Keep INVESTING Simple and Safe (KISS)
****Investment Philosophy, Strategy and various Valuation Methods****
The same forces that bring risk into investing in the stock market also make possible the large gains many investors enjoy. It’s true that the fluctuations in the market make for losses as well as gains but if you have a proven strategy and stick with it over the long term you will be a winner!****Warren Buffett: Rule No. 1 - Never lose money. Rule No. 2 - Never forget Rule No. 1.
Fixed income investments fare worse during inflationary periods than do common stocks. During inflationary periods, firms can increase prices, profits, and dividends causing their share price to increase and offsetting declines in purchasing power.
There is no underlying connection between inflation and the movement of common stock earnings and prices. Appreciation does not result from inflation, but rather from the re-investment of profits. The only way for inflation to increase common stock values is to raise the rate of earnings on capital investment, which it has not done historically.
Economic prosperity usually is accompanied by slight inflation, which does not affect returns.Offsetting factors include rising wage rates that exceed productivity gains and additional capital needs that cause interest rates to increase.
Graham describes alternatives to common stocks as a hedge against inflation. These alternatives range from gold and diamonds to rare paintings, stamps, and coins. Gold has performed poorly, far worse than returns from savings in a bank account. The latter categories, such as paying thousands of dollars for a rare coin, can not qualify as an “investment operation.” Real Estate is still another alternative; however, its value fluctuates widely, and serious errors may be made when purchasing individual locations.
Again, the defensive investor is best served by purchasing a portfolio of carefully chosen common stocks and bonds.
Successful investing is not magic, just keep things simple and maybe follow few investing and money rules of thumb and you’ll be fine in the long run.
Investment Mistakes in a Bear Market
1. Selling without any logical reasoning or attention to long-term goals. Often they all miss the fact that they are selling at the bottom to only repurchase them back at the top. Stop selling without a reason, only sell if the fundamentals have changed for the long term or the investment does not fit in your plan, not because everyone else is selling in the market.
2. The only worse thing one can do than selling out in a bear market is stop investing during the bear market. Would you stop shopping if retail prices dropped 30%? No. When you stop investing during a bear market you will miss out on many undervalued investment opportunities which can have great returns in the long run.
3. Some investors start to look at alternative investments, (e.g. gold) because they believe somehow these will perform better than the equity markets. Although alternative investments have their place in a portfolio the excessive focus during bear markets makes them dangerous.
4. Just stop wasting your time and money trying to time the markets. Investors are more likely to time the markets during a bear market, as there are often big swings, which are seen as opportunities by investors, this strategy will only hurt your portfolio.
I know bear markets hurt, but you trying to “improve” things will only make things worse.
What were your investment mistakes during this bear market?
In the short-term, market downturns feel like they will never end.
In the long-term, all corrections look like buying opportunities.
Regardless of how long this correction lasts, to win in the stock market over the long haul you must be willing to lose over the short-term." -Ben Carlson (emphasis added)
How do investors tell the difference between a bear-market rally and the birth of a new bull market?
.
Investment professionals look for certain technical signals to be in place before confirming a reversal is underway. What’s key is the number of stocks participating in a move, which is why these sorts of indicators are referred to in the parlance of market technicians as “breadth thrust” signals. The duration of the move and the price gains associated with it are also important.
The indicators that most reliably confirm that there is a shift into a new bull market are:
On the New York Stock Exchange, the NYSE American, and Nasdaq, 90% of the common stocks trade above their 10-day moving averages.
Stocks advancing on the NYSE outpace those declining by nearly a 2-to-1 margin for at least 10 days.
More than 55% of the stocks on the NYSE set new highs over a 20-day period.
These events only happen at bullish turns, says NDR’s Clissold. He highlights the end of the pandemic-induced bear market in March 2020, the shortest in history. That lasted 33 or 40 days, depending on whether you’re looking at the S&P 500 or the Dow Jones Industrial Average, where there were a series of powerful rallies that occurred through March and early April signaling a new upward move.
Faced with the worst first half for stocks and bonds in 50 years, the highest inflation in 40 years, and an endless barrage of bad economic data, investors might be excused for searching for bargains amid the rubble and assuming most of the damage is done.
Wall Street pros are at odds as to whether we are at an inflection point in the markets. Some see indications that we have likely hit the lows for stocks, while others warn of more pain ahead.
Representing the more bullish camp is James Paulsen, chief investment strategist at Leuthold Group in Minneapolis. He notes that the bottom may have already been made as the Fed is nearing the end of its tightening cycle, growth is slowing, and inflation is beginning to roll over. Moreover, he believes most of “the sellers are long gone.”
“Are there any nervous Nellies left?” he asks.
Taking the opposite view is David Kotok, co-founder and chief investment officer of Cumberland Advisors, a registered investment advisory firm in Sarasota, Florida, with $3.5 billion under management.
“We haven’t reached extreme levels of fear yet,” Kotok says. “We haven’t made a bottom because we haven’t seen extreme selling.” He expects interest rates will continue to go higher as inflation proves harder to subdue, geopolitical tensions worsen, and “shocks” emerge. He’s also concerned about “contagion risk” emanating from slowdowns in global economies
In its “three bears” scenario, NDR lays out possibilities for how the bear market plays out if a recession occurs this year, next year, or not at all.
1. If a recession occurs sometime in the second half of 2022, the stock market could drop another 10% or more. Bear markets that coincide with recessions tend to decline nearly 35% on average and last for 15.3 months. If this were to be the case, the sooner it would start, the sooner it would be over given that a bear market bottoms four months before a recession, setting the stage for a “shorter than average” recessionary bear market.
2. If a recessionoccurs in 2023 that would make the current bear market twice as long as average, and likely lead to numerous bear-market rallies that eventually fail as they have in past instances. Clissold cites 1973, 1978, and 2000 as past bear markets that saw numerous rallies between their start and finish with a maximum gain of 15.9%, 14.3%, and 15.5%, respectively.
3. The last and best scenario is if there is no recession at all. Stocks decline on average by 25% in a non-recessionary bear market over 9.1 months. In the past 50 years, the average decline has been 18% over 6.8 months.
If the Fed can achieve the delicate balance of taming inflation by slowing the economy without tipping the country into a recession, Clissold says, “the cyclical bear is likely close to being over.”
