Sunday 1 July 2012
Finding Firms with an Edge (Morningstar)
Loss Aversion
It's no secret, for example, that many investors will focus obsessively
on one investment that's losing money, even if the rest of their
portfolio is in the black. This behavior is called loss aversion.
Investors have been shown to be more likely to sell winning stocks in
an effort to "take some profits," while at the same time not wanting
to accept defeat in the case of the losers. Philip Fisher wrote in his
excellent book Common Stocks and Uncommon Profits that, "More
money has probably been lost by investors holding a stock they really
did not want until they could 'at least come out even' than from any
other single reason."
Regret also comes into play with loss aversion. It may lead us to be
unable to distinguish between a bad decision and a bad outcome.
We regret a bad outcome, such as a stretch of weak performance
from a given stock, even if we chose the investment for all the right
reasons. In this case, regret can lead us to make a bad sell decision,
such as selling a solid company at a bottom instead of buying more.
It also doesn't help that we tend to feel the pain of a loss more
strongly than we do the pleasure of a gain. It's this unwillingness to
accept the pain early that might cause us to "ride losers too long" in
the vain hope that they'll turn around and won't make us face the
consequences of our decisions.
http://news.morningstar.com/classroom2/course.asp?docId=145104&page=5&CN=COM#
Dividends and Total Returns
During the bull market, the pursuit of rapidly growing businesses
obscured the real nature of equity returns. But growth isn't all there
is to successful investing; it's just one piece of a larger puzzle.
Total return includes not only price appreciation, but income as well.
And what causes price appreciation? In strictly theoretical terms,
there's only one answer: anticipated dividends. Earnings are just a
proxy for dividend-paying power. And dividend potential is not solely
driven by growth of the underlying business--in fact, rapid growth in
certain capital-intensive businesses can actually be a drag on
dividend prospects.
Investors who focus only on sales or earnings growth--or even just
the appreciation of the stock price--stand to miss the big picture. In
fact, a company that isn't paying a healthy dividend may be setting
its shareholders up for an unfortunate fate.
In Jeremy Siegel's The Future for Investors, the market's top
professor analyzed the returns of the original S&P 500 companies
from the formation of the index in 1957 through the end of 2003.
What was the best-performing stock? Was it in color televisions
(remember Zenith)? Telecommunications (AT&T T)? Groundbreaking
pharmaceuticals (Syntex/Roche)? Surely, it must have been a
computer stock (IBM IBM)?
None of the above. The best of the best hails not from a hot, rapidly
growing industry, but instead from a field that was actually
surrendering customers the entire time: cigarette maker Philip
Morris, now known as Altria Group MO. Over Siegel's 46-year time
frame, Philip Morris posted total returns of an incredible 19.75% per
year.
What was the secret? Credit a one-two punch of high dividends and
profitable, moat-protected growth. Philip Morris made some
acquisitions over the years, which were generally successful--but the
overwhelming majority of its free cash flow was paid out as
dividends or used to repurchase shares. As Marlboro gained market
share and raised prices, Philip Morris grew the core business at a
decent (if uninspiring) rate over the years. But what if the company-
-listening to the fans of growth and the foes of taxes--attempted to
grow the entire business at 19.75% per year? At that rate it would
have subsumed the entire U.S. economy by now.
The lesson is that no business can grow faster than the economy
indefinitely, but that lack of growth doesn't cap investor returns.
Amazingly, by maximizing boring old dividends and share buybacks, a
low-growth business can turn out to be the highest total return
investment of all time. As Siegel makes abundantly clear, "growth
does not equal return." Only profitable growth--in businesses
protected by an economic moat--can do that.
http://news.morningstar.com/classroom2/course.asp?docId=145248&page=3&CN=COM
Two Approaches to Stock Valuation
There are two broad approaches to stock valuation. One is the ratio
based approach and the other is the intrinsic value approach.
If you have ever talked about a P/E ratio, you've valued a stock using
the ratio-based approach. Valuation ratios compare the company's
market value with some financial aspect of its performance--
earnings, sales, book value, cash flow, and so on. The ratio-based
approach is the most commonly used method for valuing stocks,
because ratios are easy to calculate and readily available.
