Delta and Southwest sales that had been reported and also including shares of United Airlines Holdings (NASDAQ:UAL) and American Airlines Group (NASDAQ:AAL) as well. Questioned later, the Berkshire CEO said that the company sold off its entire positions in the four airlines. As he explained it, he "just decided I made a mistake." He had initially figured that investing $7 billion to $8 billion to buy 10% stakes in the four biggest U.S. airlines would give him about $1 billion in underlying earnings, which seemed like a reasonable value. However, Buffett said, "It turned out I was wrong about the business."

Buffett didn't blame airline CEOs, who managed their companies well and did a lot of things right. However, the Berkshire leader no longer feels comfortable that airlines will ever recover to their pre-coronavirus levels, and even two to three years from now, it's possible that not nearly as many people will be flying. Unfortunately, even if airlines recover 70% to 80% of their pre-crisis passenger loads, they'll still have far too many planes. With airlines selling stock to raise capital, upside is limited. Buffett concluded, "The world changed for airlines, and we wish them well."

https://www.fool.com/investing/2020/05/02/what-warren-buffett-said-at-berkshires-2020-shareh.aspx





Related article:


Warren Buffett Adds to Delta Investment as Airlines Plunge to Value Territory

https://myinvestingnotes.blogspot.com/2020/03/warren-buffett-adds-to-delta-investment.html



Berkshire's Top Equity Holdings

Berkshire still holds3 over $180 billion in the common stock of many publicly-traded companies. Approximately 69% of the aggregate fair value was concentrated in these five companies:
  • American Express Co. (AXP): $13.0 billion
  • Apple Inc. (AAPL): $63.8 billion
  • Bank of America Corp. (BAC): $20.2 billion
  • The Coca-Cola Company (KO): $17.7 billion
  • Wells Fargo & Co. (WFC): $9.9 billion

Saturday, 2 May 2020

Building a stock portfolio that beats EPF returns

May 2, 2020

There are many people who believe that stock investing can generate double-digit returns, which is higher than the 10-Year Dividend Yield Average of 6.17% per annum EPF return from 2010 to 2019.
So, is stock investing really better?
Firstly, in stock investing, the 10+% returns are not cash-based as delivered by the EPF and often, it refers to trading gains that are derived from buying stocks at low prices to selling them at higher prices later.
Thus, this 10+% returns are not guaranteed, predictable, or even recurring in nature.
Secondly, if you do not study a stock’s business model, financial results, and future plans before investing in it, and instead buy stocks because you anticipate they will rise in the future, then you are not investing but betting.
Lastly, it is one thing to make 10+% in returns in one year but a different feat if you can replicate this success and make 10+% in returns consistently every single year.
The keyword here is “consistency”.

So how does EPF invest your money to continue declaring future dividends? 
This article sheds light, along with pointers on how you can build a stock portfolio for consistently attaining higher returns than the EPF.
1: EPF’s Strategic Asset Allocation (SAA)
The EPF employs its SAA as a framework to optimise its long-term investment returns. The EPF allocates:
  • 51% of its total investments into Fixed Income Instruments for capital preservation, 
  • 36% into Equities to grow its returns
  • 10% into Real Estate to hedge against inflation and 
  • the remaining 3% is into Money-Market Instruments to fund its day-to-day operations.

In essence, it is likened to a person who has RM100,000 in capital to invest and parks 
  • RM51,000 into FDs, 
  • RM36,000 into stocks, 
  • RM10,000 into REITs and 
  • the final RM3,000 is left in his savings account for living expenses.


2: EPF invests primarily for income (cash flow)
The EPF has multiple recurring sources of income from its investment assets. They include 
  • interest income from fixed income instruments, 
  • dividend income from equities, and 
  • rental income from real estate.

Combined, the amount of its recurring income has increased from RM16.2 billion in 2009 to RM32.6 billion in 2018.
They have contributed about 65% of EPF’s gross investment income for the past 10 years, which is key to its investment success and consistent delivery of the 6+% in annual dividends to its contributors.
EPF’s income flow from its investments.

