Yearly Archives: 2012

This is How We Invest

It’s a bit of a mystery to me that many people still find value investing so mysterious.  At its very heart is the notion of buying something for less than its true value.  Almost everyone I know likes to buy things when they go on sale, except for stocks.  When stock prices are down, that is to say they are “on sale,” the natural tendency is to sell, not buy.  Funny old world, isn’t it?  Buying in the face of bad news seems to be the most difficult of investment disciplines to acquire.  This is one reason perhaps why so many individual investors, armed only with their common sense and the information flow from the media, tend to perform poorly versus the major indices.

This year, we (my investment colleagues and I) invested in a stock that nicely explains our investment philosophy and practice.  Not every stock we buy will follow this pattern (which is actually a good thing for my blood pressure), but I think sharing this one with the reader may help understand better how we invest.

Sometime in April of this year, I was running my usual screens looking for attractive investment candidates. I use a number of data sorts that can identify stocks that look cheap on a number of measures such as price-to-earnings, price-to-book, price-to-sales, price-to-free cash flow and so forth.  The output from these screens is our starting place in the stock selection process.  Not every stock that looks cheap (inexpensive) should be bought.  Some cheap stocks truly deserve a low valuation.

So in April, I found a company that I had never heard of before.  It was a mid- to small-cap company that looked cheap on a number of the ratios we use.  It operated in a competitive industry, but seemed to have a solid handle on an attractive niche in that industry.  The balance sheet seemed ok and sentiment on the name was mixed.  We usually find these things to be positives as we analyze a stock.

One of our investment policy committee members, ran the numbers, wrote up the report and we discussed the name at length, trying to fully assess the pros and cons of the stock.  In the end, we decided to buy the name, somewhere between $8 and $9, and thought that its “fair value” was around $12.

We started to buy the name with the expectation of making an attractive return.

Very shortly after we started buying the stock, it released a disappointing earnings announcement.  The company was having trouble with pricing, was losing market share and had a couple of other technical issues that were troubling.  Wall Street analysts began to cut price targets and earnings estimates.  Sentiment on the name quickly turned very negative.

We reconvened and reviewed our investment thesis in light of this new information.  After much discussion, we concluded that the news was not a deal breaker and continued to buy the stock.

From early May to early June the overall market struggled and this stock (perhaps because of its now perceived higher risk profile) moved down sharply with the market.  Each week we review the numbers and our investment thesis on this name.  Each week we concluded that the fundamentals continued to suggest a “fair value” much higher than where the stock was trading.

By early July the shares were down about 30% from where we started to buy them.  Although we felt a bit troubled by this move, we continued to buy the stock.  We noted in one of our discussions that the stock, when it was trading below $6, was actually cheaper than the cash on its balance sheet.  The market was practically giving away the stock for free.  And yet, sentiment continued to be very negative and some “experts” were even starting to question the viability of the company as an on-going business.

This was the time that the great investor Sir John Templeton would call the “point of maximum pessimism,” the place that separates good investors from average ones.  Investors who can look this pessimism in the eye and conclude (as we did this time) that the stock should be bought are generally rewarded for their contrarian (and perhaps courageous) stand.

By the middle of July, the market had turned around a bit and so did our little headache.  In late July, we began hearing talk that another company might be interested in acquiring our stock.  The stock moved quickly higher and by September there was an actual bid on the table to take over the company.  Although the deal was a bit complicated, we found it interesting that a bid from a strategic buyer drove the stock price to the exact level ($12) that was our “fair value” estimate back in April.

The chart below shows the trajectory of this stock’s price action.

So here are a few of the key issues about this investment I wish to stress:

1)     No one recommended this stock to us.  We found it on our own, did our own research on it and reached a conclusion that was a bit contrary and wholly our own.

2)     The stock looked cheap in April, but got a lot cheaper before the market (and the strategic buyer) could see its upside potential.

