Tuesday, October 31, 2006

Keep It Simple

Successful investing doesn't require a lot of work, research, or attention. Although you may miss out on the best-performing investments, you can achieve the most important of your financial goals simply by doing two things: saving enough money, and buying sound, diversified investments that provide solid returns.

1927-1923 Chart of Pompous Prognosticators

"Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels, such as (bears) have predicted. I expect to see the stock market a good deal higher within a few months."

- Irving Fisher, Ph.D. in economics, Oct. 17, 1929

[via tairbear00@chucks_angels]

The Little Book of Value Investing

[2/12/07] The Tweedy, Browne semi-manifesto and roadmap to superior investment returns, What Has Worked in Investing: Studies of Investment Approaches and Characteristics Associated with Exceptional Returns is a wonderful compilation of some of the most important studies of both domestic and international stock market returns. Investors of all levels of experience can benefit from it. It's free as well, which makes it particularly nice for the cost-conscious.

According to the research of Tweedy, Browne, there are five characteristics that tend to mark superior investment opportunities.

[12/21/06] What started with the deceptively simple and entertaining The Little Book That Beats the Market has quickly grown into the "Little Book, Big Profit" series. The second installment comes from another renowned investor and is aptly titled The Little Book of Value Investing.

Author Christopher H. Browne is a managing director at Tweedy, Browne Company, a storied investment firm he joined in 1969. Tweedy, Browne is an esteemed member of the Superinvestors of Graham-and-Doddesville, a designation awarded to a select group of investors that first followed Graham's teachings. Buffett named seven successful investors in a talk given at Columbia University in 1984 to commemorate the 50th anniversary of Security Analysis.

This Little Book is full of references illustrating what it means to be a value investor and why investors should take notice. In Browne's words: "Why value investing? Because it has worked since anyone began tracking returns. A mountain of evidence confirms that the principles of value investing have provided market-beating returns over long periods. And it is easy to do. . Yet in the face of compelling evidence, few investors and few professional managers subscribe to the principles of value investing."

[10/31/06] With all the books in print (200,000 new ones published last year alone), what could Christopher Browne's The Little Book of Value Investing add? Almost nothing -- but that's the point. Innovation is less necessary than the value investing framework. Buying stocks for less than they are worth is an easy concept to grasp. The idea doesn't need much scholarly refinement. Maybe that's why few business schools offer value investing classes.

Thursday, October 19, 2006

Dividend Aristocrats

[10/19/06] Standard & Poor's launched its Dividend Aristocrats index in May 2005. The index is made up of 57 companies that raise dividends for 25 or more consecutive years. It is distributed among a broad range of industries and split roughly 50/50 between growth and value stocks.

The end result? A well-balanced portfolio of stable, blue-chip cash cows that offers better-than-average returns with less volatility.

-- from a post by cougar3@chucks_angels

Stock Picking Shortcuts

Investors can be entranced by “hot new investment strategies” and “shortcuts to beat the market.” Often, such rankings are also based on limited amounts of data, such as the level or consistency of historic growth rates in sales or earnings, or the level of projected earnings growth.

To analyze the predictive capacity of some of these stock-picking shortcuts, we looked at the largest 1,600 U.S. companies by market capitalization over the past 15 years. No silver bullet emerged.

• Forecasts fall flat. Stocks with the highest long-term earnings-per-share growth forecasts underperformed stocks with the lowest earnings-per-share forecasts by over 5% per year.

• History isn’t always prologue. Stocks with the highest five-year historic earnings-per-share growth rates performed no better than stocks with the lowest five-year historic growth rates. The same was true for historic sales-per-share growth rates.

• Stability can be overrated. Stocks with the most stable five-year earnings-per-share growth rates performed about the same as stocks with the most volatile trend lines. The same pattern held for sales-per-share growth rates.

• Even combos fall short. Combination strategies using sales and earnings growth rates, forecasts or stability measures showed no consistent predictive power.

There are two big problems with these shortcuts: They encourage the tendency of individual investors to project long-term trends while ignoring recent events, and most of the data is already accounted for in the prices of the stocks.

[now for the ad]

To develop a better stock selection power ranking, investors need to look beyond easy-to-compute growth rate measures and forecasts that are known to everyone else. They need to dig deeper using more inputs to analyze how that growth was and is being achieved in order to get a more accurate view (versus the consensus) of what that growth is likely to be. Sound complicated? It is. That’s why Schwab came up with its Schwab Equity Ratings to do the homework for you, and to help investors focus on what we believe is important: long-term capital appreciation—not expected or historic earnings growth at any price.

Overall, Schwab Equity Ratings favor healthy companies that are expected to deliver positive earnings surprises not anticipated by the consensus of Wall Street analysts. That means A-rated stocks favor companies exhibiting a stable growth pattern, and we expect them, on average, to keep growing beyond consensus expectations.

By Brian Burda
CFA, Vice President, Schwab Equity Ratings®
Schwab Center for Investment Research®

Wednesday, October 18, 2006

The Superstar Portfolio

Paul Farrell presents another way to build a well-diversified portfolio. It's very simple: You pick nine winners diversified across Morningstar's nine style boxes.

Here are the four steps you need to follow, once a year:
  1. Scan Morningstar's database and pick the top no-load equities in each of the nine "style box" categories, from large-cap growth to small-cap value funds.
  2. Invest an equal amount in each of the nine funds.
  3. Save regularly, add new money and stay close to your allocations.
  4. Then next year scan Morningstar's database again: If the nine funds you already own aren't still near the top, replace them. Otherwise, hang onto your winners.
We asked Morningstar research analyst Mark Komissarouk to search the company's database for us. (Anyone can screen their database using their software.) We targeted no-loads open to new investors. You'll see that all the funds picked outperformed the 10-year averages of the S&P 500 (8.9%) and the Dow (9.4%). Even more important, every single one of them outperformed their peer category, often by a wide margin.

So check the results of this grand-slam opportunity: If you had invested $10,000 in each of these nine funds a decade ago, your nine-fund portfolio would have enjoyed a fabulous average annual return of 13.4%, which is 50% higher than the S&P 500's 10-year average return of 8.9%!

Tuesday, October 17, 2006

current bull market is four years old

The S&P 500 received official bull market status on May 9, 2003, when it closed at 933.41, more than 20% above the October 9 close. (Standard & Poor's defines a bull market as an advance of at least 20% from the low set during the prior bear market.) Today the S&P 500 is 75.5% higher than it was on October 9, 2002. Yet this milestone, while certainly positive, raises a few questions. For example, how does this bull market stack up with prior bull markets, and how much longer does this bull have to run?

It should be encouraging to people who constantly worry about investing at the top of a bull market that after one year of a new bull market, an average 86% of the prior bear market's decline is recovered. It may also be surprising to learn that, on average, all of the prior bear market's decline, and then some, is recovered by the second year of the new bull market. The bull markets of 1942, 1974, and 2002, which followed bear market declines of more than 45%, are the exceptions.

-- By Sam Stovall, S&P Chief Investment Strategist

Friday, October 13, 2006

Momentum Investing from a value perspective

Morningstar's Paul A. Larson explains how a value investor uses "momentum".

Newton's first law of motion essentially states that an object in motion will stay in motion unless acted upon by another force. As applied to stocks, it is my experience that equities also carry momentum, for a little while at least.

No, I don't plan on suddenly switching gears to play the "greater fool" game, buying the market's hottest stocks at high valuations and hoping to sell even higher. Quite the opposite. My plan is to take advantage of this momentum when it causes stocks to not reflect the intrinsic value of the underlying businesses they represent.

Usually a stock starts to fall when a company announces some bad news. But then investors start to get concerned about their paper losses, worrying that they perhaps missed something, and the selling continues. This additional selling begets more selling, with everyone fearful they are about to lose big. Momentum and fear have taken over, and the stock price often disconnects from the fundamentals.

When Mr. Market goes into a panic like this, there are often bargains to be found. We haven't had any screaming panics in the portfolios this year, but do consider Wrigley (WWY). Sure, the company has hit a speed bump with its acquisition of some of Kraft's (KFT) old brands, but is a few pennies in lost (or merely delayed) earnings per share really worth the stock falling by more than $10 per share since the beginning of the year? I think not.

I will also look to take advantage of inertia on the upside. When a stock I own starts to rise merely because it has recently risen and then trades well above our estimate of its intrinsic worth, that is when I will consider selling. (Early year 2000, anyone?) One might say I will attempt to take Warren Buffett's advice and be greedy when others are fearful, and fearful when others are greedy.

Inertia not only applies to things in motion, it also applies to things that are stationary. As Newton's law tells us, an object not in motion will remain not in motion, unless acted upon by another force. But in this case, Newton's first law is not always obeyed by Mr. Market, and the only force that matters in the long run is cash flow. Sometimes, the fundamental forces of an improving competitive position and growing profits apply a strong force on a stock, yet the stock does not move. This is a time to buy.

I've described this scenario before as a "pressure- cooker" situation, and at the moment, there appear to be many opportunities of this type. Take Berkshire Hathaway (BRK.B) and Wal-Mart (WMT), both of which we currently own in the Tortoise Portfolio. These companies have all steadily improved their core businesses and grown their profits in the past couple of years, yet their stocks have a lot of stationary inertia and have not gone much of anywhere in years, only recently showing some signs of life. In my view, it is only a matter of time before the forces created by the cash flow will be felt and these stocks will rise even further.

Wednesday, October 11, 2006

Insider's reaction to new market high

How did corporate insiders react last week to the stock market’s new high?

That’s an important question, since insiders presumably know a lot more about their companies’ prospects than do the rest of us. They are a company’s officers, directors and largest shareholders.

The news turns out to be surprisingly good.

This might not be immediately obvious, since the data show that last week they sold $3.20 worth of their companies’ stock for every $1 of stock that they bought, according to the Vickers Weekly Insider Report, a newsletter that keeps track of the insider transaction data reported to the SEC. But, placed in context, this sell-to-buy ratio of 3.20-to-1 is bullish.

A bit of historical perspective helps us to understand why this is so. Perhaps the most important thing to keep in mind is that the average insider almost always sells more of his firm’s stock than he buys. That’s because a big chunk of insiders’ compensation comes in the form of shares. Insiders’ predisposition to sell has become even stronger over the last decade, in fact, because of the increased portion of insiders’ compensation that comes through options.

According to Prof. Nejat Seyhun of the University of Michigan, who has extensively studied insiders’ behavior, the normal ratio of insider selling to insider buying now stands at around 6.5 to 1. The current ratio of 3.2-to-1 therefore represents less selling than average.

The other important piece of historical context to keep in mind is that it is entirely normal for insiders to speed up the pace of their selling as the market rises. This doesn’t mean that they are particularly bearish on their companies’ prospects, but simply reflects their opportunistic behavior to take advantage
of higher prices.

For that reason, according to Vickers, last week we should have “expected ongoing deterioration in the [sell-to-buy] ratio.”

But, in fact, that didn’t happen. The week before last the sell-to-buy ratio was 4.14-to-1, according to Vickers. So in dropping to 3.20-to-1 last week, insiders actually cut back on the pace of their selling as the market reached new highs.
That’s bullish. If insiders as a group felt that the market’s new highs were only temporary, and that a pullback in their companies’ shares was imminent, they presumably would be much heavier sellers right now.

- from Tomorrow's News Today

Gonzalo Garcia-Pelayo

Garcia-Pelayo is not your average roulette player. In the early 1990s, this Madrid native discovered that certain roulette wheels were not completely random. In fact, they were biased. Because of small imperfections -- tiny flaws in the roulette wheel's gears, differences in the sizes of the pockets, or even an unlevelled floor -- some numbers tended to come up more often than others. Garcia-Pelayo painstakingly recorded the winning numbers on thousands of spins, then conducted a statistical study on this raw data.

By continuously betting on the numbers that his analysis showed came up most often, Garcia-Pelayo turned a 5% disadvantage into a near 15% advantage over the powerful casinos of Europe. What can an individual do with such a favourable proposition? Well, over a span of a just a couple of years, Garcia-Pelayo and his family exploited this edge to win more than two million euro.

the fall season

[10/11/06] Jim Jubak gives five reasons to expect a fourth-quarter rally this year

[9/7/06] Sometimes a market trend is so strong, and so historically reliable, that you should just go with it. That's the case with the market's tendency to slump from late August well into October. Then the market, most years, rallies into the end of the year.

Everyone knows that September is historically the worst month of the year for the stock market, with August and October running close behind. In most years since 1950, after a brief rally into the third week in August, stocks have trended lower into September before making a bottom around the 20th of October that sets up the traditional year-end rally.

Friday, October 06, 2006

Fortune's Formula

[3/0/07] Munger comments on the Kelly Criterion

[11/2/06] Emil Lee demonstrates how to calculate the Kelly Formula

[10/6/06] Suppose there were a simple and elegant formula that helped you to maximize your long-term investment returns while minimizing the risk of total ruin. Sounds like something you'd like to use for your portfolio, doesn't it? In his recent book, Fortune's Formula, author William Poundstone details the development, use, and criticism of an equation that purports to do just what I have described. It is known as the Kelly Formula.

Wednesday, October 04, 2006

Dow's high may draw in investors

By hitting its highest level ever, the Dow Jones Industrial Average may end up heightening awareness and stir interest that will bring new investors in and old ones back.

The DJIA’s feat solidifies the transition between the bear market bubble and the generally more orderly approach that has evolved when it comes to investing. The DJIA, after all, is made up of sturdy blue chip companies and that’s what investors chose in making it the first major stock barometer to recover.

The Standard & Poor’s 500 Index is still off about 200 points away from its peak of 1527.46. And the Nasdaq Composite Index is down about 2801 points from its peak.

It’s been a long road back for the Dow. From Oct. 9, 2002, its lowest point between the last record on Jan. 14 and the new one made on Tuesday, the Dow has gained 4469.08 points, or 61%.

And the Dow’s accomplishment may have major reverberations in terms of aiding the market, some analysts feel.

“People in the financial field live the market day in and day out,” said Art Hogan, chief market analyst at Jefferies. But when the Dow makes a new high people on Main Street start taking note. “They say we’re past the bubble and that can bring
them back in.”

In other words, according to Hogan, “It’s a broad wake-up call. It proves the market is back.”

And aside from more retail-type investors, investors in gold, real estate or other areas may feel the stock market has more appeal.”

And the Dow isn’t done, Hogan said. “I think the market will go higher from here because the dynamic that got us here isn’t going away. We’ve got consistently low energy prices and a Fed that has stopped raising interest rates. Barring some
external forces, this market sees the path of least resistance is to the upside.”

There are others who believe that the Dow’s ascent bodes well for the market.

“From a psychological standpoint it adds confidence and gives investors a sense of security,” said Andre Bakhos, president of Princeton Financial. “The money is telling you that the market is OK.”

Other strategists are hoping the rally will become more broad based.

“Oil dropping below $60 is helping the general market psychology and drawing money towards financials and technology again,” said Barry Hyman, equity market strategist at EKN Financial Services. “As long as that psychology develops that way its going be hard to sell off the market.”

That said, some traders aren’t convinced that the Dow’s record will have a wide impact.

-- from Tomorrow's News Today

Monday, October 02, 2006

The Harvard advantage

Begin with what "everyone knows" -- that a Harvard graduate will, by virtue of possessing a Harvard diploma, get better job offers, earn a higher salary, and become more of a success in life than a graduate of ACME University. But according to a landmark study published in 1999 by Princeton economist Alan Krueger and Mellon Foundation researcher Stacy Dale, the accepted wisdom has the facts completely backwards. Elite colleges don't make successful students -- successful students apply to elite colleges.

To dig down to the truth of the matter, Krueger and Dale collected admissions data from students who entered college in 1976 at a range of schools, both prestigious and less so, from all across the nation. Fast-forwarding 20 years, the researchers examined the salaries that these students were earning in 1996. They focused their study on two groups of students, both of which had applied to and been accepted by elite colleges. Students from the first group -- let's call them the "Ivies" -- accepted the offers, graduated, and entered the workforce carrying their Ivy League sheepskins. In contrast, the "non-Ivies" were also accepted, but turned the elite colleges' offers down and chose to enter more modest schools (with more modest price tags.)

Result: There was essentially no difference between the salaries earned by the two groups of students. To the contrary, the Ivy student who entered college with a 1,200 SAT in 1976 was, on average, earning about $1000 per year less than the non-Ivy student with the same SAT score. The same non-Ivy student who had turned the elite school down.

Conclusion: Smart kids tend to choose elite schools. But if kids are already smart, whether they choose to "go Ivy" or not makes no difference to their success later in life.

The Billionaire Strategy

[10/12/06] Last week, Foolish colleague Tim Hanson revealed some of the secrets of the world's billionaires. Surely his findings were obvious to most: Master investors make oodles of money, especially those who faithfully follow a strategy that plays to their inherent strengths.

What he didn't mention is that entrepreneurs dominate the same list of Forbes billionaires, including five of the top 10.

[10/2/06] What does the Forbes 400 tell you about the correct strategy to use to become a billionaire?