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Category Archives: Investing Gurus
HAPPY THANKSGIVING HOLIDAY for American readers.
Yes, I will still post on Sandstrom Gold (SAND) but another day.
The interviewer, “Adam Smith,” says the similarities among the investors are:
- They have independence of mind
- They trust their perceptions
- They stick to what they know
- They are intelligent
- They have fun
After viewing the video, whip out a piece of paper and quickly jot down what EXACTLY can YOU use in your own investing approach? Be specific! STOP! Take a walk for 20 minutes, then write down some more thoughts. See the video again. What can YOU implement?
I will post my thoughts next week.
Nygren Commentary September 30, 2017
CSInvesting: We can’t increase our IQ but we can try to improve our critical thinking skills by seeking out opposing views to the now current din of pundits screaming that this “over-valued market is set to crash.” 1987 here we come. What do you think of his arguments? I certainly agree about how GAAP accounting punishes growth investments.
At Oakmark, we are long-term investors. We attempt to identify growing businesses that are managed to benefit their shareholders. We will purchase stock in those businesses only when priced substantially below our estimate of intrinsic value. After purchase, we patiently wait for the gap between stock price and intrinsic value to close.
“All the company would have to do is raise prices 50% and the P/E ratio would fall to the low-teens.” -Analyst recommending a new stock purchase
We are nine years into an economic and stock market recovery and P/E ratios are elevated somewhat beyond historic averages. So when an experienced portfolio manager hears a young analyst make the above comment, he hears alarm bells. But instead of seeing this as a sign that the market has peaked, we purchased the stock for the Oakmark Fund. But, more on that later.
For several years, the financial media has been dominated by pronouncements that the bull market is over. Throughout my career, I can’t remember a more hated bull market. Many state that a recession is “overdue” since past economic booms have almost never lasted as long as this one. But do nine years of sub-normal economic growth even constitute a recovery, much less a boom? If recessions occur to correct excesses in the economy, has this recovery even been strong enough to create any? Maybe recessions are less about duration of the recoveries they follow and more about the magnitude. If so, earnings might not even be above trend levels.
Bears will also point to the very high CAPE ratio—or the cyclically adjusted P/E. That metric averages corporate earnings over the past decade in an attempt to smooth out peaks and valleys. But remember that the past decade includes 2008 and 2009, frequently referred to as the “Great Recession” because of how unusually bad corporate earnings were. I’ll be the first to say that if you think an economic decline of that magnitude is a once-in-a-decade event, you should not own stocks today. But if it is more like a once-in-a-generation event, then that event is weighted much too heavily in the CAPE ratio. If the stock market and corporate profits maintained their current levels for the next two years—an outcome we would find disappointing—simply rolling off the Great Recession would result in a large decline in the CAPE ratio.
Higher P/E ratios are also caused by near-zero short-term interest rates because corporate cash now barely adds to the “E” in the P/E ratio. When I started in this business in the early 1980s, cash earned 8-9% after tax. Consider a simple example of a company whose only asset is $100 of cash and the market price is also $100. In the early 1980s, the $8 or $9 of interest income would generate a P/E ratio of about 12 times. Today, $100 would produce less than $1 of after-tax income, driving the P/E ratio north of 100 times. There is, of course, uncertainty as to whether that cash will eventually be returned to shareholders or invested in plants or acquisitions, but it seems that making a reasoned guess about the value of cash is more appropriate than valuing it at almost nothing.
A less obvious factor that is producing higher P/E ratios today is how accounting practices penalize certain growth investments. When a company builds a new plant, GAAP accounting spreads that cost over its useful life—often 40 years—so the cost gets expensed through 40 years of depreciation as opposed to just flowing through the current income statement.
But when Amazon hires engineers and programmers to help it prepare for sales that could double over the next four years, those costs get immediately charged to the income statement. When Facebook decides to limit the ad load on WhatsApp to allow it to quickly gain market share, the forgone revenue immediately penalizes the income statement. And when Alphabet invests venture capital in autonomous vehicles for rewards that are years and years away, the costs are expensed now and current earnings are reduced.
The media is obsessed with supposedly bubble-like valuations of the FANG stocks—Facebook, Amazon, Netflix and Google (Alphabet). The FANG companies account for over 7% of the S&P 500 and sell at a weighted average P/E of 39 times consensus 2017 earnings. In our opinion, the P/E ratio is a very poor indicator of the value of these companies. Alphabet is one of our largest holdings, and our valuation estimate is certainly not based on its search division being worth 40 times earnings. If one removed the FANG stocks from the S&P multiple calculation—not because their multiples are high, but because they misrepresent value—the market P/E would fall by nearly a full point. And, clearly, more companies than these four are affected by income statement growth spending.