3: EPF’s stock portfolio
The EPF built itself a global portfolio worth RM300 billion in 2018 where its key markets were in Malaysia, Hong Kong, USA and Singapore.
The following can be concluded by just focusing on the EPF’s top 30 equity holdings in Bursa Malaysia.
• Sector selection
The EPF places great emphasis on stocks that are cash cows. This is evident as it is the largest investor in Malaysia’s finance sector with 9/30 finance stock such as RHB, MBB, PBB and CIMB.
It also has a focus on the palm oil sector and telecommunication stocks, which are basically income and cash flow orientated.
 Holding period
The EPF has held onto 28 of these stocks for more than 10 years. It intends to earn dividend income from these stocks, which is a vital source of income for allowing EPF to pay recurring dividends to its contributors.
 Financial results
However, out of its 30 stocks invested, only 12 have generated a consistent increase in earnings for the long-term (five-10 years). The other 18 stocks have experienced a fall in earnings during the period. This leads to the next point:
 Stock price movements
The 12 that had consistent growth in earnings have enjoyed sustainable capital appreciation in the 10-year period, except for MBB for it has DRIP which requires a different way of assessing one’s total investment returns.
Stock prices of KL Kepong, Sime Darby Plantation and IOI Corporation had been flat.
The chart shows how the stocks have fared over the last 10 years.
How EPF’s stocks have fared over 10 years.
4: What works for EPF’s stock investments?
If you look at the 12 stocks that have appreciated in 10 years, the common ground is that these stocks have achieved consistent growth in profits.
Consistent growth in profits lead to a stock’s consistent growth in its stock prices. That is, in essence, value investing 101.

5: Should you keep your money in the EPF?
Based on financial reports, EPF has built a diversified portfolio of assets that are cash-flow orientated.
With continuous contributions from existing contributors and its dividends reinvested into the fund, EPF’s ability to continue making consistent dividends to contributors is intact.
Hence, if you don’t know how to invest, it would be better to just leave the money in EPF and enjoy the annual dividends.
What you can do is diversify a portion of savings into unit trust funds via i-Invest and collect not only 6+% in net dividend yields from the EPF, but also capital gains.
With that said, capital gains are not guaranteed, and you might incur capital losses instead if the funds fail to do well.
So, whether you can invest in the stock market and beat EPF’s returns depends on how good you are as a stock investor.
Most treat stocks like lottery tickets and invest in the hope that they will magically increase in price. It is, of course, flawed thinking.
This article first appeared in kclau.com


Wednesday, 29 April 2020

What type of business will survive Covid-19?

IDEASROOM

What type of business will survive Covid-19?

