Capital Structure

When evaluating a company's merits as a possible investment, you should examine the components of its value and explore how it finances its workings. This is referred to as a company's capital structure. [via Russ]

Investing With the Stars

There are people out there who invest according to the stars, or according to patterns they see in stock prices, and sometimes even simply according to the calendar.

Google

[1/13/06] Google now has a larger market cap than IBM and Chevron [chucks_angels]

[12/22/05] Is the Google deal with AOL a good deal?

[12/21/05] What will stop Google's ascent?

[12/19/05] David Kirkpatrick says Google will stumble in 2006 (and 7 more predictions for tech)

[12/18/05] Rick Munarriz names Google as a stock to sell in 2006, with reservations.

[12/15/05] Does Google want to rule the world?

[12/6/05] David Meier faces the prospect of Google hitting $500.

[12/2/05] Google's greatest weakness

[5/9/05] Is Google cheap?

[5/7/05] I'm changing my mind as the stock goes up and it gets glowing reports from respected investors (including Jim Cramer and Ben Stein!). It may not be the greatest company. It may not be a Rule Maker. But it could be the next best thing.

[3/3/05] What's the greatest company in America? This Fool says Google (!)

(I have serious doubts on this call.)

[9/15/05] Google headed for $1 trillion market cap?

[1/3/05] How does Google make money?

[11/14/04] Is Google bringing back the bubble?

Socially Responsible Investing

[12/23/05] Socially responsible investing (SRI) is a growing trend among investors.

[12/18/05] Fools duel.

Richard Rainwater

Rainwater is no crackpot. But you don't get to be a multibillionaire investor—one who's more than doubled his net worth in a decade—through incremental gains on little stock trades. You have to push way past conventional thinking, test the boundaries of chaos, see events in a bigger context. You have to look at all the scenarios, from "A to friggin' Z," as he says, and not be afraid to focus on Z.

[discussed at chucks_angels]

To GAAP or not to GAAP

[12/17/05] Cash flow is a better indicator than GAAP earnings in determining how well a company is doing now.

[4/26/05] What's the difference between GAAP and non-GAAP earnings?

10 Comeback Kid Stocks for 2006

Harry Domash picks 10 Comeback Kids stocks for 2006.

The stocks are

Company/Symbol   Recent price* Industry 52-week price change 
Symantec (SYMC)         17.99  Software                     -46.0% 
Ford Motor (F)           8.53  Auto Mfg.                    -41.6% 
General Motors (GM)     23.00  Auto Mfg.                    -39.8% 
Fannie Mae (FNM)        49.43  Credit Services              -31.4% 
Avon Products (AVP)     27.49  Personal Products            -30.1% 
Biogen Idec (BIIB)      43.03  Biotech                      -29.5% 
Dell (DELL)             30.42  Personal Computers           -27.4% 
Zimmer Holdings (ZMH)   62.50  Medical Appliances & Equip.  -25.2% 
Gannett (GCI)           61.49  Newspaper Publishers         -25.0% 
Boston Scientific (BSX) 26.45  Medical Equipment            -23.7% 
 
*As of Nov. 11, 2005

Off-The-Wall Investments

You win some, you lose some -- nine off-the-wall investments that paid off, and four that flopped.

NEW YORK (FORTUNE) - They all laughed when Jefferson bought half the continent from France. Alaska was called "Seward's folly." Other "crazy" investments have worked out fine, too. But some oddball bets fell flat.

One of the surprising losers in our gallery is Warren Buffett, and there's a host of other investors profiled, both winners (the entrepreneur who bought the formula for a weird brown health drink called Coca-Cola) and losers (remember Webvan?).

-- from InvestorGuide (but I had to hunt down the URLs)

The Different Kinds of Companies

The fool.com describes the different kinds of companies in this primer.

In your reading, you'll run across many terms used to describe different kinds of companies. Here are some of the most common ones:

"Cyclical" companies are defined by how their businesses react to economic change. During recessions, people spend money more conservatively, putting off major purchases such as cars and refrigerators. Thus, manufacturers of large appliances are cyclical. Companies such as pharmaceutical firms that aren't so affected are "defensive." If you're taking heart medication, you're not going to stop because of an economic downturn.

"Seasonal" companies experience significantly different levels of business at various times of the year. Department stores, for example, see sales surge during the Christmas season. Swimming pool companies operate mainly in the summer.

"Blue chip" companies have been around a long time and are known for being solid, relatively safe investments. They're steady growers, usually paying dividends. Examples: General Electric, ExxonMobil, Johnson & Johnson. At the other end of the spectrum are "speculative" stocks, typically tied to young, relatively unknown and risky companies. Many promise great things but have yet to prove themselves. Examples include gold mines or companies trying to develop cures for cancer.

"Growth" stocks, favored by aggressive investors, grow faster than the market average. They often don't pay any dividends, using their cash to continue growing. Their stock prices often go up -- and down -- quickly. Some examples: Amazon.com, eBay. (Railroad and telegraph businesses were growth companies once -- fortunes change over time.)

"Value" stocks are favored by investors looking to buy the proverbial dollar for 50 cents. They seek promising companies that are out of favor.

"Income" stocks may not grow too quickly, but they pay fat dividends. In pre-deregulation days, utility companies reliably paid high dividends. Today many real estate companies do. Income stocks are often favored by those in or near retirement, who rely on the dividends to supplement pensions or savings.
Note that many companies will fit into several categories, and savvy investors will often seek firms with several characteristics, such as those that are both growing and valued attractively.

Peter Lynch places companies into one of six general companies: slow growers, stalwarts, fast growers, cyclicals, asset plays, and turnarounds.

• Slow Growers: Large and aging companies expected to grow only slightly faster than the U.S. economy as a whole, but often paying large regular dividends. These are not among his favorites.
  
• Stalwarts: Large companies that are still able to grow, with annual earnings growth rates of around 10% to 12%; examples include Coca-Cola, Procter & Gamble, and Bristol-Myers. If purchased at a good price, Lynch says he expects good but not enormous returns--certainly no more than 50% in two years and possibly less. Lynch suggests rotating among the companies, selling when moderate gains are reached, and repeating the process with others that haven’t yet appreciated. These firms also offer downside protection during recessions.
  
• Fast-Growers: Small, aggressive new firms with annual earnings growth of 20% to 25% a year. These do not have to be in fast-growing industries, and in fact Lynch prefers those that are not. Fast-growers are among Lynch’s favorites, and he says that an investor’s biggest gains will come from this type of stock. However, they also carry considerable risk.
  
• Cyclicals: Companies in which sales and profits tend to rise and fall in somewhat predictable patterns based on the economic cycle; examples include companies in the auto industry, airlines and steel. Lynch warns that these firms can be mistaken for stalwarts by inexperienced investors, but share prices of cyclicals can drop dramatically during hard times. Thus, timing is crucial when investing in these firms, and Lynch says that investors must learn to detect the early signs that business is starting to turn down.
  
• Turnarounds: Companies that have been battered down or depressed--Lynch calls these "no-growers"; his examples include Chrysler, Penn Central and General Public Utilities (owner of Three Mile Island). The stocks of successful turnarounds can move back up quickly, and Lynch points out that of all the categories, these upturns are least related to the general market.
  
• Asset opportunities: Companies that have assets that Wall Street analysts and others have overlooked. Lynch points to several general areas where asset plays can often be found--metals and oil, newspapers and TV stations, and patented drugs. However, finding these hidden assets requires a real working knowledge of the company that owns the assets, and Lynch points out that within this category, the "local" edge--your own knowledge and experience--can be used to greatest advantage.

I see that this Lynch page is on the web page of Peter A. Ammermann, Assistant Professor of Finance at Long Beach State. The content though was written by Maria Scott Crawford for the AAII Journal (she is or was the editor of the Journal). She also wrote an overview of Philip Fisher.

BlogShares

Hey, I see this blog is currently worth B$2,353,43 (whatever that B means) at blogshares. Not bad. Then again it was worth B$7,467.48 on November 15.

Seven Sins of Stock Picking

As the market bounces back and forth between heaven and heck, and fortunes are wagered on a wing and a prayer, it's a good time to check out the seven sins of stock picking, behaviors that can put a serious crimp in your upcoming earthly reward.