3)     It would have been much easier to give up on this name in May, June or July than to keep liking and buying it.  This would have been a big mistake.

4)     This stock rose to our estimate of “fair value” much faster than usual. This is why I thought it would be an interesting case study, exactly because the time frame was so compressed.

5)     Contrarian investing is not intuitive or easy, otherwise everyone would do it.

6)     We made a very attractive return in this stock.

7)     Your results may vary.

8)      Past returns are no guarantee of future results.

Each month I continue to use my screens searching for the next undervalued and unloved stock.  Each week our committee meets to look at new names and discuss new developments on the stocks we already own.  Every day, I wake up and wonder what new events will affect the markets and my stocks.  It may seem like a volatile and uncertain business to the average (normal?) person, but I really enjoy the entire process with all of its many ups and downs.

What Does Mr. Market Know?

One of the fundamental articles of faith regarding the stock market is its ability to discount future events.  That is to say, stock prices today should (if the discounting mechanism is functioning properly) reflect some of the potential future possible scenarios.  This works (when it works) because (so the theory goes) the smartest investors out there have already decided what they think is going to happen, and have already invested accordingly.  Sure, there are times when this doesn’t seem to work (the financial global crisis of 2008-2009), but most of the time Mr. Market seems to have a good handle on what’s in store.

To the average person, this notion may seem very strange.  How can the market “know” what’s going to happen?  The easy answer is that a lot of analytical power (not to mention money) is expended every day to measure and understand the current state of affairs in the economy, the various industries and each and every company out there.  There are great financial incentives for most professionals to “get it right.”  Collectively, all this brain power and financial heft adds up to a formidable forecasting machine.  This is why many professional investors do things that seem highly contrarian to the casual observer, and why they rarely speak publically about what they are doing right now (why give away your best ideas for free??).

The casual observer may read the newspaper, listen to the nightly news, and talk to some friends about the state of affairs.  Most conclusions about the stock market gathered in this way (excluding insider information, which is illegal) are likely already priced into stock prices.  Said another way, it is rare for an individual investor to do well by simply listening to the media and investing accordingly. By design, the media provides information it thinks will be readily consumed by its customers, not high-quality investment advice.

Right now, the media focus appears to be centered on the so-called “fiscal cliff.”  Each day we can read an article or listen to some “expert” about the dire consequences looming for our nation, its economy and, of course, the stock market.  These stories always sound rational and convincing.  They are obviously designed to be attractive to the consumers of such media.  In my view, they usually have a certain intuitive appeal that makes me not only sit up and take notice, but also want to do something to my portfolio.  Then, I remember that anything I hear in a public forum is mostly likely already reflected in stock prices. I then relax, sit back and enjoy the show.

So let’s boil all this down to the present time.  The consensus feeling out there is that we are facing a catastrophic event that could be horrible for the economy and the stock market.  If this were the case, could we expect this event to be discounted by the market?  I would think so.  Smart money would have already drawn its conclusions about this likelihood and invested accordingly (sold stocks, for example).

So what is Mr. Market saying about the likelihood of the “fiscal cliff” truly damaging the economy or stock market?  Well, through the end of November, the S&P 500 is up nearly 15%.  This has occurred despite slowing corporate earnings, big economic pauses in China and India, a recession in Europe and the looming fiscal cliff.  To put this performance in perspective, there have only been two other years since 2000 (2003 and 2009) with better performance than 2012.  I would submit that Mr. Market is not unduly worried about the market impact of the fiscal cliff.

As always, I don’t make predictions, but I would be very surprised to see a big sell off in stocks due to the shenanigans going on in Washington right now.  If I am surprised and we see some kind of correction, I would view it as a wonderful buying opportunity.  It’s bound to be entertaining – sit back and enjoy the show!

