Stocks have made an epic run but it won't last. "The economy isn't strong enough" to support a new bull market reports The Wall Street Journal. We are overdue for a big pullback.
You have a choice: Stay the course and suffer big losses or go on the offense!
Thursday, 21 January 2010
Wednesday, 20 January 2010
The Four Essentials of Successful Investing
In brief, here are the four rules:
Start early in life to invest.
Invest in common stocks.
Be thrifty.
Pick the right investment.
Start early in life to invest.
Invest in common stocks.
Be thrifty.
Pick the right investment.
Some rights issues are good, others can be very bad
Some rights issues are good, others can be very bad
Like most things in investment, rights issues are not simple matters.
(3) The case of the very fast growing company
To put it bluntly, a company only needs to make a rights issue when it is short of money.
(3) The company is in a very fast growing business. In fact, it is so fast growing that retained earnings and new borrowing alone are insufficient to sustain the growth.
Pricing the rights also requires proper evaluation.
Also read:
So Many Cash Calls In OuR Market!
http://whereiszemoola.blogspot.com/2010/01/so-many-cash-calls-in-our-market.html
Like most things in investment, rights issues are not simple matters.
Rights are not automatically "good things" from the shareholders' point of view. Some of the rights are good, others can be very bad.
Investors have to be careful and they should not rush in every time there is an annoucement of rights. They should classify the rights issue they are considering in accordance with the three categories indicated below:
(1) The case of the improperly managed companies
(2) The case of moving into new business area(3) The case of the very fast growing company
They should purchase only those of the last category.
Many will protest that they have neither the time nor the knowledge to carry out a detailed analysis of the company which announces the rights.
It is not possible for each and every one to carry out a careful analysis but there is an easier way out for the small timers. The dividend yield approach to stock valuation can be readily used to value a rights issue.
Why Companies Have to Make Rights Issue?
To put it bluntly, a company only needs to make a rights issue when it is short of money.
A business, any business, requires investment in various forms of assets in order to carry out its operations. A company is usually required to continually buy new assets in order to carry on its business either because its old assets have to be replaced or its expanding business requires more assets. To buy new assets, it will need new capital.
A company can obtain necessary money to purchase its assets from any one of three sources or a combination of all three.
- It can borrow the money,
- retain part or all of its profit or
- it can sell new shares.
But, companies may have to raise new capital by making rights issues under three types of abnormal circumstances. These three cases are:
(1) The company is improperly managed such that it is either not very profitable (or even losing a lot of money) such that the incoming cash is not adequate to support the need to purchase more assets. Or owing to poor management of its assets, it now requires a lot more assets to support its operations.
(2) The company is moving into another line of business which is large relative to its current size and it requires a great deal of additional capital to start up the new venture.
(3) The company is in a very fast growing business. In fact, it is so fast growing that retained earnings and new borrowing alone are insufficient to sustain the growth.
In order to be a prudent investor, we must analyse the situation of the company which has announced a rights issue carefully to see which category it falls into in the first place.
Depending on which category of rights it is issuing, we can then carry out a further analysis to decide whether the rights issue is a good or a bad one.
Through examining each type of rights issue, an intelligent investor can tell the wolves from the sheep.
Pricing the rights also requires proper evaluation.
Also read:
So Many Cash Calls In OuR Market!
http://whereiszemoola.blogspot.com/2010/01/so-many-cash-calls-in-our-market.html
How Buffett avoided mistakes by staying within his circle of competence
Understanding Your Circle of Competence
If Buffett cannot understand a company's business, then it lies beyond his circle of competence, and he won't attempt to value it.
Although it might seem obvious that investors should stick to what they know, the temptation to step outside one's circle of competence can be strong.
Buffett has written that he isn't bothered when he misses out on big returns in areas he doesn't understand, because investors can do very well (as he has) by simply avoiding big mistakes.
Buffett is simply a better investor than just about any other in the world. Brilliant, consistently rational, and blessed with a superb mind for business, he has managed to avoid the mistakes that have crushed so many portfolios. Let's look at two examples.
Burton G. Malkiel, Princeton economics professor and author of 'A Random Walk Down Wall Street,' and Charles D. Ellis, author of 'Winning the Loser's Game,' have teamed up to write 'The Elements of Investing.' He commented:
"We're both in our seventies. So is Warren Buffett. The main difference between his spectacular results at Berkshire Hathaway and our good results is not the economy and not the market, but the man from Omaha. "
If Buffett cannot understand a company's business, then it lies beyond his circle of competence, and he won't attempt to value it.
Although it might seem obvious that investors should stick to what they know, the temptation to step outside one's circle of competence can be strong.
Buffett has written that he isn't bothered when he misses out on big returns in areas he doesn't understand, because investors can do very well (as he has) by simply avoiding big mistakes.
- In early 2000, Berkshire Hathaway's portfolio had underperformed funds that enjoyed spectacular returns by loading up on stocks of technology companies and Internet startups. Buffett avoided all tech stocks. He told his investors that he refused to invest in any company whose business he did not fully understand - and he didn't claim to understand the complicated, fast-changing technology business - or where he could not figure out how the business model would sustain a growing stream of earnings. Some said he was an old fuddy-duddy. Buffett had the last laugh when Internet-related stocks came crashing back to earth.
- In 2005 and 2006, Buffett largely avoided the mortgage-backed securities and derivatives that found their way into many investment portfolios. Again, his view was that they were too complex and opaque. He called them "financial weapons of mass destruction." When they brought down many a financial institution (and ravaged our entire financial system), Berkshire Hathaway avoided the worst of the meltdown.
Burton G. Malkiel, Princeton economics professor and author of 'A Random Walk Down Wall Street,' and Charles D. Ellis, author of 'Winning the Loser's Game,' have teamed up to write 'The Elements of Investing.' He commented:
"We're both in our seventies. So is Warren Buffett. The main difference between his spectacular results at Berkshire Hathaway and our good results is not the economy and not the market, but the man from Omaha. "
Will this rally continue?
Will This Rally Continue?
By Rich Greifner
January 19, 2010
Will the recent rally continue? Or is the stock market overheated after a 65% surge?
I have no idea -- and frankly, I don't care.
Here's why you shouldn't care, either
http://www.fool.com/investing/general/2010/01/19/will-this-rally-continue.aspx
Here's why you shouldn't care, either
Of course it would be wonderful to be able to forecast stock gyrations, deftly jumping in and out as the market ebbs and flows. But unfortunately, it simply isn't possible to accomplish such a feat on a consistent basis, and investors' attempts to anticipate the market's short-term movements only cost them money in the long run.
According to a study from Dalbar Inc., the S&P 500 produced an 8.35% annual return from 1988 through 2008. However, the average equity investor realized an annual return of just 1.87% over the same period thanks to the adverse effects of market timing.
This problem has become so widespread that in 2006, Morningstar introduced an "investor return" measure to illustrate the impact of investors' timing their purchases and sales.
Still not convinced that trying to time the market is a bad idea? One final example should drive the point home.
So rather than obsess over which way the stock market is headed next, heed these wise words from investing legend Peter Lynch: "Market timing is speculating and it rarely, if ever, pays off."
What does pay off?
"I don't believe in predicting markets," Lynch wrote in his classic One Up On Wall Street. "I believe in buying great companies -- especially companies that are undervalued and/or underappreciated. … Pick the right stocks and the market will take care of itself."
That strategy worked pretty well for Lynch, who posted 29% annual returns during his 13 years at the helm of Fidelity's Magellan Fund (sadly, most Magellan investors realized much lower returns during Lynch's tenure due to their attempts to time the market).
But Lynch famously focused on consumer-facing companies whose products he enjoyed, like Taco Bell (now owned by Yum! Brands (NYSE: YUM), Hanes (NYSE: HBI), and Chrysler (now owned by the U.S. government). With unemployment at a 26-year high and the U.S. consumer on the ropes, where should investors look to find the right stocks today?
The right stocks
That's the question I posed to Jeff Fischer, lead advisor for Motley Fool Pro. Like Lynch, Jeff and his team don't get swept up in trying to forecast short-term market movements. Instead, they seek out companies with
By Rich Greifner
January 19, 2010
Of course it would be wonderful to be able to forecast stock gyrations, deftly jumping in and out as the market ebbs and flows. But unfortunately, it simply isn't possible to accomplish such a feat on a consistent basis, and investors' attempts to anticipate the market's short-term movements only cost them money in the long run.
- That means an investment of $10,000 in 1988 would have grown to $49,725 over the past two decades if left untouched.