Lousy Offices, Great Investments

Bill Barker (TMF Lazarus) writes about Peter's Principle No. 7:

The extravagance of any corporate office is directly proportional to management's reluctance to reward shareholders.

Looking it up, I see that Principle is from Peter Lynch's book Beating The Street which discusses 20 Golden Rules as well as 21 Principles

Golden West (I owned this stock back in the 1990s - looking at the chart now, I should have held on to it!) came to mine when I (re)read the above principle. Looking it up, I see it was actually mentioned in a different chapter of that same book (chapter 11).

At Golden West Financial in California, a champion of productive penny-pinching and the lowest-cost operator in the S&L business, the role of the receptionist was taken over by an old-fashioned black telephone and a sign that said, "Pick up."

Morningstar Fund Analyst Picks

Morningstar analysts are a very serious and committed group of investors. "While we each have our individual biases, more often than not, we agree about what makes a fund a good one. As such, a regular feature on Morningstar.com has been our Fund Analyst Picks, which represent our best ideas on a category-by-category basis."

So, what exactly does Morningstar look for in a Fund Analyst Pick?

In summary,

• Consistent, Thoughtful Strategies
  
• Experienced, Successful Management
  
• Low Expenses
  
• Good Stewards
  
• Other Considerations

Gold Band

From Richard Band's Journal, December 1, 2005.

Golden Crest
Thu, 01 Dec 2005 17:17:30 ET

I don't often darken the door of a coin dealer's shop -- only when I'm selling. (I do most of my buying through the mail.) This afternoon, I saw on the Net that gold was trading at an 18-year high, just over $500 an ounce. That was Mozart to my ears. So I hopped in the old van and drove as fast as I could to a shop 45 minutes away. It was time to unload most of my cache of gold coins.

Am I nuts? The dealer probably thought so. After I sat down in his disheveled office and he began examining my Double Eagles, he advised me, in a low but firm voice, to keep my coins. 'Chances are, the price of gold will be higher a year from now,' says he.

I loved it. Indeed, I was hoping the dealer would try to dissuade me from selling. That's exactly the psychology that prevails at every major market top. Did your stockbroker tell you to sell your NASDAQ darlings in March 2000? At the top, the promoters will always try to stop you from selling.

My thoughts ran back to my last visit to a coin dealer's, in April 1987. At the time, silver was at the top of a roaring bull market -- and I wanted to dump my silver dollars. (They've never fetched anywhere near the same prices since.)

I sat down and the dealer picked up the phone to call his wholesaler for a quote. 'Well, what did he say?' I asked. 'Biggest demand for silver dollars since January 1980. Everybody's buying.'

I stifled a smile. January 1980? That was the manic top, when silver hit $50 an ounce. (Even today, 25 years after that peak, silver is down 80%.)

'Sure you still want to sell?' he asked. 'Yep.'

Gold could certainly gain another $10-$20 from here without disturbing me in the least. I'm focusing on the next $100-$150 move, which I expect will be down. In 2006, the Federal Reserve's tight-money policy will bite a wide range of markets -- and the ones that will fall hardest are those (like gold) that have benefited the most from the easy money of the past few years.

If you own gold or gold-mining shares, don't waste a lot of time celebrating your good fortune. History shows that the great selling opportunities in hard assets slip away quickly, with little or no warning. Consider yourself forewarned!

Band's report reminds me of Andrew Tobias' story of his 5000 silver dimes in his book Money Angles. (I knew it sounded familiar.) Tobias alludes to the story in a 2000 column.

* * *

[12/8/05] On the other hand, toddfinances over at chuck_angels thinks gold is likely to see 4 digits.

* * *

[12/11/05] Patrick Heller (I believe it's him writing anyway) says "in my judgment, there is little potential for a significant decline of 10% or more in gold and silver prices. There is a good possibility that we have already started the massive jump in precious metal prices similar to what we experienced in 1979-1980." He further makes the "mute"d forecast.

Gold: I think there is a 75% probability that gold will reach $600 by the end of 2006, a 50% chance that it will top $700, and a 25% chance that it could reach $1000. Even though these numbers might seem fantastic, I believe I am being conservative.

Silver: I expect silver to reach $10.00 by the end of March 2006. I give it a 75% chance that it will reach $15 by year end, and a one-third chance that it will pass $20.

As of November 30, the price for gold was $494.50 and the price for silver was $8.28. (This is from Liberty's Outlook, Liberty Coin Service's Monthly Review of Precious Metals and Numismatics where Heller is the Editor. I see that it's volume 11, issue 12. So by my calculations, that would make 132 issues that they have been bullish.)

VectorVest Special Reports

VectorVest reports by Dr. Bart DiLiddo

Feb 07 - Bottom Fishing: The Art Of Buying Low and Selling High

Dec 05 - Five Stock Market Myths

Sep 05 - Timing: The Ultimate Weapon

Aug 05 - Earnings Growth: The Golden Touch

Jul 05 - Timing: The Ultimate Weapon

Jul 05 - Beating the Odds (VectorVest and market timing)

Jun 05 - How To Pick Stocks (buy undervalued, safe stocks that are going up)

Jun 05 - Stock Valuation and Stock Market Cycles

Jun 05 - Stock Safety: The Missing Link

May 05 - High Growth vs. Low P/E Stocks

And more

[originally posted 6/16/05?]

2005 Year-End Rally?

Here's how Goldman Sachs compares 2005 with 2004's year-end rally.

Similarities with 2004: (1) Seasonal Pattern: in 2004 SPX was FLAT through October 22nd and then rallied 11% to finish the year up 11%. In 2005, market was flat through October 27th and has now rallied almost 8%. (2) Sector Leadership: The 2004 rally was led by Materials (+13%) and Consumer Discretionary (+13%), the same leaders as in 2005. Financials, Health Care, Industrials were up 12% with Technology up 11%.

Differences: Breadth. The 2004 year-end rally was consistent across the market with ALL TEN sectors rallying. 8 of the 10 sectors rallied between 10% and 13%. Weakest rally was in Telecom (+7%) and Consumer Staples (+8%). HOWEVER, we have had more dispersion in the 2005 rally with Utilities (-4%) and Consumer Staples (-4%) down last month. Looking Ahead: We recommend investors overweight Energy, Technology, Industrials and Health Care, avoid Financials and the Consumer.

Slaying the Goliaths

Can Whole Foods, Google, and eBay be stopped?

Buy Low

[7/31/06] Seth Klarman's 1991 work, Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor, came and went without much notice at the time and is long out of print. Klarman holds the copyright but has never revised or even reprinted it.

Still, over the past few years this work has taken on iconic stature among value investors. Originally listed at $25, the title trades for top prices on the used-book market. About a half-dozen copies are for sale online: The best deal is $700 from a seller at Amazon.com (AMZN ). Another vendor offers it for nearly $2,500.

Since Klarman and his book are hard to come by, here's a quick summary. The term "margin of safety" refers to the cushioning, or wiggle room, that investors should build into what they pay for a security. He doesn't claim to have invented the term, which comes from Graham & Dodd. "How can investors be certain of achieving a margin of safety?" writes Klarman. "By always buying at a significant discount to underlying business value, and giving preference to tangible assets over intangibles....By replacing current holdings as better bargains come along. By selling when the market price of an investment comes to reflect its underlying value and by holding cash, if necessary, until other attractive investments become available."

Although definitions of "underlying value" abound, Klarman's interpretation opts for a more no-nonsense view that's shorn of intangible assets such as goodwill. "Since investors cannot predict when values will rise or fall," he writes, "valuation should always be performed conservatively, giving considerable weight to worst-case liquidation value as well as to other methods."

[12/5/05] Perhaps more accurate than 'buy low' is 'buy cheap'. [Seth] Klarman has identified a new class of investor he has termed value pretenders ... "These investors apply a dip strategy. They buy what's down, not what's cheap."

[11/24/05] Finding a great idea is fantastic. It's also very difficult. Harder still is waiting for your great idea to play out. The market sometimes makes your great ideas seem, well, not so great. In 2001, both McDonald's (NYSE: MCD) and Home Depot (NYSE: HD) were mauled -- the stock market simply abandoned them to the inevitability that their competitive dominance had waned. That turned out to be a pretty massive mistake; folks who bought these two stalwarts have seen their stocks triple and double, respectively. For some of us though -- those of us who already owned one or both of these stocks -- the drops in these share prices should have caused us to tremble with greed. As an owner, you have that advantage. You can act when your company is unfairly or irrationally thrown out with the trash.