NDR = Ned Davis Research, an independent provider of global investment research based in Nokomis, Florida
Bed Bath & Beyond shares plummet after company warns of potential bankruptcy
PUBLISHED THU, JAN 5
KEY POINTS
Bed Bath & Beyond warned Thursday it’s running out of cash and is considering bankruptcy.
The embattled home goods retailer is having trouble getting enough merchandise to fill its shelves and is drawing fewer customers to its stores and website.
It anticipates a net loss of about $385.8 million for the third quarter, a nearly 40% jump in losses year over year.
In this article, Bed Bath & Beyond warned Thursday it’s running out of cash and is considering bankruptcy.
The retailer, citing worse-than-expected sales, issued a “going concern” warning that in the upcoming months it likely will not have the cash to cover expenses, such as lease agreements or payments to suppliers. Bed Bath said it is exploring financial options, such as restructuring, seeking additional capital or selling assets, in addition to a potential bankruptcy.
Shares of the company fell about 30% to close the day at $1.69 after Bed Bath issued the updates in a pair of financial filings. The stock earlier touched a 52-week low earlier in the day. Its market value has fallen to about $149 million as of Thursday’s close.
Still, CEO Sue Gove said the retailer is focused on rebuilding the business and making sure its brands, Bed Bath & Beyond, Buybuy Baby and Harmon, “remain destinations of choice for customers well into the future.”
Among its challenges, Bed Bath said it is having trouble getting enough merchandise to fill its shelves and is drawing fewer customers to its stores and website.
The retailer also said it wasn’t able to refinance a portion of its debt, less than a month after notifying investors it planned to borrow more in order to pay off chunks of existing obligations.
Bed Bath’s debt load has been weighing on the company. The retailer has nearly $1.2 billion inunsecured notes, which have maturity dates spread across 2024, 2034 and 2044. In recent quarters, Bed Bath has warned it’s been quickly burning through cash.
Bed Bath’s notes have all been trading below par, a sign of financial distress.
Stalled turnaround
Bed Bath has been through an especially tumultuous stretch, with the departure of its CEO and other top executives, companywide layoffs, store closures and an overhaul of its merchandise strategy. As sales declined, its CEO Mark Tritton got pushed out in June. Gove, who stepped in as interim CEO, has assumed the role permanently.
She laid out a comeback strategy in late August. As part of the plan, she said the company would cut costs by shrinking its store footprint and workforce. Gove said it would add back more items from popular national brands, as it shifted away from an aggressive private label strategy. And she said it had secured more than $500 million in new financing to help steady the business.
The company said during its last earnings report it believed it had enough liquidity to forge ahead.
In a news release Thursday, Gove said recent sales results illustrate why that turnaround plan is so important.
“Transforming an organization of our size and scale requires time, and we anticipate that each coming quarter will build on our progress,” she said.
The company is also looking for a chief financial officer after executive Gustavo Arnal died by suicide in September.
Mounting losses
So far, Bed Bath has not seen its sales trends change. Net sales in the fiscal third quarter, which ended Nov. 26, are expected to be about $1.26 billion — a sharp drop from $1.88 billion in the year-ago period, the company said.
It anticipates a net loss of about $385.8 million for the third quarter, a nearly 40% jump in losses year over year. The quarterly losses include an approximately $100 million impairment charge, which was not specified.
The company is scheduled to deliver full quarterly results and hold an earnings call on Tuesday.
Signs of Bed Bath’s financial stress have shown up on store shelves, too. As the retailer’s cash hoards dwindle, some suppliers aren’t willing to ship large quantities of merchandise — or in some cases, any merchandise — to the company.
Gove said in a news release that reduced credit limits mean customers are seeing emptier shelves and less variety than they expect. She said the company is using the money it’s made over the holiday season to pay vendors and order more inventory.
“We have seen trends improve when in-stock levels have increased,” she said.
Bed Bath already has a history of strained relationships with key national brands, such as Dyson, Keurig and Cuisinart. During previous holiday seasons, Bed Bath didn’t have popular gift items, such as KitchenAid’s stand mixers. Meanwhile, those items were plentiful at competitors like Target.
Bankruptcy—a legal state wherein a debtor (borrower) is temporarily protected from creditors (lenders); under Chapter 11 of the federal bankruptcy code, companies may continue to operate
Chapter 11—a section of the federal bankruptcy code whereby a debtor is reorganized as a going concern rather than liquidated (see bankruptcy)
Commercial paper—short-term loans from institutional investors to businesses
Default—the status of a company that fails to make an interest or principal payment on a debt security on the required date
Exchange offer—an offer made by a company to its security holders to exchange new, less-onerous securities for those outstanding
Financial distress—the condition of a business experiencing a shortfall of cash to meet operating needs and scheduled debt-service requirements
Hold-up value— benefits accruing to participants in a class of securities who are able to extract considerable nuisance value from the holders of other classes of securities
Par—the face amount of a bond; the contractual amount of the bondholder’s claim
Recapitalization—financial restructuring of a company whereby the company borrows against its assets and distributes the proceeds to shareholders
Secured debt—debt backed by a security interest in specific assets
Senior-debt security—security with the highest priority in the hierarchy of a company’s capital structure
Shareholder’s (owner’s) equity—the residual after liabilities are subtracted from assets
Subordinated-debt security - security with a secondary priority in the hierarchy of a company’s capital structure
Working capital—current assets minus current liabilities
Earlier this week, UOB announced that they are raising the interest rate of their One Savings Account to up to 7.8% p.a interest. UOB is not alone in doing so. Across the board, we see banks in Singapore fighting to remain competitive by offering increasingly attractive interest rates to encourage people to deposit their money with them.
During the COVID-19 pandemic, many countries were cutting their federal interest rates in an effort to increase lending and spending in order to stimulate the economy. This led to record low levels of interest rates on savings accounts. Many individuals opted to expose themselves to some level of risk and invest their savings rather than leave them idle in low-interest savings accounts.
However, with the current upsized interest rates on savings accounts, is it still worthwhile to invest your money into various investment vehicles, such as fixed deposits, treasury bills or even ETFs, or are you better off saving your money in a high-interest savings account?
If You Have A Small Amount Of Savings
One major caveat to the current high-interest rate promotions banks are running on their savings accounts is that you need a large amount of money in your savings account to be able to reap the full advertised interest rate.
