Tag Archives: behavioral finance

The ART of Contrary Thinking

When everyone thinks alike, everyone is likely to be wrong.

If you wish to keep from guessing wrong, learn to think contrarily.  –Humphrey Neill

CSInvesting: Humphrey Neill wasn’t advising to blindly go against the “crowd” but to think things through rationally.   For example, investors might be excited by the new invention of the air conditioner, but the second-order effects were more powerful like increase in demand for real estate in Southern cities in the USA.

The BOOK: NEILL(H_B_)-The_Art_of_Contrary_Thinking_(1985)

Critique of the book 2016-07-29_BR_ML

Contrary thinking in action….

Has Apple Stock Peaked?
December 3, 2012|by Timothy Lutts

Has Apple (AAPL) Stock Peaked?
In the Footsteps of Coca-Cola
The Next Apple?

Everybody knows Apple.
With more than 85 million iPhones sold, $156 billion in annual revenues and a market capitalization that recently hit $660 billion, Apple is the second most respected brand on the planet. Number one is Coca-Cola.

But what does that mean for investors?

It means there’s a chance that investor perception of the company is so high that all the big investors already own as much Apple as they can carry. It means there’s more potential selling pressure on Apple’s stock than buying pressure. And that means there’s a good chance the stock has topped!

Now, some investors, looking at numbers alone, will disagree.

They’ll point out that the company is still growing fast, that the third quarter saw revenues grow 27%, and earnings grow 23%, and that analysts are expecting 12% growth in 2013 and 18% in 2014. Then they’ll point to the stock’s forward PE ratio of 12 and say, “Apple is cheap!”

But using numbers alone is a mistake in evaluating growth stocks, particularly exceptional growth stocks like Apple.

For example, we at Cabot did very well recommending Amazon.com way back when the company (selling only books) was still unprofitable, and most bean-counters wouldn’t touch it with a 10-foot pole. We jumped on little Crocs (plastic shoes!) and rode it to the moon. And we did very well with ridiculously “expensive” First Solar, in part because we sold early, while its business was still booming, but its stock was on the skids. We could have justified owning none of those stocks if all we looked at were numbers.

Bottom line: to make money in exceptional growth stocks, you can’t just look at numbers; you’ve also got to look at momentum and sentiment.

But before I get deeper into Apple’s case, I want you to study this long-term chart of Coca-Cola (KO–see above) (the number one brand in the world today), spanning the years from 1965 to the end of 1985.  See at the top of this article.Note the earnings line, with each dot marking a quarterly earnings figure. It’s a steady uptrend, with the exception of a sharp dip in late 1974 and a stumble in 1981-1982. Then look at the dividend line; Coke’s dividends were increased every year, like clockwork. Finally, observe the price line, noting that Coke’s price peaked in late 1972 and didn’t exceed that level until late 1985, 13 years later.

The explanation for those “lost 13 years” lies not in the numbers; it lies in crowd psychology, and specifically, in the investing environment of the times. Coca-Cola was one of the Nifty Fifty, popularly regarded as one-decision stocks that you would simply buy and hold forever. (Others in this august group included Digital Equipment, Eastman Kodak, J.C. Penney and Simplicity Pattern).
Well, for investors who truly had the patience and guts to hold Coke through those lost 13 years, it worked out okay. But most investors don’t work with that kind of time horizon. Most investors can’t hold five years without seeing a profit—and they shouldn’t have to!

The truth is, the extreme popularity of those stocks (call it reverence, even), was a sign of their potential to top. But it was very hard for investors to see it then!
So, getting back to Apple, I’ve already mentioned the stock’s high regard among the general public; it’s the number two brand in the world. Among institutional investors, it’s regarded as royalty, providing both a dividend and spectacular growth. In fact, if you manage institutional money, owning AAPL has become almost a requirement in recent years, and the result of all that buying power is that even after the recent correction, AAPL is still up 45% for the year!
But when everyone who might buy a stock has bought it, what happens?
The same thing that happened to Coca-Cola in 1972.

It stops going up, and to some extent—every stock is different—it goes down.
Now, I have no doubt that Apple (the company) will continue to grow revenues and earnings for years to come. I’ve been an Apple user since 1987, when I bought a Macintosh SE for Cabot (to join our IBM Displaywriter—Google that!). Today I use a MacBook Pro, an iPad and an iPhone on a daily basis, and I expect to be an Apple user to the day I die, benefiting from the company’s legendary ability to make complicated technological interactions simple.

Nevertheless, I’m bearish on Apple (AAPL) stock today and here’s why.
There’s a dirty word to describe what happens when a company’s growth slows, and when the perception of the company’s future becomes just slightly tarnished. As that word spreads, and as those perceptions spread, the stock slowly collapses, as the supply of stock (potential sellers) overwhelms demand (potential buyers).


