Given the volatility of stocks and bonds, many investors assume that gold is a smarter investment. If you also want to become a goldbug, you have several options. You might invest in gold stocks or gold mutual funds, but these can be rather volatile, too. You might buy into gold accounts at bullion banks, which require large minimum investments, or gold certificates and pool accounts, which don't. Gold coins or bars might be tempting, but you'll need a safe place to store them.
David Kathman of Morningstar.com has noted that "Returns aren't the point when you're investing in gold; diversification is ... A small amount of gold alongside your stocks can be a stabilizer." But all does not glitter in the world of gold. In his seminal book "Stocks for the Long Run" (McGraw-Hill, $30), University of Pennsylvania finance professor Jeremy Siegel reveals what a dollar invested in various things would have grown to from 1802 to 2001 (yes, nearly 200 years!): stocks, $599,605; bonds, $952; bills, $304; and gold, 98 cents. (Amounts have been adjusted for inflation.)
So, through many wars and economic times even more troubling than those we face today, gold hasn't proven to be a great long-term investment. True, it has zoomed up in recent years to nearly $700 per troy ounce, but that's a level it approached back in the late '70s and early '80s, and it spent most of the intervening years in the $300s and $400s.
In Fortune magazine, David Rynecki noted: "Gold investors are notoriously bad forecasters. From 1985 to 1987, for example, a collapse in the dollar boosted gold 76 percent and had many metalheads predicting an extended rally. Instead the price fell 15 percent the very next year." He adds: "Even bullish gold pros caution the average investor to put no more than 5 percent of a total portfolio into gold-related holdings and say it's safest to invest through funds."
Saturday, August 11, 2007
Wednesday, August 08, 2007
the more research,
Should you spend countless hours researching a stock before buying it, or just a few hours? The common wisdom is that the more time you spend on research, the better your investment results will be. But is this correct?
Not according to studies on the subject. At least two I have seen came to the conclusion that anything more than a cursory review of a company’s prospects is a waste of time. One study looked at whether more information was useful to experienced horse racing gamblers. The researchers first gave the gamblers a few items of relevant information (age of horse, pedigree, jockey, etc) and asked them to predict which horse would win the race.
They then gave out dozens more items of information about the race
and asked the experts to predict again, based on the additional information they had received. The conclusion was that the first few items of information given to them were useful but further information had no effect on the accuracy of their predictions. The gamblers were far more confident about their predictions after receiving more information, but this didn’t translate into accuracy.
Another study showed that sell-side stock analysts, who spend 50-80 hours a week on research and presumably have loads of information at their fingertips, are no better than a monkey with a dart at predicting a company’s five-year earnings growth rate. In fact, they are actually worse than a monkey with a dart because they tend to project the recent past into the distant future, rather than assuming growth will revert to the mean. If the analysts’ projections were simply random, the results may have been closer to reality.
[via pohick2@chucks_angels]
Not according to studies on the subject. At least two I have seen came to the conclusion that anything more than a cursory review of a company’s prospects is a waste of time. One study looked at whether more information was useful to experienced horse racing gamblers. The researchers first gave the gamblers a few items of relevant information (age of horse, pedigree, jockey, etc) and asked them to predict which horse would win the race.
They then gave out dozens more items of information about the race
and asked the experts to predict again, based on the additional information they had received. The conclusion was that the first few items of information given to them were useful but further information had no effect on the accuracy of their predictions. The gamblers were far more confident about their predictions after receiving more information, but this didn’t translate into accuracy.
Another study showed that sell-side stock analysts, who spend 50-80 hours a week on research and presumably have loads of information at their fingertips, are no better than a monkey with a dart at predicting a company’s five-year earnings growth rate. In fact, they are actually worse than a monkey with a dart because they tend to project the recent past into the distant future, rather than assuming growth will revert to the mean. If the analysts’ projections were simply random, the results may have been closer to reality.
[via pohick2@chucks_angels]
Tuesday, July 31, 2007
Bogle on rebalancing
We’ve just done a study for the NYTimes on rebalancing, so the subject is fresh in my mind. Fact: a 48%S&P 500, 16% small cap, 16% international, and 20% bond index, over the past 20 years, earned a 9.49% annual return without rebalancing and a 9.71% return if rebalanced annually. That’s worth describing as “noise,” and suggests that formulaic rebalancing with precision is not necessary.
We also did an earlier study of all 25-year periods beginning in 1826 (!), using a 50/50 US stock/bond portfolio, and found that annual rebalancing won in 52% of the 179 periods. Also, it seems to me, noise. Interestingly, failing to rebalance never cost more than about 50 basis points, but when that failure added return, the gains were often in the 200-300 basis point range; i.e., doing nothing has lost small but it has won big. (I’m asking my good right arm, Kevin, to send the detailed data to you.)
My personal conclusion. Rebalancing is a personal choice, not a choice that statistics can validate. There’s certainly nothing the matter with doing it (although I don’t do it myself), but also no reason to slavishly worry about small changes in the equity ratio. Maybe, for example, if your 50% equity position grew to, say, 55% or 60%.
In candor, I should add that I see no circumstance under which rebalancing through an adviser charging 1% could possibly add value.
[via roberts1001 @ chucks_angels]
We also did an earlier study of all 25-year periods beginning in 1826 (!), using a 50/50 US stock/bond portfolio, and found that annual rebalancing won in 52% of the 179 periods. Also, it seems to me, noise. Interestingly, failing to rebalance never cost more than about 50 basis points, but when that failure added return, the gains were often in the 200-300 basis point range; i.e., doing nothing has lost small but it has won big. (I’m asking my good right arm, Kevin, to send the detailed data to you.)
My personal conclusion. Rebalancing is a personal choice, not a choice that statistics can validate. There’s certainly nothing the matter with doing it (although I don’t do it myself), but also no reason to slavishly worry about small changes in the equity ratio. Maybe, for example, if your 50% equity position grew to, say, 55% or 60%.
In candor, I should add that I see no circumstance under which rebalancing through an adviser charging 1% could possibly add value.
[via roberts1001 @ chucks_angels]
Monday, July 30, 2007
Grantham sees opportunity
Jeremy Grantham says he's spotted the third great investing opportunity of his career. The first was small caps in the 1970s. The second was real estate, Treasury Inflation-Protected Securities, and value stocks during the tech bubble in 2000. Before you get too excited, I should make clear that the main opportunity today, in Grantham's view, is getting out of the way and watching the markets plummet in what he calls a slow-motion train wreck. Grantham made this call in a report published July 25--a day before the Dow got 300 points sliced off the top (talk about instant gratification!).
Grantham calls this new opportunity "anti-risk." He says the opportunity lies more in bonds than stocks. "The ideal way of playing this third great opportunity is perhaps to create a basket of a dozen or more different anti-risk bets, for to speak the truth, none of us can know how this unprecedented risk bubble with its new levels of leverage and new instruments will precisely deflate. Some components, like subprime and junk bonds, may go early, and some equity risk spreads may go later."
I asked Grantham what else individual investors could do to make some anti-risk bets of their own. The wagers he's making for clients are too complicated for individuals, but he did offer a few ideas in addition to buying TIPS.
• Hold a lot of cash so that you'll have plenty of dry powder to take advantage of cheaper markets in years to come.
• Regular bonds are not too bad to own. (This means core high-quality bonds, such as corporate or Treasury bonds.)
• Short the Russell 2000 and go long on the S&P 500.
The final notion reflects Grantham's view that low-quality small caps will be terrible after many years of outperformance and high-quality large caps will fare well after years of lagging. The S&P 500 isn't a perfect proxy for GMO's definition of high quality, but it's close. Grantham notes that 80% of the companies they consider high quality are in the United States. "If the economy weakens substantially, these stocks will be pure gold," he said.
Grantham calls this new opportunity "anti-risk." He says the opportunity lies more in bonds than stocks. "The ideal way of playing this third great opportunity is perhaps to create a basket of a dozen or more different anti-risk bets, for to speak the truth, none of us can know how this unprecedented risk bubble with its new levels of leverage and new instruments will precisely deflate. Some components, like subprime and junk bonds, may go early, and some equity risk spreads may go later."
I asked Grantham what else individual investors could do to make some anti-risk bets of their own. The wagers he's making for clients are too complicated for individuals, but he did offer a few ideas in addition to buying TIPS.
• Hold a lot of cash so that you'll have plenty of dry powder to take advantage of cheaper markets in years to come.
• Regular bonds are not too bad to own. (This means core high-quality bonds, such as corporate or Treasury bonds.)
• Short the Russell 2000 and go long on the S&P 500.
The final notion reflects Grantham's view that low-quality small caps will be terrible after many years of outperformance and high-quality large caps will fare well after years of lagging. The S&P 500 isn't a perfect proxy for GMO's definition of high quality, but it's close. Grantham notes that 80% of the companies they consider high quality are in the United States. "If the economy weakens substantially, these stocks will be pure gold," he said.
Percentage Retracements
In almost all uptrends and downtrends after a particular market move, prices retrace a portion of the previous trend before continuing the move in the original direction. Studies show these countertrend moves tend to fall into predictable percentage parameters.
The application best know in this phenomenon is the 50% retracement. For instance, a market is trending higher traveling from the 100 level to the 200 level. Most often, the subsequent reaction retraces half of the previous movement, to about 150, then regains its momentum and moves upward. This market tendency happens frequently and in all degrees of trend, such as, major and secondary. It also occurs in all trading systems including day trading, swing trading and options trading.
There are also minimum and maximum percentage parameters, one-third and two-third retracements, which are useful. Divide the trend into thirds, and site the minimum retracement as approximately 33% and the maximum as 66%. So when the corrections in the market retraces at least a third of its movement, the trader can compute a 33-50% area as a general frame for buying opportunities.
The 66% parameter becomes a critical area in the event the retracement enters that area. For the trend to be maintained, the correction must not go beyond the two-thirds mark. However, this 66% area becomes a relatively low risk buying area in an uptrend and selling area in a downtrend. Retracement beyound 66%, two-thirds, strongly indicates a trend reversal instead of just a retracement.
[via investwise]
The application best know in this phenomenon is the 50% retracement. For instance, a market is trending higher traveling from the 100 level to the 200 level. Most often, the subsequent reaction retraces half of the previous movement, to about 150, then regains its momentum and moves upward. This market tendency happens frequently and in all degrees of trend, such as, major and secondary. It also occurs in all trading systems including day trading, swing trading and options trading.
There are also minimum and maximum percentage parameters, one-third and two-third retracements, which are useful. Divide the trend into thirds, and site the minimum retracement as approximately 33% and the maximum as 66%. So when the corrections in the market retraces at least a third of its movement, the trader can compute a 33-50% area as a general frame for buying opportunities.
The 66% parameter becomes a critical area in the event the retracement enters that area. For the trend to be maintained, the correction must not go beyond the two-thirds mark. However, this 66% area becomes a relatively low risk buying area in an uptrend and selling area in a downtrend. Retracement beyound 66%, two-thirds, strongly indicates a trend reversal instead of just a retracement.
[via investwise]
Friday, July 27, 2007
America gives it away
According to a recent report from the Giving USA Foundation, in 2006, Americans donated $295 billion to charities -- a slight but impressive increase over 2005, which saw more than its share of (hopefully) once-in-a-lifetime disasters. (Back out the natural-disaster donations, and 2006 giving was up 3.2%.) Giving USA stats show that the United States ranks first worldwide in philanthropy, at 1.7% of GDP. (The United Kingdom is No. 2, at 0.73%.)
Saturday, July 21, 2007
US Equity Returns: What To Expect
Does one's entry level into the market, i.e. the valuation of the market at the time of investing, make a significant difference to subsequent investment returns?
In an attempt to cast light on this issue, an interesting multi-year comparison of the price-earnings (PE) ratios of the S&P 500 Index (as a measure of stock valuations) and the forward real returns was done by my colleagues at Plexus Asset Management. The study covered the period from 1871 to 2006 and used the S&P 500 Composite Index (and its predecessors). In essence, a total real return index and coinciding ten-year forward real returns were calculated, and used together with PEs based on rolling ten-year earnings.
In the first analysis the PEs and the ten-year forward real returns were grouped in five quintiles (i.e. 20% intervals) (Diagram A.1). The cheapest quintile had an average PE of 8,5 with an average ten-year forward real return of 11,0% p.a., whereas the most expensive quintile had an average PE of 21,6 with an average ten-year forward real return of only 3,2% p.a.
The study was then repeated with the PEs divided in smaller groups, i.e. deciles or 10% intervals (see Diagrams A.2 and A.3). This analysis strongly confirms the downward trend of the average ten-year forward real returns from the cheapest grouping (PEs of less than six) to the most expensive grouping (PEs of more than 21). The second study also shows that any investment at PEs of less than 12 always had positive ten-year real returns, while investments at PE ratios of 12 and higher experienced negative real returns at some stage.
A third observation from this analysis is, interestingly, that the ten-year forward real returns of investments made at PEs between 12 and 17 had the biggest spread between minimum and maximum returns and were therefore more volatile and less predictable.
Based on the above research findings, with the S&P 500 Index's current PE of 18.4 and dividend yield of 1.8%, investors should be aware of the fact that the market is by historical standards not in cheap territory, arguing for luke-warm returns. Although the research results offer no guidance as to when and at what level the current bull market will run out of steam, they do indicate that it would be irrational to bank on above-average returns from these valuation levels. As a matter of fact, investors should expect higher volatility and even the possibility of some negative returns.
In an attempt to cast light on this issue, an interesting multi-year comparison of the price-earnings (PE) ratios of the S&P 500 Index (as a measure of stock valuations) and the forward real returns was done by my colleagues at Plexus Asset Management. The study covered the period from 1871 to 2006 and used the S&P 500 Composite Index (and its predecessors). In essence, a total real return index and coinciding ten-year forward real returns were calculated, and used together with PEs based on rolling ten-year earnings.