In addition, no discussion of stock valuations would be complete without some consideration of opportunities available in fixed income. Many experts argue that investors should sell their stocks because the current S&P 500 P/E of 19 times is higher than the 17 times average of the past 30 years. By comparison, if we think of a long U.S. Treasury bond—say, 30 years—in P/E terms, the current yield of 2.9% results in a P/E of 34 times. The average yield on long Treasuries over the past 30 years has been 5.5%, which translates to a P/E of 18 times. Relative to the past 30 years, the long bond P/E is now 90% higher than average. We don’t think the bond market at current yields is any less risky than equities.
The point of this is not to advance a bullish case for stocks, but rather to poke holes in the argument that stocks are clearly overvalued.
We think our investors would also fare best by limiting their in-and-out trading. We suggest establishing a personal asset allocation target based on your financial position and risk tolerance. Then limit your trading to occasionally rebalancing your portfolio to your target. If the strong market has pushed your current equity weighting above your target, by all means take advantage of this strength to reduce your exposure to stocks.
Now, back to the P/E ratio distortions caused by investing for growth. This highlights a costly decision we made six years ago. In 2011, when Netflix traded at less than $10 per share, one of our analysts recommended purchase because the price-per-subscriber for Netflix was a fraction of the price-per-subscriber for HBO. Given the similarity of the product offerings and Netflix’s rapid growth, it seemed wrong to value the company’s subscribers at less than HBO’s. But, at the time, streaming was a relatively new technology, HBO subscribers had access to a much higher programming spend than Netflix subscribers and Netflix was primarily an online Blockbuster store, providing access to a library of very old movies. Netflix had only one original show that subscribers cared about, House of Cards, and churn was huge as they would cancel the service after a month of binging on the show. Despite the attractive price-per-sub, we concluded that the future of Netflix was too uncertain to make an investment.
Today, Netflix trades at $180 per share and has more global subscribers than the entire U.S. pay-TV industry. Netflix provides its subscribers access to more than two times the content spending that HBO offers, making it very hard for HBO to ever match the Netflix value proposition. Finally, Netflix is no longer just a reseller of old movies. The company has doubled its Emmy awards for original programming in each of the past two years and now ranks as the second most awarded “network.” On valuation, Netflix is still priced similarly to the price-per-subscriber implied by AT&T’s acquisition of HBO’s parent company Time Warner, despite Netflix subscribers more than quadrupling over the past four years while HBO subscribers have grown by less than one third.
Last quarter, when our analyst began his presentation recommending Netflix, selling at more than 100 times estimated 2017 earnings, I was more skeptical than usual. His opening comment was that Netflix charges about $10 per month while HBO Now, Spotify and Sirius XM each charge about $15. “All the company would have to do is raise prices 50% and the P/E ratio would fall to the low teens,” he argued. Anecdotally, those who subscribe to several of these services tend to value their Netflix subscription much higher despite its lower cost. Quantitatively, revenue-per-hour-watched suggests Netflix is about half the cost (subscription fees plus ad revenue) of other forms of video. Netflix probably could raise its price to at least $15 without losing many of its subscribers. For those reasons, Netflix is now in the Oakmark portfolio.
So, is Netflix hurting its shareholders by underpricing its product? We don’t think so. Like many network-effect businesses, scale is a large competitive advantage for content providers. Scale creates a nearly impenetrable moat for new entrants to cross. With more subscribers than any other video service, Netflix can pay more for programming and still achieve the lowest cost-per-subscriber. As shareholders of the company, we are perfectly amenable to Netflix’s decision to forfeit current income to rapidly increase scale.
Because we are value investors, when companies like Alphabet or Netflix show up in our portfolio, it raises eyebrows. Investors and advisors alike are full of questions when investors like us buy rapidly growing companies, or when growth investors buy companies with low P/Es. Portfolio managers generally don’t like to be questioned about their investment style purity, so they often avoid owning those stocks. We believe our portfolios benefit from owning stocks in the overlapping area between growth and value. Therefore, we welcome your questions about our purchases and are happy to discuss the shortcomings of using P/E ratio alone to define value.
Pitch the Perfect Investment, by two money managers who have also taught for many years at Columbia University’s Graduate Business School, can stop small caliber bullets or deflect a vicious sword blow with its heavy-gloss 496 color pages. Bad jokes aside, is the book worth the $30+ for its intended audience, young professionals seeking an investment career or can other readers gain investing insights?
The authors synthesized many academic publications for the reader to understand the subtleties behind concepts like the Wisdom of Crowds, market efficiency, behavioral finance, and risk into clearer language. This book with its colorful diagrams can help you grasp the theory of a discounted cash flow model or “DCF”; DCFs are used throughout the book because as the authors say, “all valuation is at the core a DCF, either explicitly or implicitly, whether they (analysts and portfolio managers) admit it or not.” Of course, it is a given that the young analyst can gain his or her own company and industry expertise so as to insert reasonable assumptions into the DCF model.