Five Stocks They Love

During the summer, [the Motley Fool] ran our "A Stock I'd Love to Own" contest. The rules were simple. Participants were asked to submit a short report about a great business they would hold for at least 10 years, a money-making machine that would be likely to grow and provide huge profits for years to come. Valuation didn't matter -- we were looking for superior businesses that subscribers could add to a watch list and purchase if they ever reached an attractive price. The five most compelling arguments received prizes.

The winner of the contest was Canadian Natural Resources (CNQ). Unfortunately they don't mention the other four prize winners and instead (somewhat misleadingly) list the top performers of the (approximately 40) contest entries. They were

Life Time Fitness (LTM)
J2 Global Communications (JCOM)
Expeditors International (EXPD)
Iron Mountain (IRM)
Google (GOOG)

It would be interesting to look back five years from now how well these stocks perform.

sustainable competitive advantage (moats)

[7/16/13] Morningstar mentions five main ways a company can carve out an economic moat

[4/1/09] Finding a company to hold forever

[1/18/08] four sources of sustaininable competitive advantage

[11/5/07] If a business can sell goods or services for more than it must pay to provide or produce them, it makes a profit. However, pricing power comes in many different shapes and forms, so let's take a look at some key questions to ask.

[2/26/07] Three different types of moats

[7/13/06] Michael Mauboussin talks about competitive advantage

[7/3/06] Morningstar takes a look at the relationship between moats and risk

[5/5/06] How to identify competitive advantages

[4/5/06] If you could ask only one question about a company before deciding whether to invest in it, what would it be?

[12/21/05] brknews reports that shai reports that Buffett and Pat Dorsey wrote about moats.

[11/22/05] it's easy to point to the incredible stocks of the past 15 years, but it's much harder to find the huge performers of the next 15 years. But history can still help, because what all these businesses have in common is that they really aren't run-of-the-mill companies. All of them are fantastic businesses that obliterate weaker competitors.

[11/6/05] Do numbers matter? Yes, but so do the intangibles says Nathan Slaughters. (I'd probably say, though, that the intangibles are largely reflected in the numbers.)

[10/5/05] Can small companies have moats?

[1/9/05] The best investors say they look for businesses with a competitive advantage, referring to them as moats. Here are some of those businesses.

Wealth Creation

There is an interesting philosophical discussion on the topic of accumulating wealth over at chucks_angels. knead_ansur started it off this way

I am the first generation in my family that ever made any money. I
have come to the realization that putting 10-15% per year in a
diversified mutual fund is NOT the way to create real wealth. I
have always made good money and have always saved 10-20%. I have a
nice litte nest egg, but certainly not anything approaching FckU-
money (where if you want to you can go into your boss and say FckU-I-
QUIT). I want to pass on some advise to my kids and would
appreciate any thoughts on the subject.

Here is what I have observed

1. Real Estate - I never made any money in real estate (I moved around too much). One path to riches seems to be real estate; or
   
2. Start your own business; or
   
3. Make large bets on a small group of undervalued stocks (rather than holding a diversified portfolio).
   
4. I read Rich Dad/Poor Dad. The guy had some good ideas, but he seemed like some what of a flim-flam man to me. He did emphasize the "tax trap" of working for someone else. I almost think I should invest in some small business (car washes or something), just to have some company that I can pass onto my kids so they can make
   other investments from it.

Reversal of Fortune

Mauldin relays this essay by Ed Easterling who writes about a study by Dreman and Lufkin. The work, entitled Investor Overreaction: Evidence That Its Basis is Psychological," is an analysis of investor behavior that illustrates that perceptions are more important than the fundamentals.

Dreman and Lufkin look at a database for 4,721 companies from 1973 through 1998. Each year, they divide the database up into five parts, or quintiles, based on the companies' perceived market valuations. They separately study price to book value (P/BV), price to cash flow (P/CF), and the traditional price to earnings (P/E). This creates three separate ways to analyze stocks by value for any given year so as to remove the bias that might occur from using just one measure of valuation.

The results? Almost immediately upon creating the portfolio, the price performance comparisons change, and change dramatically. The in-favor stocks underperform the market for the next five years, and the out-of-favor (value) stocks outperform the market.

How much better did the well-performing stocks do than the poorly performing stocks in the 10 years prior to creating the portfolios? The highest P/BV (price to book value) stocks outperformed the market by 187 percent. The lowest stocks underperformed the market by -79 percent for a differential of 266 percent! If you look at the P/CF (price to cash flow), the differential between the two is 172 percent.

Yet in the next five years, the hot stocks underperformed the market by -26 percent on a P/BV basis and -30 percent on a P/CF basis. The out-of-favor stocks did 33 percent and 22 percent better than the market, respectively. This is a huge reversal of trend.

Much more in the article.

Eight Tips from Morningstar

[Paul Larson writes] I had the pleasure of being the lead writer and editor of three just-published Morningstar books on stocks--How to Get Started in Stocks for beginners, How to Select Winning Stocks for those looking to dig into individual companies, and How to Refine Your Stock Strategy for those who've been running their own portfolios for a while. In the course of writing some of the chapters for these books, I came up with a list of stock-investing tips that boils down our collective experience and insights here at Morningstar. Here are some of those tips. Whether you're a beginning or seasoned investor, these tips and commentary can provide a useful framework for your investing strategy.

-- relayed by Russ (value_investment_thoughts)

America imports, Asia exports

Bob Miller is an American importer. Scott Hong is an Asian exporter. Together they epitomize an enormous imbalance in the global economy, in which the United States imports, consumes and borrows while Asian nations export, save and lend.

-- from Investorguide Daily, 11/21/05

Rules of Speculation

Says Doug Casey, "There are certain rules that will likely be just as good in the future as they have been in the past because they're based on human nature, and that hasn't changed much over the thousands of years. I've listed five signals that should be present before you enter a market. You may never find a situation where they're all there, but the more that are, the more the odds are tilted in your favor."

Casey's five signals are

1. A Climactic Bottom
   
2. Period of Accumulation
   
3. Relatively Low Bottom
   
4. Historically Low Prices
   
5. Pessimism in the Market

Though Caseys mentions these rules as applicable to "speculation", it sounds to me that they could be applicable to general contrarian investing. Furthermore, using the term speculation may throw people off. Casey says it's actually a low-risk strategy and Investopedia says it should not be considered purely gambling.

* * *

[1/6/06] Isn't buying stocks gambling?

Selena Maranjian's stock picks

[11/28/05] Selena presented six more stocks a week later. Here were the picks.

MDT    52   56
PAYX   32   42
PEP    52   60
PG     52   57
SYY    33   33
WWY    64   69

SPX  1175 1255

I didn't want to look up the exact prices, so the above are just eyeballed from the chart.

* * *

[11/16/05] Is Selena a stock picking genius?

Here's the list with the prices (Yahoo's adjusted close) in March (when the article was written) and now.

BUD  46.71  43.13
KO   41.94  42.14
FDC  40.77  41.36
GIS  51.52  47.84
IRM  30.75  43.77
JNJ  66.92  63.25


SPX   1200   1231

So one up (IRM) and the rest haven't moved much. So I guess that's pretty good for a flat market. But, of course, eight months is probably not enough time.

Why Do Stocks Get Cheap?

[11/12/05] What causes stocks to become cheap?

This is one of the most fascinating questions about the stock market. With literally millions of investors scanning the market for opportunities, a near-instantaneous flow of information, and financial reporting better than ever, how is it that stocks can become mispriced with such regularity?

[11/16/05] Profit from Panic: investing in turnarounds

time horizon (long-term vs. short-term thinking)

[11/8/05] What does sailboat racing have to do with investing?

[11/7/05] As the head of Berkshire Hathaway, master investor Warren Buffett has said that he expects to "keep permanently our primary holdings." Buffett has never sold a share of Berkshire Hathaway, and he says his performance would have been even better than 21.9% if he'd never sold a single share of any of his investments.

[10/30/05] One of the toughest lessons to learn as a value investor is how often it is absolutely critical to do nothing but sit and wait.