Nothing Sucks Like a Vacuum

U.S. Presidential elections are usually good for the economy.  The latest one spent something like $6 billion with a lot of that going to ad spending.  Besides the money it receives, the media loves these elections for other reasons.  Every day there is something fresh and newsworthy.  Candidate A is somewhere spewing strings of highly-quotable aphorisms while candidate B is doing the same thing in another part of the country.  In addition, we find daily commentary from the “experts” trying to put some kind of spin on all these pronouncements, interpret what was said, or predict what might happen.  All in all, it has been a fantastic feeding frenzy for the fifth estate.

Alas and alack, the election is over. And regardless if your guy won or not, one could make the case the biggest loser is the media!  Those who toil in this industry must now return to the more mundane matters of train wrecks, celebrity splits and the normal who, what, where and why.  Granted, Super Storm Sandy provided some sizable grist for the media mill, but that too has lost some momentum as of late.  The recent hostility in the Middle East provided some high drama worthy of the nightly news, but that too has faded into the past.

Luckily for the media, there is one item that seems qualified to fill the massive void left by the election – the FISCAL CLIFF.  It is obvious that this is the BIG STORY that seems to run on every media outlet EVERY SINGLE DAY.  Even the stock market seems to be trading on the few wisps of commentary drifting out of the backrooms of Washington.  Is today’s discussion more “constructive?”  The market trades higher.  “No visible progress?”  Sell those stocks!

As everyone must surely know at this point the “fiscal cliff” is the negative economic impact expected if Congress fails to address the changes in tax rates, automatic government spending cuts and so forth.  I offered my two bits on this issue back in May (you can see that posting here – http://www.thewolfgroup.com/blog/?paged=2), and I generally have not altered my opinion much on this matter.  I still think “kick it down the road” is the mostly likely and most politically expedient outcome here.

Not everyone agrees with me on this (no shocker there…), and many are trying to quantify how BAD IT WILL BE (the implication being that it will be bad).  There are an infinite number of possible scenarios here and many if not most of them seem pretty negative.  But, if one steps back and considers what this really is, the worry and concern now rampant (at least in the media’s eye) may fade a bit.

First of all, this is a man-made phenomenon.  The government’s difficulty in addressing spending, the tax code and entitlements has put us here.  The last “kick it down” the road legislation included these “automatic” measures as an incentive for the two sides to sit down and hammer out a workable compromise.  If they still can’t do this, what is stopping them from crafting another bit of legislation that moves these deadlines out a year?  The business cycle generally moves along without much attention to little things like this.  I suspect that the underlying business trends are likely to trump the fiscal cliff in the end.

Second, much of the negative economic impact may have already happened.  We have seem many companies reporting soft demand in capital spending, tech and other places suggesting that business decision makers have been cautious in front of this cliff.  One could argue that any resolution could quickly release a great of pent-up demand in business spending.  It is interesting to note that the U.S. consumer has been spending quite well despite the fiscal cliff hubbub.

Third, maybe the market would actually celebrate much of the fiscal cliff’s purported negatives.  Any additional negative economic impact would likely be short-lived (one quarter maybe?), and would be followed by stronger economic activity.  The market would probably like intelligent entitlement reform, but might enjoy even “stupid” across-the-board government spending cuts.  Above all else, the market hates uncertainty.   Even an apparent “negative” outcome, if it erases much of the uncertainty we currently face, might prove to be a positive for the stock market.

Finally, if the guys in Washington actually create some sort of elegant, workable and brilliant compromise to the fiscal cliff issue, how could this not be a huge positive for the market?  This may not be the odds-on bet, but it probably warrants non-zero probability status.

As always, I don’t make predictions, but I am comfortable being fully invested at this time.  I think any weakness over the next few weeks is likely to be temporary, and probably would represent a buying opportunity for anyone holding cash.

