Sunday, July 27, 2008

Investment Decision Checklists

One of Charlie Munger’s most elementary pieces of advice for investors and thinkers is to utilize checklists when ever possible, as a way to improve cognitive ability and minimize errors. In a 2003 speech to UC Santa Barbara Economics, Munger put it thusly:

You don’t have just a hammer. You’ve got all the tools. And you’ve got to have one more trick. You’ve got to use those tools checklist-style, because you’ll miss a lot if you just hope that the right tool is going to pop up unaided whenever you need it. But if you’ve got a full list of tools, and go through them in your mind, checklist-style, you will find a lot of answers that you won’t find any other way.

Gurufocus started a thread discussing investment checklists. We will create a page where users can set up their own checklist, and data in our databases will be used for users to verify each item in the checklist.

This is what they come up with.

First of All
Is this a good business?
Is this a simple business? Is there something that cannot be understood in the business operations, financial instruments?

Business Climate
Is this a cyclical business?
Where is it at the business cycle of the industry?
What are the macro-trends affecting the company?
What is the economic outlook for the companies industry?
What will recession do to the business?

Growth and Competitiveness
Will the company be around in 20 years?
Will (will, not should) earnings and sales and the dividend grow over 5 years?
What's their competitive advantage and moat?
Have sales historically increased annually?
Is the company doing something that is unconventional for their business? Does the company focus on short term profit and forget the long term viability of the business? (sub-prime loans are examples)
Where is the company at in its growth cycle?
Does the company have a moat or durable competitive advantage?

Management
Who are the founders/BOD, what other companies have they been involved in, what are their credentials/biographies?
Are they shareholder oriented?
Are they buying shares lately?

High Quality?
Good return on equity?
Recent Guru buying
What is the downside risk
What is the debt level of the company? Is it increasing or declining?
Is the business predictable? What is the predictability of the business?
Does the business have enough moat to maintain its profitability?

Valuation
What is the earning yield? Is it undervalued?
What is the valuation of the company? What is the margin of safety?
If DCF applies, what is the valuation?
Why is this company undervalued? Is this reason likely to get worse before it gets better?

Level of Confidence
If the share price went down by 50% the day after I bought, would I immediately worry about having made a mistake, or would I buy more shares?
Is this a speculation? What percentage of speculation is there with this idea?
What is the level of confidence we have?

[basically, my checklist boils down to: is it a good company? And is it selling (reasonably) cheap?]

Obama selloff in November?

says Tobin Smith.

If Barack Obama is leading by 10 points over John McCain going into November, I guarantee you that you’re going to have a sell-off purely for locking in capital gains. I mean, Obama said he wants to go to 28%. Don’t fall for the trap that Obama really thinks he’s going to become president of the United States on a platform. Right now, everybody is pimping for John Edwards’ delegates— they need 235 delegates from Edwards. So right now, Obama sounds like he’s a socialist. You have to assume that when that’s done, whenever Obama is the one who’s the leader in the clubhouse—because Edwards hates Hillary Clinton—once he gets the delegates, then you’ll see that rhetoric move back to the middle.

Alternative energy is going to kick ass. The other thing is you’re going to assume that the Fed is going to be at 2% to 2.25%, which means that financials will do well as soon as they make the turn. And the turn is that you will have clarity on Citibank and the real big guys, we’ll have real transparency. We still do not have transparency.

EQUITIES: Is there one rule of thumb regarding investing?

Smith: You have to understand that there’s no free lunch. If you want a bond rate of return, then buy the bond. If you’re looking for superior return, you have to come to grips with the idea that you’re getting paid extra because you’re willing to ride out the bumps in the road. Many times, investors sort of miss that part.Usually, themost powerful psychological ingredient is the fear of not being greedy enough. The other part is that it’s not profitable, nor is it prudent, to always own growth stocks. The thing about an S-curve change that nobody realizes is, if something’s growing rapidly, it’s also getting to satiation rapidly. If it’s slow growth, it’s going to take a long time.

[roundabout link via Mauldin, who is now appearing in Equities Magazine]

Tuesday, July 22, 2008

Have financial stocks hit bottom?

Investment strategist Barry Ritholtz wrote in his blog that one reason to doubt that the bottom is in for bank stocks is that The New York Times, The Wall Street Journal and Barron's (the latter two sharing an owner with this newswire) all produced prominent articles on Saturday suggesting the worst was over for financial stocks.

"Can you recall the last time three major media players all picked the bottom in a market or sector on the exact same day -- and were all proven correct?" he asked.