[10/28/05] How long should you wait?

[10/25/05] Admonitions to listen to and emulate the masters by having a long-term focus are everywhere. Warren Buffett has advised investors to act as if their investing careers were limited to a lifetime decision card with just 20 punches on it, and has expounded that Berkshire Hathaway makes investments in businesses, caring not a whit if the market closed for 10 years.

---

[4/23/05] Ron Baron writes about the Baron Funds time horizon in investing:

‘‘Don’t gamble. Buy some good stock and hold it til it goes up, then sell it. If it don’t go up, don’t buy it.’’ Will Rogers. 1930.

Humorist Will Rogers was ahead of his time with his 1930 market advice which, on reflection, seems to have provided the ‘‘momentum’’ traders of today with their philosophical raison d’etre, i.e., it’s not a big leap, we think, from Will Rogers’ stratagems to buying stocks while they are going up and selling them short while they are falling, a momentum traders’ credo.

But how, in momentum, news reactive, efficient markets, when everyone has access to the same information at the same time, compliments of the Internet, do we think we can purchase growth stocks at attractive prices?

We think it’s principally because we have a different time horizon than most investors. We don’t make investment decisions based upon whether next quarters’ earnings will beat or miss estimates; a contract has been awarded or denied; a drug approved or denied; or monthly same store sales will ‘‘surprise.’’ We’re trying to invest in businesses that we believe have opportunities to grow substantially over the long term and which are often currently investing in their own businesses to achieve that growth. Business capital investments intended to achieve long term growth usually do not produce immediate earnings. In fact, such expenditures usually penalize current earnings and therefore may negatively impact current stock prices. As a result, we often, despite Will Rogers’ exhortations, buy stocks that are falling
or have fallen in price. Many of which have become our most successful investments.

Our strategy, of course, has not always been successful since at times what we have judged to be short term interruptions in growth have proven to be long term problems, or worse, management deficiencies.

In the March 2004 quarterly report, Baron talks about investing in bull markets:

But, how do we find value in a bull market like the one that began in October 2002? We think by identifying trends and ideas that offer businesses significant growth opportunities before most other investors recognize and value those opportunities. By doing our own research, not relying upon others’ advice and
recommendations, and by having a long time horizon we think our shareholders will have a chance to invest in businesses at what we believe are attractive prices and benefit if those businesses grow significantly.

We invest in businesses that we think can benefit from long lasting ‘‘mega-trends’’ like proprietary schools in a technology-based society that provide secondary education which allows you to get and keep your job. Healthcare providers in an aging society when it is obvious that the older you get, the more care you’ll need. Security services in a society afraid of not just terror, but of fraud and criminal behavior. Businesses we think have longer term sustainable competitive advantages that can benefit from the Internet and other scientific advances. Differentiated entertainment for our increasingly affluent society.

These themes are just a few of the growth opportunities we’ve identified and in which we’re trying to invest for the long term.

In addition, we believe long term investors are given many opportunities every year, even during ‘‘normal’’ times, to buy and sell stocks at attractive prices when traders react to short term, unexpected news events which, for the most part are not predictable and are of little, lasting consequence to businesses. We think the terror-induced decline in mid-March is on point.

Just One Thing (by John Mauldin)

John Mauldin has come out with a new book, entitled Just One Thing. Mauldin asked eleven of his high brow friends to write a chapter on the one best idea they have learned about investing.

It sounds like an interesting read, but I can't really recommend (or not recommend) it because I haven't read it.

poker and investing

[1/30/07] I want to make money in the stock market (and not be the sucker), and you probably do, too. So how can we do it? By following some simple rules great poker players use to maximize their winnings:

1. Play more hands when the odds are in your favor and less when the odds are not.

2. Bet big when the odds are in your favor.

[1/16/06] poker tips can be applied to investing

The goal in poker is relatively straightforward. It's not about how many pots you win. It's about making good investments [starbulletin, 10/2/05]

Bull or Bear?

11/01/05 - Bull: Arne Alsin predicts Dow 13000-15000 in two or three years

8/22/05 - Bear: Woody Dorsey

8/19/05 - Bear: A. Gary Shilling

Charter Communications

High debt? Big price drop? SEC investigation?

These could all signal buying opportunities. But in the case of Charter Communications, Tom Gardner and Rex Moore thought it was too much of a bad thing.

Weitz sold out the last of his shares before 6/30/05. This is one Wally got wrong. CHTR is currently at 1.20.

Guru managers

The equities team at Morningstar is a group of stock junkies: We love investing, and we love to research and find great investment ideas. In my experience, stocks are the discussion topic of choice (since we're in Chicago, the White Sox have temporarily supplanted stocks, but hey, it's been 46 years!) as we chat around the office. We also enjoy discussing what our favorite money managers think about the market, and what stocks those managers are buying. Most of this information can be found easily, thanks to an excellent, free resource available to everyone: shareholder letters.

Among the funds are Baron Asset (Ron Baron), Clipper (James Gipson), FPA Capital (Robert Rodriguez), Legg Mason Value (Bill Miller), Longleaf (Mason Hawkins), Oak Value (David Carr), Oakmark Select (Bill Nygren), Olstein Financial Alert (Robert Olstein), Selected American Shares (Chris Davis), Sequoia (Goldfarb and Ruane), Third Avenue Value (Martin Whitman), Weitz Value (Wally Weitz). Coincidentally, many of these same managers are covered at gurufocus also.

The best predictor of mutual fund performance

[10/28/05] According to an S&P study, the most consistently top-performing funds had three common characteristics: longer manager tenure, lower expense ratios, protected downside.

[8/8/05] the expense ratio isn't only the best predictor of performance, it is the only statistically reliable predictor, according to a study by Boston-based Financial Research Corp.

FRC tested 11 popular criteria that investors use in picking mutual funds: Morningstar ratings, past performance, turnover ratios, asset size, expense ratios, fund-manager tenure, net sales as well as four measures of risk/volatility.

The results showed that out of the 11 criteria, the expense ratio was the only one that had sufficient statistical relevance in predicting fund performance. Funds with low operating costs "deliver above-average future performance across nearly all time periods," the study says.

When to sell a stock

[3/7/06] The best reason to sell

[3/2/06] Seth Jayson chimes in with signs of a superior business that shouldn't be sold.

[2/28/06] I say again. Almost never.

[10/28/05] the only good strategic reason to ever sell a position: When the reason you bought it no longer holds true.

[3/30/05] Actually Philip Fisher gives three reasons

[3/18/05] Philip Fisher wrote "almost never"

Bernanke nominated as Greenspan's successor

President Bush on Monday nominated Ben Bernanke to succeed Federal Reserve Chairman Alan Greenspan, whose term is set to expire at the end of January. Bernanke, currently chairman of the president's Council of Economic Advisers and a former Fed governor, was widely considered one of the leading candidates for the job.

Lazy Investing

Seth Jason writes

A while back, I also suggested applying some strategic sloth to your stock picking. I was trying to find businesses that required very little babysitting, but better yet, had the potential to beat the market, not in spite of, but because of those same characteristics.

Briefly put, I figure opportunity is in Wall Street's madness. As the rest of the Wise flit from next big thing to next big thing, trying to zig when the other guys are zagging, I thought we could do better by concentrating on solid, dependable business leaders that didn't require daily checkups or keep you up at night. The same characteristics that made these investments easy on the stomach should, I thought, make them superior performers over the long term.

Sounds good to me, (though I wouldn't have chosen the stocks that he chose).

Free Cash Flow

[9/9/05] The joy of free cash flow

Four cash-flow red flags

Forbes says free cash flow doesn't do justice to growth companies

Investopedia says free cash flow is a great gauge of corporate health but is not infallible

[10/5/05] Free cash flow is a great metric for measuring the cash profitability of a business over time. But it's possible to overestimate it if you don't pay careful attention to details. Nathan Parmelee walks through a few of the items he likes to check for when analyzing a company's free cash flow.

[10/18/05] If you ask 10 mathematically inclined Fools what a firm's free cash flow is, you're going to get 10 different answers

The Price-To-Sale Ratio (and other ratios)

[11/16/05] Philip Durell (himself!) discusses the usage of the p/s ratio

[10/18/05] a look at the p/b (price-to-book) ratio

[1/13/05] I often prefer to use the p/s ratio instead of (or in addition to) the p/e ratio since earnings can fluctuate more than revenue.