The downside is that making sense of valuation ratios requires quite
a bit of context. A P/E ratio of 15 does not mean a whole lot unless
you also know the P/E of the market as a whole, the P/Es of the
company's main competitors, the company's historical P/Es, and
similar information. A ratio that looks sky-high for one company
might seem quite reasonable for another.
The other major approach to valuation tries to estimate what a
stock should intrinsically be worth. A stock's intrinsic value is based
on projecting the company's future cash flows along with other
factors. You can compare this intrinsic or fair value with a stock's
market price to determine whether the stock looks underpriced, fairly
valued, or overpriced.
http://news.morningstar.com/classroom2/course.asp?docId=145096&page=5&CN=COM
Fisher's advice: Don't quibble over eighths and quarters.
After extensive research, you've found a company that you think will
prosper in the decades ahead, and the stock is currently selling at a
reasonable price. Should you delay or forgo your investment to wait
for a price a few pennies below the current price?
Fisher told the story of a skilled investor who wanted to purchase
shares in a particular company whose stock closed that day at $35.50
per share. However, the investor refused to pay more than $35. The
stock never again sold at $35 and over the next 25 years, increased
in value to more than $500 per share. The investor missed out on a
tremendous gain in a vain attempt to save 50 cents per share.
Even Warren Buffett is prone to this type of mental error. Buffett
began purchasing Wal-Mart many years ago, but stopped buying
when the price moved up a little. Buffett admits that this mistake
cost Berkshire Hathaway shareholders about $10 billion. Even the
Oracle of Omaha could have benefited from Fisher's advice not to
quibble over eighths and quarters.
http://news.morningstar.com/classroom2/course.asp?docId=145662&page=4&CN=COM
Investing for the Long Run
Introduction
The difference of only a few percentage points in investment returns
or interest rates can have a huge impact on your future wealth.
Therefore, in the long run, the rewards of investing in stocks can
outweigh the risks. We'll examine this risk/reward dynamic in this
lesson.
Volatility of Single Stocks
Individual stocks tend to have highly volatile prices, and the returns
you might receive on any single stock may vary wildly. If you invest
in the right stock, you could make bundles of money. For instance,
Eaton Vance EV, an investment-management company, has had the
best-performing stock for the last 25 years. If you had invested
$10,000 in 1979 in Eaton Vance, assuming you had reinvested all
dividends, your investment would have been worth $10.6 million by
December 2004.
On the downside, since the returns on stock investments are not
guaranteed, you risk losing everything on any given investment.
There are hundreds of recent examples of dot-com investments that
went bankrupt or are trading for a fraction of their former highs.
Even established, well-known companies such as Enron, WorldCom,
and Kmart filed for bankruptcy, and investors in these companies
lost everything.
Between these two extremes is the daily, weekly, monthly, and
yearly fluctuation of any given company's stock price. Most stocks
won't double in the coming year, nor will many go to zero. But do
consider that the average difference between the yearly high and
low stock prices of the typical stock on the New York Stock
Exchange is nearly 40%.
In addition to being volatile, there is the risk that a single company's
stock price may not increase significantly over time. In 1965, you
could have purchased General Motors GM stock for $50 per share
(split adjusted). In the following decades, though, this investment
has only spun its wheels. By June 2008, your shares of General
Motors would be worth only about $18 each. Though dividends
would have provided some ease to the pain, General Motors' return
has been terrible. You would have been better off if you had
invested your money in a bank savings account instead of General
Motors stock.
Clearly, if you put all of your eggs in a single basket, sometimes that
basket may fail, breaking all the eggs. Other times, that basket will
hold the equivalent of a winning lottery ticket.
Volatility of the Stock Market
One way of reducing the risk of investing in individual stocks is by
holding a larger number of stocks in a portfolio. However, even a
portfolio of stocks containing a wide variety of companies can
fluctuate wildly. You may experience large losses over short periods.
Market dips, sometimes significant, are simply part of investing in
stocks.
For example, consider the Dow Jones Industrials Index, a basket of
30 of the most popular, and some of the best, companies in America.