The University of Auckland's Mike Lee analyses the impact of Covid-19 on different types of business, and how they will fare in future pandemic-related crises
A global economic recession is now inevitable. 
Yet, as demonstrated in the past, not all businesses are impacted in the same way by the same recession. For instance, the luxury brand market recovered more quickly than mass appeal brands following the Global Financial Crisis and has sustained constant growth since 2010
While fundamentally different, Covid-19 is still no exception. Many of us have already experienced, first-hand, the increase in demand for hand sanitisers, fever medication, face masks and, in some countries, toilet paper. Logically, the former three industries should do well in a recession brought about by Covid-19, or any other future pandemic. Other sectors such as tourism, hospitality, and mass gatherings are more likely to suffer. Unfortunately, some companies will become bankrupt owing to a downturn in demand, combined with government protocols (rightly) prioritising health before wealth.
In this article, I will analyse the similarities and differences of businesses that will dive, survive or thrive during the Covid-19 pandemic, as well as future pandemic-related crises.
The two key factors I have used to categorise businesses into three Covid-19 outcomes (DiveSurviveThrive) are:
1) Synchronicity and 2) Location dependence.
Figure 1 (below) illustrates how most businesses may be mapped out on these two criteria, and how that might be detrimental or beneficial for any given business during this, and future crises brought about by human to human contagion.
Notably, businesses hardest hit by Covid-19 are those in the bottom left quadrant. These businesses are location dependent and rely on synchronous timing between customer and provider. For example, traditional tour operators, cruise ships, dine-in restaurants, concerts and sporting events. In all these cases, customers and providers need to be in the same place (location dependent) at the same time (synchronous service). In the climate of Covid-19, or any other future pandemic, such business models will always suffer. 
Paradoxically, such synchronous location dependent businesses require the most complex levels of coordination and scheduling, which means they are also highly inconvenient, in that all stakeholders need to be at the same place at the same time. It wasn’t that long ago that TV broadcasting was a location dependent synchronous activity. People had to be home by their TV set and wait for the news or favourite TV show to be broadcasted at a specific time. Note how (even without a global pandemic) this model was quickly displaced by asynchronous (on-demand) location independent (mobile, laptops, etc.) businesses such as Netflix. 
Figure 1:
Certainly the regular work week, Monday to Friday, 9am-5pm (and the consequent traffic jams many of us endure twice a day), was implemented to ensure most workers could be at the same place at the same time to accomplish joint projects, and also to ensure customers that they could reach our businesses at an assured time and place. 
This time and place was then elongated and expanded to make business interactions more accessible (24/7, in every corner of the globe) mainly for the convenience of the customer, but more recently for the convenience of Covid-19. Thus, it should come as no surprise businesses that rely the most on physical and temporal availability are those hardest hit by a virus that also relies on physical and temporal proximity. Covid-19 has essentially built its success on the success of our globalised economy. 
Ironically, while the virus has evolved very well to adapt to our system of international trade and commercial capitalism, many synchronous location dependent business models have not evolved much in the last 200 years, since the industrial revolution. Perhaps one silver lining in the corona cloud is that all modern businesses will be forced to question their practices in terms of synchronicity and location dependence. What is the real role of time and place for our business? 
Indeed, the next class of businesses that should be able to survive Covid-19 are those that are location-based, but able to operate asynchronously (such as self-service stations, or independent domestic nature tourism); or businesses that may rely on synchronous service but independent of location (for example, online counselling and restaurants built around delivery).
For the former (asynchronous location-dependent businesses), the place of business (the where) is important but the when is flexible, thus enabling a spreading out of physical proximity. For the latter (synchronous location independent businesses) shared timing, or the when, is critical but the location (the where) is flexible, once again, enabling a spreading out of physical proximity. 
From a commercial point of view, these businesses would be more desirable, with or without a pandemic, since both offer convenience and flexibility in either timing or location. Later, I will discuss strategies to help businesses evolve from synchronous location dependence to a slightly more flexible position, and then eventually evolve into the most flexible business model: asynchronous location independence.
These businesses, the final class and set to thrive during Covid-19, have already mastered the art of allowing the customer when and where to do business. Netflix, Amazon, Uber Eats, Fortnite, are all examples of businesses thriving before Covid-19; and now may be on track to do even better as governments, health authorities, and employers call for social distancing and self-isolation. 
Case example: Tertiary education
As a marketing professor I have noticed, over the past two decades, universities coming to terms with an audience increasingly comfortable with, nay, expectant of, asynchronous location independent service and product offerings. Even before Covid-19, our main stakeholders (students) have come to expect online lecture recordings. These are part of several changes helping universities evolve from heavily synchronous location dependent institutions to more flexible and inclusive asynchronous location independent businesses. 
Undoubtedly, during the adoption of such technological changes, many faculty staff would have complained about the watering down of the tertiary educational experience and lamented about the emerging class of graduates who can no longer be bothered ‘turning up’. Yet, if anything, Covid-19 is forcing us to confront the importance of ‘turning up’. If our off-campus students are now expected to achieve similar results via asynchronous location-independent models of pedagogy, surely many ‘real-world’ businesses should also be able to thrive, or at the very least survive, the next 18 months, and beyond?
Questions to shift your business from Dive to Survive to Thrive:
1. Critically analyse the when and where of your business operations.
    a) How important is synchronicity or temporal proximity to your business? Really?
    b) How important is physical proximity? Do you really need to be in the same place as your key stakeholders to deliver the same outcomes? 
2. Can you achieve the same outcome if time and place were not considered a fixed entity?
3. What aspects of your operations could evolve to become less reliant on temporal proximity?
4. What aspects of your operations could evolve to be less reliant on physical proximity?
5. Pick the path of least resistance to become more asynchronous or less location dependent, if achieving both is too challenging.

An Simple Introduction to Value Investing

Knowledgeable investing can impact significantly on your life:  

  • it can provide for a comfortable retirement
  • send your children to college and 
  • provide the financial freedom to indulge all sorts of fantasies.


Grocery shopping

Think of the search for value stocks like grocery shopping for the highest quality goods at the best possible price.  Understanding the philosophy of value investing, you learn to stock the shelves of your value store (portfolio of stocks) with the highest quality, lowest cost merchandise (companies) you can find.