- But investors who panicked at market bottoms and chased returns as the market rose would have only $14,485 today.
- Not surprisingly, a recent Morningstar study found that investor returns trailed fund returns over the past five years in each of the 14 mutual fund categories that Morningstar tracks.
- Thanks to big bets on Goldman Sachs (NYSE: GS), Mosaic (NYSE: MOS), and PotashCorp (NYSE: POT), Ken Heebner's CGM Focus Fund was the best-performing equity mutual fund of the past decade.
- But while CGM Focus posted an 18% annual gain over the past 10 years, the average investor in the fund lost 11% a year!
"I don't believe in predicting markets," Lynch wrote in his classic One Up On Wall Street. "I believe in buying great companies -- especially companies that are undervalued and/or underappreciated. … Pick the right stocks and the market will take care of itself."
That's the question I posed to Jeff Fischer, lead advisor for Motley Fool Pro. Like Lynch, Jeff and his team don't get swept up in trying to forecast short-term market movements. Instead, they seek out companies with
- sustainable competitive advantages,
- significant recurring revenue,
- diverse customer bases,
- strong free cash flow, and
- healthy balance sheets.
5 Dumb Investing Mistakes to Avoid
5 Dumb Investing Mistakes to Avoid
by Gary Belsky | Jan 19, 2010
In his newly revised book, Why Smart People Make Big Money Mistakes and How to Correct Them, co-author Gary Belsky says irrational behavior often leads us to make dumb and costly financial decisions. In this excerpt, Belsky reveals the investing secrets that will help you avoid such goofs.
We all commit financial follies that cost us hundreds or thousands of dollars each year. Worse, we’re often blissfully ignorant of the causes of our monetary missteps and clueless about how to correct them. But by knowing these five big investing mistakes, you can change your behavior to put more money in your pocket.
1. Letting Losses Hurt More Than Gains Please You
People generally are “loss averse.” The pain felt from losing $100 is much greater than the pleasure from gaining the same amount. That’s why people behave inconsistently when it comes to taking investment risks. You might act conservatively to protect gains (by selling your winners to guarantee the profits) but act recklessly to avoid losses (by holding onto losers, hoping they’ll bounce back). Loss aversion causes some investors to sell all their holdings during periods of market turmoil, but trying to time the market doesn’t work in the long run.
2. Placing Too Much Emphasis on Unusual Events
Many people still recall the stock market crash of 2008 with anxiety, forgetting that stocks have offered the most consistent investment gains over time. As MoneyWatch blogger Nathan Hale has written, investors often pour money into mutual funds that performed well recently on the mistaken belief that the funds’ success is the result of something other than dumb luck.
3. Being Paralyzed by Investment Choices
You can’t let yourself get so overwhelmed by a surfeit of options that you penalize your finances through inaction. Some people won’t move money out of ultra-conservative, low-yielding retirement funds because they can’t bear having to select a better alternative. So limit your choices. Find “trusted screeners” whose judgment you admire to pare down your choices or even make them for you.
4. Ignoring the ‘Small’ Numbers
People have a tendency to ignore what they think are insignificant numbers, such as mutual fund expenses. But doing so can have a deleterious effect of surprising magnitude on your investment returns over time. On a $10,000 investment, an expense ratio of 0.5 percent might cost you about $180 over three years, but a 1.5 percent expense tab could nick you by $500 or so. Over 15 years, a low-expense fund might eat up less than 7 percent of your potential investment return, while a high-expense fund could devour almost 20 percent.
5. Failing to Understand the Odds against Beating the Market
Most investors will fare best by sticking primarily with index funds mirroring the averages. You won’t just keep up with the typical investor this way; you’ll likely do better than all those brave souls who think they can beat the law of averages. High transaction and management expenses, faulty psychology, and the law of averages often burden actively managed portfolios. Index funds take much of the emotion out of investing. And the most successful investors are the ones who don’t let emotions affect their decisions.
From Why Smart People Make Big Money Mistakes and How to Correct Them by Gary Belsky & Thomas Gilovich. Copyright 1999, 2009, by Gary Belsky and Thomas Gilovich. Reprinted by permission of Simon & Schuster, Inc.
http://moneywatch.bnet.com/investing/article/investing-5-dumb-mistakes-to-avoid/384546/
by Gary Belsky | Jan 19, 2010
We all commit financial follies that cost us hundreds or thousands of dollars each year. Worse, we’re often blissfully ignorant of the causes of our monetary missteps and clueless about how to correct them. But by knowing these five big investing mistakes, you can change your behavior to put more money in your pocket.
1. Letting Losses Hurt More Than Gains Please You
People generally are “loss averse.” The pain felt from losing $100 is much greater than the pleasure from gaining the same amount. That’s why people behave inconsistently when it comes to taking investment risks. You might act conservatively to protect gains (by selling your winners to guarantee the profits) but act recklessly to avoid losses (by holding onto losers, hoping they’ll bounce back). Loss aversion causes some investors to sell all their holdings during periods of market turmoil, but trying to time the market doesn’t work in the long run.
2. Placing Too Much Emphasis on Unusual Events
Many people still recall the stock market crash of 2008 with anxiety, forgetting that stocks have offered the most consistent investment gains over time. As MoneyWatch blogger Nathan Hale has written, investors often pour money into mutual funds that performed well recently on the mistaken belief that the funds’ success is the result of something other than dumb luck.
3. Being Paralyzed by Investment Choices
You can’t let yourself get so overwhelmed by a surfeit of options that you penalize your finances through inaction. Some people won’t move money out of ultra-conservative, low-yielding retirement funds because they can’t bear having to select a better alternative. So limit your choices. Find “trusted screeners” whose judgment you admire to pare down your choices or even make them for you.
4. Ignoring the ‘Small’ Numbers
People have a tendency to ignore what they think are insignificant numbers, such as mutual fund expenses. But doing so can have a deleterious effect of surprising magnitude on your investment returns over time. On a $10,000 investment, an expense ratio of 0.5 percent might cost you about $180 over three years, but a 1.5 percent expense tab could nick you by $500 or so. Over 15 years, a low-expense fund might eat up less than 7 percent of your potential investment return, while a high-expense fund could devour almost 20 percent.
5. Failing to Understand the Odds against Beating the Market
Most investors will fare best by sticking primarily with index funds mirroring the averages. You won’t just keep up with the typical investor this way; you’ll likely do better than all those brave souls who think they can beat the law of averages. High transaction and management expenses, faulty psychology, and the law of averages often burden actively managed portfolios. Index funds take much of the emotion out of investing. And the most successful investors are the ones who don’t let emotions affect their decisions.
From Why Smart People Make Big Money Mistakes and How to Correct Them by Gary Belsky & Thomas Gilovich. Copyright 1999, 2009, by Gary Belsky and Thomas Gilovich. Reprinted by permission of Simon & Schuster, Inc.
http://moneywatch.bnet.com/investing/article/investing-5-dumb-mistakes-to-avoid/384546/
The recipe for truly high growth
The recipe for truly high growth has a handful of necessary ingredients. They are:
- A small company
- A wide market opportunity
- Meaningful macroeconomic tailwinds.
This Mistake Could Cost You a Fortune
This Mistake Could Cost You a Fortune
By Austin Edwards
January 17, 2010
Granted, it's not like I made a big bet on DryShips (Nasdaq: DRYS) at the beginning of last year -- right before it dropped more than 75% (although I know people who did). And I certainly didn’t listen to any of the doom-and-gloom pundits who suggested you short “zombie banks” like JPMorgan Chase (NYSE: JPM) and Morgan Stanley (NYSE: MS) just before their epic rebounds.
But I did move back to Big 12 country just in time to see my beloved Oklahoma Sooners lose game after game after game -- not to mention lose their Heisman-winning quarterback, Sam Bradford, to a season-ending shoulder injury mere minutes into their opener.
You see, my grandfather played football for Oklahoma, and I've been rooting for them since I was old enough to walk, so 2009 was a pretty painful year for me. But don't worry, I'll always be a Sooners fan -- no matter how bad things get. In sports, that's a virtue.
Wall Street, though, is a different ball game
For proof, just ask any longtime "fan" of:
Stock
10-Year Return
Merck (NYSE: MRK)
(22%)
Corning (NYSE: GLW)
(46%)
Home Depot (NYSE: HD)
(47%)
Sun Microsystems (Nasdaq: JAVA)
(94%)
Data provided by Yahoo! Finance.