If during the last 100 years you had held an investment tracking the
Dow, there would have been 10 different occasions when that
investment would have lost 40% or more of its value.
The yearly returns in the stock market also fluctuate dramatically.
The highest one-year rate of return of 67% occurred in 1933, while
the lowest one-year rate of return of negative 53% occurred in 1931.
It should be obvious by now that stocks are volatile, and there is a
significant risk if you cannot ride out market losses in the short
term. But don't worry; there is a bright side to this story.
Over the Long Term, Stocks Are Best
Despite all the short-term risks and volatility, stocks as a group have
had the highest long-term returns of any investment type. This is an
incredibly important fact! When the stock market has crashed, the
market has always rebounded and gone on to new highs. Stocks have
outperformed bonds on a total real return (after inflation) basis, on
average. This holds true even after market peaks.
If you had deplorable timing and invested $100 into the stock market
during any of the seven major market peaks in the 20th century,
that investment, over the next 10 years, would have been worth
$125 after inflation, but it would have been worth only $107 had you
invested in bonds, and $99 if you had purchased government
Treasury bills. In other words, stocks have been the best-performing
asset class over the long term, while government bonds, in these
cases, merely kept up with inflation.
This is the whole reason to go through the effort of investing in
stocks. Again, even if you had invested in stocks at the highest peak
in the market, your total after-inflation returns after 10 years would
have been higher for stocks than either bonds or cash. Had you
invested a little at a time, not just when stocks were expensive but
also when they were cheap, your returns would have been much
greater.
Time Is on Your Side
Just as compound interest can dramatically grow your wealth over
time, the longer you invest in stocks, the better off you will be.
With time, your chances of making money increase, and the volatility
of your returns decreases.
The average annual return for the S&P 500 stock index for a single
year has ranged from negative 39% to positive 61%, while averaging
13.2%. After holding stocks for five years, average annualized returns
have ranged from negative 4% to positive 30%, while averaging 11.9%.
These returns easily surpass those you can get from any of the other
major types of investments. Again, as your holding period increases,
the expected return variation decreases, and the likelihood for a
positive return increases. This is why it is important to have a long term
investment horizon when getting started in stocks.
Why Stocks Perform the Best
While historical results certainly offer insight into the types of
returns to expect in the future, it is still important to ask the
following questions: Why, exactly, have stocks been the best
performing asset class? And why should we expect those types of
returns to continue? In other words, why should we expect history
to repeat?
Quite simply, stocks allow investors to own companies that have the
ability to create enormous economic value. Stock investors have full
exposure to this upside. For instance, in 1985, would you have
rather lent Microsoft money at a 6% interest rate, or would you have
rather been an owner, seeing the value of your investment grow
several-hundred fold?
Because of the risk, stock investors also require the largest return
compared with other types of investors before they will give their
money to companies to grow their businesses. More often than not,
companies are able to generate enough value to cover this return
demanded by their owners.
Meanwhile, bond investors do not reap the benefit of economic
expansion to nearly as large a degree. When you buy a bond, the
interest rate on the original investment will never increase. Your
theoretical loan to Microsoft yielding 6% would have never yielded
more than 6%, no matter how well the company did. Being an owner
certainly exposes you to greater risk and volatility, but the sky is also
the limit on the potential return.
The Bottom Line
While stocks make an attractive investment in the long run, stock
returns are not guaranteed and tend to be volatile in the short term.
Therefore, we do not recommend that you invest in stocks to
achieve your short-term goals. To be effective, you should invest in
stocks only to meet long-term objectives that are at least five years
away. And the longer you invest, the greater your chances of
achieving the types of returns that make investing in stocks
worthwhile.
Quiz
There is only one correct answer to each question.
1 The average yearly difference between the high and low of the
typical stock is between:
a. 30% and 50%.
b. 10% and 30%.
c. 50% and 70%.
2 If you were saving to buy a car in three years, what percentage of
your savings for the car should you invest in the stock market?
a. 50%.
b. 70%.
c. 0%.
3 If you were investing for your retirement, which is more than 10
years away, based on historical returns in the 20th century, what
percentage of the time would you have been better off by
investing only in stocks versus a combination of stocks, bonds,
and cash?
a. 50%.
b. 100%.
c. 0%.