Follow the links for more discussion of the p/s and p/e.

Rembrandt paintings

Do stocks behave like Rembrandt paintings? Answer: sometimes they do - in the short term.

Charlie Munger, chairman of Wesco Financial (AMEX: WSC), spoke in 2000 about the price of a stock coming from a number of different places: It's valued like a bond, like a claim on earnings, and also like a Rembrandt painting, which tends to go up in value for the sheer fact that it has recently gone up in value.

Watch Warren

According to a yet unpublished research paper by Ohio University professor John Puthenpurackal and Gerald Martin, a visiting scholar at Texas A&M University, an investor who mimicked Buffett would have beaten the Standard & Poor's 500-stock index by an average of 11.6% a year from 1980 to 2003.

are good investors brain damaged?

[10/12/05] Is Warren Buffett a psychopath?

[7/23/05] People with certain kinds of brain damage may make better investment decisions. That is the conclusion of a new study offering some compelling evidence that mixing emotion with investing can lead to bad outcomes.

[09/30/02] The neuroscience of investing

Profitable Bankruptcy

One of Philip Durell's favorite places to look for undervalued opportunities is among bankruptcy survivors. (Both he and Fairholme found MCI.)

Buffett eats hamburgers

[10/7/05] In Berkshire Hathaway's 1997 chairman's letter, Warren Buffett famously wrote:

If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? ...

Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the "hamburgers" they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

[10/19/05] During the Berkshire Hathaway annual meeting, Buffett said the keys to being a successful investor are temperament and the right basic idea.

large font

Here's an interesting investing rule.

Must have large font
The most recent 10-K filing for tech giant Oracle (Nasdaq: ORCL) ran to 103 pages. Meanwhile, little Mine Safety (NYSE: MSA), a boring business whose stock has nearly tripled in two years on the Hidden Gems roster, offers its investors a mere 50 pages of reading material. Heck, with all that space, the company could go wild and print its financials in easy-to-read 12-point font -- investors would still have less paper to plow through. More important than the font size, though, is the fact that small companies like Mine Safety are transparent. Fewer pages mean fewer places to hide inconvenient facts. It means we're less likely to be surprised, and less likely to invest in something we do not understand.

Bill Gates makes it 11 in a row

Bill Gates, Microsoft Corp.'s co-founder and chairman, was the nation's wealthiest person for the 11th straight year with a net worth of $51 billion, followed again by Berkshire Hathaway chairman and chief executive Warren Buffett's $40 billion, according to Forbes.

Perhaps more noteworthy is the ascent of Google founders Sergey Brin and Larry Page, who were ranked 16th by Forbes with $11 billion each, up from No. 43 last year when they each had a net worth of $4 billion.

S&P's Top Ten

S&P's Top Ten Portfolio comprises stocks that S&P regards as best positioned to deliver big total returns in the months ahead.

The stocks are BAC, BNI, CVD, GTRC, IR, ISCA, LEN, MDC, STJ, SII.

Of the ten, I own LEN. But I wouldn't put it in my top 10 (or even 20) stocks. Though this stock has been very profitable to me in the past, I'm thinking of selling some more. In other words, take more profits.

Brownco sold

The consolidation in the US online brokerage industry continued on Thursday with E*Trade Financial agreeing to buy BrownCo from JPMorgan Chase for $1.6bn.

W. D. Gann

Who?

William Delbert Gann, better known the world over as W.D. Gann, is a legend in the world of stock and commodity trading. He was one of the most successful stock and commodity traders that ever lived. Using his own style of technical analysis, W.D. Gann took more than 50 million dollars in profits out of the markets! In today’s markets that would be closer to 500 million dollars!

Here's more.

What works?

Mauldin talks about looking for money managers. He's looking for real world results, yet says past performance is not indicative of future results.

That sounds contradictory. So he's looking for real world results plus something else.

"What do Finn and his team tell us does work? Fundamentals, fundamentals, fundamentals. As they look at scores of managers each year, the common thread for success is how they incorporate some set of fundamental analysis into their systems.

Great track records are not enough. I am going to need to know how you made that track record and then why."

The power of dividends

Question: How high would the Dow be today if dividends had been reinvested?

Answer: 900,000 according to Meir Statman. (It's currently at 10,558.)

Sustainable Growth

[8/6/05] What is the percentage of companies that will show above average growth for 10 years in a row? (scroll to "Where are the Bull Market Geniuses?")

See also Beware of Perfect Earnings

[9/17/05] Out of 1920 firms, Morningstar found 316 of them (16.5%) were able to grow revenue 10 years in a row. Earnings? 61 (3.2%). Free cash flow? 3 (0.2%). Which are the three? BRO, UNH, DHR.

Going further, how many companies have had 25% ROE ten years in a row? 23 (1.2%). How about 20% revenue growth ten years in a row? 2 (APOL, RGF).

[10/14/05] I'm looking at some old notes. Here's one from an old 1999 FDGFX report.

A company's ability to consistently grow its earnings over time is key to stock performance. When certain market sectors are performing well, however, it's easy to get caught up in a state of short-term euphoria.

... When I read that a company expects to generate 20% earnings growth annually over a five-year period, I'm very skeptical. ... In looking at companies that grew their earnings by 20% or greater in 1998, only 1% of those companies would have been able to grow at a minimum of 20% over the next four years. Also past earnings growth is no guarantee of future earnings growth. Of the companies that grew their earnings by 20% or more in each of the last five years, for instance, studies show that only 2% will sustain that level for the next five years. [I wonder what that chances of the sixth 20% year after having done the first five in a row, though.] When a stock has a projected growth rate of 20%, the market typically bids that stock up to a level that is unrealistic. When reality sets in, that stock usually falls out of favor.

Why are 15% successful (temperament)

[3/25/06] What every great investor must have

[3/26/05] Robert Hagstrom writes in the 2004 Legg Mason Growth Trust annual report.

A few weeks ago I attended a meeting with a consultant group in New York. As we were settling into our seats in the conference room one of the consultants immediately launched into a sermon, explaining to me that most portfolio managers not only have a college degree but most have attended graduate school. A large number have earned their Chartered Financial Analysts designate. Practically all institutional-level portfolio managers have several years of investment experience. He then said, ‘‘this is a business where 100% of the people are smart, but only 15% are successful.’’ He turned, looked at me and asked, ‘‘The question, Mr. Hagstrom, is why?’’

There are several reasons why most portfolio managers are not successful at beating the stock market over the long-term. Stock selection process is one. Portfolio management approach is another. Time horizon is a third. But the one reason that stuck in my mind was what Warren Buffett said at the 2004 Berkshire Hathaway annual meeting. When asked whether being smart is all one needs to be successful, he too thought for a moment and then replied, ‘‘Investing does not require extraordinary intelligence, but it does require an extraordinary temperament.’’

I turned back to the consultant and said, ‘‘Temperament.’’ When investing gets tough, and it does get tough from time to time, most portfolio managers do not have the right temperament: the combination of mental and emotional traits that allows an investor to be successful. When investing is easy, temperament may not be so important. But when investing gets difficult, temperament is what separates those who beat the market from those that do not.

[6/22/05] "Success in investing doesn't correlate with IQ -- once you're above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing." - Warren Buffett

[7/20/05] Along the same lines, here's another Buffett quote (or maybe it's the same one?): "The most important quality for an investor is temperament, not intellect".

[9/15/05] Profiting From Temperament: An Illustration

All About Margins

[8/18/05] Traditionally, margins represent the efficiency by which companies capture portions of sales dollars. This article provides an explanation of the difference between gross margin, operating margin, and net margin.

In general, I'd say a high margin is a good thing. But a high margin naturally tends to yield a high price/sales ratio which is not generally considered desirable in value investing. That's probably because high margin businesses are generally high growth businesses. And high growth businesses tend to have high P/Es. So a high margin might be good for the company, but not necessarily for the stock.

[9/12/05] I'm looking at One Up On Wall Street (Some Famous Numbers). Lynch says "as business improves, the companies with the lowest profit margins are the biggest beneficiaries ... This explains why depressed enterprised on the edge of disaster can become very big winners on the rebound ... What you want then is a relatively high profit-margin in a long-term stock that you plan to hold through good times and bad, and a relatively low profit-margin in a successful turnaround."