In the first analysis the PEs and the ten-year forward real returns were grouped in five quintiles (i.e. 20% intervals) (Diagram A.1). The cheapest quintile had an average PE of 8,5 with an average ten-year forward real return of 11,0% p.a., whereas the most expensive quintile had an average PE of 21,6 with an average ten-year forward real return of only 3,2% p.a.
The study was then repeated with the PEs divided in smaller groups, i.e. deciles or 10% intervals (see Diagrams A.2 and A.3). This analysis strongly confirms the downward trend of the average ten-year forward real returns from the cheapest grouping (PEs of less than six) to the most expensive grouping (PEs of more than 21). The second study also shows that any investment at PEs of less than 12 always had positive ten-year real returns, while investments at PE ratios of 12 and higher experienced negative real returns at some stage.
A third observation from this analysis is, interestingly, that the ten-year forward real returns of investments made at PEs between 12 and 17 had the biggest spread between minimum and maximum returns and were therefore more volatile and less predictable.
Based on the above research findings, with the S&P 500 Index's current PE of 18.4 and dividend yield of 1.8%, investors should be aware of the fact that the market is by historical standards not in cheap territory, arguing for luke-warm returns. Although the research results offer no guidance as to when and at what level the current bull market will run out of steam, they do indicate that it would be irrational to bank on above-average returns from these valuation levels. As a matter of fact, investors should expect higher volatility and even the possibility of some negative returns.
Friday, July 20, 2007
Is the party over?
It may surprise you to learn that a slowdown in the growth rate of corporate earnings doesn’t necessarily mean the party’s over for stocks. Not only are earnings slowdowns natural at this time in the economic cycle, but history has shown the market actually has performed best during such periods.
That’s because the stock market looks ahead. Once investors believe the Fed is done raising rates, price/earnings (P/E) ratios tend to expand—unless they are already unrealistically high, which they’re not now.
That positive story, combined with low core inflation, could yet provide the fuel for another leg up in the market. In such late-cycle rallies, history also suggests that growth and large-cap stocks tend to be market stars.
That’s because the stock market looks ahead. Once investors believe the Fed is done raising rates, price/earnings (P/E) ratios tend to expand—unless they are already unrealistically high, which they’re not now.
That positive story, combined with low core inflation, could yet provide the fuel for another leg up in the market. In such late-cycle rallies, history also suggests that growth and large-cap stocks tend to be market stars.
Thursday, July 19, 2007
Morningstar looks at China
Visiting China in 2007 is a bit like visiting Silicon Valley in 1999 at the height of the dot-com era. Things are happening at light speed, and the economy is white hot here, but caution is certainly warranted. The economy has grown at a 10%-13% rate for several years in a row, and on a purchasing power parity basis (excuse the economist-speak), the Chinese economy now has a GDP of about $10 trillion, trailing only the EU and the U.S. at roughly $13 trillion each. (After adjusting for currency effects, the actual value is much lower, but that's another story.) The bottom line is that like it or not, you cannot be a student of the modern world economy without taking time to study China. It is simply too large a force to be ignored.
Wednesday, July 11, 2007
Jean-Marie Eveillard is back
Jean-Marie Eveillard is back at First Eagle Fund. He just wrote his first shareholder letter reiterating his views on value investing.
First, a reminder: for more than twenty-five years, we have been in the business of establishing “intrinsic” values for securities which catch—on a preliminary basis—our attention. In a nutshell, we try to figure out what a somewhat knowledgeable buyer (“somewhat”, because we’re on the outside, looking in), expecting a reasonable long-term return, would be willing to pay —in cash—for the entire business. That number is the intrinsic value. If the market price of the security is at some discount to the intrinsic value, then we might be interested. The appropriate size of the discount is a function of how well we think we understand the business and of how much we like the business. The better we understand and like it, the smaller the required discount. As for the sale of securities, it takes place whenever we realize that our intrinsic value was overstated, in other words, when our analysis was flawed. We also sell when the price of the security moves up to the intrinsic value, though we make exceptions—not without trepidation—when we believe the odds are good that the business will continue to create value over the years.
This investment approach—the value approach—is not a recipe, a formula, a black box. But I believe it is a sound approach. As Seth Klarman, a successful value investor, has said, a long-term orientation is the biggest edge a value investor can have. Or, as Benjamin Graham put it, short-term the market is a voting machine, long-term it’s a weighing machine. In other words, we’re not interested in the psychology of the market. We’re interested in the realities of a business. We play bridge, not poker, the difference being that there is much less luck associated with bridge than there is with poker.
First, a reminder: for more than twenty-five years, we have been in the business of establishing “intrinsic” values for securities which catch—on a preliminary basis—our attention. In a nutshell, we try to figure out what a somewhat knowledgeable buyer (“somewhat”, because we’re on the outside, looking in), expecting a reasonable long-term return, would be willing to pay —in cash—for the entire business. That number is the intrinsic value. If the market price of the security is at some discount to the intrinsic value, then we might be interested. The appropriate size of the discount is a function of how well we think we understand the business and of how much we like the business. The better we understand and like it, the smaller the required discount. As for the sale of securities, it takes place whenever we realize that our intrinsic value was overstated, in other words, when our analysis was flawed. We also sell when the price of the security moves up to the intrinsic value, though we make exceptions—not without trepidation—when we believe the odds are good that the business will continue to create value over the years.
This investment approach—the value approach—is not a recipe, a formula, a black box. But I believe it is a sound approach. As Seth Klarman, a successful value investor, has said, a long-term orientation is the biggest edge a value investor can have. Or, as Benjamin Graham put it, short-term the market is a voting machine, long-term it’s a weighing machine. In other words, we’re not interested in the psychology of the market. We’re interested in the realities of a business. We play bridge, not poker, the difference being that there is much less luck associated with bridge than there is with poker.
Monday, July 09, 2007
Two Surprises are better than one
A new study suggests investors who use earnings surprises the right way can double the market's average return of 10 percent a year. That's a profitpalooza: Invest $10,000 for two decades, and it's the difference between $383,000 and $67,000.
The finding is based on an oddity that researchers have written about since the 1960s, called post-earnings announcement drift, or PEAD. Simply put, stocks don't fully "price in" good earnings news immediately after it's released. They tend to jump right away, and then gradually drift higher for up to a year. PEAD has done more than perhaps any other financial phenomenon to blow holes in the notion that markets are perfectly efficient.
That said, strategies based solely on PEAD aren't as profitable as they used to be. Earnings surprises these days, for one thing, are smaller than they were decades ago. More pros are scrutinizing larger volumes of information now, and more analysts contribute to estimates. Wall Street has gotten better at figuring out how much companies will earn next quarter. (Or perhaps, companies have gotten better at hinting.) Recent studies show that investors who buy after upside-earnings surprises can expect to beat the market by around three percentage points over the following six months.
Enter Narasimhan Jegadeesh. A finance professor and market researcher, he has consulted for and sold stock-picking models to Morgan Stanley and Deephaven Capital Management, a Minnesota hedge fund. Today he teaches investing at Emory University, occasionally playing point guard in basketball games against his Ph.D. candidates. (Undergrads run too much, he says.) Earlier this year Jegadeesh, along with Joshua Livnat, who teaches accounting at New York University, published a groundbreaking paper in the Financial Analysts Journal.
The study focuses on separating high-quality surprises from lower-quality ones. A soft-drink maker might crush estimates thanks to runaway demand for its energy drink (think Hansen Natural). That's clearly good news. A tire maker may top estimates even while selling fewer tires if it steers customers toward the most expensive ones and cuts jobs (Goodyear). That's okay, but it may not send the stock on a prolonged run.
How, then, can we tell the good earnings surprises from the not-so-good ones? Look at sales. A company that's ringing the register more has better momentum than one that's merely cutting costs. Also, studies show that instances of numbers massaging are higher among companies that miss sales forecasts but beat earnings estimates.
Jegadeesh and Livnat looked at earnings announcements from 1987 to 2003 and assumed stocks were bought a day after the news hit and held for six months. The 20 percent of stocks that had the biggest positive earnings surprises beat the market by three percentage points over six months. The top 20 percent in terms of sales surprises beat by 2.6 percentage points. Zero in on companies that turn up in both groups, according to the findings, and you'll top the market's return by 5.3 percentage points over six months.
The finding is based on an oddity that researchers have written about since the 1960s, called post-earnings announcement drift, or PEAD. Simply put, stocks don't fully "price in" good earnings news immediately after it's released. They tend to jump right away, and then gradually drift higher for up to a year. PEAD has done more than perhaps any other financial phenomenon to blow holes in the notion that markets are perfectly efficient.
That said, strategies based solely on PEAD aren't as profitable as they used to be. Earnings surprises these days, for one thing, are smaller than they were decades ago. More pros are scrutinizing larger volumes of information now, and more analysts contribute to estimates. Wall Street has gotten better at figuring out how much companies will earn next quarter. (Or perhaps, companies have gotten better at hinting.) Recent studies show that investors who buy after upside-earnings surprises can expect to beat the market by around three percentage points over the following six months.
Enter Narasimhan Jegadeesh. A finance professor and market researcher, he has consulted for and sold stock-picking models to Morgan Stanley and Deephaven Capital Management, a Minnesota hedge fund. Today he teaches investing at Emory University, occasionally playing point guard in basketball games against his Ph.D. candidates. (Undergrads run too much, he says.) Earlier this year Jegadeesh, along with Joshua Livnat, who teaches accounting at New York University, published a groundbreaking paper in the Financial Analysts Journal.
The study focuses on separating high-quality surprises from lower-quality ones. A soft-drink maker might crush estimates thanks to runaway demand for its energy drink (think Hansen Natural). That's clearly good news. A tire maker may top estimates even while selling fewer tires if it steers customers toward the most expensive ones and cuts jobs (Goodyear). That's okay, but it may not send the stock on a prolonged run.
How, then, can we tell the good earnings surprises from the not-so-good ones? Look at sales. A company that's ringing the register more has better momentum than one that's merely cutting costs. Also, studies show that instances of numbers massaging are higher among companies that miss sales forecasts but beat earnings estimates.
Jegadeesh and Livnat looked at earnings announcements from 1987 to 2003 and assumed stocks were bought a day after the news hit and held for six months. The 20 percent of stocks that had the biggest positive earnings surprises beat the market by three percentage points over six months. The top 20 percent in terms of sales surprises beat by 2.6 percentage points. Zero in on companies that turn up in both groups, according to the findings, and you'll top the market's return by 5.3 percentage points over six months.
Friday, July 06, 2007
Carlos Slim overtakes Bill Gates
The Mexican financial Web site Sentido Comun has reported that 67-year old Mexican telecom tycoon Carlos Slim Helu has overtaken Microsoft founder Bill Gates as the richest person in the world.
The Web site reported that Slim’s wealth had passed Gates following the superior performance of Slim’s telecommunications firm, America Movil. The Web site also stated that Slim’s lead over Gates amounted to billions of dollars.
"The difference between their two fortunes is around nine billion dollars in favor of Slim,” the financial Web site reportedly stated, owing Slim’s gain to a 26.5 percent rise in the shares of America Movil during the second quarter.
In addition to America Movil, Slim, the son of Lebanese immigrants, controls the INBURSA financial group and the Grupo Carso industrial firm.
In April, Forbes magazine pegged Slim’s wealth at $53.1 billion and Gate’s at $56 billion.
Among Slim’s most notable investment decisions is the one he make in 1997 when he bought 3 percent of Apple Computer at $17 a share shortly before the company launched its iMac computer. Twelve months later, Apple’s shares exceeded $100.
© 2007 Associated Press
The Web site reported that Slim’s wealth had passed Gates following the superior performance of Slim’s telecommunications firm, America Movil. The Web site also stated that Slim’s lead over Gates amounted to billions of dollars.
"The difference between their two fortunes is around nine billion dollars in favor of Slim,” the financial Web site reportedly stated, owing Slim’s gain to a 26.5 percent rise in the shares of America Movil during the second quarter.
In addition to America Movil, Slim, the son of Lebanese immigrants, controls the INBURSA financial group and the Grupo Carso industrial firm.
In April, Forbes magazine pegged Slim’s wealth at $53.1 billion and Gate’s at $56 billion.
Among Slim’s most notable investment decisions is the one he make in 1997 when he bought 3 percent of Apple Computer at $17 a share shortly before the company launched its iMac computer. Twelve months later, Apple’s shares exceeded $100.
© 2007 Associated Press
Friday, June 29, 2007
Diversification
The idea that you need 160 stocks to diversify is simply ludicrous. The chart below shows diversification benefits can largely be achieved with 30-40 stock portfolios. That is to say, you can have a return profile with roughly the same volatility as the overall equity market by holding around 30-40 stocks.
An alternative perspective is provided by showing the percentage of non-market risk that is eliminated as the number of stocks in the portfolio increases. This is shown in the chart below. Holding two stocks eliminates around 42% of the risk of owning just one stock, holding four stocks this is reduced by 68%, by 83% by holding 8 stocks, by 91% by holding 16 stocks, by 96% by holding 32 stocks. This relationship is graphed in the chart below. Holding two stocks eliminates around 42% of the risk of owning just one stock, holding four stocks this is reduced by 68%, by 83% by holding 8 stocks, by 91% by holding 16 stocks, by 96% by holding 32 stocks.
An alternative perspective is provided by showing the percentage of non-market risk that is eliminated as the number of stocks in the portfolio increases. This is shown in the chart below. Holding two stocks eliminates around 42% of the risk of owning just one stock, holding four stocks this is reduced by 68%, by 83% by holding 8 stocks, by 91% by holding 16 stocks, by 96% by holding 32 stocks. This relationship is graphed in the chart below. Holding two stocks eliminates around 42% of the risk of owning just one stock, holding four stocks this is reduced by 68%, by 83% by holding 8 stocks, by 91% by holding 16 stocks, by 96% by holding 32 stocks.