Investing is simple but not easy some say. This book provides the simple concepts in a colorful, insightful way, but you have to do the hard part—scratch out a variant perception while competing with many other professionals. Sobering.
The reader is taken through the basics of valuing an asset, a business, how to evaluate competitive advantage and value growth with simple examples (The Lemonade Stand). The authors drive home the importance of differentiating between nominal growth and profitable growth. Growth without competitive advantage earning a return above its cost of capital is useless or worse. Certainly, all investors must grasp those concepts. Every page is festooned with color cartoons, diagrams, tables and graphs. This is a visual text.
The most interesting part of the book for me was the Chapter 6, The Wisdom of Crowds. As Buffett says, “You must know two things as an investor: how to value a business, and how to think about prices.” If I can paraphrase correctly, the Wisdom of Crowds with an adequate amount of domain-specific knowledge and diverse views acting independently from each other on disseminated information will be a force to push price towards efficiency or intrinsic value. My respect for market efficiency and the person on the other side of the trade from me was reinforced. If you gain anything from this book, understand that earning an investment edge or variant perception is EXTREMELY difficult and rare. The authors may have intentionally driven home their point with their example of Cloverland Timber Company.
In their example, the analyst had the domain expertise to notice a line in the financial statement that the Cloverland was undercutting its forests, then satellite imagery was used to assess the quality of the asset and arrive at a more accurate valuation than the market’s current estimate. The information is available but not publicly disseminated. I wonder how many analysts/portfolio managers have the time, energy, money, or inclination to go this extra mile? If you are this able, then you deserve alpha. What are the implications?
If diverse individuals with independent thoughts are required to have the “Wisdom of Crowds” operate effectively, how will investment firms with their hordes of MBAs and CFAs all taught the same concepts, reading the same newspapers, magazine, research reports, and attending the same investment conferences arrive at non-consensus conclusions often–or ever?
The Wisdom of Crowds gives you an understanding of how prices are set under normal conditions when the forces of darkness and “Mr. Mayhem” (cartoon figure in the book using a magnet to pull prices away from market efficiency; he is the guy you need to spot quickly) are not strong enough to pull prices sufficiently away from intrinsic values. In other words, behavioral finance is complementary to efficient markets. One can then recognize when the Wisdom of Crowds becomes the Madness of Crowds. For an understanding of how prices are set by individuals in a free market, go to pages 79-185 in Man, Economy, and State by Murray Rothbard (Google: Man, Economy, and State.pdf) which has an analysis of how individuals set prices through direct exchange.
Another valuable chapter in the book is Chapter 9, How to Assess Risk. When investors confuse uncertainty (unknowns) with risk (losing money), then opportunity may appear.
Paul Sonkin, one of the authors, gives sobering advice to students who dream of becoming money managers. Page 151: “I’m not trying to discourage you from pursuing your dreams, but you should do it with your eyes open. Do it because you love analyzing companies, not to make a quick buck. And, if your goal is to outperform the market, keep in mind how difficult it has been in the past and the fact that it will only be more challenging in the future.” Those are true words. The investing profession may end up like acting. Only the crazy brave will pursue.
Once you have finished Section 1, The Perfect Investment, you then learn how to “Pitch” the Perfect Investment. Assuming you are diligent enough to acquire the information, assess risk, identify an actual mispricing, and know the catalyst, then convincing another of the merits of your investment should be the easy part. Unfortunately, too many do not provide a convincing case for the merits of their investment. An example, of a devastatingly compelling case: The truth shall set you free (liar, liar)
The authors lay out a framework below in this example:
Value or What Can I Make: Market price is $90 but the stock is worth $140—time horizon is less than 18 months.
Catalyst: Or Who else will figure this out: Activist with a good track record is pushing for a sale.
Mispricing: The activist did an independent appraisal which the market is unaware of showing a substantially higher value than the company appraisal. Also, the presence of the activist does not appear to be priced into the stock. The market is unaware of the activist or does not think he will be successful.
Downside: Limited. Timberland is a hard asset.
For another example of a forceful investment case with an implied catalyst: Other People’s Money Does Danny Devito provide a strong case? Does he show how much one can make, lose, what is the market missing, and the catalyst?
If you truly have a variant perception, then this is usually your reception: Michael Burry’s Variant Perception
And, only if you are right, and you make the decisions can you present this way: Michael Burry’s Investors If you read the book, The Big Short, ironically you know that Michael Burry was not making a macro bet, but on the impossibility of individual mortgage holders to make their mortgage payment when asset prices decline and/or interest rates reset higher.