Old Guys Rock

From time to time I will say something that my teenage son thinks is kind of cool.  On those rare occasions, he will sometimes say with a slight chuckle, “old guys rock,” which is about as close to a compliment us old guys can expect from the teenage generation.  Obviously “old” is a subjective concept.  My wise father-in-law would often say, “old is twenty years older than you are.”  Although I am older than I used to be, much of my thoughts and behavior “feel” younger than my actual age.  I still play Ultimate Frisbee each weekend and still enjoy playing a video game now and then.  Maybe a lot of this “old” thing is a learned behavior…

This week I had the privilege of hearing Dan Fuss, one of the most respected bond portfolio managers in the business, give a presentation to a group of professional investors.  Dan, who by my father-in-law’s definition is “old” relative to me, started in the business in 1958 and probably has forgotten more about bonds and the markets than most people know.  Dan’s comments are always entertaining, enlightening and useful.  This time was no exception.

Market Watch featured a summary of his comments from a presentation in May of this year that does a pretty good job of highlighting Dan’s views.  It is a worthy read:  http://articles.marketwatch.com/2012-05-10/finance/31642652_1_interest-rates-unemployment-rate-loomis-sayles-bond-fund

Most economists and market strategists agree that the U.S. has a number of big problems – massive entitlement spending (which only grows as our population ages), government debt, an economy growing below potential, and so on.  Most commentary from these experts is gloomy; they struggle to offer workable solutions that do not require draconian measures that seem highly unlikely (cutting Social Security payments, limiting access to health care, across the board government spending cuts, etc.).  It’s easy to conclude that these troubles are chronic and insurmountable.  This conclusion may be part of the reason for the miasma many people feel now about our nation.

Dan too is very clear-eyed about these problems and did not offer any quick and easy solutions.  Yet, he did suggest something that I had never before considered that could help matters in a big way.   It involves old people.

One key element to the prosperity our nation experienced in the late 1990s (no, it wasn’t tax increases…) was a dramatic increase in the percentage of the population in the workforce.  Putting more people in the workforce has a tremendous impact on government revenue – much greater than raising taxes on any portion of the working population.  Dan suggests that this could happen again in the U.S., and the demographic that could help out would be – wait for it – old people!

This is already happening in Japan.  The effective retirement age in Japan has risen to 69 years (up from 60) over the last few decades.  Dan told of his experience with a museum tour guide in Tokyo.  This fellow had been retired for 15 years, and he decided to go back to work in his late 70s at the museum.  It wasn’t because he had to work, but he wanted to.  With medical and technological advances continuing at a rapid pace, it is easy to imagine a world where more “older” people will be able to perform many of the jobs that now are going unfilled.  Our current effective retirement age is 67 (already above the “typical” retirement age), and it seems reasonable that this could rise over time.

Clearly this is not a sure thing and may not be any kind of panacea.  Yet, most of the analysis I see about our nation’s big problems struggles to explain why tax revenues will rise (apart from increasing taxes, which is also rarely a sure thing). Dan has identified one possible way to see higher tax revenues.

In my view, there is a bit of irony here – the generation that is causing our structural entitlement/health care cost problems (the baby boomers) may ultimately become the solution to them.  Until then be sure to get enough sleep, eat lots of fiber, exercise, take your vitamins and get ready for a more active retirement than you might have planned…

Investing Gangnam Style

One of the surprising things about this world is that you never can predict what people will like.  Case in point – the global cultural phenomenon known as “Gangnam Style.”  This song’s music video, released by the South Korean rapper known as Psy, has become an internet juggernaut, logging over 400 million views.  Not since the “Macarena” has a pop song taken the world by storm like this.  Even now, the song is climbing up the U.S. Billboard singles chart, probably headed towards number 1.

The chart above shows the daily YouTube traffic of this video.  It’s interesting to see that the initial interest was quite high (500k) relative to most stuff on YouTube.  The fact that this was just a modest beginning relative to where it would go is nothing less than amazing.  Last month “Gangnam Style” was recognized by Guinness World Records as the most “liked” video in YouTube history.

I couldn’t help but think that if “Gangnam Style” chart depicted a stock’s price movement that I would want to own it!  In many ways, it would be the perfect investment.  Kind of flat at first, allowing investors to accumulate a full position.  Then moving up steadily at a somewhat modest pace, and then accelerating near the end to the chart.  Unless “Gangnam Style” was a great long-term investment (name another one-hit wonder that was), the point of acceleration near the end of this chart might be a good time sell.  In other words, buy early before everyone knows about it, and then sell when everyone loves it.  This is a simple formula and not every stock will conform to it, but it really lies at the heart of value investing.

The above chart shows the S&P 500 index since the latest bull market began back in 2009.  The market has risen over 100% since the its lows and each correction (despite what the media and other “gurus” were telling investors at those times) was actually a buying opportunity.  Looking at this chart, some people might be tempted to sell to lock in profits now.  Unlike one-hit wonders, the stock market is a good long-term investment.  The trajectory of the U.S. stock market over time has always been upward.  The only long periods of time when the market stalled occurred after massive bull markets and irrational overvaluation (1929 and 1999).

Our current bull market was unique in my experience in that retail investors were largely absent during its entire course so far.  Retail investors have sold something like $130 billion of stocks over the last five years and cash and bond holdings are near record levels.  Never has any bull market so unloved by retail investors.

I think this is what Bill Gross meant when he said that “the cult of equities is dead.”  I don’t think he was making a comment on the market, but on retail investor mentality.  Because it was hard to make money in stock last decade (the so-called “lost decade”), many have concluded that stocks are a bad investment.  They have given up.  The “cult of equity” to which Mr. Gross refers may be the idea that stocks would always be the best investment to own, no matter what.  The 10 years following the market’s peak in 2000 has done much to destroy this notion.

Yet, investment opportunities still abound.  Earlier this year we found, via one of our quantitative screens, a small company that looked undervalued.  We did a bunch of analysis and concluded we should buy it.  We did. It went down a bunch right afterwards.  We revisited our research, ran a few more numbers, and concluded that we still liked it. We bought some more.  The stock is now up over 100% from its July lows.  The stock market is up 100% in 3.5 years; but one stock is up 100% in 3 months.  This is why we don’t’ “buy the market.” And this is why we don’t try to time the market.  There are always some stocks out there worthy of our attention that are being ignored by the market that could be great investments.

A year from now we may be wondering what ever happen to that guy who made that catchy song and highly-entertaining video.   But I know that one year from now I will still be looking for and finding attractive individual stocks to enrich all investors in my sphere of influence.  But until then, “Oppa Gangnam Style!”

Truckin’

People who know me are usually surprised to learn that I have truck driver blood flowing through my veins.  Yep, two of my uncles were career truck drivers as well as many of my cousins.  I actually drove a 26-foot Ryder rental truck ONCE from New Jersey to Florida to help a friend move.  Although I am not really a truck driver, I have a warm spot in my heart for those men and women who help keep the U.S. economy moving by their efforts.

My cousin, Bill Harris, recently visited the Washington D.C. area and we had the chance to chat a bit about the trucking business.  He owns a trucking company in Nebraska called “Harris Quality” (you can see the website here: http://www.harrisquality.com/).  Bill and I were great friends when we were young; his family lived just a few blocks from us.  It had been many years since we had this much time to reminisce about old times, talk about our families and, of course, compare rock concerts we’ve attended.

The trucking business is obviously a cyclical one – more goods are shipped when the economy expands.  Yet, even with economic improvement, many truck driver jobs go unfilled.  According to a CNN Money report back in July, as many as 200,000 job openings for long haul truckers remain unfilled.  I asked Bill why is it so hard to find good drivers.  He suggested that it’s really a life style issue.  Some drivers will spend several months on the road, living in their trucks, truck stops and cheap motels.  The work isn’t necessarily hard, but it can be tedious and balancing this career choice with family life can be a challenge.  The pay seems pretty good – with median annual wage of almost $38k, truckers can actually earn about $4k more than the median for all jobs.  The top 10% of truck drivers can pull down nearly $60k a year.

One impediment to becoming a trucker is the need for certification.  Getting a commercial driver’s license requires a long, maybe as long as eight weeks, training class and can cost about $6,000.  Obviously, we all want our truck drivers to be trained, competent and committed to their work.  Yet, I wonder if this is an area where politicians concerned about the unemployment rate could help a bit…

The government isn’t always as helpful as it could as it could be.  In the name of safety, the government keeps restricting the hours the drivers can be on the road, how much sleep they get and even dictates how often they need to rest.  On paper, these rules may make sense, but for the drivers in the trenches, it only makes their already challenging work even more difficult.

Apart from finding and keeping good drivers, I asked Bill what other things he worries about.  He said that nearly all of his truck breakdown problems revolve around emission filter technology.  Laws passed around 2000 called for a gradual phase out of oxides of nitrogen (NOx) emissions from truck diesel engines.  These filter systems are costly and complicated, but have reduced NOx pollutants to nearly zero from his trucks.  This seemed like a good thing to me (we all like clearer air, right?), but clearly we have all paid for this in one way or another.

At the end of our conversation, I felt better informed about the industry and had many chances to think back about the stories my Uncle Paul and Uncle Jim would tell us as youngsters about their time “on the road.”  Thanks to all you hard working truck drivers out there, past and present.  Keep on truckin’!

Never Forget

It was a clear, crisp Tuesday morning, just like today, as I walked from the ferry to my TriBeCa office.  Usually, I would walk directly north from the boat dock along West Street, but on that particular morning I headed west moving through the World Trade Center Plaza.  I had no real reason to go that way that day, but I recall thinking how peaceful it seemed; I was there well before the usual crush of humanity typical of lower Manhattan.

As I traversed the nearly empty plaza, I recall seeing the fountains and modern sculptures that were famous landmarks of the area.  It had been just a few weeks before when my daughters, Ashley and Stephanie, and I had enjoyed a Billy Gilman concert in the Plaza.  Sometime before then, as I was passing through the Borders bookstore at the World Trade Center, I stumbled onto a live music concert in the bookstore by Farm Dogs, a rock band featuring Bernie Taupin, Elton John’s famous songwriting partner.

Some of these thoughts may have entered my mind as I crossed the broad expanse of cement from which arose those magnificent twins, but mostly I was thinking how lucky I was to be alive, to have a good job, a loving family and every reason in the world to be happy.  I suspect thousands of others had similar thoughts as they made their way into The City that day.

Well, you know the rest of the story.  Actually, there are thousands of stories — some tragic, some heroic, some miraculous.  One of my favorites is told by my good friend Victor Guzman.  You can watch it here:

http://www.youtube.com/watch?v=mkWc_EKLs4E

 

Gloom, Despair, and Agony on Me

As a youngster growing up in Montana, I loved watching the comedy variety show “Hee Haw.”  Although not a big fan of country music, I was nonetheless smitten by the show’s corny humor, Roy Clark’s amazing guitar playing and the clever word play of Archie Campbell (see picture).  He was famous for his “That’s good, no that’s bad” routine and telling children’s fairy tales using spoonerisms (“Cinderella” became “Rindercella” who “slopped her dripper” – dropped her slipper).  Good stuff.  The show enjoyed a long run (1969-1992), and probably had a surprisingly broad viewer base.

One of the reoccurring skits was the “Gloom Despair” one, where four of the cast members would recite a four-line poem bemoaning some extraordinary misfortune they were experiencing.  At the end of the poem, they would sing together these lyrics:

Gloom, despair, and agony on me

Deep, dark depression, excessive misery

If it weren’t for bad luck, I’d have no luck at all

Gloom, despair, and agony on me

As a parent, I sometimes found myself singing these words to a child whose nose was out of joint due to some perceived mistreatment by the world.  As one might expect, these lines did little to alter my child’s morosity.