Live off your investments
Someday, your portfolio will earn more than you do.
Sure, that day may be a long way off, especially if you've just started saving for retirement. But little by little, month after month, as you save more, your investments will earn more. As you increasingly benefit from the magic of compound interest, your portfolio value will climb higher and higher. Eventually, you'll see your account balances rise and fall with the market by amounts that represent months of pay. By then, you may wonder why you're still working at all.
Sure, that day may be a long way off, especially if you've just started saving for retirement. But little by little, month after month, as you save more, your investments will earn more. As you increasingly benefit from the magic of compound interest, your portfolio value will climb higher and higher. Eventually, you'll see your account balances rise and fall with the market by amounts that represent months of pay. By then, you may wonder why you're still working at all.
Is Large Growth Now Cheap?
[7/18/07] Large caps have underperformed small caps in seven out of the last eight calendar years. [So it's due?...]
[6/28/07] Is This the Moment for Large-Cap Stocks? I'll put that question to Ron Canakaris of Aston/Montag & Caldwell Growth (MCGFX). I know what Canakaris' view will be. He recently wrote to shareholders and told them that "Now's the time!" He argued that after a very long run for small caps, the tide would turn: "The outperformance of large cap value over large cap growth has continued for an unprecedented seven years. As investment returns normalize for these two asset categories, relative returns should favor growth by a substantial margin. As a result of these performance differences, significant valuation gaps have developed. For example, the relative price to earnings multiple of the largest twenty-five companies in the S&P 500 is at one of its lowest points in twenty years and the Russell 1000 Growth's price to sales ratio relative to the Russell 1000 Value's ratio is at its lowest point since 1980. Furthermore, your equity holdings are particularly attractive at this time. As of 12/31/06 your equities were selling at a median price to present value ratio of 76%, or at a 24% discount to our calculated intrinsic value."
[4/2/07 via russ] Sometimes what you're looking for is hidden in plain sight. And if what you're looking for are some long-term conservative investments at good value, that's the case right now.
While everyone else is off hunting emerging-market equities and high-yield bonds, take a look at something really simple and obvious:
The article goes on to mention some of the growth picks Bill Nygren has been adding to his Oakmark Fund, Wal-Mart, Citigroup, Abbott Laboratories, Harley-Davidson, Home Depot. "He expects them all to not only show strong earnings growth, but also to benefit as investors become more willing to pay up for solid growth propects and send their P/E ratios higher.
[6/28/07] Is This the Moment for Large-Cap Stocks? I'll put that question to Ron Canakaris of Aston/Montag & Caldwell Growth (MCGFX). I know what Canakaris' view will be. He recently wrote to shareholders and told them that "Now's the time!" He argued that after a very long run for small caps, the tide would turn: "The outperformance of large cap value over large cap growth has continued for an unprecedented seven years. As investment returns normalize for these two asset categories, relative returns should favor growth by a substantial margin. As a result of these performance differences, significant valuation gaps have developed. For example, the relative price to earnings multiple of the largest twenty-five companies in the S&P 500 is at one of its lowest points in twenty years and the Russell 1000 Growth's price to sales ratio relative to the Russell 1000 Value's ratio is at its lowest point since 1980. Furthermore, your equity holdings are particularly attractive at this time. As of 12/31/06 your equities were selling at a median price to present value ratio of 76%, or at a 24% discount to our calculated intrinsic value."
[4/2/07 via russ] Sometimes what you're looking for is hidden in plain sight. And if what you're looking for are some long-term conservative investments at good value, that's the case right now.
While everyone else is off hunting emerging-market equities and high-yield bonds, take a look at something really simple and obvious:
Blue chip U.S. equities.
Yep, the companies everyone knows, like Johnson & Johnson (JNJ - Cramer's Take - Stockpickr - Rating), Procter & Gamble (PG - Cramer's Take - Stockpickr - Rating), IBM (IBM - Cramer's Take - Stockpickr - Rating), Intel (INTC - Cramer's Take - Stockpickr - Rating) and Citigroup (C - Cramer's Take - Stockpickr - Rating).
These are the world's biggest, best run, and most respected companies. They're global. They have underperformed the rest of the stock market, here and abroad, for years.
And that means today they are looking like pretty reasonable values -- especially compared to almost everything else
[3/23/07 via russ] After a seven-year run value stocks are pricier than ever. When Jeremy Grantham says that, it's time to think about buying growth stocks instead.
[7/9/06] In the bull market of the late ’90s, large-company growth stocks, and technology stocks in particular, enjoyed one of their most extended and significant periods of superior performance. Since that bubble burst in 2000, however, large-cap growth stocks have been perennial market laggards, trailing small-cap and value-oriented stocks in each of the past five years through 2004.
Several T. Rowe Price portfolio managers believe that stocks of higher-quality, large-cap companies may be poised to outperform. While small-cap stocks have outperformed in recent years, larger companies have generally had better earnings growth, so their relative valuations appear attractive. At the end of March [2005], small-cap stocks on average sold at a modest valuation premium to large-cap stocks, with the median P/E (price-earnings) ratio for large companies at 16.4X operating earnings compared with 16.6X for small-cap companies. Since 1983, small-caps have sold at a median P/E discount to large-caps of about 2%, according to The Leuthold Group, a market research firm. At the end of 1999, small-caps sold at an extreme 40% discount to large-cap stocks.
Large-cap growth stocks are also relatively attractive compared with large-cap value stocks. The Russell 1000 Growth Index has moved below its historic average P/E premium relative to the Russell 1000 Value Index. In addition, Leuthold observes that large-cap growth stocks, with a P/E ratio of 20.0X in March, are 7% below their historical average P/E, while large-cap value stocks (at 11.8X) are 18% above their historical average P/E.
-- T. Rowe Price Report, Spring 2005
[4/13/06] Tom Gardner says value ratios for small caps are flashing a yellow light (but not red yet).
[3/24/06] "The only thing I know for sure is that we're in a dramatically better place than in 1998 because we're getting a lot more earnings per dollar invested. ... In 1999 the largest 50 companie in the S&P 5000 traded at a 168 percent premium to the next 450 companies. Today the top 50 trade at a 5 percent discount to the next 450, and the big companies with strong balance sheets, globally diverse portfolios, high dividend yields and powerful brands are the cheapest. Statistically, it looks like the largest companies are at the lowest relative valuations they've been at in 10 or 15 years." -- Chris Davis, in the March 2006 SmartMoney.
[3/22/06] It's been seven years since growth stocks had their day in the sun. That's why many market-watchers think the time is ripe for this group of stocks to come back strong. To find a few companies that might offer good opportunities, we asked Morningstar, the Chicago research firm, to find some attractively priced growth companies.
[3/20/06] In the April SmartMoney, Jack Hough reports on James O'Shaughnessy's new book. While many are predicting that large-company stocks should start outperforming again, "O'Shaughnessey is calling for returns of 3 to 5 percent a year, after inflation, for the next 15 years." Shares of small companies, he argues, will do much better with real returns of 8-10%.
[3/20/06] There's an interesting link in this article on Emerging Market ETFs. It's a chart ranking the various asset classes for each of the last 15 years. I note that Large Growth did quite well for six straight years from 1994-1999. Then went on to do quite poorly for the next six years from 2000-2005. Small value did well from 2000-2004, then fell to the middle of the pack in 2005. Emerging growth had the worst or second worst performance in six of the seven years from 1994-2000. But it had the best performance in 1993 and 1999 and has been hot since 2003.
[3/16/06] Jeremy Grantham says "Growth stocks are merely badly overpriced--down from legendary levels--but value stocks, which were only a tiny bit overpriced, are now at least as badly overpriced as growth stocks."
[2/15/06] The current rally has made small caps less attractive from a fundamental valuation perspective, [Steven Leuthold] said. When small caps began to rise, they were 40 percent cheaper than large caps, according to measures like the price-to-earnings ratio. Today, Mr. Leuthold said, they are about 10 percent more expensive.
Worse yet, he said, their earnings momentum has slowed. And this fundamental deterioration has begun to show up in trading patterns. For the first time in six years, fewer than 50 percent of small caps are outperforming the Standard & Poor's 500-stock index, he said.
[2/12/06] Howard Ward believe the cycle is turning for large cap growth stocks. (Of course, the fact that he's the manager of a large cap growth fund may have something to do with it.)
[2/3/06] Schwab is now advising clients to overweight both large- and small-cap growth stocks relative to value stocks.
[1/2/06, Robert Hagstrom in the LMGTX quarterly report] Since the beginning of 2004, the stock market has bifurcated and we have found ourselves temporarily on the wrong side of the divide. I underscored the word ‘‘temporarily’’ because I firmly believe the relative outperformance of value stocks (which overwhelmingly include energy and utility stocks) to growth stocks (which overwhelmingly include consumer discretionary and technology stocks), will soon reverse. Of course, there is no assurance that this will occur.
Value stocks outperforming growth stocks and small-capitalization stocks beating largecapitalization stocks have now entered its sixth consecutive year. It has been an unprecedented period of relative underperformance by large-cap growth companies. We opined in our last commentary the market pendulum would soon begin to shift from defensive stocks to offensive stocks and from smaller-capitalization stocks to larger-capitalization stocks. Although this has occurred in baby steps over the past two quarters, we believe more substantial gains lie ahead for large-cap growth stocks.
... At present, growth stocks and value stocks trade at similar prices and that is very unusual. The reason why growth stocks should trade at higher multiples than value stocks is based on the differential economic returns for the two groups. Typically, growth stocks have higher growth rates, higher profitability and higher returns on capital compared to value stocks. In an efficient market, value stocks should trade at lower price earnings ratios because they achieve economic returns that are below the economic returns earned by growth stocks.
... Since 1978, the price to earnings ratios of value stocks compared to growth stocks has averaged about .65. At the end of the 1990s, the price earnings ratio of value stocks dipped to .32. By the end of 2004, this ratio reached .75—a 134% increase in valuation. Once again, value stock price earnings ratios compared to growth stocks are at a two-decade high.
* * *
[1/2/06, from Wally Weitz in the WVALX semi-annual report] As we have discussed in recent letters, several of the new stocks we have been buying look suspiciously like traditional “growth” stocks—e.g. Wal-Mart. High-quality companies with predictable earnings growth are generally not available at prices we are willing to pay. These stocks may be more affordable today because investors fled “growth” funds after having been burned in the collapse of the tech bubble and moved to “value” funds that had performed better during the bear market. It may also be that investors have sold these “blue chips” to buy commodity companies (especially energy), utilities and real estate stocks.
Grantham, Mayo, Van Otterloo (GMO), a quantitatively oriented investment firm, wrote about this phenomenon in a July, 2005 report. They point out that from January, 2000 through June, 2005, “value” stocks (which they define as the half of all stocks with less than the median price/earnings or price/sales ratios) out-performed “growth” stocks by 138%. According to their study, “value” is now less cheap relative to “growth” than at any other time in the past 27 years. They also found that “high quality” stocks (as measured by stability of earnings and balance sheet strength) were the cheapest relative to lower quality stocks than at any other time during the study.
This study does not prove that these stocks will do well, but it does help to explain why new faces are showing up in our portfolios. Wal-Mart, AIG, Anheuser-Busch, WellPoint, UnitedHealthcare and several other newcomers were selling at discounts to our estimates of their business values, and that is what attracted us.
* * *
[12/8/05] At the Value Investing Congress, held in New York City and attended by more than 400 investors, one major theme was the appeal of large-cap blue-chip stocks. Increasingly, investors appear to be starting to define these as "value" stocks.
[12/5/05] After beating the big boys for five years in a row, the small stock miracle may be ending -- for now (says CNNMoney).
[9/21/05] For the last five years, small-cap value funds have outperformed their larger counterparts. When one asset class outperforms another over an extended period, the result may be an imbalance in your portfolio, suggesting that now may be a good time to evaluate whether your large-cap growth allocation is underweight.
[8/30/05] Small-cap stocks have outperformed large caps ever since the tech bubble burst back in 2000, and for arguably the right reason -- small cap stocks had much lower valuation multiples. But from the bottom-up perspective of Schwab Equity Ratings, small-cap stocks are no longer a bargain.
During the March 2003 market bottom, the proportion of small-cap stocks that were given an A rating by Schwab Equity Ratings was about 34% near an all-time high, suggesting unusual value was still present in the small-cap sector at that time. Over the subsequent year, the small-cap Russell 2000 index outperformed the large-cap S&P 500 index by 26%.
But now large caps represent about 60% of A-rated stocks while the proportion of small caps has fallen to around 14%, near all-time lows. Since 1986, the only two times large caps constituted over 60% of A-rated stocks were September 30, 1994, and May 31, 1998. After each of those dates, the S&P 500 outperformed the Russell 2000 by an average 16% over the subsequent 12 months and 22% over the subsequent 18 months. Our research suggests that now might be a good time to take some profits in small caps and consider rebalancing your stock portfolio toward large-cap stocks. (Greg Forsythe, On Investing Magazine, Summer 2005).
* * *
[8/21/05] When Growth Is a Value: Since February 2002, the large growth issues are off 40 percent while value equities are trading higher by 50 percent. That disparate performance has made growth much cheaper than usual. As Leuthold notes, the multiple on large-cap growth, at 23.5 times, is 5 percent below its historical average, while the multiple on large-cap value, at 11.9 times, is 19 percent above its historical average. Devoted followers of the "buy cheap" doctrine with a sense of history should be looking at large-cap growth. (ref: chucks_angels post)
* * *
[7/22/05] In line with the thought that growth stocks may be due to come back into vogue is an article in the July 2005 SmartMoney entitled "The Sweet Spot".