More people owns stocks today than at any time in the past.  Stock markets around the world have grown as more people embrace the benefits of capitalism to increase their wealth.  Yet how many people have taken the time to understand what investing is all about?  No very many.




Making knowledgeable investment decisions can have a significant impact on your life.

Sensible investing, which can be found in the art and science of the tenets of value investing, is not rocket science.  It merely requires understanding a few sound principles that anyone with an average IQ can master.''

Value investing has been around as an investment philosophy since early 1930s.  The principles of value investing were first articulated in 1934 when Benjamin Graham, a professor of investments at Columbia Business School, wrote a book titled Security Analysis.  This approach to investing is easy to understand, has greater appeal to common sense, and has produced superior investment results for more years than any competing investment strategy.




Value investing is a set of principles that form a philosophy of investing.

It provides guidelines that can point you in the direction of good stocks, and just as importantly, steer you away from bad stocks.  Value investing brings to the field a model by which you can evaluate an investment opportunity or an investment manager.  Value investing provides a standard by which other investment strategies can be measured.



Why value investing? 

Because it has worked since anyone began tracking returns.  A mountain of evidence confirms that the principles of value investing have provided market-beating returns over long periods.  And it is easy to do.

Few investors and few professional money managers subscribe to the principles of value investing.  By some estimates, only 5% to 10% of professional money managers adhere to those principles.

Benjamin Graham, Walter Schloss and Warren Buffett are committed value investors.  Learn from their histories.

You need to invest but you don't need to be a genius to do it well.

Tuesday, 28 April 2020

Be patient. Patience is sometimes the hardest part of using the value approach.

The patient exercise of value investing principles works and works well.

Value investing requires more effort than brains, and a lot of patience.

Over time, investors should continue to be rewarded for buying stocks on the cheap.

Through the years, there have been changes in the methods of finding value stocks and in the criteria that define value.



Changes in the method of finding value stocks and trading

In Ben Graham's time, the search for undervalued stocks meant poring through the Moody's and Standard & Poor's tomes for stocks that fit the value criteria.  Now, you can accomplish this with the click of a mouse.  You can access almost all the data off your Bloomberg terminals.  The 10k reports or annual shareholder letters are all right there on the Internet for you to access for stocks all over the world.

Trading has changed as well.  For the most part, trading is now done electronically with no effort at all.  You can trade stocks in New York, Tokyo or London just as easily as you can in your own country.


Criteria that define value has changed over time

Just as the access to information and the methods of trading stocks have changed in the past two decades, so have the criteria for value changed.


1.  Net current assets
In 1969, the investors were looking through the Standard & Poor's monthly stock guide for stocks selling below net current assets.  This was the primary source of cheap stocks in those days.  The method had been pioneered by Graham and was very successful.  Generally, they were buying stocks that sold for less than their liquidation value.  Back then, manufacturing companies dominated the US economy.


2.  Earnings
As the US economy grew in the 1960s, 1970s, and 1980s, it began to move away from the heavy industrial manufacturing companies such as steel and textiles.  Consumer product companies n service companies became more a part of the landscape.   These companies needed less physical assets to produce profits, and their tangible book values were less meaningful as a measure of value.  Many value investors had to adopt and began to look more closely at earnings--based models of valuation.  Radio and television stations and newspapers were examples of businesses that could generate enormous earnings with little in the way of physical assets and thus had fairly low tangible book value.  The ability to learn new ways to look at value allows you to make some profitable investments that you might well have overlooked had you not adopted wit the times.


3.  Earnings growth 
There was a great deal of money to be made buying companies that could grow their earnings at a faster rate than the old industrial type companies.  Warren Buffett said that growth and value are joined at the hip.  The difference between growth and value was mostly a question of price.  Paying a little more than just buying stocks based on book value and the investors found great bargains like American Express, Johnson & Johnson, and Capital Cities Broadcasting.  Companies like these were able, and in many cases still are able, to grow at rates significantly greater than the economy overall and were worth a higher multiple of earnings than a basic manufacturing business..