Or ask my fellow Fools Rich Greifner or Adam Wiederman. Or even ask Jim Cramer. In his book Real Money, Cramer reminds investors, "This is not a sporting event; this is money. We have no room for rooting or hoping."
Yet it happens all the time -- and time after time, investors ride stocks right into the ground because they're emotionally attached to a company's story, products, or management.
I, for one, am sitting on a major loss in Clearwire. And if we're being honest, the only reason I bought shares in the first place was because I liked that it was backed by Google, Comcast, and a handful of other tech heavyweights.
Ditch that loser!
One of the "20 Rules for Investment Success" from Investor's Business Daily is to "cut every loss when it's 8% below your cost. Make no exceptions so you'll avoid any possible huge, damaging losses."
To a sports fan, that might seem cruel and unusual, but is it good investment advice?
To find out, I dug through David and Tom Gardner's Motley Fool Stock Advisor picks. You see, they often re-recommend a stock even after a big run-up -- or a sharp fall.
As it turns out, I found three examples when breaking IBD's rule actually paid off big-time:
Stock Advisor Pick
Decline After Recommendation
Gain After Re-Recommendation
Netflix
23%
294%
Quality Systems
14%
1,189%
Dolby Labs
10%
163%
These weren't flukes, either
In his re-recommendation write-up for Netflix, David Gardner admitted, "We're currently sitting on a 23% loss." But he went on to say, "I think this is one cheap stock at $11, backed by a great management team that's going to create value for us going forward."
And he had well-thought-out reasons for continuing to own the stock: "It remains first and best in a growing industry, creates convenience for millions of consumers, and is led by visionary management that markets aggressively." Netflix stock has risen 313% since then.
So when do you sell?
Many investors have hard-and-fast numerical rules. Others -- like the Gardners -- stick to a more analytical and intellectual approach to determine when to recommend that their Stock Advisor subscribers sell a stock. So when do David and Tom Gardner consider dumping a stock? Primarily when they encounter:
Investors may never agree on when or why to sell a stock. But it is important to have an emotionless, well-thought-out strategy in place. If you don't, you may suffer major losses -- or miss out on massive gains.
For what it's worth, David and Tom Gardner rarely sell, and it works for them. In fact, Tom's average Stock Advisor pick is performing more than 35 percentage points better than a like amount invested in the S&P 500. Meanwhile, David's are performing 66 points better on average.
http://www.fool.com/investing/general/2010/01/17/this-mistake-could-cost-you-a-fortune.aspx?source=irasitlnk0000001&lidx=3
By Austin Edwards
January 17, 2010
For proof, just ask any longtime "fan" of:
10-Year Return
(22%)
(46%)
(47%)
(94%)
One of the "20 Rules for Investment Success" from Investor's Business Daily is to "cut every loss when it's 8% below your cost. Make no exceptions so you'll avoid any possible huge, damaging losses."
Decline After Recommendation
Gain After Re-Recommendation
23%
294%
14%
1,189%
10%
163%
In his re-recommendation write-up for Netflix, David Gardner admitted, "We're currently sitting on a 23% loss." But he went on to say, "I think this is one cheap stock at $11, backed by a great management team that's going to create value for us going forward."
Many investors have hard-and-fast numerical rules. Others -- like the Gardners -- stick to a more analytical and intellectual approach to determine when to recommend that their Stock Advisor subscribers sell a stock. So when do David and Tom Gardner consider dumping a stock? Primarily when they encounter:
- Untrustworthy management.
- Deteriorating financials.
- Mergers, acquisitions, and spinoffs that could damage the business.
Investors may never agree on when or why to sell a stock. But it is important to have an emotionless, well-thought-out strategy in place. If you don't, you may suffer major losses -- or miss out on massive gains.
Charlie Munger is negative about the economy, but positive about stocks
The strategy sounds simple enough, but Mr Munger says few investors practise it.
“You can’t believe the way that conventional wisdom invests money,” he explains. “They tend to rush into whatever fad has worked lately. In my opinion, a lot of them are going to get creamed.”
17th May 2009: Today he's negative about the economy, but positive about stocks -- a bullish sign. In the late 1990s, Munger complained that he didn't see much to buy. The market quickly proved him right. But, at current market prices, Munger sees many long-term investment opportunities.
"I am willing to buy common stocks with long-term money at these prices," Munger said. "Is Coca-Cola worth what it's selling for? Yes. Is Wells Fargo? Yes." He owns both.
"If you wait until the economy is working properly to buy stocks, it's almost certainly too late," he said. "I have no feeling that just because there's more agony ahead for the economy you should wait to invest."
But you need to be selective.
“You can’t believe the way that conventional wisdom invests money,” he explains. “They tend to rush into whatever fad has worked lately. In my opinion, a lot of them are going to get creamed.”
17th May 2009: Today he's negative about the economy, but positive about stocks -- a bullish sign. In the late 1990s, Munger complained that he didn't see much to buy. The market quickly proved him right. But, at current market prices, Munger sees many long-term investment opportunities.
"I am willing to buy common stocks with long-term money at these prices," Munger said. "Is Coca-Cola worth what it's selling for? Yes. Is Wells Fargo? Yes." He owns both.
"If you wait until the economy is working properly to buy stocks, it's almost certainly too late," he said. "I have no feeling that just because there's more agony ahead for the economy you should wait to invest."
But you need to be selective.
Is Value Investing Dead?
Is Value Investing Dead?
By Jordan DiPietro
January 14, 2010
Every year thousands of people make the trip to Omaha for Berkshire Hathaway's annual shareholder meeting. They come in fanatical droves -- from as far away as South Africa and Singapore -- to see the man whose extraordinary success has been largely attributed to one strategy: value investing.
Unfortunately, the original value crusaders, Benjamin Graham and David Dodd, are long gone, while Warren Buffett has become a touchstone in an investing landscape riddled with leveraged corpses, speculative traders, and overzealous CEOs.
We've squeezed almost every gem of wisdom from his meetings and transcripts, and we've analyzed his moves from every conceivable angle. All of this ultimately raises one question: Once Warren is gone, will the end of an era also mark the end of value investing?
Old school values
When Graham and Dodd's seminal piece, Security Analysis, was written in 1934, it was much easier to be a value investor.
First, the time was right. Still reeling from the Great Depression and unemployment of up to 25%, the Dow had lost about 90% of its value in three years. The tenets of Graham and Dodd -- to buy stocks for prices significantly below their intrinsic values and even their book values -- were especially applicable because prices were distorted, and many stocks were significantly undervalued.
Second, with most of the Dow 30 comprised of metal, oil, or manufacturers, balance sheets were pretty straightforward. Valuing stocks wasn't necessarily easy, but there were some pretty common elements to look for: book value, tangible assets, etc.
Third, if you look at all the value crusaders, they all share one unique attribute: tenacity. They had the doggedness to perform painstakingly tedious work, laboring over worksheets, completing arithmetic by hand. They just seemed to work, well, the hardest.
New school values
Seventy years have come and gone, and value investing has come under increasing criticism. In fact, I've seen money managers tell their clients that if their time horizon is less than two decades away, value investing is not for them.
Why? Take a look at the comparative performance of value versus growth over the last five years.
Indices
Top Holdings
2009 Return
3-Year Return
5-Year Return
Russell 1000 Value Index (IWD)
JPMorgan Chase (NYSE: JPM), General Electric (NYSE: GE)
19.2%
(7.9%)
(1%)
Russell 1000 Growth Index (IWF)
Cisco Systems (Nasdaq: CSCO), Wal-Mart (NYSE: WMT)
36.7%
(2.1%)
2.5%
What gives? Well, business is much more complex than it used to be. With intellectual property rights, patents, and licensing fees, studying balance sheets is a bit murky. Companies like Qualcomm (Nasdaq: QCOM), Pfizer (NYSE: PFE), and Merck (NYSE: MRK) are all wrapped up in intangibles, and its simply harder to predict future earnings.
In addition, the days of sweating over spreadsheets are over. Computer programs and stock screeners make it simple to find a company that fits a certain mold -- even the laymen can whittle down enormous loads of data and draw conclusions. The advantage of having the fortitude to do the "hard work" is gone, lost in a sea of statistics and a market inundated with information.
And finally, being a value investor requires a temperament few have -- especially given the above considerations. Asset manager Jean-Marie Eveillard said, in response to the question of why there aren't more value investors, given Buffett's success, "If you are a value investor, every now and then you lag, or experience what consultants call tracking error. It can be very painful. To be a value investor, you have to be willing to suffer pain."