Value Investing 101

[3/3/05] Value Investing 101 (Bruce Greenwald)

10 Commandments of Value Investing

Contrarian Investing

Value Investing - 5 Key Principals [this was written by Ye of Quovax using Seth Klarman as a reference -- and yeah I know it should be Principles not Principals, but that's what he wrote 3/7/09 a.m.]

fast grower or low p/e?

In seeming contradiction to some of the "value vs. growth" studies noted elsewhere here, Peter Lynch (in his book One Up On Wall Street) states it is preferable to purchase a business at a higher P/E that grows earnings at a higher rate than a lower P/E business that grows earnings at a slower rate.

However the example, as presented in the linked ticonline article (an excellent site by the way), does not demonstrate full [or any] understanding of the issue. Naturally the 15% grower would outperform the 10% grower if the p/e doesn't change! The very reason for buying a low p/e stock is the value investor's expectation that the p/e will rise as the value of the stock is discovered. And the danger of a high growth, high p/e stock is that the p/e cannot be sustained over time.

Let me adjust the example. Let's say the fast grower starts with a p/e of 25 and ends up with a p/e of 20 ten years later. And the low p/e stock starts with a p/e of 8 and ends with a p/e of 12. The 4.05 performance of the fast grower would be cut to 3.24. And the 2.59 performance of the low p/e stock would be boosted to 3.89. In this example, the low p/e stock would outperform the faster grower.

That said, if you can get a high enough sustained growth rate, the faster grower will outperform even with a shrinking p/e ratio. Lynch's actual example is located in the "Some Famous Numbers" chapter, in the section called "Growth Rate". He compares a 20% grower to a 10% grower. The 20% grower handily outperforms the 10% grower even if the p/e shrinks from 20 to 15.

In any case, this interplay between the growth rate and the multiple (p/e here) is at the heart behind the bulk of my investment decisions. The performance of any investment is a function of both growth and value.

Beware of Perfect Earnings

[7/12/05] Another good article referenced from Fat Pitch Financials

I like to look for companies that grow earnings year after year, but earnings can be manipulated. That's why I also like to look at sales and I think I'll start looking more at free cash flow (provided by morningstar). But the point is even those trends don't last forever.

The conclusion: "there are very few really great businesses".

[8/8/05] Gaming a financial statement to meet earnings expectations has its own colorful nomenclature: cookie-jar accounting, channel stuffing and "the big bath."

[8/18/05] Earnings can be manipulated -- and even when they aren't, they can be unintentionally deceptive. No single measure of corporate performance or stock value is perfect or totally tamper- proof. That's why many professional investors look at stocks using several different measures.

a piece of pi from Google

A year after its blockbuster debut as a public company, Google Inc. said Thursday it plans to offer another 14.2 million shares, currently worth about $4 billion, as competition heats up with rivals Yahoo Inc. and Microsoft Corp.

But here's what I found interesting interesting. The exact number of shares to be sold -- 14,159,265 -- happens to be the eight digits beyond the decimal point in the mathematical value Pi. Google's founders, Sergey Brin and Larry Page, were raised by math teachers and studied computer science at Stanford University. (I liked it, but fuddy duddy Kudlow didn't. 8)

Don't Invest Like Peter Lynch

What? Peter Lynch is one of the great investors of all time. And much of my investing philosophy is based on his books. But you shouldn't invest like him says FatBoy. Why? Because Lynch is now investing in (gasp) penny stocks!

One of the his picks is Rainmaker Systems. When I look at the numbers, revenue has slid from 61m in 1999 to 15m in 2004. Net income has never been positive. Accordingly the stock has slid above 3 last year to like a quarter earlier this year. It would seem to me that this is a stock to avoid.

So maybe I should be saying, "I don't invest like Peter Lynch" in this situation. But I'd venture to say it's OK to invest like Peter Lynch -- if you're Peter Lynch (or Gordon Gekko)!

Unexpected Returns (what drives stock market returns?)

What's the one main driver for stock market returns? It's got to be economic growth, right? Growth is paramount to the increase in stock prices. After all, that's what we're told every single day by the financial media.

Actually, according to a new book by Crestmont Research's Ed Easterling, that's basically wrong. The single biggest determinant of stock market gains is the trend in inflation. His new book, Unexpected Returns: Understanding Secular Stock Market Cycles, is destined to be an investing classic.

Reading further into Bill Mann's review, this book is a follow-up to Mauldin's Bullseye Investing. And if you replace the term "inflation" with the term "p/e" it all becomes a little clearer. The bull market from 1980 to 1999 was driven by a p/e expansion from 7 to 23.

What about now? As expected from a follow-up to Mauldin, the premise is that the current p/e of 20 is still high historically which would would mean a bear market is mathematically likely to follow.

My take is that though the p/e of 20 is high, the current interest rate is still low and so the market isn't all that overvalued if at all. But with the rates still in a general uptrend, that thesis is slowly eroding.

For more, see the article on Vandeberg.

[8/28/05] An article in Barron's makes the same case that "the major determinant of stock-price returns
isn't growth in corporate profits, but rather changes in price-
earnings multiples". I'm trying to verify my own statement above that the p/e expanded from 7 in 1980 to 23 in 1999. The only 23 in the article I see now is that it was the p/e in 1965. Maybe I was confused. Looking at Barra, I see the p/e for the S&P 500 at the end of 1999 was 34. In 1980, it was 9.40. In 1979, it was 7.58. Barra's data goes back to 1977.

[2/23/05] Vitaly Katsenelson looks at Unexpected Returns

How reliable are earnings estimates?

[John Mauldin pointed out that] David Dreman pointed out in a study that he conducted from 1982 through 1997 analysts were ON AVERAGE wrong by 200%. (Forbes, July 8, 2002)

Dreman tells us, "Earnings performance for 2002's first half was a sorry one. Company after company was forced to lower expectations or restate past results downward. How can the consensus justify such a healthy-looking multiple for the year as a whole? By forecasting a second-half profit boom that gushes up from nowhere: a 48% gain (from a year earlier) in the third quarter and a 45.7% one in the fourth, according to S&P analysts' forecasts. Included in the forthcoming profit explosion, as reported in First Call, are a 127% income increase in technology stocks in the third quarter and a 73% jump in the fourth and a hardly modest 19-fold rise in transportation earnings in the third quarter (mainly airlines), with an even larger gain forecast for the fourth."

Another longer-term study published by the National Bureau of Economic Research shows that analysts typically overstate earnings by at least a factor of 2. From the report: "Analysts predicted a five-year growth for the top 20% of companies to be 22.4% which turned out to be only 9.5%. [The researchers also pointed out the actual return rate should be lower because many companies actually failed over that period.]

They created sample portfolios based upon analysts' forecasts. Predictably, the top portion of the portfolios actually returned only about half of what the analysts predicted: 11% actual versus 22% predicted. "These results suggest that in general caution should be exercised before relying too heavily on long-term forecasts as estimates of expected growth in valuation studies."

Anecdotally though, it seems to me that the majority of estimates are pretty close. It's fairly rare that an earnings surprise is way out in left field. [Just look at the InvestorGuide reported vs. expected earnings for example.] In some cases it happens, so that would skew the averages. Five year estimates may be something different though. It's pretty hard to forecast accurately five years out. For example, a few years ago they were probably forecasting CSCO to earn 40% a year. Now it's more like 15%.



[9/5/08] Dreman studied and wrote a good deal about analysts and their predictive powers (or lack thereof). In his book "Contrarian Investment Strategies," he wrote: "There is only a 1 in 130 chance that the analysts' consensus forecast will be within 5 percent for any four consecutive quarters. . . . To put this in perspective, your odds are ten times greater of being the big winner of the New York State Lottery than of pinpointing earnings five years ahead."

... [Dreman] used it as a reason to invest in beaten-down stocks. For highflying stocks, a good earnings surprise doesn't help that much, because the stock is already riding on great expectations. A negative surprise, however, can send its price plummeting.

Beaten-down stocks, on the other hand, have such low expectations that a negative earnings surprise won't hurt them too much, while a positive earnings surprise can send them soaring. The message for Dreman: Since analysts are often wrong and earnings surprises are frequent, it makes sense to focus on beaten-down contrarian plays.