4.  Leveraged buyout business
In the mid-1980s, the leveraged buyout business (LBO) was born.  The US economy was emerging from a period of high inflation and high interest rates.  Inflation had increased the value of the assets of many companies.  For example, if ABC Ice Cream had built a new factory 5 years ago for $10 million and was depreciating it over  10 year period, it would have been written down to $5 million on ABC's books.  However, after  years of inflation, it might cost $15 million to replace that factory.  Its value is understated on the company's books.  Using the factory as collateral, the company might have been able to borrow 60% of its current value or $9 million.  This is what LBO firms did with all sorts of assets in the 1980s.  They would borrow against  company's assets to finance the purchase of the company.

The record high interest rates of the late 1970s and early 1980s drove stock prices to their lowest levels in decades.  The price-to-earnings ratio of the Standard & Poor's 500 was in the single digits.  With long-term Treasury bonds yielding 14%, who needed to own stocks?  The combination of significant undervalued collateral and low PE ratios made many companies ripe for acquisition at very low prices.  

A typical deal in the mid-1980s might be done at only 4.5 or 5 times pretax earnings.  Today, that number is more in the range of 9 to 12 times pretax earnings.  This period was a once-in-a-lifetime opportunity to buy companies at record cheap prices in terms of both assets and earnings.

By using this model to screen for companies that are selling in the stock market at a significant discount to what an LBO group might pay, this  LBO model gave one more way of defining "cheap"


{Summary:  Price to Book Value, Price to Earnings and Leveraged Buyout Appraisal Value]




Value Investing

The basic idea of buying stocks for less than they are worth and selling them as they approach their true worth is at the heart of value investing.

The methods and criteria have changed over the years and they will evolve further with the march of time and inevitable change.  What is important is that the principles have not changed.

On balance, value investing is easier than other forms of investing.  It is not necessary to spend eight hours a day glued to a screen trading frenetically in and out of stocks.  By paying attention to the basic principle of buying below intrinsic value with a margin of safety and exercising patience, investors will find that the value approach continues to offer investors the best way to beat the stock market indexes and increase wealth over time.



Patience is sometimes the hardest part of using the value approach 

When you find a stock that sells for 50% of what you determined it is worth , your job is basically done.  Now it is up to the stock. 

  • It may move up toward its real worth today, next week, or next year.  
  • It may trade sideways for 5 years and then quadruple in price.  
  • There is simply no way to know when a particular stock will appreciate, or if, in fact, it will.   
There will be periods when the value approach will under-perform other strategies, and that can be frustrating.

Perhaps even more frustrating are those times when the overall market has risen to such high levels that we are unable to find many stocks that meet our criterion for sound investing.

It is sometimes tempting to give in and perhaps relax one criterion just a bit, or chase down some for the hot money stocks that seem to go up forever.  But, just about the time that value investors throw in the towel and begin to chase performance is when the hot stocks get ice cold.




It is time in the market, not market timing, that counts.

There is no short-term timing strategy that works accurately and consistently

Many people believe that the fastest way to the highest market returns is by short-term trades that are accurately timed.  But many years in the investment arena, there is no short-term timing strategy that works.  

All nature of pundits have come and gone over the years.

  • For a short time, any of them may be right and may make one or two amazingly accurate predictions.  
  • Eventually, all of them lose the interest of the public when the predictions prove inaccurate.  
There is no sure way to accurately and consistently time short-term market movements, and again, the research of scholars have highlighted this.



Better in the market invested in value stocks than play the timing game

It is simply better to be in the market, invested in the value stocks that offer the highest potential return, than to play the timing game.

  • Between 80 and 90% of the investment return on stocks occurs around 2% to 7% of the time.  
  • It is a daunting task to find a way to reliably predict the 7% of the time stocks do well.  
As a long term investor, the real danger and threat to your nest egg is being out of the market when the big moves occur.  You simply have to accept that you must endure some temporary market declines.  

The reality is (and it has  been proven) that the biggest portions of investment returns come from short periods of time but trying to identify those periods and coordinate stock purchases to them is nearly impossible.  Two issues are at play here, both equally important:

(1) short-term timing doesn't work; and
(2) the highest returns are achieved by being fully invested in the market at nearly all times so that you can capture the times when stocks rise the most.  You have to be in the game to win it!



Long-term value investing is like flying long distance

Long-term value investing is like flying from Singapore to London.  While you may encounter some air turbulence over Europe, if your plane is in good shape, there is no reason to bail out.  You will eventually reach your destination safely, and probably even on time.