For example, with the UOB One savings account, you are only able to enjoy the full 7.8% interest on your savings if you have an account monthly average balance of over S$75,000.
If you have less than S$30,000 in your savings account, you will only enjoy an interest rate of 3.85% p.a. This is almost half of the advertised high-interest rate of 7.8% p.a.
This is in contrast to the six-month tenor for Singapore Treasury Bills, released on 8 December 2022, which has an interest rate of 4.30%. The minimum bid amount for a Treasury Bill is S$1,000. Hence, with a smaller amount of money, you can get a higher rate of return if you invest rather than place your money in a high-interest savings account.
Furthermore, if you do not have a large amount of capital right now but are able to budget a small amount of your monthly income towards investing, taking a dollar-cost averaging approach might also be more lucrative for you in the long run.
The S&P 500, an index that tracks the 500 largest companies in the United States, has averaged an annual rate of return of 11.88% from 1957 to 2021. Choosing to dollar-cost average into an ETF every month might be a better allocation of your money. Granted, this incurs more risk than a savings account as you are exposing yourself to market volatility. However, the risk-to-reward ratio might be easier to stomach when working with a smaller budget.
If You Have A Large Amount Of Savings
Conversely, if you have a large amount of capital, choosing to deposit it into a high-interest savings account like UOB One might be a good option. With Singapore’s inflation rate in 2022 sitting at around 6%, an interest rate of 7.8% is not only matching but slightly beating inflation.
There are currently very low hurdles to achieve the 7.8% p.a. interest rate on deposit accounts with more than S$75,000. All that is required is for you to credit your monthly salary of at least S$1,600 into your UOB One account and spend at least S$500 on any UOB credit or debit card. For the average working adult, it should not be too difficult to meet this requirement.
Savings accounts are seen as an extremely low-risk asset. The Singapore Deposit Insurance Corporation (SDIC) insures all member banks and financial companies for up to S$75,000. This means that in the very unlikely event that a bank goes bankrupt, all of your deposits, up to S$75,000, will be guaranteed and returned to you. Hence, there is very little risk of you losing your initial capital, unlike when you are invested in the stock market.
Furthermore, a savings account provides the most liquidity. There is no lock-up period like with a fixed deposit or Singapore treasury bill. Savings accounts are also not subject to market fluctuations the way ETFs are. If you need to dip into this pot of savings for emergencies or investing opportunities along the way, you can do so without facing any penalties or losses.
This prevents one from jumping into an investment that they do not have a full understanding of just because they do not want to let their idle cash get eroded by inflation. With a high-interest savings account, you are able to buy yourself time to wait on the sidelines for the perfect investmentopportunity to arise.
Conclusion
Whether you choose to take advantage of the high-interest savings accounts now or to continue investing depends on both your personal financial situation and risk appetite.
While choosing to invest may not be as lucrative a decision if you have a smaller amount of savings, the peace of mind you get from knowing that your money is currently accruing interest in a rather risk-free vehicle could be good enough, even if you do not enjoy the full 7.8% p.a. interest rate.
For more information on different options available to you on the market right now, check out our round-up of the best savings accounts out there.
We are definitely in an environment of higher rates.
We witnessed the pandemic disrupts worldwide supply chains and meaningful fiscal stimulus employed.
It is not surprising this led to inflation embedded in our economic system fairly consistently.
We are now in the process of unwinding this.
Inflation is such a punitive tax on economic activities and naturally you see monetary policies shift rather quickly to a period of higher rates.
The treasury curve is inverted. The market is making an assumption that we will reach the terminal rate sometimes soon, and the forward, will bring the rates back down. After some time, looking at the interest rate cycle historically, we do see reversal of the rates.
Still early, still uncertain. Economy is still strong. Look at the tight labour market. We still has a way to go before taming inflation.
"Anyone who tells you they know, they don't know."
2.30
Our economists are calling for a lower growth next year; 1.9% economic growth globally.
They are of the view that there is a reasonable chance of a soft landing. Definition of soft landing means: inflation back close to 4%, 5% terminal rate with 1% growth.
There is also a very reasonable possibility of a recession. Most CEOs are cautious in how they operate their businesses. They are looking through the lenses, I don't know and I will rather prepare for that period of tough economic environment. They are more cautious and that creates a negative cycle, slow down on planning, hold back their spending, start trimming excess labour in preparation for a more difficult environment.
Goldman Sach's business is very correlated to the world economic activities, thus in an environment that slows down quickly, this has an impact on our business. We have record revenues and earnings in 2020, 2021 and even higher; our footprint grew not surprisingly, therefore we have to trim in some areas. We have to narrow our footprint a little bit.
4.32
GS is a professional, human capital business. 50% in GS around the world are in their 20s. They are in GS for the experience, to work in teams, to learn; these are at present fragmented. We need a culture of bringing people back quickly to the office as we think this is hurting part of our competitive advantage in the business. Bottom line, we are now operating closely to where we operated before the pandemic. Working from home is an issue mainly in the US and not in the rest of the world.
6.00
Ukraine war. China.
Deglobalization.
Variety of global forces in place for a long time that are expanding and connecting economic activities around the world. Inflation may have a negative effect on poverty especially in the developing world, example, the energy crisis. We would rather be economically intertwined globally. In a more complex geo-political environment, people started making different decisions.
For the last few decades we operated with the ethos all over the world that we make it in the place where it is least expensive as possible and sell it in the place where we can establish the highest margins.
Now people are rethinking: on energy, food, minerals, certain healthcare needs, microchips, people are saying, "I need security. Although I consider the cost of frictions, but I need also access and stability." These by themselves are inflationary. These are by themselves maybe permanent shifts. But this does not mean we are deglobalising. In this globalised world, we are choosing more carefully and more thoughtfully, who our partners are on certain things. These issues are being amplified at the moment because the geopolitical world has got more complex.
8.04
Business in China
Deploying more capital into China.(?)
We are dealing mainly with global companies operating in China. We are more cautious in our plans and our outlook. Talking to those in Washington and the hill, there is a risk of a more restricted capital allocation policies coming from either sides. For capital allocation, we may have to have a tighter control of our resources so that you have less exposure to that given the uncertainty of the environment you are operating in.
We are cautious, we need more clarity on how the policies will be in the coming years. In 2019, our dialogue on China would have been different. We have allocated a narrower footprint in China than we might have had 3 or 4 years ago.