Monday, July 21, 2008

taxing the rich

Washington is teeing up "the rich" for a big tax hike next year, as a way to make them "pay their fair share." Well, the latest IRS data have arrived on who paid what share of income taxes in 2006, and it's going to be hard for the rich to pay any more than they already do. The data show that the 2003 Bush tax cuts caused what may be the biggest increase in tax payments by the rich in American history.

The nearby chart shows that the top 1% of taxpayers, those who earn above $388,806, paid 40% of all income taxes in 2006, the highest share in at least 40 years. The top 10% in income, those earning more than $108,904, paid 71%. Barack Obama says he's going to cut taxes for those at the bottom, but that's also going to be a challenge because Americans with an income below the median paid a record low 2.9% of all income taxes, while the top 50% paid 97.1%.

... If Mr. Obama does succeed in raising tax rates on the rich, we'd also wager that the rich share of tax payments would fall. The last time tax rates were as high as the Senator wants them -- the Carter years -- the rich paid only 19% of all income taxes, half of the 40% share they pay today. Why? Because they either worked less, earned less, or they found ways to shelter income from taxes so it was never reported to the IRS as income.

The way to soak the rich is with low tax rates, and last week's IRS data provide more powerful validation of that proposition.

[via john/chucks_angels]

Saturday, July 19, 2008

Zacks Rank is wrong

.. 44% of the time. Which means it's right 56% of the time.

Steve Reitmeister explains (video) how this short-term (1 to 3 months) strategy beats the markets despite being wrong nearly half the time.

The Bear is Back

If any of us needed further confirmation that things are bad out there, we got the signal right before the July 4 holiday -- the markets officially dipped into bear-market territory. The Dow Jones Industrial Average, Nasdaq Composite, and the S&P 500 Index are all down more than 20% from last fall's highs.

A lot of investors have lost a good chunk of their portfolio since those highs. And with a black cloud hanging over the financial sector, home values continuing to plummet, and gas prices resting comfortably above $4/gallon, the economic outlook is murky at best.

No one will deny that seeing the market fall 20% or more is unsettling. But if you're a truly long-term investor, does it really matter?

The market has endured bear markets before -- 33 of them since the Dow Jones Industrial Average was created. Since 1896, then, the market has dropped more than 20% on 33 separate occasions -- and each time, it recovered to reach new highs.

Sure, the length of time it took the market to recover those losses varied, but in most cases, the year or two directly following the end of the bear market saw a considerable jump in average share prices.

[Then again, the times it didn't jump back in a year or two were the ones that really hurt.]

market sentiment hits bottom?

Financial market turmoil has returned with a vengeance, weighing on the dollar and pressuring global stocks to distressing lows. However, an extreme in negative investor sentiment, a break in oil prices and some better-than-expected bank earnings spurred a rally in stocks this week—led by an impressive comeback in financials.

Stresses in the short-term funding markets are elevated once again, but not to the extent seen in mid-March. The Federal Reserve's aggressive rate cuts and lending facilities appear to be working. The latest market riot revolved around worries about the stability of the broader financial system—specifically the fate of government-sponsored entities (GSEs) Fannie Mae (FNM) and Freddie Mac (FRE).

Together, the GSEs own roughly $1.5 trillion in mortgages and guarantee $3.7 trillion. According to BCA Research, a failure would expose $4.3 trillion in mortgage-backed securities (MBSs) to losses, as well as $1.5 trillion in agency debt to potential default. Of course, the government cannot allow this to happen: An emergency weekend meeting July 12–13 of the Federal Reserve and the U.S. Treasury Department resulted in a plan to keep the GSEs in the "current form," assuaging concerns that they will be allowed to fail.

However, in one of the largest bank failures in U.S. history, the FDIC was forced to take over IndyMac Bancorp (IDMC), which was a large player in the Alt-A and subprime mortgage market. Although the majority of IndyMac's deposits are insured, the bank's failure sparked concerns that many other regional banks could potentially see the same fate.

With many financial institutions scheduled to report second-quarter financial results, investors became increasingly concerned that banks would not be able to raise fresh capital to cover losses—particularly because sovereign wealth funds (SWFs) could potentially shy away after seeing their investments during the past year lose value.

This dour outlook on the financial sector, in combination with still-high oil prices, pressured nearly all investor sentiment measures to below the March-low levels and close to the lows seen in the 1998 Long-Term Capital Management crisis (an infamous Fed-orchestrated bailout) and the 2002 tech bubble. Volume and volatility measures have not registered capitulation levels, but the depressed market and economic sentiment set the market up for a significant bounce. Although more banks and thrifts are likely to fail, calamitous failures (like IndyMac) have historically occurred near market lows.

Remember, it's not just fundamentals that drive stocks and markets but the relationship between fundamentals and expectations. At market lows, the expectations bar has usually been set sufficiently low for fundamentals to hurdle them, even if those fundamentals remain weak in absolute terms.