The Case for (and against) Investment Newsletters

[10/29/05] Here's another view of investment newsletters performance. The takeaway? They ain't so hot.

Don't invest in newsletter model portfolio
Special to Coloradoan
Fort Collins Coloradoan
October 23, 2005

I first learned of mutual funds in 1956, as a beginning accountant working for a CPA firm in Hammond, Ind.

One of the firm's clients was Dow Theory Forecasts, founded by LeRoy Evans and publisher of Dow Theory Forecasts investment advisory newsletter. Evans wanted to start a mutual fund using his stock-picking skills. He did - the Dow Theory Mutual Fund. Trouble was, in its short life the fund posted a dismal record. Evans retained financial doctorate degrees from Northwestern University to fix the problem. They couldn't and the fund was eventually sold and merged out of business.

Many readers will recognize the name Mark Hulbert, founder of the Hulbert Financial Digest. The digest begin tracking advisory newsletter performance in 1981 and has 25 years of newsletter history.

Hulbert recently conducted an experiment to determine if some newsletter writers really have special stock-picking skills.

He chose newsletter model portfolios at Jan. 1 of each year based solely on their performance in the previous year.

The experiment revealed that if an investor had followed this strategy beginning in 1992, as of the end of August 2005 (14 years and eight months), the investor would have lost an astonishingly 24 percent annualized.

The total nonannualized loss exceeded 98 percent.

What if the investor chose the best performing newsletter model portfolio over five years?

Hulbert says the investor's portfolio would have gained 5.5 percent annualized compared with the 3.9 percent annualized return the investor would have earned by investing in 90-day treasury bills.

Maybe 10-year model portfolios would show better results. They do, returning 9.4 percent annualized, according to Hulbert. "Not bad," you may think. But the Wilshire 5000 index gained 11.9 percent annualized over the same 10-year period.

Hulbert continued his experiment to see how the best performing newsletter model portfolio in 2004 has performed.

That newsletter is published by Hager Technology Research and Hulbert calculates its model portfolio is down 80.3 percent from Jan. 1 through Aug. 31.

I logged onto the newsletter's Web site. The 20-point type headline reads: "It's official. According to the independent audit of the Hulbert Financial Digest, Fredhager.com has the No. 1 performing investment newsletter of 2004, up 154.8 percent."

Now that is impressive. If my math is correct, a $10,000 investment in the fund at the beginning of 2004 was worth $25,480 at year-end 2004. As of Aug. 31, the value had declined 80.3 percent or $20,460 and the $10,000 investment reduced to $5,020. That is some model.

If instead of picking the one-year best performing newsletter model portfolio you chose the best five-year performing model portfolio, Corcoran's Chronicle, you would have been down 10.7 percent at Aug. 31. The Wilshire 5000 index was up 3.1 percent.

The best 10-year model portfolio with an annualized gain of 11.5 percent was recorded by The Prudent Speculator. Its model portfolio, in my opinion, is only for those who would get into a craps game with strangers. Its volatility is unchallenged.

Come to think of it, many investors might do better in a craps game than investing in a newsletter model portfolio.

Personal financial specialist James L. Watt, CPA/PFS, is a fee-only, NAPFA-registered financial adviser. Reach him at jimwatt100@msn.com or 225-1440.

* * *

[8/7/05] Even though newsletters traditionally underperform the market, I was suprise to learn that individual investors subscribing to newsletters outperform those that don't subscribe. Well, I guess the Motley Fool folks would be happy to hear that.

Shortly after the dawn of the stock market, the investment
newsletter industry was born. Today industry sources believe
there are over 2000 investment newsletters (including online
versions) with total annual revenues in the billions. Below we
will discuss the benefits of investment newsletters and how to
find one that best meets your needs.

Benefits of Investment Newsletters

At the end of the day, the reason to subscribe to investment
newsletters comes down to performance. Studies show that
investors who subscribe to newsletters outperform the average
investor. Unfortunately most investors left to their own
devices follow a scattered approach that leads to sub-par
returns. Whereas investors that subscribe to newsletters are
in affect subscribing to a time-tested investment philosophy.
The philosophy is usually based upon sound investing principles
and gives clear buy and sell signals. Most important are the
sell signals since most investors have difficulty selling
stocks at the right time. If their stock picks are down, then
investors will hold on until the price returns to breakeven
(which almost never happens). Or investors try to ride winners
too long and do not lock in profits. Investment newsletters
provide the holistic approach needed to help investors succeed.

Another benefit of newsletters is value. Consider that
investors keep vast amounts of their wealth in mutual funds.
Unfortunately, as most of you already know, 85% of the funds
underperform the market. And for this sub-par performance,
investors pay mutual funds 1.5% of assets. Even a modest sized
portfolio of $50,000 pays $750 in mutual fund management fees
to underperform the market. Note the average newsletter costs
only $250 per year and provides superior results.

-- Zacks, Profit from the Pros, 1/19/05

I'm not sold on that last paragraph. Though newsletters outperform the average investor and mutual funds generally underperform the market, it does not logically follow that newsletters outperform mutual funds.

[6/1/14 reply to roy]  Most newsletters (and mutual funds and individual investors) don't outperform the market.

Question: Recently I've been reviewing a few financial newsletters that provide market advice. I don't trust most of them but have been intrigued by some. Would I just be wasting my money ($200 or $300 a piece) or could I actually see some better than average returns? How does the current downturn in the economy affect the advice offered by these newsletters?

The Mole's Answer: This is an easy one. You'd be much better off just throwing the money in the nearest dumpster than buying these newsletters and risking a big chunk of your nest egg in following the newsletters' advice.

[6/1/14 update] Consider the 51 advisers out of more than 200 on the Hulbert Financial Digest's list who beat the market in the decade-long period that ended April 30, 2012, as measured by the Wilshire 5000 Total Market index, including reinvested dividends.

Of that group, just 11—or 22%—have outperformed the overall market since then.

***

The Reserve Bank of New York also did a broad-ranging study in 1998 which looked at investment newsletters. This paper analyzes the recommendations of common stocks made in the HFD database from 1980 to 1996. They found that newsletters typically recommend 10-16 stocks. They tend to recommend growth rather than value stocks, smaller than the value-weighted average of market capitalizations. They generally encourage much higher turnover of holdings than found among mutual funds.

In terms of performance, they concluded that:

1) Newsletter recommendations do not on average outperform benchmarks based on market capitalization, book-to-market and stock price. Including trading costs (and newsletter costs), newsletters likely underperform.

***

The Hulbert Financial Digest is a monthly newsletter that serves as an impartial, independent reviewer of all the leading stock and mutual fund newsletter services (publications that recommend and advise on what to invest in). Run by editor Mark Hulbert for more than 20 years, over 180 stock recommendation letters are tracked each month, with data going back as far as 1980 for services that have been around that long. Hulbert's tracking and research shows that 80% of these professional stock pickers can't beat the market indices -- which might make you think twice before paying their subscription fees and following their investment advise.

***

Where's my book on newsletters?  Here it is.  The Wall Street Gurus by Peter Brimelow (1986).  Chapter four is on Hulbert.

"At the end of June 1985, after five years of rating the letters, Hulbert's results looked like this (see pages 68 through 75).  It would be easy to say that these results were devastating.

How Buffett spends his day

[7/30/05] How does Warren Buffett spend his day? Reading, talking on the phone, and thinking. <!- what do I do? look up these stupid links 8/6/05 -->

"All intelligent investing is value investing - to acquire more than you are paying for. Investing is where you find a few great companies and then sit on your ass.
- Charlie Munger at Berkshire Hathaway's 2000 Shareholder Meeting

[8/31/14 - a slightly different version of the quote:  "If you buy something because it's undervalued, then you have to think about selling it when it approaches your calculation of its intrinsic value. That's hard to do. But if you buy a few great companies, then you can sit on your ass. That's a good thing."]

[8/5/05] Buffett succeeds at nothing (also linked at the temperament entry)

[8/5/05] "Lethargy bordering on sloth remains the cornerstone of our investment style" - Berkshire Hathaway 1990 annual report <!- quoted by Jason Yee in the Janus Worldwide 2005 semiannual report -->

[8/13/05] "You make more money sitting on your ass," Marty Whitman indelicately explained to Jim Grant recently.