In the late 1990s -- the days of outsize expectations -- investors bid up growth stocks to outrageous levels, relative to value. The Russell 2000 Growth Index peaked in June 2000 at a p/e ratio of 128; the index's value counterpart warranted a multiple of just 14. These days, though, the growth index carries a p/e of 21, while the value index has a p/e of 17. Same goes for funds, says Lipper analyst Andrew Clark. "Fund P/Es in terms of growth and value are almost on top of each other these days," he says.
"This is the most extreme swing," says Harry Lange, manager of Fidelity Capital Appreciation, who says that his fund has become "increasingly growth," with names such as Dell, Genentech, and Univsion added in the past year. "Growth hasn't been this cheap in 30 years. A lot of these stocks have been beaten down so much, we're looking for pretty big runs -- a 50 percent increase in most cases."
The article goes on to mention some of the growth picks Bill Nygren has been adding to his Oakmark Fund, Wal-Mart, Citigroup, Abbott Laboratories, Harley-Davidson, Home Depot. "He expects them all to not only show strong earnings growth, but also to benefit as investors become more willing to pay up for solid growth propects and send their P/E ratios higher.
Thursday, June 28, 2007
Valuation Spreads
David Nelson of Legg Mason writes about a historical chart of valuation spreads, which compares the top quintile of stocks (the cheapest 20%) to the market average.
As is visually apparent from the chart, valuation spreads are about as compressed now as they have been at any time since 1952. Spreads were similarly-but not as consistently-compressed for much of the 1960s and in the mid-to-late 1990s.
Goldstein's chart raises a couple of interesting questions, in our view. First, what is the investment significance of spread compression? And second, can we learn anything about the current market environment from analyzing past periods of valuation spread compression? I believe the answer to the second question is yes, but before we get to that, we need to answer the first.
Based on visual inspection of the chart and my own market experience, valuation spreads tend to be widest at, or near, major market bottoms-1974, 1982, 1991 and 2002. These are normally periods of high stress in the market, where most stocks are going down, but some sectors are getting absolutely killed. As this happens, the spread between the very cheapest stocks in the market and the average stock tends to widen out. In these environments, historically, the best investment strategy - though often the most painful if you're early - has been to load up on the very cheapest stocks (which are usually concentrated in a few sectors) and wait. If you don't get fired by your clients for owning really scary stocks first, you normally make a lot of money as the market turns and valuation spreads begin to narrow.
In contrast, market environments where valuation spreads are compressed tend to occur after the market has been doing well for a period of time. As the market advances, pockets of severe undervaluation get identified and exploited. Ultimately, this process of identification and exploitation leads to a market, such as we have today, where everything is priced the same. Obviously, that last statement is a bit of an exaggeration, but the spirit of the comment is true, in my judgment. In many industries and sectors today, we see little valuation discrimination between the very best companies and the merely average.
In market environments where valuation spreads are compressed, it would seem to make sense to focus on high-quality, high-return businesses that can grow, because you don't have to pay a premium-or much of one-for them. In short, it seems to us that it should pay to focus on growth stocks. That proved to be true in the mid-to-late 1990s, as well as the 1960s.
As is visually apparent from the chart, valuation spreads are about as compressed now as they have been at any time since 1952. Spreads were similarly-but not as consistently-compressed for much of the 1960s and in the mid-to-late 1990s.
Goldstein's chart raises a couple of interesting questions, in our view. First, what is the investment significance of spread compression? And second, can we learn anything about the current market environment from analyzing past periods of valuation spread compression? I believe the answer to the second question is yes, but before we get to that, we need to answer the first.
Based on visual inspection of the chart and my own market experience, valuation spreads tend to be widest at, or near, major market bottoms-1974, 1982, 1991 and 2002. These are normally periods of high stress in the market, where most stocks are going down, but some sectors are getting absolutely killed. As this happens, the spread between the very cheapest stocks in the market and the average stock tends to widen out. In these environments, historically, the best investment strategy - though often the most painful if you're early - has been to load up on the very cheapest stocks (which are usually concentrated in a few sectors) and wait. If you don't get fired by your clients for owning really scary stocks first, you normally make a lot of money as the market turns and valuation spreads begin to narrow.
In contrast, market environments where valuation spreads are compressed tend to occur after the market has been doing well for a period of time. As the market advances, pockets of severe undervaluation get identified and exploited. Ultimately, this process of identification and exploitation leads to a market, such as we have today, where everything is priced the same. Obviously, that last statement is a bit of an exaggeration, but the spirit of the comment is true, in my judgment. In many industries and sectors today, we see little valuation discrimination between the very best companies and the merely average.
In market environments where valuation spreads are compressed, it would seem to make sense to focus on high-quality, high-return businesses that can grow, because you don't have to pay a premium-or much of one-for them. In short, it seems to us that it should pay to focus on growth stocks. That proved to be true in the mid-to-late 1990s, as well as the 1960s.
Wednesday, June 27, 2007
Value wins (and so do small caps)
[6/14/11] Zacks article on the Fama and French study.
[6/27/07] Research from Brandes Institute, updated from a previous report. "Out of favor stocks often are associated with companies experiencing hard times, operating in mature industries, or facing similarly adverse circumstances. Alternatively, fast-growing "glamour" firms frequently function in dynamic industries with a relatively high profile. This start contrast in attributes leads to a natural question: which stocks perform better, value or glamour?"
Research from Brandes Institute found that value stocks outperformace remained substantial, even when the study's samples was adjusted to include Nasdaq stocks and exclude micro caps. For example, annualized five-year returns for the lowest price-to-book (value) stocks in Nasdaq-inclusinve, cap-screened sample averaged 17.9% over the 1968 ti 2006 period, while returns for the highest price-to-book (glamour) stocks average 10.45.
[4/16/07] Way back in 1981, Rolf Banz published a paper in the Journal of Financial Economics demonstrating that over the long-term small caps tended to outperform large caps. However, that was pretty much the last time the small cap effect was seen! Using data from Ken French, the chart below shows vividly that in the pre-1981 the US small cap effect was pronounced, running at the rate of just under 4% p.a. In the period since the study was published small caps have outperformed large caps by only 0.4% p.a. (strangely enough indistinguishable from zero).
[3/30/07] The best type of stock to have owned over time is small-cap value. Here are the results for the 50 years from 1956 to 2005, as calculated by Eugene Fama and Kenneth French:
[12/3/06] Small cap value trumps large cap growth
[9/21/06] Ibbotson Associates did a study comparing the performance of value stocks, growth stocks, and the S&P 500 between 1968 and 2002. Their results are clear.
Ibbotson Associates did a study comparing the performance of value stocks, growth stocks, and the S&P 500 between 1968 and 2002. Their results are clear.
[8/3/06] If small caps are good, and value is good, then microcaps and deeper value should be better, right?
[7/29/06] Often, you'll hear that there are two types of investors, value and growth. The truth is there isn't much difference.
[1/13/06] What's 70 times better than the next Microsoft? Answer: unknown, boring companies
[1/13/06] The danger of buying large growth
[1/1/06] Small caps had a better year than large caps. Again. And value stocks outperformed growth stocks. Again.
[1/1/06] Not too surprisingly (when you think about it) the top 10 performing stocks of the past 10 years were generally small and obscure. Does that mean you should buy small and obscure stocks? Maybe. But you'd better do your homework. I'd wager many of the small and obscure stocks of ten years ago are now bankrupt.
[11/9/05] There is solid evidence that, as a group, small caps tend to outperform large caps. In his book Investment Fables, Professor Aswath Damodaran pulls together research pertaining to various investing strategies. Using data from Gene Fama and Ken French, Damodaran found that smaller stocks earned higher average annual returns than larger stocks of equivalent risk for the period 1927-2001. When comparing the smallest subset of stocks to the largest, the difference is considerable: 20% vs. 11.74% on a value-weighted basis, with an even greater difference on an equally weighted basis.
[8/4/05] A SmartMoney article on why value beats growth
[7/13/05] This study, by LLakonishok, Shleifer, and Vishny, found that "value stocks" or unloved, low-expectation nobodies outperformed high-priced, high-expectation "glamour stocks". A portfolio favoring high (cheap) E/Ps and low growth outperforms its glamour opposite by 11% per year.
[7/18/05] I wrote about this in January too :)
[5/7/05] Jeremy Siegel writes in the December 2004 Money that if you'd invested $1000 in 1957 in the 100 stocks in the S&P with the highest price-to-earnings ratios, and rebalanced annually, you'd have had $56,700 by 2003; if you'd have bought the 100 stocks with the lowest P/Es, you'd have had $425,700. [The S&P 500 index was created in 1957.]
[7/18/05] Hey I see already wrote about this in January.
[4/29/05] So why not just invest in small cap value stocks?
[4/8/05] Philip Durell, of the Motley Fool Inside Value newsletter, found that value outperformed growth from 12/68 to 12/02 (according to Ibbotson). Considering the source, no big surprise.
What's more surprising is that both value and growth outperformed the S&P 500. So what that tells me is that smaller cap stocks outperformed during that period.
Looking at the Ibbotson paper shows the groups were ranked in the following order: micro-cap value, small-cap value, mid-cap value, large-cap value, large-cap growth, mid-cap growth, small-cap growth, and micro-cap growth.
The next question I have is how they determined whether a stock was a growth or value stock. They split each category into two by their book/price ratio. Growth was considered low b/p and value was considered high b/p.
While I would consider a low p/b a value stock, I wouldn't consider a high p/b a growth stock. So to me this study is not comparing value to growth, it's comparing cheap to expensive. And so it makes sense that cheap wins.
But then one could argue that high p/b stocks are probably high growth stocks (investors have bid up the price because the stocks have been fast growing).
In any case, the ranking of the eight categories was an interesting finding.
[1/28/05] Nirvana and Xanadu: better than Hell
[1/18/05] Rick Munarriz duels Philip Durell in the ongoing growth vs. value debate
[1/14/05] This study found value stocks outperformed glamour stocks.
The term "low growth" kind of threw me. But I'll interpreted that as non-super-high-growth-stocks-that-are-selling-at-ridiculous-valuations.
[6/27/07] Research from Brandes Institute, updated from a previous report. "Out of favor stocks often are associated with companies experiencing hard times, operating in mature industries, or facing similarly adverse circumstances. Alternatively, fast-growing "glamour" firms frequently function in dynamic industries with a relatively high profile. This start contrast in attributes leads to a natural question: which stocks perform better, value or glamour?"
Research from Brandes Institute found that value stocks outperformace remained substantial, even when the study's samples was adjusted to include Nasdaq stocks and exclude micro caps. For example, annualized five-year returns for the lowest price-to-book (value) stocks in Nasdaq-inclusinve, cap-screened sample averaged 17.9% over the 1968 ti 2006 period, while returns for the highest price-to-book (glamour) stocks average 10.45.
[4/16/07] Way back in 1981, Rolf Banz published a paper in the Journal of Financial Economics demonstrating that over the long-term small caps tended to outperform large caps. However, that was pretty much the last time the small cap effect was seen! Using data from Ken French, the chart below shows vividly that in the pre-1981 the US small cap effect was pronounced, running at the rate of just under 4% p.a. In the period since the study was published small caps have outperformed large caps by only 0.4% p.a. (strangely enough indistinguishable from zero).
[3/30/07] The best type of stock to have owned over time is small-cap value. Here are the results for the 50 years from 1956 to 2005, as calculated by Eugene Fama and Kenneth French:
| Value | Growth | |
| Large caps | 13.3% | 9.7% |
| Small caps | 17.3% | 8.7% |
| Total Stock Market | 10.5% |
[12/3/06] Small cap value trumps large cap growth
[9/21/06] Ibbotson Associates did a study comparing the performance of value stocks, growth stocks, and the S&P 500 between 1968 and 2002. Their results are clear.
Ibbotson Associates did a study comparing the performance of value stocks, growth stocks, and the S&P 500 between 1968 and 2002. Their results are clear.
S&P 500 6.5%Investors focused on value finished with twice as much cash as the growthies, and four times as much as the plain-vanilla indexers. [So I guess the other lesson would be to not invest in the S&P 500.]
Growth 8.0%
Value 11.0%
[8/3/06] If small caps are good, and value is good, then microcaps and deeper value should be better, right?
[7/29/06] Often, you'll hear that there are two types of investors, value and growth. The truth is there isn't much difference.
[1/13/06] What's 70 times better than the next Microsoft? Answer: unknown, boring companies
[1/13/06] The danger of buying large growth
[1/1/06] Small caps had a better year than large caps. Again. And value stocks outperformed growth stocks. Again.
[1/1/06] Not too surprisingly (when you think about it) the top 10 performing stocks of the past 10 years were generally small and obscure. Does that mean you should buy small and obscure stocks? Maybe. But you'd better do your homework. I'd wager many of the small and obscure stocks of ten years ago are now bankrupt.
[11/9/05] There is solid evidence that, as a group, small caps tend to outperform large caps. In his book Investment Fables, Professor Aswath Damodaran pulls together research pertaining to various investing strategies. Using data from Gene Fama and Ken French, Damodaran found that smaller stocks earned higher average annual returns than larger stocks of equivalent risk for the period 1927-2001. When comparing the smallest subset of stocks to the largest, the difference is considerable: 20% vs. 11.74% on a value-weighted basis, with an even greater difference on an equally weighted basis.
[8/4/05] A SmartMoney article on why value beats growth
[7/13/05] This study, by LLakonishok, Shleifer, and Vishny, found that "value stocks" or unloved, low-expectation nobodies outperformed high-priced, high-expectation "glamour stocks". A portfolio favoring high (cheap) E/Ps and low growth outperforms its glamour opposite by 11% per year.