As an investment advisor, I am tempted to sing this song whenever the negativity about the economy, the markets and politics becomes ubiquitous. Now is one of those times.  I am not sure the reason for this massive dose of pessimism – perhaps it’s the political adds promising some sort of Armageddon if we don’t elect the candidate who endorsed the ad; maybe it’s the fear of troubles in Europe escalating, maybe it’s all the talk of the dangers of the “fiscal cliff” looming in the not-too-distant future.  Regardless of the cause, this gloomy mood is out there, and frankly it baffles me.

Usually these peaks in pessimism occur when the stock market is struggling.  That is not the case this year.  Year to date, the S&P 500 is up 12%, the Russell 2000 is up almost 10% and even the Dow Jones Industrial Average is up over 7%.  So, it is unlikely that this gloomy mood is being caused by a weak stock market.  Frankly, I don’t know what the cause is, but I find the manifestations of this negativity quite interesting.

Some people I speak with have become so negative that they doubt the official data reported by the government and other sources.

“I can’t believe that corporate earnings are growing.”  Yep, they are.  S&P 500 earnings for 2012 will be another record year.  Corporate earnings have grown steadily since 2009.  All indications suggest growth in 2013 as well.  (And yes, this is occurring while Europe is in recession and China is slowing down…)

Here are some S&P 500 earnings per share numbers:

2007               $82.54

2010               $83.66

2011               $96.44

2012 (est)      $105.64

2013 (est)      $119.35

“The economy is so weak.”  Actually, the U.S. economy has posted quarterly growth every quarter since the third quarter of 2009.  We are more than three years into the current economic recovery.  That’s the fact.

“All sorts of bad things could happen.”  This is my favorite.  At any point in time, one could conjure up an infinite number of negative scenarios.  Most of the time, none of the really bad ones ever happen.  “Black Swan” events, like the 2008 global financial crisis are called “Black Swan” exactly because they are rare.  To expect a flock of black swan landing in one’s pond any minute now is to miss the whole point of the “Black Swan” idea.

In my experience, peaks in pessimism are usually good times to buy stocks.  The market looks like it’s trying to figure out what to do in the short run, but I feel pretty good about the future.  The U.S. Presidential election (when it’s over) will remove some uncertainty about government actions and policies.  The fiscal cliff deadlines will soon pass and we will have that uncertainty removed as well.  The stock market looks undervalued by a number of metrics and I continue to find many, many attractively valued stocks I want to own.

And as an antidote to the gloom I feel surrounding me, I will smile when I buy them =)

That Which We Can Measure

This weekend I replaced some wooden planks in our backyard deck.  This is only noteworthy if one understands my aptitude with tools and wood.  I majored in finance for good reasons.  To complete the job, I needed to use a crowbar, reciprocating saw, tape measure, hammer and about 20 nails.  On these rare occasions when I work with wood and saws, I can’t help but remember the old carpenter’s saw (!), “Measure twice, cut once.”

As I reflected on this saying, I was struck with the idea that so many activities require precise measurement and exact execution.  Whether you are a surgeon or a chef, an airplane pilot or a pharmacist, you must follow certain procedures and recipes with exactness, or dire consequences may follow (like a fallen soufflé!).

Then there are other professions, such as being a professional investor, where such exactness is much harder to come by.  We all would like some kind of formula or recipe that would guarantee positive returns.  I constantly see ads from people claiming that they have discovered the “secret” of investing.  Listen, if there was one way to assure positive returns, we would all be doing it.  Take my word on this one; there is no “magic secret” to investing.

That said, there are some things that investors can measure with precision that may help them achieve attractive returns.  I spend a lot of my research effort measuring such things.

Book Value.  The book value of a company is what’s left over after you subtract its liabilities from its assets.  I like this number because it does not change rapidly for most companies, and it usually grows over time.  I can measure how a stock is trading using the price/book value ratio.  Knowing the historical relationship between the share price and the company’s book value can tell me something about the stock.  In general, stocks trading at the low end of their price/book value range may be considered “cheap” or “inexpensive” and may have more upside than downside.  I do not look exclusively at this ratio, but it is one I can measure with precision, and one that tells me a lot about a stock’s value.

Earnings.  The price/earnings ratio (P/E) is one of the most widely used valuation ratios around.  Although we can know with precision past earnings (barring those pesky revisions), I think the market usually cares more about future earnings.  I use simple consensus estimates for future earnings to calculate P/Es.  Earnings estimates are generally much more volatile than book values and are vulnerable to company-specific surprises and the overall quality of equity analysts.  That said, many companies will trade in a well-defined P/E range, and understanding the current P/E can give us a good idea about how the market feels about the stock.

Sentiment.  How investors feel about the market can be measured via sentiment surveys.  Our favorite is one conducted and published weekly by The American Association of Individual Investors (AAII).  This organization asks individual investors how they view the market: bullish, bearish or neutral.  This survey has been a pretty good predictor of future market moves.  As the reader may recall, sentiment is a contra-indicator, that is, the more bearish the survey, the more likely the market is to move up.  Although sentiment is not a perfect indicator of the future (there are none, in my opinion), it is a pretty good one, and one that I watch constantly.  The latest AAII survey shows 30.2% bullish, 35.0% neutral and 34.7% bearish.  One could interpret these figures as generally bullish for the stock market.

There are many other things that I measure and monitor on a regular basis.  I don’t spend much time trying to predict “big” things like GDP, currency exchange rates, politics or the likelihood of the next “black swan.”  The great complexity and volatility of these metrics make them very hard to predict with the level of precision I would need to use them as guideposts for investing.

Will Rogers offered good advice about stock investing, “Don’t gamble; take all your money and buy some good stock, and hold it till it goes up, then sell it.  If it don’t go up, don’t buy it.”  I would amend this slightly, “Don’t gamble; take some of your money and buy well-diversified portfolio filled with inexpensive stocks, and actively measure the value of each stock in the portfolio.  If a stock doesn’t go up, don’t worry, if it’s cheap enough, it probably will go up over time.”

Okay, so I’m no Will Rogers, but I think I know how to invest without gambling. That may actually be worth more than crafting catchy phrases.

Thomas Jefferson – Still Relevant in the Modern World

Careful readers of this blog will realize that its title comes from a quotation by Thomas Jefferson, the third president of the United States.  Rarely do I say much about him or quote from his sizable body of work, but over the weekend Barron’s ran an article that reminded me how impressive this fellow was.

The essay, titled “Jefferson’s Great Idea,” penned by John Steele Gordon, explains Jefferson’s role in the development of our nation’s currency.  Mr. Gordon explains that before the American Revolution, colonists here used an odd mix of the money of other nations, including Spain, Portugal, France, and Great Britain as well as non-sovereign scrip such as warehouse certificates for tobacco.  After the Revolution, the country needed to create a system of currency all its own.  Rather than adopting the British system of dividing the basic unit into 20ths and 12ths or using the Spanish method of eighths, Jefferson suggested using decimal fractions of the dollar.  He said, “In all cases where we are free to choose between easy and difficult modes of operation, it is most rational to choose the easy.”  Mr. Gordon calls this idea “the Jeffersonian equivalent of Ockham’s razor.”

Mr. Jefferson was the first person to propose a decimal system for a nation’s currency, and the United States was the first to adopt such a system.  This “great idea” quickly spread, and now every nation on earth is using a decimal currency system.

I did not know this about Mr. Jefferson.  I guess this just underscores the breadth and depth of his genius.  We in this country, continue to live in liberty and freedom in large part to his vision of a nation whose citizens enjoy certain rights that are not given by the government, but “by their Creator.”  This was a revolutionary and novel idea back then and one that still contains great power today.

“We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.”

Happy Birthday America, and good work Mr. Jefferson!