An investment edge: There are only three ways to gain an edge
In summary, while I do not agree with the book-jacket blurb:
Mr. Nicholas Gallucio, CEO of Teton Advisors, who said, “In this era of hyper-competition on Wall Street ……even the smallest edge can make the difference between success and failure. Pitch the Perfect Investment will give the professional investor that edge.” I do believe the book is worth $30 for a beginning and intermediate investor who wants to refine their understanding of key investment concepts and to review how to make clear and convincing investment pitches. Even if an investor does not have a boss to pitch to, the investor should always write down a succinct investment case for each investment.
Remember, I’m biased. I’m a cheapie who went Dutch on his honeymoon, charged an entrance fee, and had a cash bar. Sure, I made a profit, but the divorce cost a fortune. Perhaps, I confused price with value.
Buffett comments on the shiny metal in his discussion on investors’ choices: The Basic Choices for Investors and the One We Strongly Prefer
- The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else – who also knows that the assets will be forever unproductive – will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century.
This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it even more avidly in the future.
The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.
What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As “bandwagon” investors join any party, they create their own truth – for a while.
Over the past 15 years, both Internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well-publicized rising prices. In these bubbles, an army of originally skeptical investors succumbed to the “proof” delivered by the market, and the pool of buyers – for a time – expanded sufficiently to keep the bandwagon rolling. But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again: “What the wise man does in the beginning, the fool does in the end.”
Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A.
Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?
Beyond the staggering valuation given the existing stock of gold, current prices (In 2011, gold traded at an average price of $1,700 in $US) make today’s annual production of gold command about $160 billion. Buyers – whether jewelry and industrial users, frightened individuals, or speculators – must continually absorb this additional supply to merely maintain an equilibrium at present prices.
A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.
Admittedly, when people a century from now are fearful, it’s likely many will still rush to gold. I’m confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.
- Our first two categories enjoy maximum popularity at peaks of fear: Terror over economic collapse drives individuals to currency-based assets, most particularly U.S. obligations, and fear of currency collapse fosters movement to sterile assets such as gold. We heard “cash is king” in late 2008, just when cash should have been deployed rather than held. Similarly, we heard “cash is trash” in the early 1980s just when fixed-dollar investments were at their most attractive level in memory. On those occasions, investors who required a supportive crowd paid dearly for that comfort.
My own preference – and you knew this was coming – is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola, IBM and our own See’s Candy meet that double-barreled test. Certain other companies – think of our regulated utilities, for example – fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets.
Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See’s peanut brittle. In the future the U.S. population will move more goods, consume more food, and require more living space than it does now. People will forever exchange what they produce for what others produce.
Our country’s businesses will continue to efficiently deliver goods and services wanted by our citizens. Metaphorically, these commercial “cows” will live for centuries and give ever greater quantities of “milk” to boot. Their value will be determined not by the medium of exchange but rather by their capacity to deliver milk. Proceeds from the sale of the milk will compound for the owners of the cows, just as they did during the 20th century when the Dow increased from 66 to 11,497 (and paid loads of dividends as well). Berkshire’s goal will be to increase its ownership of first-class businesses. Our first choice will be to own them in their entirety – but we will also be owners by way of holding sizable amounts of marketable stocks. I believe that over any extended period of time this category of investing will prove to be the runaway winner among the three we’ve examined. More important, it will be by far the safest.
CSInvesting: I agree with all the above except that comparing gold as an investment to productive companies is not comparing like-with-like. Of course, owning a highly productive company or business that can compound over time will beat a sterile asset like cash or gold, but even Buffett will hold cash if he can’t buy great businesses at a good price. Gold is “money” that can’t be created by governments—by fiat.
An excellent article: Inflation Swindles the Equity Investor by Buffett.