As panic gives way to the reality that the financial system and federal regulatory bodies are well-equipped to deal with this crisis, and/or if oil prices continue their descent, we see the potential for additional sharp rallies like those we witnessed this week. However, we remain skeptical that an enduring rally is in the offing until inflation pressures ease significantly and the U.S. housing market stabilizes.

Wednesday, July 16, 2008

Bombay near capitulation?

[7/13] Indian ADR's got the hammering of their life at the Nasdaq/NYSE Friday last, slicing 13 per cent off the market cap of Infosys, 7 per cent for ICICI Bank and 4 per cent for HDFC Bank. Banks, Real Estate and Technology stocks should be the key contributors to a possible enmasse selling this Monday, as investors move out in droves towards the EXIT gates.

-Conditions are now set for a mass capitulation beginning July 14, 2008 and getting close to a situation where the Buyer's side will become non-existent.

[via Maverick@investwise]

Tuesday, July 15, 2008

To the rescue of Fannie and Freddie

The Bush administration hastily arranged the dramatic Sunday evening rescue of Fannie Mae and Freddie Mac after Wall Street executives and foreign central bankers told Washington that any further erosion of confidence could have a cascading effect around the world, officials said on Monday.

Treasury Secretary Henry M. Paulson Jr. and other top officials were warned, after Fannie and Freddie lost nearly half their stock market value on Friday morning, that any more turmoil threatened to reduce the value of trillions of dollars of the companies’ debt and other obligations, which are held by thousands of domestic and foreign banks, pension funds, mutual funds and other investors, government officials said.

The warnings of a potential systemic failure led to the resulting rescue package, and one of the most striking — though unspoken — regulatory shifts in modern times. For decades, Treasury secretaries and Federal Reserve chairmen have insisted that the government did not stand behind the debt of Fannie and Freddie. But the safety net Mr. Paulson announced on Sunday sends the opposite message: that the government is determined not to let either one fail.

The plan calls on Congress to give officials the power to inject billions of dollars into the beleaguered companies through investments and loans. Until the plan is adopted, the Federal Reserve has agreed to let the companies have access to its so-called discount lending window, a move that most regard as a symbolic gesture intended to show the markets that the government stands ready to help the companies if they need cash.

Saturday, July 12, 2008

Six in a row

It's clear that the "crisis of confidence" in Fannie Mae (FNM) and Freddie Mac (FRE) was a prime factor in driving the stock market down this week to its sixth weekly loss in a row (Standard & Poor's 500 index).

Losing streaks of this length are rare. In fact, the last run of six down weeks ended at the major market bottom in October 2002. However, I still firmly believe that we're due for a bounce any day now, although the market will probably come back and "test" today's lows later in the summer.

-- Richard Band

Freddie and Fannie in Freefall

The dike might be cracking on the U.S. financial system and U.S. regulators are trying to figure out how to make sure it doesn't burst.

Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE), the behemoth caretakers of U.S. home ownership financing, are looking increasingly unstable. Their demise would spell disaster, and the U.S. cannot allow that to happen.

The market went nuts this week as former St. Louis Fed President Albert Poole suggested that Freddie Mac is technically insolvent. What does the market think? As of Friday morning, Fannie and Freddie stock were down 53% and 64%, respectively ... just this week!

IndyMac fails

WASHINGTON (Reuters) - U.S. banking regulators swooped in to seize mortgage lender IndyMac Bancorp Inc on Friday after withdrawals by panicked depositors led to the third-largest banking failure in U.S. history.

California-based IndyMac, which specialized in a type of mortgage that often required minimal documents from borrowers, became the fifth U.S. bank to fail this year as a housing bust and credit crunch strain financial institutions.

The federal takeover of IndyMac capped a tumultuous day for U.S. markets that saw stocks slide on a surging oil price and renewed fears about the stability of the top two home financing providers, Fannie Mae and Freddie Mac.

IndyMac will reopen fully on Monday as IndyMac Federal Bank under Federal Deposit Insurance Corp supervision, but tensions ran high as customers at a branch at its Los Angeles-area headquarters read a notice in the window saying it was closed.

Friday, July 11, 2008

upgraded broker ratings

I'm sure a lot you have experienced the pleasure of waking up and finding that a covering broker upgraded their rating on one of your stocks.

I'm also guessing that you probably experienced the opposite, and found that one of the brokers downgraded your stock.

While nobody can perfectly guard against downgrades (or forecast all upgrades), it's important to know how the market reacts. Therefore, you can stay in your upgraded winners (or buy if you're on the fence) and consider getting out if a downgrade comes your way.

When I'm screening for new stocks, I like to look for companies that have recently seen a broker rating upgrade. Tests have proven that stocks with broker rating upgrades outperform those that don't get upgraded and really outperform those that get downgraded.

-- Kevin Matras, Zacks.com

Wednesday, July 09, 2008

Reinvigorating the PEG ratio

Marc Gerstein ran a series of backtests to examine different strategies using the PEG ratio.

Even the gurus are down

If you haven't been having a great time in the market since last spring, you may take some consolation by seeing how many 'fund managers of the year' and other top-notch investors have been faring over the recent past. Even Warren Buffett is now in negative territory for both the 6 and 12-month periods just ended.

[via g66k]

Tuesday, July 08, 2008

Sir John Templeton

Sir John Templeton, a Tennessee-born investor and philanthropist who amassed a fortune in global stocks and gave away hundreds of millions of dollars to foster understanding in what he called "spiritual realities," died on Tuesday in Nassau, the Bahamas, where he had lived for decades. He was 95.

His death, at Doctors Hospital in Nassau, was caused by pneumonia, said Don Lehr, a spokesman for the Templeton Foundation.

The foundation awards the Templeton Prize, one of the world's richest, and sponsors conferences and studies reflecting the founder's passionate interest in "progress in religion" and "research or discoveries" on the nebulous borders of science and religion.

In a career that spanned seven decades, Sir John dazzled Wall Street, organized some of the most successful mutual funds of his time, led investors into foreign markets, established charities that now give away $70 million a year, wrote books on finance and spirituality and promoted a search for answers to what he called the "Big Questions" — realms of science, faith, God and the purpose of humanity.

Along the way, he became one of the world's richest men, gave up American citizenship, moved to the Bahamas, was knighted by the Queen of England and bestowed much of his fortune on spiritual thinkers and innovators: Mother Teresa, Billy Graham, Aleksandr Solzhenitsyn, the physicist Freeman Dyson, the philosopher Charles Taylor and a pantheon of Christians, Jews, Muslims, Buddhists and Hindus.

* * *

Templeton's 16 Rules to Investment Success

Friday, July 04, 2008

Neglected stocks

Last week, Mark Hulbert reported on a new study in The New York Times that found that from 1962 to 2003, stocks that could go at least a day without trading any shares -- like Brazil Fast Food -- outperformed stocks that traded every day by more than 8 percentage points annually. And that was the case even though the "neglected stock portfolio," as researchers Athanasios Bolmatis and Evangelos Sekeris called it, contains "a disproportionate number of stocks that underperform the market by a dramatic margin."

Good To Great

Jim Collins, already established as one of the most influential management consultants, further established his credibility with the wildly popular Good to Great: Why Some Companies Make the Leap...and Others Don’t, originally published in 2001. The book went on to be one of the bestsellers in the genre, and it is now widely regarded as a modern classic of management theory.

Collins takes up a daunting challenge in the book: identifying and evaluating the factors and variables that allow a small fraction of companies to make the transition from merely good to truly great. ‘Great,’ an admittedly subjective term, is operationally defined according to a number of metrics, including, specifically, financial performance that exceeded the market average by several orders of magnitude over a sustained period of time. Using these criteria, Collins and his research team exhaustively catalogued the business literature, identifying a handful of companies that fulfilled their predetermined criteria for greatness. Then, the defining characteristics that differentiated these ‘great’ firms from their competitors were quantified and analyzed.

[via gfs1354@chucks_angels]

Thursday, July 03, 2008

price anchoring

Price anchoring is a mental mistake that can be very costly to your long-term returns.

As soon as your intuition seizes on a number -- any number -- it becomes stuck, as if it had been coated in glue. That's why real estate agents will usually show you the most expensive house on the market first, so the others will seem cheap by comparison -- and why mutual fund companies nearly always launch new funds at $10.00 per share, enticing new investors with a "cheap" price at the beginning.

Share prices are complicated things -- they account for not only the underlying quality of the company, but also public opinion, assumed earnings growth, and investor enthusiasm.

Anchoring to a price means you'll ignore the more important trait -- value.

Tuesday, July 01, 2008

financial stocks are cheap

says Richard Pzena.

In brief, the subprime mortgage and liquidity crisis has sent investors into panic mode about financial stocks, driving their prices far below their underlying value. Major firms with strong franchises have fallen precipitously, despite their historical records.

A bubble not unlike that seen with internet stocks in the late 1990s seems to have formed, with energy, commodities, and industrial cyclicals being bid up with little regard to earnings. Indeed, the spread in valuations between commodity and financial stocks is wider than at any time in the past 55 years, and financials represent one of the most compelling investment opportunities we have ever seen.