10.16
Quick firing questions and answers
In a year's time, will this asset be up or down?
US Stocks - lower
Treasury yield - we are on the curve.
10 year Treasury yield - if we get the soft landing, this will be higher. If not a soft landing, you will see reversal of policies, then the rates will be the same or lower.
US dollar - slightly stronger
Soft landing - 35% probability
Oil - higher
Residential real estate - lower
Commercial real estate - lower Real estates at the end of the day is a financing trade, when interest is higher, real estate by definition, the cap rate, is going to be lower.
Crypto - what about it? 11.46 Very focused on the underlying technology; the ability to innovate financial services and financial infrastructures. Speed of transacting reduces risk and freeing capital from being tied up. Hope going forward, regulatory measures will allow the big financial institutions to participate more broadly in its innovations.
Crpto tokens - Bitcoin - any value in 10 years? - I don't know. (I don't care.) Value of bitcoin is a speculative thing. I don't see any use case for Bitcoin.
FTX bankruptcy - will there be more cryptos falling too? - stable coin, tokenization. Stable coin is just any form of bank deposits. Rules need to be set around them. Central bank digital currency. Cryptocurrency. etc. All these fall into a big basket we call crypto. (14.00)
We still excluded from participating in a lot of these by regulatory perspectives. We are spending a lot of time in trying to innovate using the blockchain technology. Digital loan administrative platform. How can this technology take risks out of the market system and strengthen the market system?
16.06
Scope of Goldman Sachs. 30 to 40 items to focus on.
Wreckage of the technology industry, any thing here to benefit Goldman Sachs?
Developer is a big part of Goldman Sachs. Competition for engineering talents is fierce. Puzzle of the digitalisation of the financial world. Banking is a highly regulated industry. Moving these into the clouds, connecting the clients on the platform. Good opportunities for Goldman Sachs.
18.46
Twitter
How much do you think Twitter is worth? I don't know.
A super interesting platform. Can Elon get it right and turns it into a great business.
Leveraged finance and buyout market. Buyout market is presently constrained. Significant repricing on multiples and significant repricing on financing, and these quickly brought down the activities to significant lower levels (constrained very quickly).
Historically, leveraged lending on large bank balance sheet that is underwater, is at a historically low level. When you think about other cycles when you have a pretty aggressive cycle and then something stops the cycle, the revaluation of the leveraged finance broadly, risk exposures are much much modest at that point than at other points in a similar cycle.
21.00
What happens to due diligence? Due diligence is an incredibly important part of the process of anything you do - whether you are going to invest, you are going to acquire, or you are going to be involved with a partner, As a long term observer of the market for a long term, there are periods of ebullience in the market, where people are riding the momentum wave and making a lot of money on the momentum wave, and disappointing behaviour when it weakens. We see this again and again. People choose to do things with a velocity, speed and vigor; and when they choose to do it early in the momentum train, they get away with it. Sometimes they get caught and get left off in a bad place. However, this is not the way a good professional investor operates and I don't see much change in the behaviour of the investors.
22.22
Pensions near-explosion in UK (gilt-rates went up the roof). Commercial real estates, challenges around liquidity.
Where do you see the greatest risk in the financial system? Significant growth in government debt around the world. In 2020, market functioning around government debts at time when governments are increasing borrowings. A lot of activities of the banking system which are now outside the regulatory banking system the last 10 to 15 years. Leverage of financing around that. A lot of direct lending occurs outside the regulatory banking system; this is good but needs to be watched especially people are using leverage to drive returns and capabilities around that.
So far in this contraction and tightening of the economic conditions, we haven't really seen material moves in the credit spreads. To the degree that something is moving the credit spreads in a material way, then I will be looking at lending activities. How concern are you on liquidity risk? Commercial estate and long term funds looking for liquidity. The problem of rising interest rates and people not coming into offices to work, is this a cause for concern? Real estate is valued at how much it cost to finance it. If the people are financed very long in the real estate, they can withstand all sorts of things for many cycles. If you are financed short term, if have not financed your assets to match your tenants and the rent flows, then you are obviously more vulnerable to that. I feel prime commercial real estate in prime cities are relatively protected. Third class real estates in most cities are going to have a relatively tough time. because of this debate whether people are going back to their work places or not. The expectation of what you get in a world class building and the evolution of space continues to make the older buildings require more capital to make it competitive in the market.
25.57
Corporate responsibility
Diversity in the governance in listed companies, public and private.