Other views on the current gold market:
- Incrementum keynote3
- http://www.acting-man.com/?p=49082 (Macro fundamentals)
QUESTIONS? Gold as money has far out-performed currencies over the past decades
What are your alternatives? Quality ain’t cheap………..(source: seekingalpha.com)
and….assets to fin assets
|Ticker||Industry Group||Price/ Earnings Forward||% Free Cash Flow/ Market Cap||% Forward Dividend Yield||Debt to Equity Latest Qtr||Financial Health Grade||Economic Moat||Stewardship|
|3M Co||MMM||Industrial Products||21.6||4.7||2.51||1.04||A||Wide||E|
|BlackRock Inc||BLK||Asset Management||18.25||3.06||2.56||0.17||B||Wide||E|
|Coca-Cola Co||KO||Beverages – Non-Alcoholic||22.17||3.57||3.55||1.21||A||Wide||E|
|Colgate-Palmolive Co||CL||Consumer Packaged Goods||25.25||3.83||2.1||—||A||Wide||E|
|CSX Corp||CSX||Transportation & Logistics||23.7||1.45||1.5||0.94||B||Wide||S|
|CVS Health Corp||CVS||Health Care Plans||13.81||9.46||2.47||0.7||B||Wide||S|
|Emerson Electric Co||EMR||Industrial Products||23.98||5.65||3.17||0.49||A||Wide||S|
|Exxon Mobil Corp||XOM||Oil & Gas – Integrated||19.76||1.75||3.67||0.17||A||Narrow||E|
|General Dynamics Corp||GD||Aerospace & Defense||19.27||3.17||1.61||0.27||A||Wide||E|
|Honeywell International Inc||HON||Industrial Products||17.73||4.63||2.13||0.63||A||Wide||S|
|International Business Machines Corp||IBM||Application Software||13.14||8.38||3.08||2.09||A||Narrow||S|
|Johnson & Johnson||JNJ||Drug Manufacturers||17.15||4.05||2.63||0.32||A||Wide||S|
|Nike Inc B||NKE||Manufacturing – Apparel & Furniture||22.22||2.85||1.25||0.28||A||Wide||E|
|PepsiCo Inc||PEP||Beverages – Non-Alcoholic||21.41||4.71||2.75||2.67||A||Wide||S|
|Procter & Gamble Co||PG||Consumer Packaged Goods||23.81||4.26||2.94||0.32||A||Wide||S|
|The Hershey Co||HSY||Consumer Packaged Goods||22.88||3.09||2.28||2.99||A||Wide||S|
|The Home Depot Inc||HD||Retail – Apparel & Specialty||20.24||4.74||2.46||3.97||A||Wide||E|
|United Technologies Corp||UTX||Aerospace & Defense||17.15||1.98||2.36||0.79||A||Wide||S|
|Wal-Mart Stores Inc||WMT||Retail – Defensive||16.47||9.73||2.86||0.54||A||Wide||S|
|Walt Disney Co||DIS||Entertainment||18.45||4.39||1.42||0.34||A||Wide||S|
Data source: Morningstar
Fundamental vs. Technical Analysis
Technical analysis, in all of its forms, uses the past price movements to predict the future price movements. In some cases (e.g. momentum analysis) it calculates an intermediate signal from the price signal (momentum is the first derivative of price). But no matter the style, one analyzes price history to guess the next price move.
This is necessarily probabilistic. There is no way to know that a particular price move will follow the chart pattern you see on the screen. There is no certainty. And when it does work, it is often because of self-fulfilling expectations. Since all traders have access to the same charts, and the same chart-reading theories, they can buy or sell en masse when the chart signals them to do so.
Fundamentals or Arbitrage:
Arbitrage works just like a spring. If the price in the futures market is greater than the price in the spot market, then there is a profit to carry gold—to buy metal in the spot market and sell a futures contract. If the price of spot is higher, then the profit is to be made by decarrying—to sell metal and buy a future.
There are two keys to understanding this. One, when leveraged speculators push up the price of gold futures contracts, then that increases the basis spread. A greater basis is a greater incentive to the arbitrageur to take the trade. Two, when the arbitrageur buys spot and sells a future, the very act of putting on this trade compresses the spread.
If someone were to come along and sell enough futures contracts to push down the price of gold by $50 or $150 or whatever amount is alleged, then this selling would be on futures only. It would push the price of futures below the price of spot, a condition called backwardation.
Backwardation just has not happened at the times when the stories of the big “smash downs” have claimed. Monetary Metals has published intraday basis charts during these events many times.
The above does not describe technical analysis. It describes physics—how the market functions at a mechanical level.
There are other ways to check this. If there was a large naked short position in a contract that was headed into expiry, how would the basis behave? The arbitrage theory predicts the opposite basis move. We will leave the answer out as an exercise for the interested reader, as thinking this through is really good work to understand the dynamics of the gold and silver markets (and you can Google our past articles, where we discuss it).
This check can be observed every month, as either gold or silver has a contract expiring (right now it’s gold, as the April contract is close to First Notice Day).
Ackman and Valeant
Ackman and his disasterous investment in Valeant The are many psychological lessons in this article. What can you learn?
Ironically, one of the best research on Valeant was done by Allergan: Allergan analysis of Valeant 2014. Did Ackman’s analysts even read it? At least you have an example of solid research.
Compare to Ira-Sohn-2015-Presentation on Valeant and Other Platform Companies Studying the two different presentations provides a FREE course on valuation and presenting a research idea. But not 1 person in 10,000 would be willing to sweat the details like studying the two documents linked above.