Five Steps to An Organized Financial Life

[1/19/09] What records can you really throw away?

[5/25/06] How long you should keep your financial records

[8/6/05] Advice for keeping your financial documents in order

Dump trash-worth documents

Baidu!

Baidu (BIDU) the Chinese Google opened for trading today. It was up 95.54 to 122.54. (Sell-sell-sell?) How did GOOG do on its first day? On 8/19/94, it was up 15.34 to 100.34. How sad.

[8/10/05] three lessons

Still Bubbling (says the Fed Model?)

Using the median p/e, Arnold Van Den Berg asserted (over a year ago) there is little upside to the market.

When the article was written, the median p/e was 19.5 compared to the highest peak ever at 20.7. So he's saying there is little upside and substantial downside.

However Arnie is using a bond rate of 6.75% in his model which would translates to a 15 p/e. If you take the 10-year tnote rate of 4%, you'd get a p/e of 25. [Today's Schwab Alerts says the 10-year bond yield is now up to 4.4%, the highest in four months. That works out to a p/e of 23.] [Here's one guy, Ed Keon, who interprets the Fed model as being bullish.]

I don't have answers for his other bearish arguments though. The market cap / GNP ratio chart looks especially scary.

In any case, even if the market is high, money can be made in individual situations. As Cramer always says, "there is always a bull market somewhere."

Orphan Stocks

According to a study that tracked more than 5,000 orphan stocks (stocks that trade under $5) over the course of 11 years, these unloved babes have less than a one-in-eight chance of recovering to above $10. Ever.

how to calculate your return

[8/1/05] follow-up

[1/8/05] Here's how to calculate your annual return.

And here's how the mutual funds do it (part 1 and part 2)

Is the run in Small Cap stocks over?

[7/31/06] The latest reign of small-cap outperformance peaked at 85 months in March, closing in on the longest run of outperformance (small caps for 88 months from 1983-1990) since the creation of the Russell indices in 1978. As a result of the weakened relative performance, and not at all surprising, mutual fund flows have followed suit. The Leuthold Group estimates a $3.3 billion net outflow from small-cap equity funds in June, compared to a $1.2 billion net outflow in May.

[7/30/05] Maybe so. But Mauldin may have been a little early as he was writing about it three years ago.

Are Dogs Barking In Your Portfolio?

Four reasons to get rid of your dogs. (I still have a few.)

more IV calculators

[7/2/05] Here's a couple more places to check for estimates on your stock's valuation (besides quicken.com, vectorvest, S&P).

ValuePro

Price Check Calculator

[7/27/05] Warren Buffett Intrinsic Value Formula (?)

MarketThoughts.com

It's sort of a blog, but not exactly. Anyway, I found it while doing a search of Buffett and Microsoft and saw some interesting articles here. These guys seem pretty intelligent. Here's a few articles that caught my interest.

The Art of Value Investing

Buffett Bashing in Perspective

Reigning in Fannie Mae

Comments on the Buffett interview at Kansas

A link to the comments of the interview.

1. Buy stuff cheaply
   
2. A big pool of capital makes it harder to earn big returns
   
3. The highest IQ doesn't automatically win
   
4. Do what you love
   
5. Buffett was lucky (and so are many of us)
   
6. The U.S. dollar is spinning down
   
7. Retail is tough to turn around (it won't be easy for Lampert)
   

Interview with Ralph Wanger

Stray from the herd every once in awhile, know when to sell, and understand the stock market is a loser's game.

http://www.howestreet.com/story.php?ArticleId=1376

- from chucks_angels

[10/6/14]  The above link is dead.

Try these.

http://www.trustprofessionals.com/f-digest/2005/2005-07-18-f.html (scroll down to How Losers Win)

http://www.trustprofessionals.com/f-digest/2005/2005-06-13-f.html#wanger

Ralph Wanger was the manager of the Acorn Fund.

growth outperforming

From InvestorGuide Daily comes this thestreet.com snippet.

According to fund tracker Lipper, the average large-cap growth fund rose 3.5% from April through June, compared to 1.4% for the S&P 500 index. Mid-cap growth funds added 3.1% in the quarter, while small-cap growth funds led all categories with a gain of 4.2%. On the value side, small-cap funds also bested the big guys, returning 3.1%. That compares with gains at mid- and large-cap value funds of 2.6% and 1.3%, respectively.

The numbers don't seem to add up. The only class that underperformed was large-cap value. And by only 0.1%. I'm guessing what must have happened was that the large cap funds in the S&P 500 underperformed and weighted down the index (which is cap weighted). So I'm guessing that means stocks like MSFT and CSCO were dragging down the index. Checking the charts though shows both MSFT and CSCO were up in the quarter. More so for CSCO.

Morningstar pans Marketocracy

[11/28/05] I see in this Mauldin letter of some months ago that out of 70,000 investors at marketocracy, only 2% have beaten the S&P both long-term and monthly.

The Marketocracy Fund is run by top 100 managers at Marketocracy. Here's how Ken Kam (the guy who run Marketocracy) describes them.

Wall Street investment houses, says Kam, recruit the wrong people. The top-drawer firms look for high achieving, well spoken generalists from the best business schools. But good investors, Kam says, tend to be savants with a passion. They're nerds. They're freaks. They're too young or too old. They eat junk food and stare at the monitor and perhaps forget to bathe. They live and breathe stocks. They tend to be sector specialists who know the underlying science, product cycles, supply chains and b habits in their sectors."

* * *

[7/18/05] Morningstar has a dim view of the Marketocracy Masters 100 fund. The major beef seems to be the high expense ratio (1.95% according to Yahoo). The other beef is their low opinion of us amateurs.

However looking at the Yahoo chart, MOFQX has actually slightly outperformed the S&P 500 since inception in late 2001. It was well ahead at the end of 2003, but had a miserable 2004 to fall back to near even. Turning to the marketocracy site, it looks even better, outperforming the S&P 500 29.49% to 15.08% (7.34% to 3.92% annualized). What's more, it has a beta of only 0.78 (compared to the S&P 500's 1.00).

Why investors underperform

There seems to be two oft-cited studies explaining why most investors underperform the market.

Barber and Odean looked at the trading activity at a discount broker between February 1991 and December 1996. They broke down the investors into quintiles based on their portfolio turnover. The highest turnover group had a 10% annualized return, while the lowest turnover group had a 17.5% return.

The other study which seemed to be a popular reference a couple of years ago was made by Dalbar. They looked at mutual fund returns from 1984 through 2000. The average fund returned 14% over that time period. But the typical investor had only a 5% return.

This is apparently an ongoing study. The 1984 through 1996 numbers were 16% and 6%. The 1984 through 2002 numbers were 12.22% and 2.57% (see Halbert below). The latest numbers (apparently 1984 through 2003) are 12.98% and 3.51%.

Here's what Richard Band said about it on his 8/28/03 hotline

It's a scandal nobody in the fund business wants to talk about. The folks from Dalbar, the Boston mutual fund research organization, have just released their latest study showing how well (or poorly) investors fared with their mutual funds. Dalbar analyzes cash flows into and out of the fund industry. For the 19 years from 1984 through 2002, the researchers found that the average equity-fund investor earned a compound return of only 2.57% a year. Meanwhile, the S&P 500 index returned 12.22%.

... The real killer is that too many investors chase "hot" funds. They buy whatever funds have rolled up big profits in the recent past (such as the technology funds in the late 1990s). As a result, the average investor arrives late to the party. Then, turning a mistake into a catastrophe, John Doe and Mary Roe dump the same funds after a stretch of poor performance—generally near the bottom of the market.

Halbert discussed the Dalbar study in his e-letter. Travis Morien looked at both studies plus a few others.

[8/14/06] The Odean/Barber studies are mentioned briefly in Belsky and Gilvich's book Why Smart People Make Big Money Mistakes which is excerpted in the book What Do I Do With My Money Now?

[5/10/08] Mauldin writes more on Why Investors Fail

[7/10/11] links from Cougar3 (3/10/10):
http://tinyurl.com/yamaojt
http://tinyurl.com/yl6xpp5
http://tinyurl.com/2c55wy