4 Well known stocks like General Motors:
a. Always outperform the stock market.
b. Are too highly priced for the average investor.
c. Can underperform the stock market.
5 Which of the following is true?
a. After adjusting for inflation, bonds outperform stocks.
b. When you invest in stocks, you will earn 12% interest on your
money.
c. Stock investments should be part of your long-term
investment portfolio.
http://news.morningstar.com/classroom2/course.asp?docId=142859&page=1&CN=COM
Saturday 30 June 2012
Tesco's recent fortunes illustrate how, like economies, companies move cyclically
Cycle path - Tesco's recent fortunes illustrate how, like economies, companies move cyclically
26 Jan 2012
We have discussed in the past how the broader economy moves in cycles – and how value investing looks to exploit how the market responds to different points within those cycles. However, the recent profit warning issued by supermarket giant Tesco illustrates how individual industries and even individual companies can have cycles of their own.
Over the last decade or more, Tesco has enjoyed an extraordinary rise from being just one of the food retailing herd to become, by some distance, one of the biggest beasts in the global retail jungle. At present there is no question the group dominates all aspects of retailing in the UK, from convenience stores, through traditional supermarkets and increasingly the online space as well.
Inevitably, when a company finds a formula that brings it as much success as Tesco has enjoyed in the UK, natural economic forces begin to assert themselves – perhaps, for example, the competition learns from what a winning business has done, or maybe some of the people at the top of the winning business grow so used to success that a bit of complacency slips in. Either of those factors and no doubt plenty of others could have come into play at Tesco in recent years to slowly chip away at the lead it had established from rivals.
Just as value investors will seek to take advantage of extremes of valuation thrown up by economic cycles they will also look to do so with an industry or company-specific cycle. Businesses go through phases of good and bad operational performance and of being liked and disliked by the stock market, indeed until quite recently Tesco has been a relatively loved company. The negative reaction to its recent setback may turn out to be much more extreme than is actually justified as even if Tesco is no longer the supermarket winner in the UK that does not mean it has become a bad business overnight.
In all probability and provided its management behave sensibly, Tesco can still earn good returns in the UK and operates a large foreign business that has further to grow. Even if the next 10 years does not see it scale the heights of the previous decade relative to competitors, investors who can find the right entry point in terms of valuation could still make good returns from its shares.
Stock investments versus bonds are a ‘no-brainer’, says Warren Buffett
October 6th, 2010 by John Doherty
Stock investments are superior to investment in bonds, despite the general view that bonds investments are relatively low-risk, according to the world’s most successful investor, Warren Buffett.
Speaking at a conference for top US businesswomen organised by Fortune magazine, Buffett said of stocks investments: “It’s quite clear that stocks are cheaper than bonds. I can’t imagine anyone having bonds in their portfolio when they can have equities.”
For the world’s 3rd-richest man, with a personal net worth estimated at $47 billion in March 2010, low-risk investments may no longer be necessary – but even for the ordinary investor prepared to put their money away for a decade or two, the arguments for stocks and shares investments are what Buffett might call a ‘no-brainer’.
By charting the performance of a long-term investment in stocks and shares made in 1945, figures released recently by Scottish Widows shows that returns over a 60-year term were 70 times greater than investing the same sum as cash in a bank or building society account.
A sum of £100 invested in a building society account in 1945 would have been worth just £1,767 by 2006, according to Scottish Widows. Invested in bonds, the sum would have been worth £4,323.
However, the same £100 invested in the UK stock markets, as measured by the Barclays Equity Index and including dividends reinvested, would have grown to £125,243 over the same time period.
While bonds may be attractive for an investment of 5-10 years, as you are told in advance what your minimum return will be, stocks and shares investments are the clear winner in the longer term.
Warren Buffett’s investment activities are carried on through his investment company Berkshire Hathaway, which has been voted the world’s most respected company by the leading US business publication Barron’s Magazine.
Tesco weighs future of Fresh & Easy
By James Davey
CARDIFF (Reuters) - World No. 3 retailer Tesco (TSCO.L) promised to pull the plug on its loss-making Fresh & Easy chain in the United States if it continued to disappoint, and rejected renewed calls for an independent review of its strategy for the venture.