So does this mean value investing is dead?
WWWD?
Value investing isn't dead -- but it's not going to look the same in the 21st century as it did in the 20th.
We just have to look at Buffett, who, like always, adapts to the times. As the market collapsed around us and blue chips fell by the wayside, he scooped up some $3 billion worth of General Electric, and recently invested in ExxonMobil and Nestle. He lent Goldman Sachs $5 billion and locked in 10% annual gains -- and of course negotiated an option that has already netted him close to $2.4 billion.
Deliberate, prudent, unyielding -- classic Buffett.
Today's market offers something unique to the 21st century -- a plethora of booms and busts. There have been more financial crashes in the last 30 years than in any other time period -- and that means there are price distortions that investors can take advantage of, just like Buffett has done lately. Value investing isn't dead, nor is it immaterial.
Don't get distracted by puzzling trading strategies or speculate on leveraged financials (thank you, Citigroup). Understand a business and invest in your area of competence -- when it's cheap.
And remember as well that the last five years don't dictate the future. From 1927-2005 (78 years!), value investing has outperformed both small and large cap growth stocks by a substantial margin. From 1975-2005, value stocks outperformed growth stocks in 12 out of 13 developing countries. Clearly, in both the U.S. and abroad, value reigns supreme.
So don't let the naysayers get you down -- there are still plenty of tremendous value stocks out there! Our Motley Fool Inside Value team practices what Warren preaches and scours the market for the best deals each month. This has been a difficult few years for our analysts, but they're still managing to beat the S&P 500 by over seven percentage points -- that's pretty impressive considering the challenging environment.
If you believe like we do that value investing is here to stay, and you want to know the seven value stocks you should be buying right now, we're currently offering a 30-day free trial to Inside Value. Click here for more information.
Fool contributor Jordan DiPietro owns shares of General Electric. Berkshire Hathaway is a Motley Fool Stock Advisor recommendation. Berkshire Hathaway, Pfizer, and Wal-Mart Stores are Inside Value recommendations. The Fool owns shares of Berkshire Hathaway. The Fool's disclosure policy is always looking for a discount.
http://www.fool.com/investing/value/2010/01/14/is-value-investing-dead.aspx
By Jordan DiPietro
January 14, 2010
Every year thousands of people make the trip to Omaha for Berkshire Hathaway's annual shareholder meeting. They come in fanatical droves -- from as far away as South Africa and Singapore -- to see the man whose extraordinary success has been largely attributed to one strategy: value investing.
Unfortunately, the original value crusaders, Benjamin Graham and David Dodd, are long gone, while Warren Buffett has become a touchstone in an investing landscape riddled with leveraged corpses, speculative traders, and overzealous CEOs.
We've squeezed almost every gem of wisdom from his meetings and transcripts, and we've analyzed his moves from every conceivable angle. All of this ultimately raises one question: Once Warren is gone, will the end of an era also mark the end of value investing?
Old school values
When Graham and Dodd's seminal piece, Security Analysis, was written in 1934, it was much easier to be a value investor.
First, the time was right. Still reeling from the Great Depression and unemployment of up to 25%, the Dow had lost about 90% of its value in three years. The tenets of Graham and Dodd -- to buy stocks for prices significantly below their intrinsic values and even their book values -- were especially applicable because prices were distorted, and many stocks were significantly undervalued.
Second, with most of the Dow 30 comprised of metal, oil, or manufacturers, balance sheets were pretty straightforward. Valuing stocks wasn't necessarily easy, but there were some pretty common elements to look for: book value, tangible assets, etc.
Third, if you look at all the value crusaders, they all share one unique attribute: tenacity. They had the doggedness to perform painstakingly tedious work, laboring over worksheets, completing arithmetic by hand. They just seemed to work, well, the hardest.
New school values
Seventy years have come and gone, and value investing has come under increasing criticism. In fact, I've seen money managers tell their clients that if their time horizon is less than two decades away, value investing is not for them.
Why? Take a look at the comparative performance of value versus growth over the last five years.
Indices
Top Holdings
2009 Return
3-Year Return
5-Year Return
Russell 1000 Value Index (IWD)
JPMorgan Chase (NYSE: JPM), General Electric (NYSE: GE)
19.2%
(7.9%)
(1%)
Russell 1000 Growth Index (IWF)
Cisco Systems (Nasdaq: CSCO), Wal-Mart (NYSE: WMT)
36.7%
(2.1%)
2.5%
What gives? Well, business is much more complex than it used to be. With intellectual property rights, patents, and licensing fees, studying balance sheets is a bit murky. Companies like Qualcomm (Nasdaq: QCOM), Pfizer (NYSE: PFE), and Merck (NYSE: MRK) are all wrapped up in intangibles, and its simply harder to predict future earnings.
In addition, the days of sweating over spreadsheets are over. Computer programs and stock screeners make it simple to find a company that fits a certain mold -- even the laymen can whittle down enormous loads of data and draw conclusions. The advantage of having the fortitude to do the "hard work" is gone, lost in a sea of statistics and a market inundated with information.
And finally, being a value investor requires a temperament few have -- especially given the above considerations. Asset manager Jean-Marie Eveillard said, in response to the question of why there aren't more value investors, given Buffett's success, "If you are a value investor, every now and then you lag, or experience what consultants call tracking error. It can be very painful. To be a value investor, you have to be willing to suffer pain."
So does this mean value investing is dead?
WWWD?
Value investing isn't dead -- but it's not going to look the same in the 21st century as it did in the 20th.
We just have to look at Buffett, who, like always, adapts to the times. As the market collapsed around us and blue chips fell by the wayside, he scooped up some $3 billion worth of General Electric, and recently invested in ExxonMobil and Nestle. He lent Goldman Sachs $5 billion and locked in 10% annual gains -- and of course negotiated an option that has already netted him close to $2.4 billion.
Deliberate, prudent, unyielding -- classic Buffett.
Today's market offers something unique to the 21st century -- a plethora of booms and busts. There have been more financial crashes in the last 30 years than in any other time period -- and that means there are price distortions that investors can take advantage of, just like Buffett has done lately. Value investing isn't dead, nor is it immaterial.
Don't get distracted by puzzling trading strategies or speculate on leveraged financials (thank you, Citigroup). Understand a business and invest in your area of competence -- when it's cheap.
And remember as well that the last five years don't dictate the future. From 1927-2005 (78 years!), value investing has outperformed both small and large cap growth stocks by a substantial margin. From 1975-2005, value stocks outperformed growth stocks in 12 out of 13 developing countries. Clearly, in both the U.S. and abroad, value reigns supreme.
So don't let the naysayers get you down -- there are still plenty of tremendous value stocks out there! Our Motley Fool Inside Value team practices what Warren preaches and scours the market for the best deals each month. This has been a difficult few years for our analysts, but they're still managing to beat the S&P 500 by over seven percentage points -- that's pretty impressive considering the challenging environment.
If you believe like we do that value investing is here to stay, and you want to know the seven value stocks you should be buying right now, we're currently offering a 30-day free trial to Inside Value. Click here for more information.
Fool contributor Jordan DiPietro owns shares of General Electric. Berkshire Hathaway is a Motley Fool Stock Advisor recommendation. Berkshire Hathaway, Pfizer, and Wal-Mart Stores are Inside Value recommendations. The Fool owns shares of Berkshire Hathaway. The Fool's disclosure policy is always looking for a discount.
http://www.fool.com/investing/value/2010/01/14/is-value-investing-dead.aspx
4 Ways to Screw Up Your Portfolio
4 Ways to Screw Up Your Portfolio
By Selena Maranjian
January 19, 2010 | Comments (0)
Sometimes, it can be easy to make money in the stock market. Dumping the bulk of your nest egg into broad-market index funds can instantly make you a part-owner of such successful companies as Apple (Nasdaq: AAPL), General Electric (NYSE: GE), and UnitedHealth (NYSE: UNH). If you'd rather fly solo, finding the right individual stock can bring you massive gains -- witness Intuitive Surgical (Nasdaq: ISRG) and its 50% average annual returns over the past five years.
Sadly, though, it can be even easier to lose money when investing. Some losses just can't be foreseen; they happen even to good investors invested in seemingly solid companies. But other times, investors make a classic error -- and pay the price for it.
Here are four blunders you'd do well to avoid:
Too few metrics
If you focus only on a single aspect of a given company, such as its price-to-earnings ratio, you could miss out on the bigger picture. Check out the different ratings our CAPS community has assigned to stocks with similarly low P/Es:
Company
CAPS Stars (out of five)
P/E
Noble (NYSE: NE)
*****
7
Merck (NYSE: MRK)
****
10
Garmin
***
12
Qwest Communications (NYSE: Q)
**
10
Data: Motley Fool CAPS.