Oh well, opportunity for those who work.
NERVES OF STEEL
The Little Newsletter That Crushed the Market
The Prudent Speculator has more than tripled the broad stock market since 1980. What’s its secret?
Feb. 23, 2017 5:48 a.m. ET
It pays to have nerves of steel.
That’s the most important lesson to emerge from the Prudent Speculator’s position as one of this country’s most successful investment newsletters of the past four decades.
The advisory service, which celebrates its 40th birthday March 10, has pursued a riskier strategy than almost all other newsletters—far riskier than many investors can tolerate. But those who could and did were richly rewarded. Its advice has made more money over the past 40 years than any of the nearly 200 other services monitored by the Hulbert Financial Digest.
CSInvestor: the author defines risk as volatility!
Since mid-1980, when we began monitoring the investment newsletter industry, through the end of January, the Prudent Speculator’s model portfolios on average produced a 16,937% gain, versus 4,952% for buying and holding the broad stock market (as measured by the Wilshire 5000 index).
That’s equivalent to the difference between 15.1% and 11.3%, annualized. (These performance numbers assume all model-portfolio transactions were executed on the day a subscriber would have been able to act on the newsletter’s advice; dividends and transaction costs, but not taxes, were taken into account.) To put this into perspective, consider that the best-performing U.S. equity mutual fund over this same period produced an annualized return of 13.6%, or 1.5 percentage points per year less than the Prudent Speculator. (The fund, according to Thomson Reuters Lipper, was Waddell & Reed Advisors Science & Technology [ticker: UNSCX]).
The Prudent Speculator newsletter, which was founded in March 1977 by Al Frank and is based in Aliso Viejo, Calif., was initially named the Pinchpenny Speculator. Frank had become interested in investing several years earlier while working toward his Ph.D. in educational philosophy at the University of California, Los Angeles. He started the newsletter in part to report on the performance of his personal portfolio. From the start, his strategy was to purchase undervalued stocks and hold them through for the very long term. The newsletter’s current yearly subscription rate is $295.
In the 1990s, Frank—who died in 2002—began handing the newsletter over to an associate, John Buckingham, now 51, who had been with the firm since 1987. The transition to Buckingham has been unusually successful; the norm in the newsletter business is for services to either languish or close down completely upon the death of their founders. Not in this case. On a risk-adjusted basis, the newsletter’s model portfolios have performed even better over the past two decades than in the first two.
What’s the secret to the newsletter’s success?
It’s definitely not market timing, since it has actively argued against market timing throughout its history. Most commentators assume that the newsletter must owe its success to superior stock selection. But though the newsletter’s stock-picking has been commendable, many other advisors favor stocks with similar characteristics.
Not for the Faint of Heart
Recent examples of the newsletter’s picks include Zimmer Biomet Holdings (ZBH),Williams-Sonoma (WSM), Nike (NKE), Schlumberger (SLB), and Digital Realty Trust (DLR). In an interview, Buckingham insisted that he pursues value wherever he can find it. But my computer’s statistical software shows that the newsletter’s recommended stocks tilt to the value end of the value-versus-growth spectrum and the quality end of the so-called quality-versus-junk spectrum, and tend to have smaller market values than the components of broad market averages such as the Standard & Poor’s 500 index.
If neither market timing nor stock selection is the key to the Prudent Speculator’s outstanding long-term record, what is? In my opinion, it’s those nerves of steel I referred to above.
Almost all other advisors who recommend smaller-cap, higher-quality value stocks are unwilling to hold them through thick and thin. Though these value-oriented advisers have longer holding periods than most others, their average currently is 18 months. The average holding period of the Prudent Speculator’s currently held stocks, by contrast, is four years. And there have been many times during the newsletter’s history when its average holding period was even longer than four years. Its current holding period is this short because the market’s extraordinary strength has propelled many of its previously recommended stocks above their target prices.
By selling out too early, Buckingham told Barron’s, other advisors find themselves with either one or two strikes against them. The first strike applies even if those advisors immediately reinvest the proceeds of their premature sales in other undervalued stocks: They still leave too much money on the table, since
The second strike is when advisors go to cash after selling. These advisors often end up bailing out of stocks near the bottom of bear markets. Because it almost always takes them a long time to get back into equities after the market begins to recover, they enjoy only some of the market’s recovery after suffering the bulk of its decline—and therefore lag the market over the long term.
By not deviating from its commitments to equities, the Prudent Speculator sidesteps both of these strikes.
Consider Frank’s reaction to the 1987 crash—the biggest one-day drop in U.S. stock-market history, during which Frank’s model portfolio lost nearly 60%. Far from cashing in his chips and going home, as most of us would have been tempted to do in the wake of a one-day loss that big, Frank said he saw no reason to alter the basics of his long-term strategy.