[7/18/05] I wrote about this in January too :)
[5/7/05] Jeremy Siegel writes in the December 2004 Money that if you'd invested $1000 in 1957 in the 100 stocks in the S&P with the highest price-to-earnings ratios, and rebalanced annually, you'd have had $56,700 by 2003; if you'd have bought the 100 stocks with the lowest P/Es, you'd have had $425,700. [The S&P 500 index was created in 1957.]
[7/18/05] Hey I see already wrote about this in January.
[4/29/05] So why not just invest in small cap value stocks?
[4/8/05] Philip Durell, of the Motley Fool Inside Value newsletter, found that value outperformed growth from 12/68 to 12/02 (according to Ibbotson). Considering the source, no big surprise.
What's more surprising is that both value and growth outperformed the S&P 500. So what that tells me is that smaller cap stocks outperformed during that period.
Looking at the Ibbotson paper shows the groups were ranked in the following order: micro-cap value, small-cap value, mid-cap value, large-cap value, large-cap growth, mid-cap growth, small-cap growth, and micro-cap growth.
The next question I have is how they determined whether a stock was a growth or value stock. They split each category into two by their book/price ratio. Growth was considered low b/p and value was considered high b/p.
While I would consider a low p/b a value stock, I wouldn't consider a high p/b a growth stock. So to me this study is not comparing value to growth, it's comparing cheap to expensive. And so it makes sense that cheap wins.
But then one could argue that high p/b stocks are probably high growth stocks (investors have bid up the price because the stocks have been fast growing).
In any case, the ranking of the eight categories was an interesting finding.
[1/28/05] Nirvana and Xanadu: better than Hell
[1/18/05] Rick Munarriz duels Philip Durell in the ongoing growth vs. value debate
[1/14/05] This study found value stocks outperformed glamour stocks.
The term "low growth" kind of threw me. But I'll interpreted that as non-super-high-growth-stocks-that-are-selling-at-ridiculous-valuations.
Thursday, June 21, 2007
What’s the Right Time to Invest?
Imagine for a moment that you’ve just received a year-end bonus or income tax refund. You’re not sure whether to invest now or wait. After all, the market recently hit an all-time high. Now imagine that you face this kind of decision every year—sometimes in up markets, other times in downdrafts. What’s a good rule of thumb to follow?
Our research definitively shows that the cost of waiting for the perfect moment to invest far exceeds the benefit of even perfect timing. And because timing the market perfectly is, well, about as likely as winning the lottery, the best strategy for most of us mere mortal investors is not to try to market-time at all. Instead, make a plan and invest as soon as possible.
Five investing styles
But don’t take my word for it. Consider our research on the performance of five long-term investors following very different investment strategies. Each received $2,000 at the beginning of every year for the 20 years ending in 2006 and left the money in the market once invested. Check out how they fared:
The results are in: Investing immediately paid off
For the winner, look at the graph, which shows how much wealth each of the five investors had accumulated at the end of the 20 years (1987–2006). Actually, we looked at 62 separate 20-year periods in all, finding similar results across almost all time periods.
Naturally, the best results belonged to Peter, who waited and timed his annual investment perfectly: He accumulated $146,761. But the study’s most stunning findings concern Ashley, who came in second with $141,856—only $4,905 less than Peter Perfect. This relatively small difference is especially surprising considering that Ashley had simply put her money to work as soon as she received it each year—without any pretense of market timing.
Matthew’s dollar-cost-averaging approach delivered solid returns, earning him third place with $134,625 at the end of 20 years. That didn’t surprise us. After all, in a typical 12-month period, the market has risen 75% of the time.2 So Ashley’s pattern of investing first thing did, over time, yield lower buying prices than Matthew’s monthly discipline and, thus, higher ending wealth.
Rosie Rotten’s results also proved surprisingly encouraging. While her poor timing left her about $18,262 short of Ashley (who didn’t try timing investments), Rosie still earned significantly more than double what she would have if she hadn’t invested in the market at all.
And what of Larry Linger, the procrastinator who kept waiting for a better opportunity to buy stocks—and then didn’t buy at all? He fared worst of all, with only $61,622. His biggest worry had been investing at a market high. Ironically, had he done that each year, he would have still earned more than twice as much over the 20-year period.
[see also DCA or lump sum?]
Our research definitively shows that the cost of waiting for the perfect moment to invest far exceeds the benefit of even perfect timing. And because timing the market perfectly is, well, about as likely as winning the lottery, the best strategy for most of us mere mortal investors is not to try to market-time at all. Instead, make a plan and invest as soon as possible.
Five investing styles
But don’t take my word for it. Consider our research on the performance of five long-term investors following very different investment strategies. Each received $2,000 at the beginning of every year for the 20 years ending in 2006 and left the money in the market once invested. Check out how they fared:
- Peter Perfect was a perfect market timer. He had incredible skill (or luck) and was able to place his $2,000 into the market every year at the lowest monthly close.
For example, Peter had $2,000 to invest at the start of 1987. Rather than putting it immediately into the market, he waited and invested after month-end November 1987—that year’s monthly low point for the S&P 500® Index (a proxy for the stock market).
At the beginning of 1988, Peter received another $2,000. He waited and invested the money after January 1988, the monthly low point for the market for that year. He continued to time his investments perfectly every year through 2006. - Ashley Action took a simple, consistent approach: Each year, once she received her cash, she invested her $2,000 in the market at the earliest possible moment.
- Matthew Monthly divided his annual $2,000 allotment into 12 equal portions, which he invested at the beginning of each month. This strategy is known as dollar cost averaging. You may already be doing this through regular investments in your 401(k) plan or an Automatic Investment Plan (AIP), which allows you to deposit money into mutual funds on a set timetable.
- Rosie Rotten had incredibly poor timing—or perhaps terribly bad luck: She invested her $2,000 each year at the market’s peak, in stark defiance of the investing maxim to “buy low.” For example, Rosie invested her first $2,000 at the end of August 1987—that year’s monthly high point for the S&P 500. She received her second $2,000 at the beginning of 1988 and invested it at the end of December 1988, the peak for that year.
- Larry Linger left his money in cash (using Treasury bills as a proxy) every year and never got around to investing in stocks at all. He was always convinced that lower stock prices—and, therefore, better opportunities to invest his money—were just around the corner.
The results are in: Investing immediately paid off
For the winner, look at the graph, which shows how much wealth each of the five investors had accumulated at the end of the 20 years (1987–2006). Actually, we looked at 62 separate 20-year periods in all, finding similar results across almost all time periods.
Naturally, the best results belonged to Peter, who waited and timed his annual investment perfectly: He accumulated $146,761. But the study’s most stunning findings concern Ashley, who came in second with $141,856—only $4,905 less than Peter Perfect. This relatively small difference is especially surprising considering that Ashley had simply put her money to work as soon as she received it each year—without any pretense of market timing.
Matthew’s dollar-cost-averaging approach delivered solid returns, earning him third place with $134,625 at the end of 20 years. That didn’t surprise us. After all, in a typical 12-month period, the market has risen 75% of the time.2 So Ashley’s pattern of investing first thing did, over time, yield lower buying prices than Matthew’s monthly discipline and, thus, higher ending wealth.
Rosie Rotten’s results also proved surprisingly encouraging. While her poor timing left her about $18,262 short of Ashley (who didn’t try timing investments), Rosie still earned significantly more than double what she would have if she hadn’t invested in the market at all.
And what of Larry Linger, the procrastinator who kept waiting for a better opportunity to buy stocks—and then didn’t buy at all? He fared worst of all, with only $61,622. His biggest worry had been investing at a market high. Ironically, had he done that each year, he would have still earned more than twice as much over the 20-year period.
[see also DCA or lump sum?]
Tuesday, June 19, 2007
The Rich Get Richer
In 1976, Richard Freeman wrote a book called “The Overeducated American.” So many Americans had been getting college degrees that the relative wages of white-collar professionals had started to fall. It no longer paid to go to college and, for most of the ’70s, fewer people did. Just so, incomes of the educated began to rise again.
People like Freeman, a labor-market economist, waited for the cycle to turn. They expected that with white-collar types riding high again, more people would stay in school, and incomes at the top would level off once more.
But they never did. Instead, the rich kept getting richer. Across the spectrum of American society, the higher your income category, the more your income continued to grow. And for a quarter-century, albeit with zigs and zags along the way, that rich-get-richer pattern has held. The figures are striking. In 2004, according to the Congressional Budget Office’s latest official analysis, households in the lowest quintile of the country were making only 2 percent more (adjusted for inflation) than they were in 1979. Those in the next quintile managed only an 11 percent rise. And the middle group was up 15 percent. Do you sense a pattern? The income of families in the fourth quintile — upper-middle-class folks with an average yearly income of $82,000 — rose by 23 percent. Only when you get to the top quintile were the gains truly big — 63 percent.
Some redistribution is clearly good for the entire economy — providing public schooling, for instance, so that everyone gets an education. But public education aside, the United States has a pretty high tolerance for inequality. Americans care about “fairness” more than about “equalness.” We boo athletes suspected of taking steroids, but we admire billionaires.
The extreme divergence of American incomes we see today, however, is actually rather new. For most of the 20th century, America was becoming more egalitarian. The United States seemingly conformed to the standard theory of development, which held that industrialization produces fat cats at first (as factory owners rake it in) and then a more general prosperity as workers become more productive. It’s a feel-good theory that says, “Don’t worry if the rich are prospering; the poor will have their day.”
[via brknews, excerpted]
People like Freeman, a labor-market economist, waited for the cycle to turn. They expected that with white-collar types riding high again, more people would stay in school, and incomes at the top would level off once more.
But they never did. Instead, the rich kept getting richer. Across the spectrum of American society, the higher your income category, the more your income continued to grow. And for a quarter-century, albeit with zigs and zags along the way, that rich-get-richer pattern has held. The figures are striking. In 2004, according to the Congressional Budget Office’s latest official analysis, households in the lowest quintile of the country were making only 2 percent more (adjusted for inflation) than they were in 1979. Those in the next quintile managed only an 11 percent rise. And the middle group was up 15 percent. Do you sense a pattern? The income of families in the fourth quintile — upper-middle-class folks with an average yearly income of $82,000 — rose by 23 percent. Only when you get to the top quintile were the gains truly big — 63 percent.
Some redistribution is clearly good for the entire economy — providing public schooling, for instance, so that everyone gets an education. But public education aside, the United States has a pretty high tolerance for inequality. Americans care about “fairness” more than about “equalness.” We boo athletes suspected of taking steroids, but we admire billionaires.
The extreme divergence of American incomes we see today, however, is actually rather new. For most of the 20th century, America was becoming more egalitarian. The United States seemingly conformed to the standard theory of development, which held that industrialization produces fat cats at first (as factory owners rake it in) and then a more general prosperity as workers become more productive. It’s a feel-good theory that says, “Don’t worry if the rich are prospering; the poor will have their day.”
[via brknews, excerpted]
Wednesday, June 06, 2007
Traits of Extremely Wealthy People
Have you ever wondered why some people are magnets for wealth and most others just flounder by the wayside? I bet you want to know the secret traits these wealthy people possess.
Steve Jobs got rich creating and selling computers. J.K. Rowling is wealthy because she switched gears and started writing books. Jeff Bezos got rich selling books. Oprah Winfrey became wealthy connecting to people on TV. Wayne Huizenga became rich by hauling trash. Bill Gates started coding software and is a multi-billionaire.
Their businesses have nothing in common. Just look at your community. People are becoming wealthy in a variety of businesses.
What do Oprah, Jeff, Steve, Bill, Wayne, and J.K. have in common?
1. They have Persistence. Overcoming obstacles and moving on is a given.
2. They invest in other businesses and own their own companies. Start your own business.
3. They are creative. Innovation is imperative to becoming wealthy. Constantly observe and generate new ideas.
4. They are doing what comes most naturally to them. If you love what you do, you forget you are working. Imagine that.
5. They give their wealth back. Sharing wealth and knowledge benefits you and others. The more you give, the more you receive.
6. They are constantly learning. Enormously wealthy people understand that your mind is your greatest asset. They constantly read books, listen to wealth-building CDs and attend seminars.
7. They hire out the work. Rich people know they can’t do everything themselves. Bill Gates hires programmers to write software. Doing everything yourself will limit your financial growth opportunities.
8. They are grateful. With gratitude you can’t go wrong. In fact, gratitude allows your mind to focus on creating products that help and uplift other people’s lives.
Notice that all these traits use the power of the mind. Nothing compares to getting your mind to work for you. It’s a tool most people don’t use. Here is your opportunity to take a quantum leap into wealth consciousness.
“It is mathematically certain that you can succeed if you will find out the cause of success, and develop it to sufficient strength, and apply it properly to your work." – Wallace D. Wattles
Steve Jobs got rich creating and selling computers. J.K. Rowling is wealthy because she switched gears and started writing books. Jeff Bezos got rich selling books. Oprah Winfrey became wealthy connecting to people on TV. Wayne Huizenga became rich by hauling trash. Bill Gates started coding software and is a multi-billionaire.
Their businesses have nothing in common. Just look at your community. People are becoming wealthy in a variety of businesses.
What do Oprah, Jeff, Steve, Bill, Wayne, and J.K. have in common?
1. They have Persistence. Overcoming obstacles and moving on is a given.
2. They invest in other businesses and own their own companies. Start your own business.
3. They are creative. Innovation is imperative to becoming wealthy. Constantly observe and generate new ideas.
4. They are doing what comes most naturally to them. If you love what you do, you forget you are working. Imagine that.
5. They give their wealth back. Sharing wealth and knowledge benefits you and others. The more you give, the more you receive.
6. They are constantly learning. Enormously wealthy people understand that your mind is your greatest asset. They constantly read books, listen to wealth-building CDs and attend seminars.
7. They hire out the work. Rich people know they can’t do everything themselves. Bill Gates hires programmers to write software. Doing everything yourself will limit your financial growth opportunities.