Tax-loss selling—selling just prior to year-end to realize losses for tax purposes
Technical analysis—analysis of past security-price fluctuations using charts
Tender offer—a cash bid to buy some or all of the securities of a target company
Thrift conversion—the conversion of a mutual thrift institution to stock ownership
Top-down investing—strategy involving making a macroeconomic forecast and then applying it to choose individual investments
Torpedo stocks—stocks for which investors have high expectations and which are therefore vulnerable to substantial price declines
Trader—a person whose job it is to buy and sell securities, earning a spread or commission for bringing buyers and sellers together
Trading flat—available for sale or purchase without payment for accrued interest
Treasury bills (T-bills)—noninterest-bearing obligations of the U.S. government, issued on a discount basis with original maturities ranging from three months to one year; the interest income from Treasury bills is the difference between the purchase price and par
Treasury bonds (T-bonds) —U.S. government obligations with original maturities of ten years or more; interest is paid semiannually
Treasury notes (T-notes) —U.S. government obligations with original maturities ranging from one to ten years; interest is paid semiannually
Value - the worth, calculated through fundamental analysis, of an asset, business, or security
Value investing—a risk-averse investment approach designed to buy securities at a discount from underlying value
Value investment—undervalued security; a bargain
Volume—the number of shares traded
Window dressing—the practice of making a portfolio look good for quarterly reporting purposes
Working capital—current assets minus current liabilities
Writing call options—selling call options on securities owned
Yield —return calculated over a specific period
Zero-coupon bond—a bond that accrues interest until maturity rather than paying it in cash
Puttable bond—bond with embedded put features allowing holders to sell the bonds back to the issuer at a specified price and time (see callable bond)
Recapitalization—financial restructuring of a company whereby the company borrows against its assets and distributes the proceeds to shareholders
Relative-performance orientation—the tendency to evaluate investment results by comparing one’s investment performance with that of the market as a whole
Return—potential gain
Rights offering—a financing technique whereby a company issues to its shareholders the preemptive right to purchase new stock (or bonds) in the company or occasionally in a subsidiary company
Risk—amount and probability of potential loss
Risk arbitrage—a specialized area involving investment in far-from-risk-free takeovers as well as spinoffs, liquidations, and other extraordinary corporate transactions
Secured debt—debt backed by a security interest in specific assets
Security—a marketable piece of paper representing the fractional ownership of a business or loan to a business or government entity
Self-tender—an offer by a company to repurchase its own securities
Senior-debt security—security with the highest priority in the hierarchy of a company’s capital structure
Sensitivity analysis—a method of ascertaining the sensitivity of business value to small changes in the assumptions made by investors
Share buybacks—corporate stock repurchases
Shareholder’s (owner’s) equity—the residual after liabilities are subtracted from assets
Short-selling—the sale of a borrowed security (see going long)
Short-term relative-performance derby—manifestation of the tendency by institutional investors to measure investment results, not against an absolute standard, but against broad stock market indices resulting in an often speculative orientation
Sinking fund—obligation of a company to periodically retire part of a bond issue prior to maturity
Speculation—an asset having no underlying economics and throwing off no cash flow to the benefit of its owner (see investment)
Spinoff—the distribution of the shares of a subsidiary company to the shareholders of the parent company
Stock—a marketable piece of paper representing the fractional ownership of an underlying business
Stock index Futures—contracts for the future delivery of a market basket of stocks
Stock market proxy—estimate of the price at which a company, or its subsidiaries considered separately, would trade in the stock market
Subordinated-debt security - security with a secondary priority in the hierarchy of a company’s capital structure
Tactical-asset allocation—computer program designed to indicate whether stocks or bonds are a better buy
Takeover multiple— multiple of earnings, cash flow, or revenues paid to acquire a company
Net operating-loss carryforward (NOL)—the carryforward of past losses for tax purposes, enabling a company to shield future income from taxation
Net present value (NPV)—calculation of the value of an investment by discounting future estimates of cash flow back to the present
Non-cash-pay securities—securities permitted to pay interest or dividends in kind or at a later date rather than in cash as due (see cash-pay securities, pay-in-kind, and zero-coupon bond)
Nonrecourse—the lender looks only to the borrowing entity for payment
Open end mutual fund—mutual fund offering to issue or redeem shares at a price equal to underlying net asset value
Opportunity cost—the loss represented by forgone opportunities
Option—the right to buy (call) or sell (put) specified items at specified prices by specified dates
Over-the-counter (OTC)—the market for stocks not listed on a securities exchange (e.g., New York, American, Philadelphia, Boston, Pacific, Toronto)
Par—the face amount of a bond; the contractual amount of the bondholder’s claim
Pay-in-kind (PIK)—a security paying interest or dividends in kind rather than in cash
Plan of reorganization—the terms under which a company expects to emerge from Chapter 11 bankruptcy
Portfolio cash flow—the cash flowing into a portfolio net of outflows
Portfolio insurance—a strategy involving the periodic sale of stock-index futures designed to eliminate downside risk in a portfolio at a minor up-front cost
Post petition interest—interest accruing from the date of a bankruptcy filing forward
Preferred stock—an equity security senior in priority to common stock with a specified entitlement to dividend payments
Prepackaged bankruptcy—a technique whereby each class of creditors in a bankruptcy agree on a plan of reorganization prior to the bankruptcy filing
Prepetition interest—interest accruing from the most recent coupon payment up to the date of a bankruptcy filing
Price/earnings (P/E) ratio—market price of a stock divided by the annualized earnings per share
Price-to-book-value ratio—market price of a stock divided by book value per share
Principal— the face amount or par value of a debt security
Principal-only mortgage security (PO)—principal payments stripped from a pool of mortgages which, in response to changes in interest rates, fluctuate in value in the same direction as conventional mortgages but with greater volatility
Private-market value—the price that a sophisticated businessperson would be likely to pay for a business based on the valuation multiples paid on similar transactions
Pro forma financial information —earnings and book value adjusted to reflect a recent or proposed merger, recapitalization, tender offer, or other extraordinary transaction
Proxy contest—a fight for corporate control through the solicitation of proxies or the election of directors
Prudent-man standard—the obligation under ERISA to restrict one’s investments to those a “prudent” (conservative) person would make (see Employee Retirement Income Security Act of 1974 (ERISA)
Put option—a contract enabling the purchaser to sell a security at a fixed price on a particular date
Inside information—information unavailable to the public, upon which it is illegal to base transactions
Institutional investors —money managers, pension fund managers, and managers of mutual funds
Intangible asset—an asset without physical presence; examples include intellectual property rights (patents) or going-concern value (goodwill)
Interest—payment for the use of borrowed money
Interest-coverage ratio—the ratio of pretax earnings to interest expense
Interest-only mortgage security (IO)—interest payments stripped from a pool of mortgages which, for a given change in interest rates, fluctuates in value inversely to conventional mortgages (see principal-only mortgage security)
Interest rate reset—a promise made by an issuer to adjust the coupon on a bond at a specified future date in order to cause it to trade at a predetermined price
Internal rate of return (IRR)—calculation of the rate of return of an investment that assumes reinvestment of cash flows at the same rate of return the investment itself offers
Investment—an asset purchased to provide a return; investments, in contrast to speculations, eventually generate cash flow for the benefit of the owners (see speculation)
Investment banking—profession involving raising capital for companies as well as underwriting and trading securities, arranging for the purchase and sale of entire companies, providing financial advice, and opining on the fairness of specific transactions
Investment grade—fixed income security rated BBB or higher
Junk bond - fixed-income security rated below investment grade
Leveraged buyout (LBO)—acquisition of a business by an investor group relying heavily on debt financing
Liability—a debt or other obligation to pay
Liquidating distribution—cash or securities distributed to shareholders by a company in the process of liquidation
Liquidating trust—an entity established to complete a corporate liquidation