Similarly, consider Buckingham’s advice to clients on March 9, 2009, the day that turned out to be the bottom of the 2007-09 bear market—though of course no one at that time could have known that. Buckingham’s average model portfolio was sitting with a loss of more than 60% since the 2007 high, and yet his message to clients that day—as it had been every other day during that bear market—was that “our long-term enthusiasm [for stocks] remains intact.”
Many investors no doubt find it boring to remain fully invested to stocks through thick and thin and to hold stocks for many years. In fact, Buckingham says, one of the most challenging parts of his job as newsletter editor is continually finding new and interesting ways of saying the same thing: Remain focused on the long term with patience and discipline.
Easier said than done–90% of investing is character.
Note: He leans toward smaller (more apt to be mispriced) stocks, value more than growth (so he faces lest risk of overpaying for growth), quality over junk (so less chance of bankruptcy risk), and then allows AT LEAST four years for value to come out or be recognized. His edge is his patient, long-term perspective.
The Fundamentals of Buffett-Style Investing
Learn the investment techniques of Warren Buffett, the world’s most legendary investor. Examine case studies of Buffett’s acquisitions in order to review the real-world principles that the “Oracle of Omaha” uses to pick companies. Topics include both quantitative methods, such as valuation metrics and cash flow analysis, as well as qualitative principles, such as competitive advantage and economic moats. As a final project, partner with a classmate to present a publicly traded company you believe Buffett would buy. At the conclusion, understand what Buffett means by a “great business at a good price.” This course is appropriate for beginners in the industry and for individuals with a broad array of backgrounds. The final session is taught synchronously from the Berkshire Hathaway annual meeting in Omaha.
You’ll Walk Away with
- An understanding of the investment techniques of Warren Buffett, the world’s most legendary investor
- The opportunity to present a publicly traded company you believe Warren Buffett would buy
- Students with little to no knowledge of investing
- Professionals across the experience spectrum in regard to investing
CSInvesting Editor: Let me know if you attend. Several readers took the class last year and enjoyed it.
I received this email:
Dear Mr. Chew,
You were very kind last year to post a notice about our Buffett investing class on your website. We had several students from your site, all of whom were excellent and dedicated. According to end-of-semester student surveys, the students enjoyed the class quite a bit. You clearly attract a high caliber of investor to your online community. We would be very grateful if you would consider posting a notice of this year’s class, which starts April 1st.
New York University’s School of Professional Studies is offering an online class focused on the time-honored techniques of value investing, as practiced by the world’s most legendary investor, Warren Buffett.
By examining case studies of Buffett’s acquisitions, students will explore the real-world principles that Buffett uses to pick companies. The class starts online April 1st and is open to the public for registration.
If it’s about value investing, I’m interested. I run a global equities fund that invests in the United States, Europe and Asia. As the president and founder of JBGlobal.com LLC, a registered investment advisory firm, I manage separate accounts for high-net-worth individuals and trusts. As a faculty member in the Finance Department of the NYU School of Professional Studies, I teach Corporate Finance and the Fundamentals of Buffett-Style Investing. My book, Lessons from the Lemonade Stand: a Common Sense Primer on Investing, winner of the 2013 Next Generation Indie Award for Best Non-Fiction eBook, is a guide for the first-time investor of any age. I received a B.A. from Harvard University and a J.D. from Harvard Law School. My wife, daughter and I live in Greenwich Village where I find the lessons of value investing as useful with life as with money.
An article from the Instructor on Buffett
The One Word Missing from Buffett’s Annual Letter
Warren Buffett just did.
As a value investing aficionado and Berkshire shareholder, I anticipate the annual missive from the Oracle of Omaha with bated breath. When it popped online today, I knew enough not to expect much commentary on the economic or the political. A secret to Buffett’s success has been an agnostic view on the too-many moving pieces of the macro scene. By avoiding the human obsession with the short-term and fortune telling, Buffett has always concentrated on the only thing that matters: buying wonderful businesses at fair prices. As Peter Lynch says: “If you spend more than 13 minutes analyzing economic and market forecasts, you’ve wasted 10 minutes.” I myself have found no other investing mantra more important.
But really? No mention of the greatest threat to the democratic process and the rule of law since Nixon–or beyond?
Geico is mentioned 22 times, Charlie Munger 17 times, hedge funds 12 times, table tennis once. Trump zero.
In April of 2016, Buffett went on record saying that Berkshire would do fine even with a Trump presidency. But that was at last year’s meeting–well before the election, and well before anyone thought it was a serious concern. And Buffett made some further post-election comments in December about still buying stocks, but this letter was his first major written opportunity to hold forth.