The same goes for investing.  If your portfolio is well constructed, a bit of market turbulence is no reason to bail.  You will reach your financial goals.




Predicting short-term stock market direction is a fool's game

Predicting short-term stock market direction, however, is a fool's game and is disservice to the investing public.

Long term, the market is going up.  Always has, and most likely always will.

Market timers like to think they can capture large returns by jumping in the market to profit during periods when stocks are up, and jumping out of the market when stocks are down. 

  • It may get you ahead for a brief period but you will quickly give up gains when abrupt events that could never have been predicted (such as the tragedy of 9/11, geopolitical evens, and even weather cause brief downturns that are almost always followed by rising prices).  
  • You will also give up your profits to the increased costs of trading from commissions to taxes.



The majority of investors buy high and sell low.

All manner of studies have proven, in many ways under many scenarios, that the majority of investors buy high and sell low.

1.  Peter Lynch, the legendary and highly successful manage of the Fidelity Magellan Fund for many years, once remarked that he calculated that more than half of the investors in his fund lost money.  This happened because money would pour in after a couple of good quarters and exit after a couple of not so good quarters.

2.  Nobel Prize winner William Sharpe found that a market timer must be right a staggering 82% of the time to match a buy and hold return. That's a lot of work to achieve that could be accomplished by taking a nap.

3.  Even worse, other research shows that the risks of market timing are nearly two times as great as the potential rewards.

  • Between 1985 and 2005, the annually compounded rate of return for the Standard & Poor's 500 Index was 11.9%.  
  • However, a recent research study concluded that the average investor only compounded at 3.9% over that period.  
  • Why?  The research paper concludes that most investors head for the hills during period of market declines, thinking the decline will go on indefinitely. Once the market has rebounded, they return, having missed the best part of the rebound.



Day by day, minute by minute prices are so widely available

One of the more difficult factors in maintaining a long-term approach is that prices are so widely available.  We can check the value of all of our stock holdings day by day, minute by minute.   We can see how they fluctuate around short-term factors, and in many cases this information can make us a little nervous.

An example of a successful commercial real estate broker who saved at least half of his earnings each year.  His money was invested for the long term, and he could afford to leave it invested.  But he could not stand to see the prices of stocks rise and fall each day.  If he owned a stock and it closed down on a particular day, he was deeply upset.   He did not realise that bonds also fluctuate in price; but since he could not check their closing prices every day he was not worried.  He got his regular interest check, which he reinvested and was happy.  Over the ensuing 10 years, his municipal bond portfolio grew at an assumed interest rate of 5%.  If the same funds had been invested in the Standard & Poor's 500 index, he would have made 15.3% annually compounded rate of return.  His loss for not being invested in stocks was staggering.



Would you take a minute-by-minute pricing approach with anything else you own?  

How would you react if your house was priced every day and the quotes listed in the local newspaper?  Would you panic and move if you lost 2% of your home's value because a neighbour didn't mow his lawn?  Would you rejoice and sell if it went up 5% in one day because another neighbour finally painted his house.

A collection of businesses bought at  excellent prices is no less a long-term asset than a piece of real estate and should be treated the same way.  Prices will fluctuate both up and down.  What is most important is that you own the right stocks when the market does go higher.  


You have to play  to win.  

Using the tenets of value investing and always keeping in mind the margin of safety, the odds of winning with our approach are a bit better than playing the lottery and is is far more remunerative than sitting on the sidelines.



Missing the 10, 30 and 50 best days in the market

According to an investment study, if you had ridden out all the bumps and grinds of the market from 1990 to 2005, $10,000 invested would have grown to $51,354.  

If you have missed the 10 best days over that 15-year period, your return would have dropped to $31,994. 

If you had missed the 30 best days - one month out of 180 months - you would have made $15,739.  

Had he missed the 50 best days you would have come out a net loser, and your $10,000 would now be worth only $9,030.



The evidence is clear.

It is pretty close to impossible to consistently make money market timing, and you are better off investing for the long term, riding out the bumps. 

Value investors have the extra security of knowing that they own stocks that have one or more of the characteristics of long-term winners  and that they have paid careful attention to investing with a margin of safety.

It is a marathon, not a sprint.

Buy and Hold? Really? Depends on your AGE and NEEDS

How should you choose between stocks and bonds?

Financial advisors are risk averse.  Their risk aversion may have less to do with your financial situation than their reputations.  Conventional wisdom is that a portfolio that is invested one-third in bonds and two-thirds in stocks is the way to go irrespective of the level of your assets.  The one-third, two-thirds formula is the standard.  It is safe because that is what the herd recommends.

The conventional model of portfolio construction, the one-third bonds two-thirds stocks, requires that you periodically rebalance your holdings.  By this, they mean that if your stocks had a particularly great year and now are 75% or 80% of your portfolio, you should sell some stocks and invest the proceeds in more bonds.  That is like selling your winners and reinvesting in your losers

  • How smart is that?  
  • If you already have enough cash to ride out three down years, why do you need more?


The major brokerage houses issue "asset allocation" formulas depending on their view of the stock market in the near term.  This sounds like market timing.  
However, people are different.  Your financial assets and your needs vary tremendously.  

  • What if you have a lot of dollars and need only a pittance to maintain your lifestyle?  
  • Why would you invest one-third of your money in an under-performing asset?



The two most important considerations in formulating an asset allocation formula are:

  • age.  and
  • how much money you have to support your desired lifestyle.




Jeremy Siegel's book - Stocks for the Long Run

In every rolling 30-year period between 1871 and 1992, stocks as measured by an index, beat bonds or cash in every period.  

In rolling 10-year periods, stocks beat bonds or cash 80% of the time.  

Bonds and cash did not beat the rate of inflation over 50% of the time.  



So why would anyone own a bond?  The answer comes back to age and need.

If you are young (20 years to 35 years) and have a job that pays your bills, you can take a long view on investments.

A lot of what you do in investing is just simple common sense.  Many investors think they should be proactive and keep looking for ways to tweak their investment portfolio when just sitting tight, if they made the correct choices in the first place, often would be the better course.





Examples: 

Asset allocation is based on age and need.

1.  A friend liquidated an asset and wished to invest in the stock market.  However, he will need this money for a project he is working on at end of the year.   He should not invest this money in stock, as his need for the money did not anticipate any setback in the stock market.  If he could not be in for the long term, he should not be in.

2.  In early 1980s, a widow inherited a $4 million account with an investment firm and in addition $30 million of Berkshire Hathaway stock.  She anticipated retiring and needed some income going forward.  She had lived comfortably but modestly, given her wealth.   The reason she was so rich was because all her assets had been well invested in stocks Her accountant replied that she had all her assets in the stock market which was, by definition, risky. He suggested a charitable remainder trust into which she could put the Berkshire stock, sell it without paying any capital gains taxes, and reinvest the proceeds in bonds for current income.   On the other hand, her investment advisor replied even if the stock market dropped 50%, she had enough money to live comfortably until her very old age and asked why she would want to stop enjoying the benefits of future appreciation. She decided to leave everything as it was and received her income needs out of the money she had invested with the investment firm.   A number of years later, she reviewed her plan.  She had $180 million.  Today, she has upward of $300 million.  


Monday, 27 April 2020

When is a bargain not a bargain?

Once you have assembled a list of likely bargain candidates, you have to determine

  • which to put your money into and 
  • which to avoid and move on.


Many of the companies in your initial list are cheap for a reason;; they have fundamental problems that make them decidedly not valuable.

On the list of value candidates whose stock price had fallen significantly in the past were Enron, Global Crossing, MCI, US Airlines and Pacific Gas and Electric.   These companies ended up filing for bankruptcy and shareholders lost a significant portion of their investment if not all their money.


To achieve your wealth-building goals, you have to determine 

  • why a company's shares are cheap and 
  • which ones have little chance of recovery.



1.  Too much debt

The first and most toxic reason that stocks become cheap is too much debt.  In good times, companies with decent cash flow may borrow large amounts of money on the theory that if they continue to grow, they can meet the interest and principal payments in the future.  UNFORTUNATELY, the future is unknowable, and companies with with too much debt have a much smaller chance of surviving an economic downturn.  

Ben Graham explained that he used a simple yardstick to measure health.  A company should own twice as much as it owes.  This philosophy can help you avoid companies that owe too much to survive.