The Dirty Word
The word is deceleration, which is a fancy phrase for slowing down. And Apple is decelerating! That third quarter earnings growth of 23% followed second quarter earnings growth of 20%. Those were the slowest quarters since mid-2009! And looking forward, the projected 12% growth in 2013 is even slower, though 18% for 2014 provides hope.

Now, 12% growth is nothing to sneeze at; many companies would kill for 12% growth. And 18% is excellent! But it’s quite a comedown from the nine consecutive quarters from 2010 into 2012 where Apple’s earnings grew more than 50%! It’s deceleration.

And that brings us to the stock’s performance, which is where the rubber meets the road. Because more important than numbers, more important than sentiment, is the stock’s actual performance. So here’s Apple’s chart, since the 2009 bottom.

As on Coke’s chart, you see the earnings line, trending higher, but rounding somewhat recently; that’s the deceleration of earnings. There’s no dividend line on this chart; Apple’s dividend history is short but healthy. But there is another line on this chart and that’s the RP line. RP stands for Relative Performance; it depicts the performance of the stock relative to the broad market.

Note that over the past four years, whenever AAPL corrected, its RP line basically flattened out (ignoring the tiny weekly movements). But in this year’s correction, AAPL’s RP line turned down, and for eight weeks, AAPL performed worse than the overall market.

Now, this underperformance alone is not the kiss of death. Many stocks can pull out of similar corrections and move out to new highs.

But look back at Coke’s chart. If you look at the RP line, you’ll see the same pattern! From 1964 through 1973, KO was pretty healthy, beating the broad market overall, and holding its own in corrections. But after 1973, as sentiment turned, and the selling pressures slowly overwhelmed buying pressures, KO’s RP turned clearly negative, beginning a pattern that lasted many years longer than most investors could stomach.

And that’s very likely where AAPL is today.
So when you put it all together…
• The extremely high market cap
• The extremely positive public opinion
•The extremely high level of institutional ownership
• The deceleration of earnings growth
• The weakening relative performance line
…it looks ominous.

Now, big, well-respected stocks don’t collapse overnight. To the contrary; when a high-quality stock like Apple pulls back, you’ll hear a new chorus of “It’s a great value down here” and “Buy the dips.” But as time goes by, and the stock fails to return to its old highs, those choruses fade, and the stock falls slowly out of the limelight—just like Coca-Cola did in the 1970s.

Stepping back to look at the big picture, it’s worth remembering that investing is not a science. Uncertainty is a given.

But to be a successful investor, you need to put the odds in your favor, and today, the odds are not good for investors in Apple.  See more  http://www.timothylutts.com/

ALAS, NEVER CEASE TO DO YOUR OWN THINKING.

You might have sold out of a uniquely profitable company as AAPL went on to triple over the next five years!~

 

Another CASE STUDY on Accounting; Free Course on Behavioral Finance

Science of hitting Don’t Invest until you see the money lying there on the floor–Jim Rogers, Investor.

From the 1997 Berkshire Hathaway (BRKaShareholder Letter:

In his book The Science of Hitting, Ted explains that he carved the strike zone into 77 cells, each the size of a baseball. Swinging only at balls in his “best” cell, he knew, would allow him to bat .400; reaching for balls in his “worst” spot, the low outside corner of the strike zone, would reduce him to .230. In other words, waiting for the fat pitch would mean a trip to the Hall of Fame; swinging indiscriminately would mean a ticket to the minors.

If they are in the strike zone at all, the business “pitches” we now see are just catching the lower outside corner. If we swing, we will be locked into low returns. But if we let all of today’s balls go by, therecan be no assurance that the next ones we see will be more to our liking. Perhaps the attractive prices of the past were the aberrations, not the full prices of today. Unlike Ted, we can’t be called out if we resist three pitches that are barely in the strike zone; nevertheless,just standing there, day after day, with my bat on my shoulder is not my idea of fun.

When the above was written, the party that ultimately led to the tech bubble era valuations* had already begun in the equity markets.

http://theinvestmentsblog.blogspot.com/2011/06/fat-pitch-ted-williams-science-of.html

And check out: www.theinvestmentsblog.blogspot.com/

Case Study on Earnings Qualithy

Our last case on earnings quality was National Electric found by going into the case study value vault found in the blog post in the following link: http://wp.me/p2OaYY-1ub    I promised to provide an answer. Before submitting my write-up on that case, perhaps the following case would be a good supplement to learn more about uncovering earnings quality.  This case should be pretty obvious. Don’t cheat! Just use the material provided in the link below and answer the three questions in the HBS Case Study.

 

John Chew shared a folder with you via YouSendIt.