Liquidation value—the expected proceeds if the assets of a company were sold off, but not as part of an ongoing enterprise
Liquidity—having ample cash on hand
Liquid security—a security that trades frequently and within a narrow spread between the bid and asked prices
Making a market—acting as a securities dealer by simultaneously bidding for and offering a security
Margin of safety—investing at considerable discounts from underlying value, an individual provides himself or herself room for imprecision, bad luck, or analytical error (i.e., a “margin of safety”) while avoiding sizable losses
Market price—the price of the most recent transaction in a company’s publicly traded stock or bonds
Maturity—the date on which the face value of a debt security is due and payable
Merchant banking—an activity whereby Wall Street firms commit their own capital while acting as principal in investment banking transactions
Merger—a combination of two corporations into one
Mutual fund—a pooled investment portfolio managed by professional investors
Net asset value (NAV)—the per share value of a mutual fund calculated by dividing the total market value of assets by the number of shares outstanding
Net-net working capital—net working capital less all long-term liabilities
Efficient— market hypothesis-speculative notion that all information about securities is disseminated and becomes fully reflected in security prices instantaneously
Employee Retirement Income Security Act of 1974 (ERISA)—legislation that requires institutional investors to act as fiduciaries for future retirees by adopting the “prudent-man standard” (see prudent-man standard)
Equity “stubs”—low priced, highly leveraged stocks, often resulting from a corporate recapitalization (see recapitalization)
Exchange offer—an offer made by a company to its security holders to exchange new, less-onerous securities for those outstanding
“Fallen angels”—bonds of companies that have deteriorated beneath investment grade in credit quality
Financial distress—the condition of a business experiencing a shortfall of cash to meet operating needs and scheduled debt-service requirements
Friendly takeover—corporate acquisition in which the buyer and seller both support the transaction enthusiastically
Fulcrum securities—the class of securities whose strict priority bankruptcy claim is most immediately affected by changes in the debtor’s value
Full position—ownership of as much of a given security as an investor is willing to hold
Fundamental analysis— analyzing securities based on the operating performance (fundamentals) of the underlying business
Ginnie Mae (GNMA)—pool of mortgages insured by the Government National Mortgage Association, a U.S. government agency
Going long —buying a security (see short-selling)
Goodwill amortization—the gradual expensing of the intangible asset known as goodwill, which comes into existence when a company is purchased for more than its tangible book value
Guaranteed investment contract (GIC)—an insurance-company-sponsored investment product that automatically reinvests interest at a contractual rate
Hedge—an investment that, by appreciating (depreciating) inversely to another, has the effect of cushioning price changes in the latter
Holding company—a corporate structure in which one company (the holding company) is the owner of another
Hold-up value— benefits accruing to participants in a class of securities who are able to extract considerable nuisance value from the holders of other classes of securities
Illiquid security—a security that trades infrequently, usually with a large spread between the bid and asked prices (see liquid security)
Income statement—accounting statement calculating a company’s profit or loss
Indexing—the practice of buying all the components of a market index, such as the Standard and Poor’s 500 index, in proportion to the weightings of that index and then passively holding them
Initial public offering (IPO)—underwriting of a stock being offered to the public for the first time
Catalyst—an internally or externally instigated
corporate event that results in security holders realizing some or all of a company’s
underlying value
Chapter 11—a section of the federal bankruptcy code whereby a
debtor is reorganized as a going concern rather than liquidated (see bankruptcy)
Closed-end mutual fund—mutual fund having a fixed number of outstanding
shares that trade based on supply and demand at prices not necessarily equal to
underlying net asset value (see open-end mutual fund)
Collateralized bond
obligation (CBO)—diversified investment pools of junk bonds that issue
their own securities, usually in several tranches, each of which has risk and
return characteristics that differ from those of the underlying junk bonds
themselves
Commercial paper—short-term loans from institutional investors
to businesses
Commission—a charge for transacting in securities
Complex
securities—securities with unusual cash flow characteristics
Contingent-value
rights—tradable rights that are redeemable for cash if a stock fails to reach
specified price levels
Convertible arbitrage—arbitrage transactions designed to take
advantage of price discrepancies between convertible securities and the securities
into which they are convertible
Convertible bonds—bonds that can be exchanged for
common stock or other assets of a company at a specified price
Coupon—the
specified interest payment on a bond expressed as a percentage
Covered-call
writing—the practice of purchasing common stocks and then selling call options
against them
Cram-down security—security distributed in a merger
transaction, not sold by an underwriter
Credit cycle—the ebb and flow in the
availability of credit
Debtor-in-possession (DIP) financing—loan to a
bankrupt company operating in Chapter 11
Debt-to-equity ratio—the ratio of a company’s outstanding debt to the book value of
its equity; a measure of a company’s financial leverage
Default—the status of a
company that fails to make an interest or principal payment on a debt security
on the required date
Default rate of junk bonds—calculated by many
junk-band-market participants as the dollar volume of junk-bond defaults occurring
in a particular year divided by the total volume of junk bonds outstanding
Depreciation—an accounting procedure by which long-lived assets are
capitalized and then expensed over time
Discount rate—the rate of interest that
would make an investor indifferent between present and future dollars
Diversification—ownership of many rather than a small number of
securities; the goal of diversification is to limit the risk of company-specific events on
one’s portfolio as a whole
Dividend—cash distributed by a company to its
shareholders out of after-tax earnings
Earnings before interest, taxes, depreciation,
and amortization (EBITDA)—a nonsensical number thought by some
investors to represent the cash flow of a business
Earnings per share—a company’s
after-tax earnings divided by the total number of shares outstanding
Absolute-performance orientation—the tendency to evaluate investment results
by measuring one’s investment performance against an absolute standard such as
the risk-free rate of return
Annuity—a stream of cash in perpetuity
Arbitrage—
the practice of investing in risk-free transactions to take advantage of pricing
discrepancies between markets (see risk arbitrage)
Arbitrageur—investor in
risk-arbitrage transactions
Asked price (offer)—the price at which a security is
offered for sale (see bid price)
Asset—something owned by a business or
individual
Average down—to buy more of a security for less than one’s earlier
purchase price(s), resulting in a reduction of the average cost
Balance sheet—
accounting statement of a company’s assets, liabilities, and net worth
Bankruptcy—a legal state wherein a debtor (borrower) is temporarily protected
from creditors (lenders); under Chapter 11 of the federal bankruptcy code, companies
may continue to operate
Bear market—an environment
characterized by generally declining share prices (see bull market)
Beta—a
statistical measure used by some academics and market professionals to quantify
investment risk by comparing a security’s or portfolio’s historical price performance
with that of the market as a whole
Bid price—the price a potential buyer is
willing to pay for a security (see asked price)
Blocking position—the ownership of
a sufficient percentage of a class of securities to prevent undesirable actions from
occurring (a creditor owning one-third or more of a class of bankrupt debt
securities is able to “block” approval of a plan of reorganization not to his or her
liking)
Bond—a security representing a loan to a business or government entity
Book
value—the historical accounting of shareholders’ equity; this is, in effect, the residual
after liabilities are subtracted from assets
Bottom—up investing-strategy
involving the identification of specific undervalued investment opportunities one at a
time through fundamental analysis
Breakup value—the expected proceeds if the
assets of a company were sold to the highest bidder, whether as a going concern or
not (see liquidation value)
Bull market—an environment characterized by
generally rising share prices (see bear market)
Callable bond—a bond that may
be retired by the issuer at a specified price prior to its contractual maturity (see
puttable bond)
Call option—a contract enabling the owner to purchase a security
at a fixed price on a particular date (see put option)
Cash flow—the cash gain or loss
experienced by a business during a particular period of operations
Cash-pay
securities—securities required to make interest or dividend payments in cash
(see non-cash-pay securities)
How far is it reasonable to go in pursuit of information
The investment research process is complicated by the
blurred line between publicly available and inside, or privileged,
information.