"If we see there is no chance of success, we'll do as we've just done in Japan," said chief executive Philip Clarke, referring to Tesco's deal this month to exit that market.
"It is not about ego, we are businessmen," he told the British grocer's annual meeting in the Welsh capital, Cardiff, on Friday.
The Change to Win Investment Group, which advises U.S. trade union-sponsored pension funds, during the meeting asked Tesco to establish a committee of non-executive directors to review Fresh & Easy's future and set fixed benchmarks to measure its success.
"We will not be doing that," responded chairman Richard Broadbent.
He said the strategy for Fresh & Easy was regularly reviewed by the whole board, with the retailer providing full disclosure on the business in its annual report and accounts.
"We're not hiding anything at all on Fresh & Easy," he said.
Change to Win's proposals have been ignored by Tesco for several years. It regards them as union motivated. Fresh & Easy does not recognize trade unions.
Clarke has this year rejected shareholder calls to pull the group out of the United States.
In April he said he did not expect the chain to break even until its 2013/14 financial year, against a previous target of 2012/13.
This month, Tesco reported underlying sales growth at Fresh & Easy slowed to 3.6 percent in its first quarter from 12.3 percent in the fourth quarter of last year.
"What shareholders want to know is, where is Fresh & Easy going and how much will it cost to get there?," said Michael Zucker, Change to Win's director of retail initiatives.
PAY APPROVED
Once one of the most consistent British companies in terms of earnings growth, Tesco stunned investors in January with its first profit warning in more than 20 years, saying it needed to invest heavily to stem a steady decline in UK market share.
However, it avoided becoming the latest victim of the 'shareholder spring' which has seen investors resist big pay rises at underperforming companies.
The phenomenon has led to the departures of Aviva (LSE:AV.) boss Andrew Moss and Sly Bailey, head of newspaper group Trinity Mirror (TNI.L).
Some 96.9 percent of shareholders who voted at the meeting backed Tesco's executive pay report, even though Pensions Investment Research Consultants (Pirc), a pension fund consultant, had called on investors to vote against it.
Last month's move by Clarke not to take his 372,000 pounds ($576,800) bonus may have headed off any potential rebellion.
He told the meeting Tesco's strategy to revive its core UK business, which accounts for about one in every 10 pounds spent in British shops, and about 70 percent of Tesco's annual trading profit, was making progress as he addressed shareholder concerns ranging from empty shelves to rodent-infested stores.
This month, Tesco reported a fall in first-quarter underlying sales in Britain and said tough trading conditions showed no sign of improving.
Broadbent gave Clarke his backing when one shareholder asked if the latter would resign if he could not deliver recovery in the U.S. and the UK.
"Phil is evidently one of the best retailers in the world. There is absolutely no question of Philip Clarke resigning," said the chairman.
After the meeting Clarke was asked if the British government should be doing more to stimulate economic growth.
"I think there's a case for it," he told reporters.
"Peoples' disposable incomes are squeezed. Until there's some change I think it will be hard for everybody."
But he welcomed this week's move by the government to scrap a planned increase in fuel duty and took some comfort from recent falls in the oil price.
Shares in Tesco, which lags France's Carrefour (CA.PA) and U.S. industry leader Wal-Mart (WMT.N) in annual sales, have lost nearly a quarter of their value over the last year. They closed down 0.6 percent at 310 pence.
30.6.2012
Mr. Market vs. The Intelligent Investor
- The Intelligent Investor uses logical and mathematical analysis and doesn't trade on emotion.
- The Intelligent Investor buys things that have done bad whose fundamentals are intact.
- The Intelligent Investor sells things that have done good whose fundamentals are damaged.
- The Intelligent Investor takes advantage of the economic cycle as opposed to becoming a victim of it.
- The Intelligent Investor looks forward to economic collapses because that is when we make the most money.
- The Intelligent Investor fears a great booming economy because that is when we could lose everything.
- The Intelligent Investor milks the profits of a good business and doesn't sell unless the business has gone bad.
- The Intelligent Investor is aware that the future cannot be predicted.
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