8. They are grateful. With gratitude you can’t go wrong. In fact, gratitude allows your mind to focus on creating products that help and uplift other people’s lives.
Notice that all these traits use the power of the mind. Nothing compares to getting your mind to work for you. It’s a tool most people don’t use. Here is your opportunity to take a quantum leap into wealth consciousness.
“It is mathematically certain that you can succeed if you will find out the cause of success, and develop it to sufficient strength, and apply it properly to your work." – Wallace D. Wattles
blue chips not equal to diamonds
"Blue chip" stocks -- the stocks of large, established companies -- were long touted as great investments for "widows and orphans," who weren't expected to manage their money actively. And historically speaking, some blue chips have been great investments. Companies like General Electric (NYSE: GE) and Johnson & Johnson (NYSE: JNJ) have been rewarding shareholders with solid growth and strong dividends for decades. But as hedge fund manager Mohnish Pabrai points out in his recent book Mosaic: Perspectives on Investing, even blue chips don't last forever.
The average Fortune 500 company has a life expectancy of 40-50 years, and given that it can take 25 years or more for a new company to grow to Fortune 500 size, many so-called blue chips cease to exist less than 20 years after they make the list! Size is no guarantee of longevity -- just ask all those Enron shareholders. And even among more established firms, times and businesses change. I'm sure that most of the investors who bought Ford (NYSE: F) 15 or 20 years ago didn't foresee a time when the stock would be trading in single digits and the company desperately clinging to life.
The average Fortune 500 company has a life expectancy of 40-50 years, and given that it can take 25 years or more for a new company to grow to Fortune 500 size, many so-called blue chips cease to exist less than 20 years after they make the list! Size is no guarantee of longevity -- just ask all those Enron shareholders. And even among more established firms, times and businesses change. I'm sure that most of the investors who bought Ford (NYSE: F) 15 or 20 years ago didn't foresee a time when the stock would be trading in single digits and the company desperately clinging to life.
Wednesday, May 30, 2007
Surprise Anticipation
[6/29/07] Schwab research has found that companies that subsequently perform better or worse than current consensus expectations have some distinct traits. As the "Surprise Anticipation Matrix" graphic below illustrates, stocks with low, but rising expectation levels tend to report positive surprises. To identify these opportunities, we look for stocks with traits such as:
[5/30/07] Professional stock analysts focus much of their time attempting to forecast companies' future earnings growth. Clearly, perfect foresight of future earnings would be valuable information, but that brings us to our third research principle: The fact that a correct forecast could have value is not sufficient reason to attempt such a forecast—one must also be able to make correct forecasts at a rate higher than chance alone.
To quantify the value of accurate EPS forecasting, a few years ago, Schwab measured the potential returns an investor could have earned with perfect foresight of EPS growth one year into the future. If it were possible in advance to buy the 20% of stocks with the highest subsequent one-year EPS growth, your portfolio would have grown an average of 38.7% annually from 1986 to 2004 vs. only 14.3% annually for all stocks included in our study. By contrast, a portfolio of the 20% of stocks with the lowest EPS growth (a negative growth rate in most cases) would have lost an average of 10.4% annually.
Clearly, accurate EPS forecasting could have a large payoff, but what's the probability of actually making accurate forecasts? Unfortunately, accurately forecasting EPS is extremely difficult. Schwab research has found historically that only 15% of quarterly EPS forecasts are within 1% of actual reported EPS. If at the beginning of each year, you bought the 20% of stocks with the highest consensus one-year EPS growth forecasts, your portfolio would have slightly underperformed the average stock included in our study. In other words, our findings have shown that analyst forecasts have historically been so inaccurate that basing stock purchase decisions on one-year EPS growth forecasts has been a completely futile approach to outperforming the stock market!
Forecast "surprises," not earnings
So if forecasting EPS isn't viable, what should you forecast? It's critical to understand that a company's stock price is based not just on its current fundamentals, but on all expected future cash flows, discounted back to the present according to anticipated risk. In other words, today's stock price reflects consensus expectations of future fundamentals. Consequently, meaningful stock price changes occur only when investor expectations change. And since expectation changes are triggered by the unexpected, a key element to a market-beating stock selection strategy is "surprise anticipation."
Successful equity research must be able to identify stocks that perform better than the expectations embedded in their stock prices at the time of purchase. If your stock picks experience positive surprises more often than negative surprises, you have a good chance to outperform the market in the long run. Unfortunately, investors often fail to appreciate the importance of expectations. For example, they cling to the notion that great companies will be top-performing stocks, forgetting that such greatness is generally already reflected in stock prices.
Surprise anticipation sounds nice, but is it actually possible to forecast the unexpected? The good news is that what is a surprise to most investors doesn't have to be a surprise to you! Behavioral finance researchers have discovered that investor expectations tend to err in two predictable ways.
First, investors seem to believe that successful companies will continue to succeed and that struggling companies will continue to struggle. This tendency to extrapolate past trends drives expectation levels to extremes for many companies. Yet research has shown that the forces of competition typically lead to long-term business success being more likely to reverse than to be sustainable. Therefore, one powerful way to anticipate surprises is to bet on what statisticians call mean-reversion, which is the tendency for high or low values to return to the mean, or average. When investor expectations are extremely low for a stock, you should anticipate future surprises to be positive as the company does better than pessimistic expectations. And when investor expectations are extremely high for a stock, anticipate future surprises to be negative as the company does worse than optimistic expectations.
The second way investor expectations err predictably reflects investors' reluctance to change held beliefs. For example, if a company reports a positive earnings surprise, investors typically notch up their future expectations, but they seek further confirmation by waiting to see if the company can do it again next quarter. Behavioral finance researchers have shown that this "anchor-and-adjust" process creates a tendency for short-term expectation changes to lag behind fundamental reality. Therefore, a second powerful way to anticipate surprises is to bet on systematic underreaction to newly reported information. If recent expectation changes have been positive for a stock, you should expect more positive changes in the near future as expectations play catch-up, but if recent expectation changes have been negative, expect more negative changes in the near future.
We have created a Surprise Anticipation Matrix that encapsulates these general tendencies. As the graphic below illustrates, stocks with low but rising expectation levels tend to report positive surprises while stocks with high but falling expectations tend to report negative surprises.
Schwab Equity Ratings: a surprise anticipation tool
If applying all of these research principles sounds like a lot of work, consider using Schwab Equity Ratings as a time-saving shortcut. Schwab Equity Ratings are, in essence, a sophisticated surprise anticipation tool. Indeed, since the ratings were launched in May 2002, through March 2007, A-rated stocks have reported quarterly earnings above consensus forecasts 74% of the time, while F-rated stocks have beat consensus forecasts only 41% of the time. We believe surprise anticipation is a key reason why A-rated stocks have outperformed the average rated stock by over 5% per year on a 52-week buy-and-hold basis since inception, while F-rated stocks have underperformed by a similar margin.
So in conclusion, successful equity research must be a process of discovering relevant information. When you buy a stock, you are implicitly forecasting that you know something material that other investors don't know. It seems to us that professional analysts who focus their research on EPS forecasting and investors who use those forecasts haven't accepted the fact that earnings forecasts have historically been too inaccurate to be the basis for a successful stock selection strategy. Fortunately, we believe there is a more reliable forecasting strategy available to investors called surprise anticipation.
by Greg Forsythe, CFA, Senior Vice President, Schwab Equity Ratings®, Schwab Center for Investment Research®
[6/14/07] See also Forsythe's article "Are Stocks With High Earnings Growth Good Investments?"
A recent academic paper showed that firms with above-average EPS growth in the previous five-year period were no more likely than chance to deliver above-average EPS growth in the five years that followed.2 Furthermore, since stocks with above-average historical growth tend to have above-average P/E ratios, investors in these stocks often get double-whammied: Not only does expected future EPS not materialize, but P/E ratios contract as investor expectations are adjusted downward to the new reality.
and his article in the Summer 2007 Charles Schwab OnInvesting
Investor expectations of a company's future earnings growth tend to be highly correlated to its past growth. Yet researchers have found that historical earnings growth rates have little ability to predict future earnings growth. Nonetheless, analyst forecasts reflect excessive extrapolation of past growth trends and influence investors to award high (low) price-to-earnings (P/E) multiples to stocks with high (low) EPS growth forecasts. Reflecting this overreaction tendency, research has shown that high P/E stocks tend to underperform as actual results fall short of optimistic forecasts, while low P/E stocks tend to outperform as actual results exceed pessimistic forecasts.
- Low price multiples (e.g., low price-earnings ratios and low price-to-book ratios).
- Management that is returning cash to investors (e.g. dividends, share buybacks, debt repayment).
- Buying by corporate insiders and short sellers (i.e., "smart money" investors).
Growing free cash flow (definition: cash from operations less capital expenditures and dividends). - Sales growth exceeding asset growth (i.e., improving operating efficiency).
- Recent reported earnings above consensus forecasts.
- Recent positive analyst earnings-per-share (EPS) forecast revisions.
- Recent stock price outperformance vs. overall market.
[5/30/07] Professional stock analysts focus much of their time attempting to forecast companies' future earnings growth. Clearly, perfect foresight of future earnings would be valuable information, but that brings us to our third research principle: The fact that a correct forecast could have value is not sufficient reason to attempt such a forecast—one must also be able to make correct forecasts at a rate higher than chance alone.
To quantify the value of accurate EPS forecasting, a few years ago, Schwab measured the potential returns an investor could have earned with perfect foresight of EPS growth one year into the future. If it were possible in advance to buy the 20% of stocks with the highest subsequent one-year EPS growth, your portfolio would have grown an average of 38.7% annually from 1986 to 2004 vs. only 14.3% annually for all stocks included in our study. By contrast, a portfolio of the 20% of stocks with the lowest EPS growth (a negative growth rate in most cases) would have lost an average of 10.4% annually.
Clearly, accurate EPS forecasting could have a large payoff, but what's the probability of actually making accurate forecasts? Unfortunately, accurately forecasting EPS is extremely difficult. Schwab research has found historically that only 15% of quarterly EPS forecasts are within 1% of actual reported EPS. If at the beginning of each year, you bought the 20% of stocks with the highest consensus one-year EPS growth forecasts, your portfolio would have slightly underperformed the average stock included in our study. In other words, our findings have shown that analyst forecasts have historically been so inaccurate that basing stock purchase decisions on one-year EPS growth forecasts has been a completely futile approach to outperforming the stock market!
Forecast "surprises," not earnings
So if forecasting EPS isn't viable, what should you forecast? It's critical to understand that a company's stock price is based not just on its current fundamentals, but on all expected future cash flows, discounted back to the present according to anticipated risk. In other words, today's stock price reflects consensus expectations of future fundamentals. Consequently, meaningful stock price changes occur only when investor expectations change. And since expectation changes are triggered by the unexpected, a key element to a market-beating stock selection strategy is "surprise anticipation."
Successful equity research must be able to identify stocks that perform better than the expectations embedded in their stock prices at the time of purchase. If your stock picks experience positive surprises more often than negative surprises, you have a good chance to outperform the market in the long run. Unfortunately, investors often fail to appreciate the importance of expectations. For example, they cling to the notion that great companies will be top-performing stocks, forgetting that such greatness is generally already reflected in stock prices.
Surprise anticipation sounds nice, but is it actually possible to forecast the unexpected? The good news is that what is a surprise to most investors doesn't have to be a surprise to you! Behavioral finance researchers have discovered that investor expectations tend to err in two predictable ways.
First, investors seem to believe that successful companies will continue to succeed and that struggling companies will continue to struggle. This tendency to extrapolate past trends drives expectation levels to extremes for many companies. Yet research has shown that the forces of competition typically lead to long-term business success being more likely to reverse than to be sustainable. Therefore, one powerful way to anticipate surprises is to bet on what statisticians call mean-reversion, which is the tendency for high or low values to return to the mean, or average. When investor expectations are extremely low for a stock, you should anticipate future surprises to be positive as the company does better than pessimistic expectations. And when investor expectations are extremely high for a stock, anticipate future surprises to be negative as the company does worse than optimistic expectations.
The second way investor expectations err predictably reflects investors' reluctance to change held beliefs. For example, if a company reports a positive earnings surprise, investors typically notch up their future expectations, but they seek further confirmation by waiting to see if the company can do it again next quarter. Behavioral finance researchers have shown that this "anchor-and-adjust" process creates a tendency for short-term expectation changes to lag behind fundamental reality. Therefore, a second powerful way to anticipate surprises is to bet on systematic underreaction to newly reported information. If recent expectation changes have been positive for a stock, you should expect more positive changes in the near future as expectations play catch-up, but if recent expectation changes have been negative, expect more negative changes in the near future.
We have created a Surprise Anticipation Matrix that encapsulates these general tendencies. As the graphic below illustrates, stocks with low but rising expectation levels tend to report positive surprises while stocks with high but falling expectations tend to report negative surprises.
Schwab Equity Ratings: a surprise anticipation tool
If applying all of these research principles sounds like a lot of work, consider using Schwab Equity Ratings as a time-saving shortcut. Schwab Equity Ratings are, in essence, a sophisticated surprise anticipation tool. Indeed, since the ratings were launched in May 2002, through March 2007, A-rated stocks have reported quarterly earnings above consensus forecasts 74% of the time, while F-rated stocks have beat consensus forecasts only 41% of the time. We believe surprise anticipation is a key reason why A-rated stocks have outperformed the average rated stock by over 5% per year on a 52-week buy-and-hold basis since inception, while F-rated stocks have underperformed by a similar margin.