Although trading based on inside information is
illegal, the term has never been clearly defined.
As investors
seek to analyze investments and value securities, they bump
into the unresolved question of how far they may reasonably go
in the pursuit of information.
For example, can an investor
presume that information provided by a corporate executive is
public knowledge (assuming, of course, that suitcases of money
do not change hands)?
Similarly, is information that emanates
from a stockbroker in the public domain?
How about
information from investment bankers?
If not the latter, then
why do investors risk talking to them, and why are the
investment bankers willing to speak?
How far may investors go in conducting fundamental
research?
How deep may they dig?
May they hire private
investigators, and may those investigators comb through a
company’s garbage?
What, if any, are the limits?
Do different rules apply to equities than to other securities?
Debt market
The troubled debt market, for example, is event driven.
Takeovers, exchange offers, and open-market bond repurchases
are fairly routine.
What is public knowledge, and what is not?
If
you sell bonds back to a company, which then retires them, is
knowledge of that trade inside information?
Does it matter how
many bonds were sold or when the trade occurred?
If this
constitutes inside information, in what way does it restrict you?
If you are a large bondholder and the issuer contacts you to
discuss an exchange offer, in what way can that be construed
as inside information?
When does inside information become sufficiently old to no
longer be protected?
When do internal financial projections
become outdated?
When do aborted merger plans cease to be
secret?
There are no firm answers to these questions.
Stay within the law, err on the side of ignorance or seek advice
Investors must
bend over backward to stay within the law, of course, but it
would be far easier if the law were more clearly enunciated.
Since it is not, law abiding investors must err on the side of
ignorance, investing with less information than those who are
not so ethical.
When investors are unsure whether they have
crossed the line, they would be well advised to ask their
sources and perhaps their attorneys as well before making any
trades.
Conclusion
Investment research is the process of reducing large piles of
information to manageable ones, distilling the investment
wheat from the chaff.
There is, needless to say, a lot of chaff
and very little wheat.
The research process itself, like the
factory of a manufacturing company, produces no profits.
The
profits materialize later, often much later, when theundervaluation identified during the research process is first
translated into portfolio decisions and then eventually
recognized by the market.
In fact, often there is no immediate
buying opportunity; today’s research may be advance
preparation for tomorrow’s opportunities.
In any event, just as
a superior sales force cannot succeed if the factory does not
produce quality goods, an investment program will not long
succeed if high-quality research is not performed on a
continuing basis.
In their search for complete information on businesses,
investors often overlook one very important clue. In most
instances no one understands a business and its prospects
better than themanagement.
Therefore investors should be
encouraged when corporate insiders invest their own money
alongside that of shareholders by purchasing stock in the open
market.
It is often said on Wall Street that there are many
reasons why an insider might sell a stock (need for cash to pay
taxes, expenses, etc.), but there is only one reason for buying.
Investors can track insider buying and selling in any of several
specialized publications, such as Vickers Stock Research.
Management stock-options provide the specific incentive to boost the company's share price
The motivation of corporate management can be a very
important force in determining the outcome of an investment.
Some companies provide incentives for their managements
with stock-option plans and related vehicles.
Usually these
plans give management the specific incentive to do what they
can to boost the company’s share price.
Be alert to the motivations of managements at the companies
While management does not control a company’s stock price,
it can greatly influence the gap between share price and
underlying value and over time can have a significant influence
on value itself.
If the management of a company were
compensated based on revenues, total assets, or even net
income, it might ignore share price while focusing on those
indicators of corporate performance.
If, however, management
were provided incentives to maximize share price, it wouldfocus its attention differently.
For example, the management of
a company whose stock sold at $25 with an underlying value of
$50 could almost certainly boost the market price by
announcing a spinoff, recapitalization, or asset sale, with the
result of narrowing the gap between share price and underlying
value.
The repurchase of shares on the open market at $25
would likely give a boost to the share price as well as causing
the underlying value of remaining shares to increase above $50.
Obviously investors need to be alert to the motivations of
managements at the companies in which they invest.
Two shortcomings on trying to obtain perfect knowledge
Some investors insist on trying to obtain perfect knowledge
about their impending investments, researching companies
until they think they know everything there is to know about
them.
They study the industry and the competition, contact
former employees, industry consultants, and analysts, and
become personally acquainted with top management.
They
analyze financial statements for the past decade and stock price
trends for even longer.
This diligence is admirable, but it has
two shortcomings.
First, no matter how much research is
performed, some information always remains elusive; investors
have to learn to live with less than complete information.
Second, even if an investor could know all the facts about an
investment, he or she would not necessarily profit.
80/20 rule
This is not to say that fundamental analysis is not useful. It
certainly is.
But information generally follows the well-known
80/20 rule: the first 80 percent of the available information is
gathered in the first 20 percent of the time spent.
The value of
in-depth fundamental analysis is subject to diminishing
marginal returns.
Information is not always easy to obtain.
Some companies
actually impede its flow. Understandably, proprietary
information must be kept confidential.
The requirement that all
investors be kept on an equal footing is another reason for the
limited dissemination of information; information limited to a
privileged few might be construed as inside information.