A closer look at these companies' other metrics would likely reveal varying debt and cash levels, growth rates, profit margins, and competitive advantages. It can be useful to seek out low-P/E stocks, since they may have been overly punished and due to rebound. But a low P/E can't and shouldn't be your sole criteria for making an investment.
Tax obliviousness
Forgetting about the IRS can lead to another needless error. If you net a $5,000 gain in Home Surgery Kits (Ticker: OUCHH), but sell it less than 365 days after you bought it, you'll be the one wishing you had some anaesthetic. Short-term gains -- stocks held for less than a year -- are taxed at your standard income rate; at 28%, you'd pay $1,400 in tax on that $5,000 profit. Long-term gains -- held for more than a year -- get dinged for a much smaller 15%, or just $750 in our example.
Looking the other way
Failing to follow your investments closely enough can be another major mistake. You might buy into a biotechnology or pharmaceutical company, for example, because you're enthusiastic about the exciting drugs in its pipeline. But if one or more of those candidates fail to win FDA approval, or report poor results in clinical trials, the company's future could suddenly become less bright.
Wandering too far
Finally, we often stray beyond our circle of competence.
As you invest, focus not only on all the things you do right, or the amazing companies you come across, but also on mistakes you may be making. The more blunders you eliminate from your repertoire, the better the performance you can expect from your portfolio.
http://www.fool.com/investing/value/2010/01/19/4-ways-to-screw-up-your-portfolio.aspx
By Selena Maranjian
January 19, 2010 | Comments (0)
If you focus only on a single aspect of a given company, such as its price-to-earnings ratio, you could miss out on the bigger picture. Check out the different ratings our CAPS community has assigned to stocks with similarly low P/Es:
CAPS Stars (out of five)
P/E
*****
7
****
10
***
12
**
10
Forgetting about the IRS can lead to another needless error. If you net a $5,000 gain in Home Surgery Kits (Ticker: OUCHH), but sell it less than 365 days after you bought it, you'll be the one wishing you had some anaesthetic. Short-term gains -- stocks held for less than a year -- are taxed at your standard income rate; at 28%, you'd pay $1,400 in tax on that $5,000 profit. Long-term gains -- held for more than a year -- get dinged for a much smaller 15%, or just $750 in our example.
Failing to follow your investments closely enough can be another major mistake. You might buy into a biotechnology or pharmaceutical company, for example, because you're enthusiastic about the exciting drugs in its pipeline. But if one or more of those candidates fail to win FDA approval, or report poor results in clinical trials, the company's future could suddenly become less bright.
Finally, we often stray beyond our circle of competence.
- Do you really understand biotechnology? Or the energy industry? Or telecommunications?
- If you don't have a firm grasp of a company's industry and its position in it, you're at a great disadvantage as an investor.
- You need to be aware of developments in and threats to a given industry, and have a clear sense of its winners and losers, before you start investing there.
Relying on a single metric misses out on the bigger picture
Too few metrics
If you focus only on a single aspect of a given company, such as its price-to-earnings ratio, you could miss out on the bigger picture. Check out the different ratings our CAPS community has assigned to stocks with similarly low P/Es:
Company
CAPS Stars (out of five)
P/E
Noble (NYSE: NE)
*****
7
Merck (NYSE: MRK)
****
10
Garmin
***
12
Qwest Communications (NYSE: Q)
**
10
Data: Motley Fool CAPS.
A closer look at these companies' other metrics would likely reveal
CAPS Stars (out of five)
P/E
*****
7
****
10
***
12
**
10
- varying debt and cash levels,
- growth rates,
- profit margins, and
- competitive advantages.
3 Ways to Prepare for the Next Big Drop
3 Ways to Prepare for the Next Big Drop
By Dan Caplinger
January 19, 2010 | Comments (0)
This time last year, even a dart-throwing monkey could have made money in the stock market -- all you needed was the courage to buy at one of the scariest times in history. Now, though, financial markets of all sorts have risen sharply, and there's a lot more to making a winning investment than picking a stock ticker at random and buying shares.
It's a whole new ball game
If you're like many people, you've probably done your best to repress your memories of early 2009. Back then, the stock market was falling apart, after a failed attempt to put together a rally off the lows set during 2008's panic. Everyone was convinced that companies like MGM Mirage (NYSE: MGM) and Bank of America (NYSE: BAC) were just a few steps from bankruptcy, and even the prospects for healthier companies seemed grim.
Now, though, fear has given way to greed. Many of the stocks that seemed most likely to fail instead topped the performance charts for 2009. Stock markets around the world saw huge gains, with the U.S. market's rise relatively small in comparison to jumps in emerging markets like Brazil and China. Moreover, after a terrible end in 2008, commodities also regained much of their lost luster, as gold jumped to new highs and energy prices made a sharp recovery from their huge drop to $30 from nearly $150.
If those big gains make you nervous, you're not alone. If you think it's time for these roller-coaster markets to start another downswing and don't want to go along for the ride, then here are three things to think about for various parts of your portfolio.
1. With stocks, think quality
Amid all the big gains of last year, many stocks have gotten left behind, at least compared to the overall market. Johnson & Johnson (NYSE: JNJ), Procter & Gamble (NYSE: PG), and AT&T (NYSE: T) are among the big-name companies that haven't seen anything close to the gains of even the S&P 500, let alone the multibagger performance that dozens of stocks produced last year.
But there are two reasons to look for lagging sectors. First, as bull markets evolve, they tend to go through sector rotation, in which stocks that haven't performed as well catch up with the top performers. So if this is the beginning of a longer-term bull market, then you can expect large caps that have thus far been left behind to see some gains.
On the other hand, the stocks that have risen the most also have the furthest to fall. If the stock market's rally reverses itself soon, then you can expect stocks that are still value-priced to hold up better than highfliers without the fundamentals to back up their lofty valuations.
2. With bonds, think duration
Everyone's stretching for yield right now, as interest rates have remained low. When you need income from your portfolio to survive, times like these can lead you to take desperate measures.
But you need to resist the urge to buy longer-term bonds just to get higher yields. Rates show signs of rising soon, and if they do, falling prices could wipe out the higher interest you'll receive on long bonds. In contrast, short-term bonds won't pay as much income up front, but they also won't lose as much value per percentage-point move in a rising-rate environment.
Finally, just as speculative stocks may have gotten ahead of themselves, lower-quality corporate bonds have also jumped in front of Treasuries. Consider rebalancing your portfolio to get its risk profile back where you want it.
3. With alternative investments, be wary
Commodities and real estate are becoming more mainstream investments than ever. But while having some exposure can help your portfolio, now isn't the time to make huge bets on them.
Whether you use stocks like Freeport-McMoRan Copper & Gold (NYSE: FCX) and Precision Drilling Trust (NYSE: PDS) as proxies for metals and energy or invest in specialized ETFs with direct exposure to commodities, prices have jumped a lot over the past year. Hedging your holdings, either by selling some of those investments or with other strategies such as writing covered calls or buying puts, can take some risk off the table.
Watch your greed
Most investors are in much better shape now than they were this time last year. But you don't want to lose those hard-fought gains. By taking steps to secure your portfolio, you'll help to keep yourself from enduring the same trials you suffered through during the financial crisis.
With so many stocks seeing big gains, focusing on value stocks might seem hopelessly outdated. Jordan DiPietro takes a closer look at whether value investing is dead.
http://www.fool.com/retirement/general/2010/01/19/3-ways-to-prepare-for-the-next-big-drop.aspx
By Dan Caplinger
January 19, 2010 | Comments (0)
This time last year, even a dart-throwing monkey could have made money in the stock market -- all you needed was the courage to buy at one of the scariest times in history. Now, though, financial markets of all sorts have risen sharply, and there's a lot more to making a winning investment than picking a stock ticker at random and buying shares.
It's a whole new ball game
If you're like many people, you've probably done your best to repress your memories of early 2009. Back then, the stock market was falling apart, after a failed attempt to put together a rally off the lows set during 2008's panic. Everyone was convinced that companies like MGM Mirage (NYSE: MGM) and Bank of America (NYSE: BAC) were just a few steps from bankruptcy, and even the prospects for healthier companies seemed grim.