So in conclusion, successful equity research must be a process of discovering relevant information. When you buy a stock, you are implicitly forecasting that you know something material that other investors don't know. It seems to us that professional analysts who focus their research on EPS forecasting and investors who use those forecasts haven't accepted the fact that earnings forecasts have historically been too inaccurate to be the basis for a successful stock selection strategy. Fortunately, we believe there is a more reliable forecasting strategy available to investors called surprise anticipation.
by Greg Forsythe, CFA, Senior Vice President, Schwab Equity Ratings®, Schwab Center for Investment Research®
[6/14/07] See also Forsythe's article "Are Stocks With High Earnings Growth Good Investments?"
A recent academic paper showed that firms with above-average EPS growth in the previous five-year period were no more likely than chance to deliver above-average EPS growth in the five years that followed.2 Furthermore, since stocks with above-average historical growth tend to have above-average P/E ratios, investors in these stocks often get double-whammied: Not only does expected future EPS not materialize, but P/E ratios contract as investor expectations are adjusted downward to the new reality.
and his article in the Summer 2007 Charles Schwab OnInvesting
Investor expectations of a company's future earnings growth tend to be highly correlated to its past growth. Yet researchers have found that historical earnings growth rates have little ability to predict future earnings growth. Nonetheless, analyst forecasts reflect excessive extrapolation of past growth trends and influence investors to award high (low) price-to-earnings (P/E) multiples to stocks with high (low) EPS growth forecasts. Reflecting this overreaction tendency, research has shown that high P/E stocks tend to underperform as actual results fall short of optimistic forecasts, while low P/E stocks tend to outperform as actual results exceed pessimistic forecasts.
Death, Taxes, and Short-Term Underperformance
Research from Brandes Institute on Death, Taxes, and Short-Term Underperformance. This research focuses on the performance results of a wide range of U.S. mutual funds over the last decade. Observations suggest that underperformance in shorter time periods - such as one quarter, one year, or even three years - is to be expected, even for portfolios that perform strongly over the long term.
Monday, May 28, 2007
DivestTerror.org
What can you, an average citizen, do to help defend America against terrorists sworn to our destruction? How about not investing in them?
A campaign to cut off such investments is gaining momentum. The Center for Security Policy, a Washington think tank, has organized a “Divest Terrorism Initiative” — a campaign to persuade pension funds, college endowments, 401(k) plans, retirement account managers, and individual investors to make sure their money is not used to support regimes that underwrite terrorism.
Highest on the priority list: Iran, Sudan, Syria and North Korea. These countries have been sanctioned by the United States government as sponsors of terrorism, said Sarah Steelman, the Treasurer of Missouri, the first state in the nation whose pension fund has divested from companies doing business with terrorist masters. Investing in terrorist countries is not acceptable to the citizens or the public employees of Missouri.
A campaign to cut off such investments is gaining momentum. The Center for Security Policy, a Washington think tank, has organized a “Divest Terrorism Initiative” — a campaign to persuade pension funds, college endowments, 401(k) plans, retirement account managers, and individual investors to make sure their money is not used to support regimes that underwrite terrorism.
Highest on the priority list: Iran, Sudan, Syria and North Korea. These countries have been sanctioned by the United States government as sponsors of terrorism, said Sarah Steelman, the Treasurer of Missouri, the first state in the nation whose pension fund has divested from companies doing business with terrorist masters. Investing in terrorist countries is not acceptable to the citizens or the public employees of Missouri.
Wednesday, May 23, 2007
After the record
According to Standard & Poor's Chief Technical Strategist Mark Arbeter, the technical picture for the S&P 500 indicates the benchmark will probably eclipse its record closing high of 1527.46, set on March 24, 2000, sometime in May or June of this year.
If Arbeter is right (and he usually is) what will that mean for future market action once the adrenaline rush has subsided?
If history can serve as a guide (but remember past performance is no guarantee of future results), we will likely see sub-par price performance in the first month following the setting of a new high, and then find above-average price appreciation in the three and six months after. In addition, the next market top usually occurred around three years after the setting of a record high.
If Arbeter is right (and he usually is) what will that mean for future market action once the adrenaline rush has subsided?
If history can serve as a guide (but remember past performance is no guarantee of future results), we will likely see sub-par price performance in the first month following the setting of a new high, and then find above-average price appreciation in the three and six months after. In addition, the next market top usually occurred around three years after the setting of a record high.
Common Sense buying and selling
James B. Stewart explains his Common Sense guide to buying and selling in his column in the June 2006 SmartMoney.
My traditional focus on buying is one of the reasons that I introduced the Common Sense guide to buying and selling, which has been the underpinning of this column since its inception. At periodic intervals, this system forces me to be disciplined and take some profits when stocks are high. As I've explained in previous columns, my goal is simply to buy low and sell high. When the market drops, I add to my holdings at intervals of 10% declines in the Nasdaq composite index, my preferred barometer. During rallies, I sell some of my stocks at intervals of 25% advances. These numbers aren't arbitrary. They're the midpoints of average bear market declines (20%) and bull market rallies (50%).
My traditional focus on buying is one of the reasons that I introduced the Common Sense guide to buying and selling, which has been the underpinning of this column since its inception. At periodic intervals, this system forces me to be disciplined and take some profits when stocks are high. As I've explained in previous columns, my goal is simply to buy low and sell high. When the market drops, I add to my holdings at intervals of 10% declines in the Nasdaq composite index, my preferred barometer. During rallies, I sell some of my stocks at intervals of 25% advances. These numbers aren't arbitrary. They're the midpoints of average bear market declines (20%) and bull market rallies (50%).
Thursday, May 17, 2007
Ten Stocks for the Next Ten Years
[SmartMoney Magazine, May 2007] For our 15th-anniversary issue, we've taken what we've learned over the past decade and a half to create another 10-year portfolio. To identify our top-10 stocks this time, we also demanded a demonstrable history of sales growth. Then, as in past years, we sorted through the remaining stocks one by one, looking for common themes that were likely to play out over the next decade. In the end, we identified four themes: clean water, health, wireless technology and global growth.
WATER SERVICES
Fresh water is becoming an increasingly important commodity. Water-infrastructure and water-treatment companies will clean up as emerging and developed economies build and rebuild their systems.
Tetra Tech (TTEK) is a consulting firm specializing in water-resource management and environmental cleanups.
At first glance, you might not think a company that invented a hot-water valve in the early 1900s would be a high-growth prospect for the next decade. But Watts Water Technologies (WTS), which supplies water-control, purification, safety and flow devices to the construction industry, should see strong gains in the years ahead.
HEALTH
Demographics favor medical-equipment manufacturers, from dental equipment to respiratory care to imaging systems. Natural foods, too, will continue to grow as Americans adopt healthier lifestyles.
Sirona Dental Systems (SIRO). It may be that no one enjoys a visit to the dentist, but health- and appearance-conscious baby boomers are sure going.
Viasys Healthcare (VAS) is a cluster of high-technology medical-equipment and diagnostic companies that focus on respiratory care and neuro diagnostics — the monitoring of the brain and nervous system.
OSI Systems (OSIS) is a hybrid medical/defense company, with half of its revenue from medical equipment and half from scanning and inspection equipment and optical gear used by the defense and aerospace industries.
Wherever you run into organic produce, chances are it got there thanks to United Natural Foods (UNFI). The company is the largest national distributor of organic and natural foods, offering more than 40,000 products from 17 distribution sites nationwide.
WIRELESS TELECOM
As broadband-like speeds come to wireless communications, demand for ever more sophisticated handsets and the infrastructure that powers them will drive the industry's next leap forward.
Powerwave Technologies (PWAV) makes the amplifiers, antennas and other equipment that enable wireless phones and handheld devices to transmit and receive voice and data.
Brightpoint (CELL) is the middleman for the wireless industry and should be ideally positioned to profit from its continued growth.
GLOBAL GROWTH
Globalization is creating new opportunities in areas as disparate as market research and global air transport. Our two picks give investors worldwide reach as the global economy grows.
Best known for its Harris Poll, ubiquitous during American election campaigns since the 1950s, Harris Interactive (HPOL) is one of the top 15 market-research firms worldwide.
Atlas Air Worldwide (AAWW) offers an unusual opportunity to profit from growing global trade, a trend we expect to intensify in the coming decade.
WATER SERVICES
Fresh water is becoming an increasingly important commodity. Water-infrastructure and water-treatment companies will clean up as emerging and developed economies build and rebuild their systems.
Tetra Tech (TTEK) is a consulting firm specializing in water-resource management and environmental cleanups.
At first glance, you might not think a company that invented a hot-water valve in the early 1900s would be a high-growth prospect for the next decade. But Watts Water Technologies (WTS), which supplies water-control, purification, safety and flow devices to the construction industry, should see strong gains in the years ahead.
HEALTH
Demographics favor medical-equipment manufacturers, from dental equipment to respiratory care to imaging systems. Natural foods, too, will continue to grow as Americans adopt healthier lifestyles.
Sirona Dental Systems (SIRO). It may be that no one enjoys a visit to the dentist, but health- and appearance-conscious baby boomers are sure going.
Viasys Healthcare (VAS) is a cluster of high-technology medical-equipment and diagnostic companies that focus on respiratory care and neuro diagnostics — the monitoring of the brain and nervous system.
OSI Systems (OSIS) is a hybrid medical/defense company, with half of its revenue from medical equipment and half from scanning and inspection equipment and optical gear used by the defense and aerospace industries.
Wherever you run into organic produce, chances are it got there thanks to United Natural Foods (UNFI). The company is the largest national distributor of organic and natural foods, offering more than 40,000 products from 17 distribution sites nationwide.
WIRELESS TELECOM
As broadband-like speeds come to wireless communications, demand for ever more sophisticated handsets and the infrastructure that powers them will drive the industry's next leap forward.
Powerwave Technologies (PWAV) makes the amplifiers, antennas and other equipment that enable wireless phones and handheld devices to transmit and receive voice and data.
Brightpoint (CELL) is the middleman for the wireless industry and should be ideally positioned to profit from its continued growth.
GLOBAL GROWTH
Globalization is creating new opportunities in areas as disparate as market research and global air transport. Our two picks give investors worldwide reach as the global economy grows.
Best known for its Harris Poll, ubiquitous during American election campaigns since the 1950s, Harris Interactive (HPOL) is one of the top 15 market-research firms worldwide.
Atlas Air Worldwide (AAWW) offers an unusual opportunity to profit from growing global trade, a trend we expect to intensify in the coming decade.
Wednesday, May 16, 2007
Mason Hawkins
Mason Hawkin's six principles than any true investor must have in order to succeed in the long-term:
1. You need a sound philosophy
2. Good Search Strategy
3. Ability to value businesses and assess management quality
4. Discipline to say no.
5. Patience
6. Courage to make a significant investment at the point of maximum pessimism
-- via brknews
1. You need a sound philosophy
2. Good Search Strategy
3. Ability to value businesses and assess management quality
4. Discipline to say no.
5. Patience
6. Courage to make a significant investment at the point of maximum pessimism
-- via brknews
Sunday, May 13, 2007
Seth Klarman pulled it off
Manager Frets Over the Market, but Still Outdoes It
By GERALDINE FABRIKANT
Published: May 13, 2007
EARNING 22 percent on your investments while holding half of your portfolio in cash is no easy trick, but last year Seth A. Klarman pulled it off, and it was not the first time.
Mr. Klarman, a 49-year-old hedge fund manager, has turned in market-beating performances since 1983, while perpetually warning that the markets were dangerous and that investors should minimize risk.
What is his investment approach? He will not spell it out, although lots of people would like to know. On the Web, the price for his out-of-print 1991 book — “Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor” — has gone for $1,200 on Amazon and $2,000 on eBay.
At a time when hedge fund managers seem to be grabbing headlines with stories about their homes, hobbies, philanthropy and outsize compensation, Mr. Klarman keeps a low profile, and is reticent about the investments of his $7 billion Baupost Group of hedge funds, which has been closed to new money for the last seven years.
But his book, his letters to investors and other fund documents provide some clues about his thinking, and he added to the picture in a telephone interview. Mr. Klarman clearly sees himself as a deep value investor, in the mold of Warren E. Buffett or Benjamin Graham, the Columbia professor who pioneered value investing.
He is also a world-class worrier. In one letter, Mr. Klarman said, “At Baupost, we are big fans of fear, and in investing, it is clearly better to be scared than sorry.” In an earlier note, he wrote, “Rather than ratchet up risk, our approach has been to hold cash in the absence of opportunity.”
Last year, the cash holdings of his hedge funds amounted to 49.8 percent of assets, an enormous proportion for actively managed investments, but not an anomaly at Baupost: a year earlier, the cash holdings amounted to 45.8 percent. To add safety to his portfolios, he said that he usually eschews leverage, or debt, in his funds, using it only in some real estate investments. Instead, he has profited handsomely from investing in the debt of other companies, particularly those in financial distress.
Mr. Klarman, who is based in Boston and works with a team of 24 people, does not make bets on the overall market. Instead, his funds look for specific opportunities that he deems worthy. But he warns that Wall Street often tries to sell customers overvalued assets. For example, he said that he is wary of new issues because in the pursuit of large fees, banks may underwrite overpriced or highly risky securities.
By GERALDINE FABRIKANT
Published: May 13, 2007
EARNING 22 percent on your investments while holding half of your portfolio in cash is no easy trick, but last year Seth A. Klarman pulled it off, and it was not the first time.
Mr. Klarman, a 49-year-old hedge fund manager, has turned in market-beating performances since 1983, while perpetually warning that the markets were dangerous and that investors should minimize risk.
What is his investment approach? He will not spell it out, although lots of people would like to know. On the Web, the price for his out-of-print 1991 book — “Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor” — has gone for $1,200 on Amazon and $2,000 on eBay.
At a time when hedge fund managers seem to be grabbing headlines with stories about their homes, hobbies, philanthropy and outsize compensation, Mr. Klarman keeps a low profile, and is reticent about the investments of his $7 billion Baupost Group of hedge funds, which has been closed to new money for the last seven years.