Restrictions on the dissemination of information can complicate
investors’ quest for knowledge nevertheless.
Business information is highly perishable.
Moreover, business information is highly perishable.
Economic conditions change, industries are transformed, and
business results are volatile.
The effort to acquire current, let
alone complete information is never-ending.
Meanwhile, other
market participants are also gathering and updating
information, thereby diminishing any investor’s informational
advantage.
David Dreman recounts “the story of an analyst so
knowledgeable about Clorox that ‘he could recite bleach shares
by brand in every small town in the Southwest and tell you the
production levels of Clorox’s line number 2, plant number 3. But
somehow, when the company began to develop massive
problems, he missed the signs....’ The stock fell from a high of
53 to 11.”
Wall Street analysts' recommendations may be less than stellar
Although many Wall Street analysts have excellent insight
into industries and individual companies, the results of
investors who follow their recommendations may be less than
stellar. In part this is due to the pressure placed on these
analysts
to recommend frequently rather than wisely, but
it
also exemplifies the difficulty of translating information into
profits.
Industry analysts are not well positioned to evaluate the
stocks they follow in the context of competing investment
alternatives.
Merrill Lynch’s pharmaceutical analyst may know
everything there is to know about Merck and Pfizer, but he or
she knows virtually nothing about General Motors, Treasury
bond yields, and Jones & Laughlin Steel first-mortgage bonds.
Investors frequently benefit from uncertainty and making decision with less than perfect knowledge
Most investors strive fruitlessly for certainty and precision,
avoiding situations in which information is difficult to obtain.
Yet high uncertainty is frequently accompanied by low prices. By the time the uncertainty is resolved, prices are likely to have
risen.
Investors frequently benefit from making investment
decisions with less than perfect knowledge and are well
rewarded for bearing the risk of uncertainty.
The time other
investors spend delving into the last unanswered detail may
cost them the chance to buy in at prices so low that they offer a
margin of safety despite the incomplete information.
Out-of-favor
securities may be undervalued; popular securities almost never
are.
What the herd is buying is, by definition, in favor.
Securities in favor have already been bid up in price on the
basis of optimistic expectations and are unlikely to represent
good value that has been overlooked.
Where may value exist?
If value is not likely to exist in what the herd is buying, where
may it exist?
In what they are
selling,
unaware of, or
ignoring.
When the herd is selling a security, the market price may fall
well beyond reason.
Ignored, obscure, or newly created
securities may similarly be or become undervalued.
Contrarians are almost always initially wrong
Investors may find it difficult to act as contrarians for they can
never be certain whether or when they will be proven correct.
Since they are acting against the crowd, contrarians are almost
always initially wrong and likely for a time to suffer paper
losses.
By contrast, members of the herd are nearly always right
for a period.
Not only are contrarians initially wrong, they may
be wrong more often and for longer periods than others because
market trends can continue long past any limits warranted by
underlying value.
When contrary opinion can be put to use.
Holding a contrary opinion is not always useful to investors,
however.
1. When widely held opinions have no influence on the
issue at hand, nothing is gained by swimming against the tide.
It is always the consensus that the sun will rise tomorrow, but
this view does not influence the outcome.
2. By contrast, when
majority opinion does affect the outcome or the odds, contrary
opinion can be put to use.
When the herd rushes into home
health-care stocks, bidding up prices and thereby lowering
available returns, the majority has altered the risk/ reward ratio,
allowing contrarians to bet against the crowd with the odds
skewed in their favor.
When investors in 1983 either ignored or
panned the stock of Nabisco, causing it to trade at a discount to
other food companies, the risk/reward ratio became more
favorable, creating a buying opportunity for contrarians.
The research task does not end with the discovery of an
apparent bargain. It is incumbent on investors to try to find out
why the bargain has become available.
If in 1990 you were
looking for an ordinary, four-bedroom colonial home on a
quarter acre in the Boston suburbs, you should have been
prepared to pay at least $300,000.
If you learned of one available
for $150,000, your first reaction would not have been,
“What a
great bargain!” but,
“What’s wrong with it?”
A bargain should be inspected and re-inspected for possible flaws.
The same healthy skepticism applies to the stock market. A
bargain should be inspected and re-inspected for possible flaws.
Irrational or indifferent selling alone may have made it cheap,
but there may be more fundamental reasons for the depressed
price.
Perhaps there are contingent liabilities or pending
litigation that you are unaware of.
Maybe a competitor is
preparing to introduce a superior product.
When reason for undervaluation can be clearly identified, the outcome is more predictable
When the reason for the undervaluation can be clearly
identified, it becomes an even better investment because the
outcome is more predictable.
By way of example, the legal
constraint that prevents some institutional investors from
purchasing low-priced spinoffs is one possible
explanation for undervaluation. Such reasons give investors
some comfort that theprice is not depressed for an undisclosed
fundamental business reason.
Other institutional constraints
can also create opportunities for value investors. For example,
many institutional investors become major sellers of securities
involved in risk-arbitrage transactions on the grounds that their
mission is to invest in ongoing businesses, not speculate on
takeovers. The resultant selling pressure can depress prices,
increasing the returns available to arbitrage investors.
Institutional investors are commonly unwilling to buy or hold
low-priced securities. Since any company can exercise a degree
of control over its share price through splitting or reverse splitting its outstanding shares, the financial rationale for this
constraint is hard to understand. Why would a company’s
shares be a good buy at $15 a share but not at $3 after a five for-one stock split or vice versa?
Market inefficiencies cause stocks to sell at depressed levels
1. Obscurity and a very thin market can cause stocks to sell at depressed levels.
Many attractive investment opportunities result from market
inefficiencies, that is, areas of the security markets in which
information is not fully disseminated or in which supply and
demand are temporarily out of balance.
Almost no one on Wall
Street, for example, follows, let alone recommends,small
companieswhose shares are closely held and infrequently
traded; there are at most a handful of market makers in such
stocks. Depending on the number of shareholders, such
companies may not even be required by the SEC to file quarterly
or annual reports.
2. Year-end tax selling also creates market inefficiencies.
The
Internal Revenue Code makes it attractive for investors to
realize capital losses before the end of each year.
Selling driven
by the calendar rather than by investment fundamentals
frequently causes stocks that declined significantly during the
year to decline still further.