Another Case Study Dec 2012
View this folder

If you get stuck, here is a hint: (don’t look until you have tried to solve the case on your own! http://youtu.be/l-O5IHVhWj0   With practice, certain figures and phrases in the notes to the financials should SCREAM OUT at you.  Whatever happened to the CFO?

A Christmas Vault with goodies for all will be posted if someone posts their solution.

Free Behavioral Finance Course! (Coursera)

I have signed up!

https://www.coursera.org/course/behavioralecon

Workload: 7-10 hours/week

About the Course

Behavioral economics and the closely related field of behavioral finance couple scientific research on the psychology of decision making with economic theory to better understand what motivates investors, employees, and consumers. This course will be based heavily on my own research. We will examine topics such as how emotion rather than cognition determines economic decisions, “irrational” patterns of thinking about money and investments, how expectations shape perceptions, economic and psychological analyses of dishonesty by presumably honest people, and how social and financial incentives combine to motivate labor by everyday workers and CEOs alike. This highly interdisciplinary course will be relevant to students with interests in General Management, Behavioral Finance, Entrepreneurship, Social Entrepreneurship, and Marketing.

This class has two main goals:

  1. To introduce you to the range of cases where people (consumers, investors, managers, and significant others) make decisions that are inconsistent with standard economic theory and the assumptions of rational decision making. This is the lens of behavioral economics.
  2. To help you think creatively about the applications of behavioral economic principles for the development of new products, technology based products, public policies, and to understand how business and social policy strategies could be modified with a deeper understanding of the effects these principles have on employees and customers.

About the Instructor(s)

Dan Ariely is the James B. Duke Professor of Psychology and Behavioral Economics at Duke University, with appointments in the Fuqua School of Business, the Center for Cognitive Neuroscience, and the department of Economics. As one of the foremost leaders in psychology and behavioral economics, Dr. Ariely has published his research in top economic, medical and psychology journals and is the author of Predictably Irrational (2008), The Upside of Irrationality (2010), and The (Honest) Truth About Dishonesty (2012), three bestselling general audience books about research in behavioral economics. In addition, he is the founding member of The Center For Advanced Hindsight.  More information about Dan can be found at:  www.danariely.com

Take an MBA course on Buffett: http://cba.unomaha.edu/execmgmt/buffettgenius/

The Difference Between Mainstream Economics and Austrian Economics

http://www.fee.org/library/detail/the-foundational-difference-between-austrian-economics-and-the-mainstream#axzz2F3xyQj7U

BOOK LISTS

The 2012 Holiday Book Survey has been tallied and the results can be found here. I want to thank everyone who participated in the survey.

The biography & memoir genre continues to lead the survey (Steve Jobs – Walter Isaacson & new comer The Passage of Power – Robert Caro) with social science still having a strong showing (The Signal and the Noise – Nate Silver & Thinking, Fast and Slow – Daniel Kahneman). Atlas Shrugged continues to breach the top 5 although falling from its #2 spot in the last two years to #5. Overall, biography & memoir and business & finance showed the strongest growth.

I hope you enjoy this years’ book list and find something of interest to read or gift. If you have any suggestions on how to improve on the survey, please let me know.

All the best and happy holidays.


Barry Pasikov, Managing Member of HazeltonCapital Partners in Highland Park, IL 60035    Tel: 312-970-9202

 

 

Answer to Case Study: So What Is It Worth?

If you haven’t tried the case study, go here:

http://csinvesting.org/2011/09/19/so-what-is-it-worth/

After 20 minutes to complete the case study, go here for my comments and analysis:

http://www.scribd.com/doc/66676207/Enron-Case-Study-So-What-is-It-Worth

The above scribd document has an Appendix on page 20 where you can find other links to more indepth studies of the company. A diligent student can continue to hone their analytical skills.

If you are not willing to read the primary documents like a company’s 10-K to understand the operational and financial characteristics of the company, then be prepared to feel like this (without a parachute) when investing:

http://www.youtube.com/watch?v=go9uekKOcKM&feature=fvst

Again, this case study should drive home the points of asking simple questions, walking away from the difficult and finally, showing humility. The legions of MBA and CFA analysts who blew up their clients may have more to do with the fact that they have neither competence nor humility rather than pure intelligence.

Update: http://www.marketwatch.com/story/lopsidedly-bullish-consensus-on-apple-2012-09-19?link=MW_story_popular

 

So What is it Worth?

Let’s take 15 minutes to look at assessing, valuing or passing on the case study with the link below:

http://www.scribd.com/doc/65500378/Case-Study-So-What-is-It-Worth

If you do the work, you will learn many moral, philosophical and business lessons from this case. I promise.

I will post late this week the “answer” or my analysis with further links on this company. We’ll have fun with this one.