Now, though, fear has given way to greed. Many of the stocks that seemed most likely to fail instead topped the performance charts for 2009. Stock markets around the world saw huge gains, with the U.S. market's rise relatively small in comparison to jumps in emerging markets like Brazil and China. Moreover, after a terrible end in 2008, commodities also regained much of their lost luster, as gold jumped to new highs and energy prices made a sharp recovery from their huge drop to $30 from nearly $150.
If those big gains make you nervous, you're not alone. If you think it's time for these roller-coaster markets to start another downswing and don't want to go along for the ride, then here are three things to think about for various parts of your portfolio.
1. With stocks, think quality
Amid all the big gains of last year, many stocks have gotten left behind, at least compared to the overall market. Johnson & Johnson (NYSE: JNJ), Procter & Gamble (NYSE: PG), and AT&T (NYSE: T) are among the big-name companies that haven't seen anything close to the gains of even the S&P 500, let alone the multibagger performance that dozens of stocks produced last year.
But there are two reasons to look for lagging sectors. First, as bull markets evolve, they tend to go through sector rotation, in which stocks that haven't performed as well catch up with the top performers. So if this is the beginning of a longer-term bull market, then you can expect large caps that have thus far been left behind to see some gains.
On the other hand, the stocks that have risen the most also have the furthest to fall. If the stock market's rally reverses itself soon, then you can expect stocks that are still value-priced to hold up better than highfliers without the fundamentals to back up their lofty valuations.
2. With bonds, think duration
Everyone's stretching for yield right now, as interest rates have remained low. When you need income from your portfolio to survive, times like these can lead you to take desperate measures.
But you need to resist the urge to buy longer-term bonds just to get higher yields. Rates show signs of rising soon, and if they do, falling prices could wipe out the higher interest you'll receive on long bonds. In contrast, short-term bonds won't pay as much income up front, but they also won't lose as much value per percentage-point move in a rising-rate environment.
Finally, just as speculative stocks may have gotten ahead of themselves, lower-quality corporate bonds have also jumped in front of Treasuries. Consider rebalancing your portfolio to get its risk profile back where you want it.
3. With alternative investments, be wary
Commodities and real estate are becoming more mainstream investments than ever. But while having some exposure can help your portfolio, now isn't the time to make huge bets on them.
Whether you use stocks like Freeport-McMoRan Copper & Gold (NYSE: FCX) and Precision Drilling Trust (NYSE: PDS) as proxies for metals and energy or invest in specialized ETFs with direct exposure to commodities, prices have jumped a lot over the past year. Hedging your holdings, either by selling some of those investments or with other strategies such as writing covered calls or buying puts, can take some risk off the table.
Watch your greed
Most investors are in much better shape now than they were this time last year. But you don't want to lose those hard-fought gains. By taking steps to secure your portfolio, you'll help to keep yourself from enduring the same trials you suffered through during the financial crisis.
With so many stocks seeing big gains, focusing on value stocks might seem hopelessly outdated. Jordan DiPietro takes a closer look at whether value investing is dead.
http://www.fool.com/retirement/general/2010/01/19/3-ways-to-prepare-for-the-next-big-drop.aspx
Tuesday, 19 January 2010
How investors are rebelling against professional money managers
By Edmund Conway Economics Last updated: January 18th, 2010
14 Comments Comment on this article
It is hardly headline news to say we’ve all lost rather a lot of our faith in the financial Masters of the Universe during this crisis. We all know they proved just how little they knew or understood the risks they were taking, and as we can see from the recent bonus rows, their standing has diminished considerably as a result.
What I hadn’t realised is that many of people are already putting their money where their mouth is on this one. According to analysts at Goldman Sachs, over the past year or so, people have been pulling their money out of funds managed by professional investors and fund managers, and choosing instead to invest it themselves, whether in simple shares or in exchange traded funds.
The story, according to Goldman’s chief US equity strategist, David Kostin, and as told by the chart above, is that despite the 25pc increase in the stock market over the past year or so, not one dollar went into US equity funds (in fact, there was a net outflow) – and yet over the first nine months of the year there was about $225bn of direct purchases of common shares.
It represents, according to Kostin, a “repudiation of the professional investor class by individuals, who are investing in ETFs and direct purchases of stocks.”
He prefers to frame this phenomenon (which reflects the US, but may well be mirrored over here in the UK) as a sign that people are becoming more independent when it comes to their finances, plus that they are aware that there are tax advantages of investing through exchange traded funds (which can track indices and commodities, but without having to pay a fund manager to do the legwork). However, one could just as easily see it as a sign of revulsion in professional asset managers. And for good reason.
Throughout this crisis, much of the criticism over what happened has been levelled at the banks, but far less at bank investors. And while bankers are not blameless for having done far too much in the way of slicing and dicing assets, creating toxic debt and pushing sub-prime mortgages, a semi-legitimate excuse on their part is that there was demand for these toxic assets. Which indeed there was: professional investors have been given far too easy a ride for investing in some of the dross that contributed to the crisis. They have also been given too easy a ride for not monitoring the banks fiercely enough in previous years. After all, if a few more bank shareholders (and I’m talking big pension funds and asset managers here) had scrutinised the banks (which they own), they might have realised that capital and liquidity were at paper-thin levels, leaving the banks at risk of insolvency.
Against this backdrop, and given how much wealth was lost as a result, it is hardly surprising that people are steering clear of the fund managers for the time being. That sounds like a pretty functional market reaction to me.
http://blogs.telegraph.co.uk/finance/files/2010/01/goldman.jpg
14 Comments Comment on this article
It is hardly headline news to say we’ve all lost rather a lot of our faith in the financial Masters of the Universe during this crisis. We all know they proved just how little they knew or understood the risks they were taking, and as we can see from the recent bonus rows, their standing has diminished considerably as a result.
What I hadn’t realised is that many of people are already putting their money where their mouth is on this one. According to analysts at Goldman Sachs, over the past year or so, people have been pulling their money out of funds managed by professional investors and fund managers, and choosing instead to invest it themselves, whether in simple shares or in exchange traded funds.
The story, according to Goldman’s chief US equity strategist, David Kostin, and as told by the chart above, is that despite the 25pc increase in the stock market over the past year or so, not one dollar went into US equity funds (in fact, there was a net outflow) – and yet over the first nine months of the year there was about $225bn of direct purchases of common shares.
It represents, according to Kostin, a “repudiation of the professional investor class by individuals, who are investing in ETFs and direct purchases of stocks.”
He prefers to frame this phenomenon (which reflects the US, but may well be mirrored over here in the UK) as a sign that people are becoming more independent when it comes to their finances, plus that they are aware that there are tax advantages of investing through exchange traded funds (which can track indices and commodities, but without having to pay a fund manager to do the legwork). However, one could just as easily see it as a sign of revulsion in professional asset managers. And for good reason.
Throughout this crisis, much of the criticism over what happened has been levelled at the banks, but far less at bank investors. And while bankers are not blameless for having done far too much in the way of slicing and dicing assets, creating toxic debt and pushing sub-prime mortgages, a semi-legitimate excuse on their part is that there was demand for these toxic assets. Which indeed there was: professional investors have been given far too easy a ride for investing in some of the dross that contributed to the crisis. They have also been given too easy a ride for not monitoring the banks fiercely enough in previous years. After all, if a few more bank shareholders (and I’m talking big pension funds and asset managers here) had scrutinised the banks (which they own), they might have realised that capital and liquidity were at paper-thin levels, leaving the banks at risk of insolvency.
Against this backdrop, and given how much wealth was lost as a result, it is hardly surprising that people are steering clear of the fund managers for the time being. That sounds like a pretty functional market reaction to me.
http://blogs.telegraph.co.uk/finance/files/2010/01/goldman.jpg
Investment students need only two well-taught courses
"In our view, though, investment students need only two well-taught courses -
- How to Value a Business, and
- How to Think About Market Prices."
****Constructing a Portfolio
Now that you have learned to analyse companies and pick stocks, it is time to focus on putting groups of stocks together to construct your stock portfolio.
No one answer is right for everyone when it comes to portfolio construction. It is more art than science. And perhaps that's why many believe portfolio management may be the difference that separates a great investor from an average mutual fund manager.
Famed international stock-picker John Templeton has often said that he's right about his stock picks only about 60% of the time. Nevertheless, he has accumulated one of the best track records in the business. That's because great managers have a tendency to have more money invested in their big winners and less in their losers.
The Fat-Pitch Approach
You should hold relatively few great companies, purchased at a large margin of safety, and that you shouldn't be afraid to hold cash when you can't find good stocks to buy. But why?