2.  Company falls short of analysts' earnings estimates.

Analysts seem to be more focused on short-term earnings gains than future long-term success   These quarterly or yearly earnings estimates have been proven to be notoriously unreliable.  Routinely, large and good companies get pushed to new stock price lows because they missed the estimates of the thundering herd of Wall Street  Missing earnings is not fatal, and it tends to create opportunity for the value buyer; if the trend continues, however, the shares will likely continue to fall.


3.  Cyclical stocks

Some cyclical stocks may show up on your list of potential bargains.  They are highly dependent on how the economy is doing.  Industries like automobiles, large appliances, steel and construction will experience lean times and stock prices are likely to reflect this fact.   Although we have had recessions of varying lengths and depths, the economies of industrialised nations have always rebounded.  It is important to note that in the bad times, cyclical companies with heavy debt loads may well face insurmountable problems.  Adhering to a policy of avoiding overly leveraged companies will serve you well.


4.  Labour contracts

Stocks may also fall because of labour contracts.  During good times, some companies and industries cave into labour union demands that were affordable at the time.  Little did they realize that they were mortgaging their future.  As new competition unburdened by costly labour contracts enters their industries, their profits disappear.  In many cases, the unions have been unwilling to grant concessions.   It is never easy to give back something you have, even if not doing so threatens the very existence of the company you work for.  Although holding on to expensive contracts may or may not benefit management or the unions in the long run, the one person that most assuredly does not benefit is the stockholder.  

Many large corporations (old-line industrial companies) have pension liabilities - benefits promised to workers - that they simply will be unable to pay  Generally speaking, if a company has excessive pension liabilities or there exists a contentious labour environment, it may be best to put these companies' shares on the no-thank-you list.


5.  Increased competition

Highly profitable industries attract new competition.  The most serious form of this comes when an industry in one country has high-priced labour or expensive regulatory rules.  Other nations unburdened by such costs can often produce and export the same goods cheaper.  Think China.  Throughout the world, countries have seen foreign manufacturers of automobiles, appliances and other goods make significant inroads into their market.  If a company is facing strong competition from a more efficient competitor with lower costs, it is perhaps best to utter those comforting words "no, thank you" and move on to the next candidate.


6.  Obsolescence

Obsolescence is another potentially fatal cause for falling prices.

Although the last large scale manufacturer of buggy whips or hand-cranked automobile starters made a very fine product, there was simply no longer a need for its product.  There may be some small demand for these products, but a company that depended on them for most of its sales would soon be out of business

Consider the field of technology.  The rate of "creative destruction" has never been faster.  Newer and better products turn up every day making the older products obsolete  The new products are a boon to the consumer but the bane of the legacy company.  

Today, we can go online and order any movie from NetFlicks and never have to leave the comfort of your own home.  For this reason, you should avoid companies that are subject to technological obsolescence.  The world is simply changing too fast to depend on products and services that someone else can deliver better and for less cost.  Avoid these.


7.  Corporate or accounting frauds

These are perhaps one of the most dangerous reasons for share price drops is corporate or accounting fraud.

Although these crimes against investors are the exception and not the rule, and most CEOs are dedicated leaders who care about their companies and their shareholders, fraud does happen.  In recent years, the world has experienced some of the largest cases in history, Enron, Parmalat, Tyco, WorldCom and others.  Regulators have since done much to help prevent future occurrences but there will always be some form of shenanigans.

Criminals exist in every walk of life.  There is almost no way to uncover fraud before it becomes public.  By the time it is discovered, it is too late  The best the investor can do is to steer clear of financial reports that seem overly complicated.


8.  Companies you do not understand or are not comfortable with

If there is something you do not understand or are not comfortable with, put these in the no-thank-you pile.   If a company has too many problems - too much debt, union and pension problems, stiff foreign competition, they too go to the no-thank-you pile.  You have the luxury of filling your portfolio with stocks you are comfortable with and want to own for the long term wealth building it offers.



Summary

You should approach your list of investment candidates with a healthy dose of scepticism.

You should stick to businesses you understand and for which there is an ongoing need (products or services).

You should also like food, beverage, and consumer staples like detergents, toothpaste, pens, and pencils - the stuff you consume on a daily basis. Many of these products engender brand loyalty that keeps the same product day after day, week after week.  We are all creatures of habit, and we will usually repeat our consumer preference when we go shopping.

Your best friend in the whole investing world is your no-thank-you pile.  Knowing your no-thank-you pile gives you the value investing opportunities to build your wealth building portfolio.