Monday, November 28, 2005

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.

Thursday, November 24, 2005

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.

Wednesday, November 23, 2005

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.

Tuesday, November 22, 2005

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.

Monday, November 21, 2005

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

Wednesday, November 16, 2005

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.

Saturday, November 12, 2005

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

Tuesday, November 08, 2005

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.

Sunday, November 06, 2005

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.

Saturday, November 05, 2005

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]

Tuesday, November 01, 2005

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