Most investors will discover only a few good ideas in any given year - maybe five or six, sometimes a few more. Investors who hold more than 20 stocks at a time are often buying shares of companies they don't know much about, and then diversifying away the risk by holding lots of different names. It is tough to stray very far from the average return when you hold that many stocks, unless you have wacky weightings like 10% of your portfolio in one stock and 2% in each of the other 45.
About 90% of the maximum benefit of diversification was derived from portfolios of 12 to 18 stocks. If you own about 12 to 18 stocks, you have obtained more than 90% of the benefits of diversification, assuming you own an equally weighted portfolio.
If you want to obtain a higher return than the markets, you increase your chances by being less diversified. At the same time, you also increase your risk.
If you own more than 18 stocks, you will have achieved almost full diversification, but now you will just have to keep track of more stocks in your portfolio for not much marginal benefit.
When you own too many companies, it becomes nearly impossible to know your companies really well. When you lose your focus and move outside your circle of competence, you lose your competitive advantage as an investor. Instead of playing with weak opponents for big stakes, you begin to become the weak opponent.
Non-Market Risk and a Concentrated Portfolio
Interestingly, holding a concentrated portfolio is not as risky as one may think. Just holding two stocks instead of one eliminates 46% of your unsystematic risk. Using a twist on the 80/20 rule of thumb, holding only eight stocks will eliminate about 81% of your diversifiable risk.
Unsystematic Risk and the Number of Stocks in a Portfolio
Number of Stocks Non-Market Risk Eliminated (%)
1======== 0%
2 ========46%
4 ========72%
8 ========81%
16======= 93%
32======= 96%
500====== 99%
9,000==== 100%
What about range of returns?
Joel Greenblatt in his book You Can Be a Stock Market Genius explains that during one period that he examined,
Greenblatt noted that if your portfolio is limited to only :
Portfolio Weighting
In addition to knowing how many stocks to own in your portfolio and which stocks to buy, the percentage of your portfolio occupied by each stock is just as important. Unfortunately, the science and academics behind this important topic are scarce, and therefore, portfolio weighting is, again, more art than science.
The great money managers have a knack for having a great percentage of their money in stocks that do well and a lesser amount in their bad picks. So how do they do it?
Essentially, a portfolio should be weighted in direct proportion to how much confidence you have in each pick. If you have a lot of confidence in the long-term outlook and the valuation of a stock, then it should be weighted more heavily than a stock you may be taking a flier on.
If a stock has
Weight your portfolio wisely. Don't be afraid to have some big weightings, but be certain that the highest-weighted stocks are the ones you feel the most confident about. And, of course, don't go off the deep end by having, for example, 50% of your portfolio in a single stock.
Portfolio Turnover
If you follow the fat-pitch method, you won't trade very often. Wide-moat companies selling at a discount are rare, so when you find one, you should pounce. Over the years, a wide-moat company will generate returns on capital higher than its cost of capital, creating value for shareholders. This shareholder value translates into a higher stock price over time.
If you sell after making a small profit, you might not get another chance to buy the stock, or a similar high-quality stock, for a long time. For this reason, it's irrational to quickly move in and out of wide-moat stocks and incur capital gains taxes and transaction costs. Your results, after taxes and trading expenses, likely won't be any better and may be worse. That's why many of the great long-term investors display low turnover in their portfolios. They've learned to let their winners run and to think like owners, not traders.
Circle of Competence and Sector Concentration
If you are investing within your circle of competence, then your stock selections will gravitate toward certain sectors and investment styles.
Maybe you:
However, if all your stocks are in one sector, you may want to think about the effects that could have on your portfolio. For instance, you probably wouldn't want all of your investments to be in unattractive areas such as the airline or auto industry.
Adding Mututal Funds to a Stock Portfolio
In-the-know investors buy stocks. Those less-in-the-know, or those who choose to know less, own mutual funds.
But investing doesn't have to be a choice between investing directly in stocks or indirectly through mutual funds. Investors can - and many should - do both. The trick is determining how your portfolio can benefit most from each type of investment. Figuring out your appropriate stock/fund mix is up to you.
Begin by looking for gaps in your portfolio and circle of competence.
Some funds invest in micro-caps, others invest around the globe, still others focus on markets, such as real estate. Stock investors who turn over some of their dollars to an expert in these areas gain exposure to new opportunities without having to learn a whole new set of analytical skills.
Ultimately, your choice depends on your circle of competence and comfort level. While many may feel comfortable with picking their own international stocks, others may prefer to own an international equity fund.
Our Objective
Modern Portfolio Theory has been built on the assumption that you can't beat the stock market. If you can't beat the market porfolio, then the best you can do is to match the market's performance. Therefore, academic theory revolves around how to build the most efficient portfolio to match the market.
We have taken a different approach. Our objective is to outperform the market. Therefore, we believe that our odds increase by holding (not actively trading) relatively concentrated portfolios of between 12 and 20 great companies purchased with a margin of safety. The circle of competence will be unique to every person; therefore, your stock portfolio will naturally have sector, style, and country biases. If lacking in any area, such as international stocks, a good mutual fund can be used to balance your overall portfolio.
The Fat-Pitch Approach
1======== 0%
2 ========46%
4 ========72%
8 ========81%
16======= 93%
32======= 96%
500====== 99%
9,000==== 100%
- the average return of the stock market was about 10% and
- statistically, the one-year range of returns for a market portfolio (holding scores of stocks) in this period was between negative 8% and positive 28% about two-thirds of the time.
- That means that one-third of the time, the returns fell outside this 36-point range.
- 5 stocks, the expected return remains 10%, but your one-year range expands to between negative 11% and positive 31% about two-thirds of the time.
- 8 stocks, the range is between negative 10% and positive 30%.
In other words, it takes fewer stocks to diversify a portfolio than one might intuitively think.
Portfolio Weighting
In addition to knowing how many stocks to own in your portfolio and which stocks to buy, the percentage of your portfolio occupied by each stock is just as important. Unfortunately, the science and academics behind this important topic are scarce, and therefore, portfolio weighting is, again, more art than science.
The great money managers have a knack for having a great percentage of their money in stocks that do well and a lesser amount in their bad picks. So how do they do it?
Essentially, a portfolio should be weighted in direct proportion to how much confidence you have in each pick. If you have a lot of confidence in the long-term outlook and the valuation of a stock, then it should be weighted more heavily than a stock you may be taking a flier on.
If a stock has
- a 10% weighting in your portfolio, then a 20% change in its price will move your overall portfolio 2%.
- a 3% weighting, a 20% change has only a 0.6% effect on your portfolio.
Weight your portfolio wisely. Don't be afraid to have some big weightings, but be certain that the highest-weighted stocks are the ones you feel the most confident about. And, of course, don't go off the deep end by having, for example, 50% of your portfolio in a single stock.
Portfolio Turnover
If you follow the fat-pitch method, you won't trade very often. Wide-moat companies selling at a discount are rare, so when you find one, you should pounce. Over the years, a wide-moat company will generate returns on capital higher than its cost of capital, creating value for shareholders. This shareholder value translates into a higher stock price over time.
If you sell after making a small profit, you might not get another chance to buy the stock, or a similar high-quality stock, for a long time. For this reason, it's irrational to quickly move in and out of wide-moat stocks and incur capital gains taxes and transaction costs. Your results, after taxes and trading expenses, likely won't be any better and may be worse. That's why many of the great long-term investors display low turnover in their portfolios. They've learned to let their winners run and to think like owners, not traders.
Circle of Competence and Sector Concentration
If you are investing within your circle of competence, then your stock selections will gravitate toward certain sectors and investment styles.
Maybe you:
- work in the medical field and thus are familiar with and own a number of pharmaceutical and biotechnology stocks, or,
- you've been educated in the Warren Buffett school of investing and cling to entrenched, easy-to-understand businesses such as Coca-Cola and Wrigley.
However, if all your stocks are in one sector, you may want to think about the effects that could have on your portfolio. For instance, you probably wouldn't want all of your investments to be in unattractive areas such as the airline or auto industry.
Adding Mututal Funds to a Stock Portfolio
In-the-know investors buy stocks. Those less-in-the-know, or those who choose to know less, own mutual funds.
But investing doesn't have to be a choice between investing directly in stocks or indirectly through mutual funds. Investors can - and many should - do both. The trick is determining how your portfolio can benefit most from each type of investment. Figuring out your appropriate stock/fund mix is up to you.
Begin by looking for gaps in your portfolio and circle of competence.
- Do you have any foreign exposure?
- Do your assets cluster in particualr sectors or style-box positions?
Some funds invest in micro-caps, others invest around the globe, still others focus on markets, such as real estate. Stock investors who turn over some of their dollars to an expert in these areas gain exposure to new opportunities without having to learn a whole new set of analytical skills.
Ultimately, your choice depends on your circle of competence and comfort level. While many may feel comfortable with picking their own international stocks, others may prefer to own an international equity fund.
Our Objective
Modern Portfolio Theory has been built on the assumption that you can't beat the stock market. If you can't beat the market porfolio, then the best you can do is to match the market's performance. Therefore, academic theory revolves around how to build the most efficient portfolio to match the market.
We have taken a different approach. Our objective is to outperform the market. Therefore, we believe that our odds increase by holding (not actively trading) relatively concentrated portfolios of between 12 and 20 great companies purchased with a margin of safety. The circle of competence will be unique to every person; therefore, your stock portfolio will naturally have sector, style, and country biases. If lacking in any area, such as international stocks, a good mutual fund can be used to balance your overall portfolio.
PPB Group a 'buy', says Kim Eng
PPB Group a 'buy', says Kim Eng
Published: 2010/01/19
PPB Group Bhd, a Malaysian plantation and property group, was raised to “buy” from “hold” at Kim Eng Research Sdn Bhd, which said the stock is an “attractive proxy” for its palm oil trading affiliate, Wilmar International Ltd.
The share price estimate for PPB was raised to RM19.20 from RM14.68, Kim Eng said in a report today. -- Bloomberg
Published: 2010/01/19
PPB Group Bhd, a Malaysian plantation and property group, was raised to “buy” from “hold” at Kim Eng Research Sdn Bhd, which said the stock is an “attractive proxy” for its palm oil trading affiliate, Wilmar International Ltd.
The share price estimate for PPB was raised to RM19.20 from RM14.68, Kim Eng said in a report today. -- Bloomberg
Public Bank rises to new record
Public Bank rises to new record
Published: 2010/01/19
Public Bank Bhd, Malaysia’s third largest lender, rose to a new record in Kuala Lumpur trading ahead of its fourth-quarter earnings report this week.
HWANG DBS Vickers Research Sdn Bhd yesterday said the bank’s 2009 earnings may exceed market projections.
The stock rose 1.5 per cent to RM12.02 at 9:17 am local time, its fourth straight day of gains. -- Bloomberg
Published: 2010/01/19
Public Bank Bhd, Malaysia’s third largest lender, rose to a new record in Kuala Lumpur trading ahead of its fourth-quarter earnings report this week.
HWANG DBS Vickers Research Sdn Bhd yesterday said the bank’s 2009 earnings may exceed market projections.
The stock rose 1.5 per cent to RM12.02 at 9:17 am local time, its fourth straight day of gains. -- Bloomberg
****Strategies of the Greats: Graham, Fisher, Buffett and Lynch
Benjamin Graham
Born in London in 1894 as Benjamin Grossbaum, Graham emigrated to the United States when he was one year old. Graham graduated from Columbia University in 1914 and was offered a teaching position in three different Columbia departments.
Graham's Security Analysis, published in 1934, was the first book to articulate a framework for the systematic analysis of stocks and bonds. Graham later wrote The Intelligent Investor to bring many of the same concepts to the lay investor. Both books should be at the very top of the required reading list for serious value investors.
One of Graham's most successful investments was in the automobile insurer GEICO, where he served as chairman of the board.
One of Graham's favorite investment techniques was to purchase net-current-asset bargains, or net-nets. Net-net were stocks that traded for less than the value of their current assets minus all liabilities.
Graham's students, such as Warren Buffett and Bill Ruane, are among some of the best investors of the past century.
Philip Fisher
Fisher's career spanned 74 years. After training as an analyst, Fisher started his San Francisco-based investment advisory firm in 1931. His classic book on investing, Common Stocks and Uncommon Profits, was first published in 1958.
Fisher said that, "If the job has been correctly done when a common stock is purchased, the time to sell it is almost never." As an example, Fisher first purchased shares of Motorola in 1955 and held them until his death in 2004.
Fisher put all of his potentital investments through 15 step checklist in order to gauge the quality of a company.
According to Fisher, there are only three reasons to sell a stock:
1) If you have made a serious mistake in your assessment of the company;
2) If the company no longer passes the 15 points as clearly as before;
3) If you could reinvest the money in another, far more attractive company.
Warren Buffett
Buffett uses a discounted cash-flow analysis to estimate the fair value of companies.
Unless analysing a business falls within his circle of competence, Buffett does not try to value the business.
Buffett seeks companies with sustainable competitive advantages. (Companies with economic moats.)
Though Buffett believes it's important to work with competent, honest managers, the economics of a business are the most important factor.
Buffett is not swayed by popular opinion.
Since no discounted cash-flow analysis is perfect, Buffett requires a margin of safety in his purchase price.
Rather than diversify and dilute his potential returns, Buffett conccentrates his investments on his best ideas.
Peter Lynch
Lynch obtained his legendary investor status managing the Fidelity Magellan Fund. Under Lynch's leadership, the Magellan fund grew from $20 million in assets to $13 billion and achieved an average total return of 25% per year.
Despite his success as a professional money manager, Lynch believes that average investors have an edge over Wall Street experts and can outperform the market by looking for investment ideas in their daily lives.
The Lynch investment philosophy has four main components:
1. Invest only in what you understand.
2. Do your homework and research the company thoroughly.
3. Focus only on the company's fundamentals and not the market as a whole.
4. Invest only for the long run and discard short-term market gyrations.
Although he is best known for trend-spotting, Lynch's stock-picking approach mirrors that of Warren Buffett.
Born in London in 1894 as Benjamin Grossbaum, Graham emigrated to the United States when he was one year old. Graham graduated from Columbia University in 1914 and was offered a teaching position in three different Columbia departments.
Graham's Security Analysis, published in 1934, was the first book to articulate a framework for the systematic analysis of stocks and bonds. Graham later wrote The Intelligent Investor to bring many of the same concepts to the lay investor. Both books should be at the very top of the required reading list for serious value investors.
One of Graham's most successful investments was in the automobile insurer GEICO, where he served as chairman of the board.
One of Graham's favorite investment techniques was to purchase net-current-asset bargains, or net-nets. Net-net were stocks that traded for less than the value of their current assets minus all liabilities.
Graham's students, such as Warren Buffett and Bill Ruane, are among some of the best investors of the past century.
Philip Fisher
Fisher's career spanned 74 years. After training as an analyst, Fisher started his San Francisco-based investment advisory firm in 1931. His classic book on investing, Common Stocks and Uncommon Profits, was first published in 1958.
Fisher said that, "If the job has been correctly done when a common stock is purchased, the time to sell it is almost never." As an example, Fisher first purchased shares of Motorola in 1955 and held them until his death in 2004.
Fisher put all of his potentital investments through 15 step checklist in order to gauge the quality of a company.
According to Fisher, there are only three reasons to sell a stock:
1) If you have made a serious mistake in your assessment of the company;
2) If the company no longer passes the 15 points as clearly as before;
3) If you could reinvest the money in another, far more attractive company.
Warren Buffett
Buffett uses a discounted cash-flow analysis to estimate the fair value of companies.
Unless analysing a business falls within his circle of competence, Buffett does not try to value the business.
Buffett seeks companies with sustainable competitive advantages. (Companies with economic moats.)
Though Buffett believes it's important to work with competent, honest managers, the economics of a business are the most important factor.
Buffett is not swayed by popular opinion.
Since no discounted cash-flow analysis is perfect, Buffett requires a margin of safety in his purchase price.
Rather than diversify and dilute his potential returns, Buffett conccentrates his investments on his best ideas.
Peter Lynch
Lynch obtained his legendary investor status managing the Fidelity Magellan Fund. Under Lynch's leadership, the Magellan fund grew from $20 million in assets to $13 billion and achieved an average total return of 25% per year.
Despite his success as a professional money manager, Lynch believes that average investors have an edge over Wall Street experts and can outperform the market by looking for investment ideas in their daily lives.
The Lynch investment philosophy has four main components:
1. Invest only in what you understand.
2. Do your homework and research the company thoroughly.
3. Focus only on the company's fundamentals and not the market as a whole.
4. Invest only for the long run and discard short-term market gyrations.
Although he is best known for trend-spotting, Lynch's stock-picking approach mirrors that of Warren Buffett.
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