But his book, his letters to investors and other fund documents provide some clues about his thinking, and he added to the picture in a telephone interview. Mr. Klarman clearly sees himself as a deep value investor, in the mold of Warren E. Buffett or Benjamin Graham, the Columbia professor who pioneered value investing.
He is also a world-class worrier. In one letter, Mr. Klarman said, “At Baupost, we are big fans of fear, and in investing, it is clearly better to be scared than sorry.” In an earlier note, he wrote, “Rather than ratchet up risk, our approach has been to hold cash in the absence of opportunity.”
Last year, the cash holdings of his hedge funds amounted to 49.8 percent of assets, an enormous proportion for actively managed investments, but not an anomaly at Baupost: a year earlier, the cash holdings amounted to 45.8 percent. To add safety to his portfolios, he said that he usually eschews leverage, or debt, in his funds, using it only in some real estate investments. Instead, he has profited handsomely from investing in the debt of other companies, particularly those in financial distress.
Mr. Klarman, who is based in Boston and works with a team of 24 people, does not make bets on the overall market. Instead, his funds look for specific opportunities that he deems worthy. But he warns that Wall Street often tries to sell customers overvalued assets. For example, he said that he is wary of new issues because in the pursuit of large fees, banks may underwrite overpriced or highly risky securities.
Mr. Klarman’s record has generated intense loyalty from investors. Since he began Baupost in 1983, it has posted an average annual total return of 19.55 percent, according to data provided by the hedge fund group. Declines have been posted in only 11 of the total 97 quarters since Baupost’s debut.
In 2006, Baupost’s portfolio held an array of assets, including United States, European, Asian and Canadian equities, which accounted for 17.1 percent of the portfolio; debt and real estate, which each made up 10 percent; and 4.7 percent in private equity funds. And there was that big dollop of cash.
“Seth has a remarkable record, and even more so when you realize that he has achieved it by holding significant amounts of cash,” said Jack R. Meyer, who until 2005 ran Harvard’s endowment, which has been a longtime investor in Baupost.
“In other words, his risk-adjusted numbers are spectacular. What is unusual is the high return and the high cash levels,” added Mr. Meyer, who now runs the investment fund Convexity Capital.
Mr. Klarman grew up in Baltimore, where his father was a health economist. After graduating from Cornell with a degree in economics in 1979, he worked for Max Heine and Michael Price at Mutual Shares for a year and a half, then went on to Harvard Business School, where he graduated with an M.B.A. in 1982. Immediately afterward, four wealthy families, including those of two Harvard professors, put up $27 million for Mr. Klarman to manage.
While his actual compensation has not been disclosed, years of high returns have made him wealthy. Baupost charges a 1 percent management fee on investments in its funds, as well as 20 percent of annual profit. It was managing roughly $6 billion at the end of 2005 — which would mean a $60 million management fee for Baupost. In addition, its 22 percent return on investments last year would suggest profit of about $1.3 billion — generating a 20 percent share for Baupost of about $260 million. The only leverage Mr. Klarman said he used was on the 10 percent of holdings in real estate, where the leverage was one to one.
Despite more than two decades of smart choices, Mr. Klarman seems to obsess continually about potential crises. In his most recent letter, he said that while investors had been upbeat because of relatively low market volatility and inexpensive credit, he was worried about trade imbalances and high levels of consumer debt, which he said could set off market declines. Writing about the stock market rally in 2006, he said: “There was nothing about this party that would have made you want to leave early, unless you were a value investor. The only adverse trend was the scarcity of mispricing opportunities.”
One place in which he said he had found some mispricing was in the shares of News Corporation stock, which rose 37 percent in 2006. While Baupost sold 1.8 million shares last year, at the end of December, it still owned 4.19 million shares, according to company filings. Last week, Mr. Klarman said he believed the stock was still undervalued. He added that he was not concerned about Rupert Murdoch’s bid for Dow Jones & Company, at a price many have described as extremely generous, because it would be a relatively small transaction for a company the size of News Corporation.
Other Baupost equity holdings include Home Depot and Posco, a Korean steel manufacturer, two stocks that happen to be held by Berkshire Hathaway, Mr. Buffett’s company.
Figuring out which distressed bonds Baupost owns is more difficult. For competitive reasons, Baupost does not name the companies, but last year Mr. Klarman told investors that its second-largest single annual gain came from an holding in NationsRent, a company that rents equipment to builders. NationsRent filed for bankruptcy in 2001. The next year Baupost invested about $100 million in the defaulted bank debt.
A year later, NationsRent reorganized. Baupost put in about $50 million in fresh capital in exchange for stock and ended up with a total of more than two-thirds of the stock. Last year, Sunbelt Rentals bought the company for $1 billion in cash and the assumption of debt. Mr. Klarman said that Baupost more than doubled its investment.
In the interview, Mr. Klarman said that he found bankruptcy investing appealing because the process of bankruptcy itself can help unlock the value of an investment.
“There is a catalyst,” he said, “because the way you make money is dependent on specific situations; the bankruptcy process itself will deliver you securities in the reorganized company.”
DESPITE Baupost’s stellar returns, Mr. Klarman’s team continues to take out what he calls “disaster insurance.” Last year it emphasized gold, which would appreciate if the dollar and other currencies declined in value. Although Baupost did not indicate the size of its wager, it did tell investors in one of its funds that 2.87 percentage points of about 20 percent in total fund profit came from a bet that the precious metal would rise. He wrote that gold was underpriced because investors in this “goldilocks” era have not worried enough about currency devaluation.
Baupost has had its setbacks. In 2006 it lost money on an investment in TRM, which operates automated teller machines. “It seemed cheap on cash flow, but its business deteriorated after Hurricane Katrina,” Mr. Klarman said. “It did not turn out to be as stable a business as we thought.”
Baupost has done better with real estate. Last year, Coastal Management Resources, a company in which Baupost has an equity stake, bought the neighboring Cojo and Jalama Ranches north of Santa Barbara, Calif. Although neither the size of Baupost’s investment in Coastal Management nor the purchase price of the ranches is known, the asking price was $155 million.
The ranch purchases may reflect Mr. Klarman’s passion for horses. He has owned racehorses, and even at the track his penchant for details is manifest. One of his horses, now retired, is named Read the Footnotes.
[4/8/08] Klarman can clearly be an active seller of stocks. He sells when a stock reaches fair value, but he also replaces current holdings with better opportunities as they come along. It's not rocket science, but it isn't a strategy most investors follow.
Wednesday, May 09, 2007
Chasing Performance
Know When to Hold ... and When to Fold
New research turns conventional wisdom - a buy-and-hold strategy is best - on its head.
ANY GAMBLER will tell you never fold with a winning hand. And yet all investors know not to buy a fund simply because it has been doing well. That's called chasing performance, and that's bad. We've said it ourselves countless times. The thing is, though, that advice may be wrong.
No, we're not suddenly advocating jumping on any enticing investing bandwagon. But Dan Weiner, founder of AdviserInvestment, which manages $1.1 billion primarily in Vanguard and Fidelity funds, has quietly shared some interesting research positing that strategic buying and selling of top performing funds can beat the market.
Simply purchase the top-performing diversified equity fund (pick domestic or international, but avoid sector funds) in the past 12-month period. Hold it for one year. Sell it and purchase the new No. 1 fund. AdviserInvestment backtested the strategy on Vanguard funds and found it delivered average annual returns of 20 percent over 10 years, compared with an average of 13.7 percent for the Standard & Poor's 500. Jim Lowell of the Fidelity Investor newsletter, came up with similar results based solely on Fidelity funds. Morningstar found the strategy worked best with domestic stock funds showing a 23 percent annualized return over 20 years, handily beating the broad market's 11.6 percent.
The reason for the phenomenon is simple: Trends don't confine themselves to any given 12-month period. Interestingly, some months seem to be stronger than others. Buying the top funds in June or October worked better than buying and selling in February. If the top-performing fund is closed to new investors, go ahead and buy the second best.
So what might work now? Based on our preliminary look, two good options appear be Fidelity International Small Cap Opportunities (FSCOX) and AIM Trimark Endeavor (ATDAX), a midcap fund.
-- Dyan Machan, SmartMoney, May 2007, page 33
New research turns conventional wisdom - a buy-and-hold strategy is best - on its head.
ANY GAMBLER will tell you never fold with a winning hand. And yet all investors know not to buy a fund simply because it has been doing well. That's called chasing performance, and that's bad. We've said it ourselves countless times. The thing is, though, that advice may be wrong.
No, we're not suddenly advocating jumping on any enticing investing bandwagon. But Dan Weiner, founder of AdviserInvestment, which manages $1.1 billion primarily in Vanguard and Fidelity funds, has quietly shared some interesting research positing that strategic buying and selling of top performing funds can beat the market.
Simply purchase the top-performing diversified equity fund (pick domestic or international, but avoid sector funds) in the past 12-month period. Hold it for one year. Sell it and purchase the new No. 1 fund. AdviserInvestment backtested the strategy on Vanguard funds and found it delivered average annual returns of 20 percent over 10 years, compared with an average of 13.7 percent for the Standard & Poor's 500. Jim Lowell of the Fidelity Investor newsletter, came up with similar results based solely on Fidelity funds. Morningstar found the strategy worked best with domestic stock funds showing a 23 percent annualized return over 20 years, handily beating the broad market's 11.6 percent.
The reason for the phenomenon is simple: Trends don't confine themselves to any given 12-month period. Interestingly, some months seem to be stronger than others. Buying the top funds in June or October worked better than buying and selling in February. If the top-performing fund is closed to new investors, go ahead and buy the second best.
So what might work now? Based on our preliminary look, two good options appear be Fidelity International Small Cap Opportunities (FSCOX) and AIM Trimark Endeavor (ATDAX), a midcap fund.
-- Dyan Machan, SmartMoney, May 2007, page 33
Saturday, May 05, 2007
Spike Higher?
[5/1/07] Major stock market tops are characterized by elation, ecstasy, and euphoria - not the fear of falling prices. We believe the combination of a fairly vibrant stock market and rising levels of fear is bullish for stocks, as sentiment gauges are best read from a contrarian perspective. We would use the bear's misguided feeling to our advantage.
One way to gauge market sentiment is to watch the short-interest ratio on the New York Stock Exchange. First, the short-interest ratio is the number of shares sold short divided by average daily volume. This is often called the "days-to-cover ratio" because it tells - given the stock's average trading volume - how many days it will take short sellers to cover their positions. Short sellers are, of course, betting on a price decline.
Since 1994, the NYSE short-interest ratio has oscillated between 3.7 and 7.5. The higher the ratio, the more investors are betting on a market decline. The lower the number, the more investors are looking for a rise in stock prices. The average ratio over this period has been 5.4. We view readings of 6 and above as bullish and readings of 4.6 and below as bearish. The current NYSE short-interest ratio is 7.4, or right near the top of the range since 1994 and just below the all-time high of 7.5 in October 1996.
With the ratio very high once again, and the market doing relatively well, the bears must have a case of severe indigestion and will, in all likelihood, be forced to cover their mistakes at even higher prices, adding more fuel to the fire.
* * *
[4/4/07] Mark Arbeter, S&P Chief Technical Strategist, sees a higher market.
It's not often we predict a spike higher. That fraternity of market mavens who, among other non-bull's-eyes, have called nine of the last six recessions is just not where we'd care to be.
That said, certain technical measures we follow suggest higher prices could be in store later this year.
We're talking about the put/call ratio, which tracks options contracts purchased on the Chicago Board of Options Exchange. Puts are, of course, options to sell; calls are options to buy. The ratio is used widely as a gauge of market sentiment. When there are more calls than puts, Mr. Market is bullish. More puts than calls, and Mr. Market is bearish.
Recently this measure hit an all-time high, suggesting Mr. Market had just taken a room at the Bates Motel — a glut of fear, in other words. Interestingly enough, this occurred during what was by historical standards a relatively modest pullback. This excessive fear is, we suggest, bullish.
And so on.
One way to gauge market sentiment is to watch the short-interest ratio on the New York Stock Exchange. First, the short-interest ratio is the number of shares sold short divided by average daily volume. This is often called the "days-to-cover ratio" because it tells - given the stock's average trading volume - how many days it will take short sellers to cover their positions. Short sellers are, of course, betting on a price decline.
Since 1994, the NYSE short-interest ratio has oscillated between 3.7 and 7.5. The higher the ratio, the more investors are betting on a market decline. The lower the number, the more investors are looking for a rise in stock prices. The average ratio over this period has been 5.4. We view readings of 6 and above as bullish and readings of 4.6 and below as bearish. The current NYSE short-interest ratio is 7.4, or right near the top of the range since 1994 and just below the all-time high of 7.5 in October 1996.
With the ratio very high once again, and the market doing relatively well, the bears must have a case of severe indigestion and will, in all likelihood, be forced to cover their mistakes at even higher prices, adding more fuel to the fire.
* * *
[4/4/07] Mark Arbeter, S&P Chief Technical Strategist, sees a higher market.
It's not often we predict a spike higher. That fraternity of market mavens who, among other non-bull's-eyes, have called nine of the last six recessions is just not where we'd care to be.
That said, certain technical measures we follow suggest higher prices could be in store later this year.
We're talking about the put/call ratio, which tracks options contracts purchased on the Chicago Board of Options Exchange. Puts are, of course, options to sell; calls are options to buy. The ratio is used widely as a gauge of market sentiment. When there are more calls than puts, Mr. Market is bullish. More puts than calls, and Mr. Market is bearish.
Recently this measure hit an all-time high, suggesting Mr. Market had just taken a room at the Bates Motel — a glut of fear, in other words. Interestingly enough, this occurred during what was by historical standards a relatively modest pullback. This excessive fear is, we suggest, bullish.
And so on.