He even mentions the worthwhile contributions of immigrants but somehow never calls out Trump by name. Perhaps the silence is deafening. Buffett was an ardent supporter of Hillary Clinton in the election and his failure to mention Trump may be the most damning maneuver of all.
Because if there’s one thing I wanted as a Buffett follower, it was a reasoned and sober commentary–refracted through the prism of his extraordinary, eminently sensible brain–on what this erratic, errant president means for our country, our markets and our lives.
James Berman teaches The Fundamentals of Buffett-Style Investing, an online class starting April 1 offered by NYU’s School of Professional Studies.
Where is he now? http://ericcinnamond.com/buffett-1999-vs-buffett-2017/
Buffett 1999 vs. Buffett 2017
This may sound awful coming from a value investor, but I don’t read Berkshire Hathaway’s annual reports cover to cover. I did earlier in my career. In fact, I’d eagerly await its release, just as many investors do today. However, over the years I’ve gravitated more to what makes sense to me and have relied less on the guidance from investment oracles such as Warren Buffett (see post What’s Important to You?).
While I know significantly less about Warren Buffett than most dedicated value investors, it seems to me that he has changed over the years. I suppose this shouldn’t be surprising as we all have our seasons. And maybe I’m the one who has changed, I really don’t know. But I remember a different tone from Buffett almost twenty years ago when stocks were also breaking record highs. It was during the tech bubble when he went out of his way to warn investors of market risk and overvaluation.
I found an old article from BBC News with several Buffett quotes during that period (link). The article discusses Warren Buffett’s response to a Paine Webber-Gallup survey conducted in December 1999. The survey showed that investors expected stocks to rise 19% annually over the next decade. Clearly investors were extrapolating recent returns far into the future. Fortunately, Warren Buffett was there to save the day and help euphoric investors return to their senses.
The article states, “Mr Buffett warned that the outsized returns experienced by technology investors during 1998 and 1999 had dulled them into complacency.”
“After a heady experience of that kind,” he said, “normally sensible people drift into behaviour akin to that of Cinderella at the ball.
“They know that overstaying the festivities…will eventually bring on pumpkins and mice.”
I really like and can relate to the Warren Buffett of nearly twenty years ago. If I could go back in time and show the 1999 Buffett today’s market, I wonder what he would say. I’d ask him if investor psychology and the current market cycle appears much different than the late 90s.
Similar to 1999, have investors experienced outsized returns this cycle? From its lows in 2009, the S&P 500 has increased 270%, or 17.9% annually. This is very close to the annual returns investors were expecting in the 1999 survey, when Buffett was warning investors.
Have investors been dulled into complacency? Volatility remains near record lows, with every small decline being saved by central banks and dip buyers. Investors show little fear of losing money.
Are today’s investors not Cinderella at the ball overstaying the festivities? It’s the second longest and one of the most expensive bull markets in history!
There are of course differences between 1999 and today’s cycle. While valuation measures are elevated, today’s asset inflation is much broader than in 1999. The tech bubble was extremely overvalued, but narrow. A disciplined investor could not only avoid losses in the 1999 bubble, but due to value in other areas of the market, could make money when it burst. Given the broadness of overvaluation in 2017, I don’t believe that will be possible this cycle. In my opinion, it will be much more challenging to navigate through the current cycle’s ultimate conclusion than the 1999 cycle.
The broadness in overvaluation this cycle makes Buffett’s recommendation to buy a broadly diversified index fund even more difficult for me to understand. Furthermore, given the nosebleed valuations of many high quality businesses, I’m not as confident as Buffett in buying and holding quality stocks at current prices. It again reminds me of the late 90s. At that time, there were many high quality companies that were so overvalued it took years and years for their Es catch up to their Ps. But these are important (and long) topics for another day.
Let’s get back to Buffett 1999. I find it interesting to compare him to Buffett 2017. Surprisingly, Buffett 2017 doesn’t seem nearly as concerned about valuations this cycle. Buffett writes, “American business — and consequently a basket of stocks — is virtually certain to be worth far more in the years ahead [emphasis mine]. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that. Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle.”
You can include me as a naysayer of current prices and valuations of most risk assets I analyze. Based on the valuations of my opportunity set, I’ll take the advice from another naysayer – the Warren Buffett of 1999. As he recommended, I plan to avoid extrapolating outsized returns and will not ignore signs of investor complacency. I plan to remain committed to my process and discipline. By doing so, when the current market cycle concludes, I hope to achieve two of my favorite Warren Buffett rules of successful investing – avoid losing money and profit from folly.
Tim McElvaine explains his simple but effective process.
2016-05_conference_transcript_McElvaine Fund An excellent tutorial on Graham-like investing. Note his simple four-pronged approach. Read more below: