The following is based upon a recent study on mutual fund investor performance by DALBAR's Quantitative Analysis of Investor Behavior (QAIB).
According to DALBAR, the S&P 500 returned 8.35% over the 20 years that ended in 2008 while, on average, equity fund investors earned just 1.87% (less than the inflation rate of 2.89%).
Beyond the performance of the actively managed equity mutual funds themselves, much of these poor returns come down to investor behavior. Buying the hot stock or mutual fund because it has been going up a lot recently and selling after the market has gone down out of panic or fear. That's a tough way to make money but studies have revealed how common this behavioral pattern is among investors. Many may think they can overcome this tendency but the prevailing evidence strongly suggests most do not. From the annual DALBAR study according to this press release and post:
"The dramatic events that continue to plague our financial markets have provoked panic, which exacerbates the ongoing carnage," said Lou Harvey, president of DALBAR. "For 15 years, QAIB has shown that investor returns lag what performance reports and prospectuses would lead one to believe is achievable. While those returns are, in fact, theoretically achievable, the reality is that investors are not rational, and make buy and sell decisions at the worst possible moments," he said.
That pattern wrecks long-term returns. It's a defect that needs to be unlearned and replaced with a more effective trained response. If good businesses are selling below intrinsic value, buy especially when it feels bad and the headlines are awful (and sell some holdings whenever you sense euphoria entering the equation and equities have become plainly expensive).*
"Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well." - Warren Buffett
Easier said but having the right temperament definitely matters.
Learning from this might help erase some of that 6.5% performance gap. It won't change the fact that too many professional managers underperform.
Still, investors would generally get improved results if they didn't chase performance and bought when the prevailing economic conditions are ugly and no one seems to want to own stocks.
Adam
* For many investors index funds make a lot of sense. The added risk and complexity of owning individual stocks works against long-term returns unless the investor truly understands business economics, consistently judges value well, and always buys with an appropriate margin of safety. The evidence supporting the idea that index funds are often the way to go is not insignificant. Yet whether buying individual marketable stocks or index funds it's important to not be buying what is popular at the moment. If it feels good to buy it's probably not cheap.
Related:
- Investors behaving badly
- You are Probably Bad at Investing
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Thursday, July 30, 2009
Tuesday, July 28, 2009
High Growth Doesn't Equal High Investor Returns
So China's economy apparently grew 7.9%. Here's a recent article in the Wall Street Journal. The article makes the point that high growth does not equate to high stock returns. In fact, the economies with high growth produce the lowest stock returns by quite a margin.
Highest Growth Countries: 6% avg annual return
Slowest Growth Countries: 12% avg annual return
According to the article, this is based upon decades of data from 53 countries.
On a $ 50,000 investment...
As usual, higher growth attracts competition and the new companies require capital. Labor costs are increased. Pricing power is diminished.
All of this may be good for civilization but generally adds up to reduced return on capital for investors.
It's a widely held false notion that high economic growth is correlated with high stock returns.
Adam
Related posts:
The Growth Myth Revisited - Jul 2009
The Growth Myth - Jun 2009
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Highest Growth Countries: 6% avg annual return
Slowest Growth Countries: 12% avg annual return
On a $ 50,000 investment...
- At 6%/year over 35 years you'd have $384,000
- At 12%/year over 35 years you'd have $2,640,000
As usual, higher growth attracts competition and the new companies require capital. Labor costs are increased. Pricing power is diminished.
All of this may be good for civilization but generally adds up to reduced return on capital for investors.
Adam
Related posts:
The Growth Myth Revisited - Jul 2009
The Growth Myth - Jun 2009
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Monday, July 27, 2009
Jeremy Grantham's Latest Letter
Here's some excerpts from the July letter. Always a good read.
"As value purists (at least most of the time), we were very constrained by the fact that we still measured U.S. quality blue chips as the highest return global equities even at the very low. This was in complete contrast to the situation at the low in 2002, where the best values were in risky emerging markets and small caps..." - Jeremy Grantham
"The easy winner of the cheapest equity sub-category contest is still high quality U.S. blue chips. They were really trashed on a relative basis by the second quarter rally in junk." - Jeremy Grantham
"Without an unexpectedly strong improvement in the economy, it is hard to see high quality stocks losing much more ground, given their extreme value gap over junky stocks – more than an 11 percentage point spread per year on our seven-year forecast!" - Jeremy Grantham
Grantham admits "high quality" is subjective but that they've been estimating this way for 30 years and have a good record with it.
So U.S. high quality stocks seem rather inexpensive relative to other asset classes. This was not true roughly a decade ago.
Adam
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
"As value purists (at least most of the time), we were very constrained by the fact that we still measured U.S. quality blue chips as the highest return global equities even at the very low. This was in complete contrast to the situation at the low in 2002, where the best values were in risky emerging markets and small caps..." - Jeremy Grantham
"The easy winner of the cheapest equity sub-category contest is still high quality U.S. blue chips. They were really trashed on a relative basis by the second quarter rally in junk." - Jeremy Grantham
"Without an unexpectedly strong improvement in the economy, it is hard to see high quality stocks losing much more ground, given their extreme value gap over junky stocks – more than an 11 percentage point spread per year on our seven-year forecast!" - Jeremy Grantham
Grantham admits "high quality" is subjective but that they've been estimating this way for 30 years and have a good record with it.
So U.S. high quality stocks seem rather inexpensive relative to other asset classes. This was not true roughly a decade ago.
Adam
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Friday, July 24, 2009
Munger on Accounting
Charlie Munger said the following in the Stanford Lawyer back in 2002:
"Proper accounting is like engineering. You need a margin of safety. Thank God we don't design bridges and airplanes the way we do accounting."
He also added the following during a talk at USC Business School in back in 1994:
"...you have to know accounting. It's the language of practical business life. It was a very useful thing to deliver to civilization. I've heard it came to civilization through Venice which of course was once the great commercial power in the Mediterranean. However, double-entry bookkeeping was a hell of an invention.
And it's not that hard to understand.
But you have to know enough about it to understand its limitations—because although accounting is the starting place, it's only a crude approximation. And it's not very hard to understand its limitations. For example, everyone can see that you have to more or less just guess at the useful life of a jet airplane or anything like that. Just because you express the depreciation rate in neat numbers doesn't make it anything you really know."
Financial statements provide an estimate, not some absolute truth about what's going on in a business. As a result, sound judgment on the impossible or hard to measure aspects of a business matters a bunch.
If you cannot measure something well it doesn't necessarily make the factor lose significance. Over-analyzing the easy to measure stuff while ignoring what's difficult to measure but important can prove rather costly for an investor.
Adam
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
"Proper accounting is like engineering. You need a margin of safety. Thank God we don't design bridges and airplanes the way we do accounting."
He also added the following during a talk at USC Business School in back in 1994:
"...you have to know accounting. It's the language of practical business life. It was a very useful thing to deliver to civilization. I've heard it came to civilization through Venice which of course was once the great commercial power in the Mediterranean. However, double-entry bookkeeping was a hell of an invention.
And it's not that hard to understand.
But you have to know enough about it to understand its limitations—because although accounting is the starting place, it's only a crude approximation. And it's not very hard to understand its limitations. For example, everyone can see that you have to more or less just guess at the useful life of a jet airplane or anything like that. Just because you express the depreciation rate in neat numbers doesn't make it anything you really know."
Financial statements provide an estimate, not some absolute truth about what's going on in a business. As a result, sound judgment on the impossible or hard to measure aspects of a business matters a bunch.
If you cannot measure something well it doesn't necessarily make the factor lose significance. Over-analyzing the easy to measure stuff while ignoring what's difficult to measure but important can prove rather costly for an investor.
Adam
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Wednesday, July 22, 2009
Coca-Cola's 2Q Earnings
Some comments by Coca Cola's CEO Muhtar Kent on the earnings conference call yesterday:
A full transcript of the conference call can be found here.
Also, here is a summary of Coke's 2Q results from the 2Q09 earnings press release.
Adam
Long position in KO
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
QUESTION: Can you give us your assessment of the macro, the consumer environment, particularly markets like Russia or eastern Europe where trends have been pretty weak?
RESPONSE: Think of four different quadrants as far as the consumer sentiment is concerned. On the top left quadrant, you've got Europe, you've got North America and maybe a couple of other economies where we will probably be experiencing resets in terms of the consumer psyche where they will probably do things differently than they have done in the past and mostly related to, in terms of durable consumers, consumer consumption habits, but also in general. There will be a reset in the mind.
And then you've got on the top right, you've got China, India, other parts of Brazil, where I think there will be a very strong, quick rebound.
Then you've got on the bottom left quadrant a Japan stagnation and then you've got ... eastern Europe, Russia, Ukraine, on the bottom right quadrant, which is basically I call volatility, more zigs than zags. It could come could back quickly, then could go back down quickly.
I think we're in for a few years of zigs and zags for Russia, eastern Europe and so forth.
A full transcript of the conference call can be found here.
Also, here is a summary of Coke's 2Q results from the 2Q09 earnings press release.
Adam
Long position in KO
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Tuesday, July 21, 2009
Stocks to Watch
Below is a list of stocks I like* for my own portfolio at the right price. As an example: JNJ's recent price of $ 59.23/share is still below the $ 65/share I'd be willing to pay. Some other stocks on the list below are currently selling above what I'd pay (RMCF, PKX, HANS, LOW, MHK, MO) but I still think they are great businesses to buy shares of at the right price.
These are all intended to be long-term investments. A ten year horizon or longer. No trades here.
The stocks in bold have two things in common. They are:
1) currently owned by Berkshire Hathaway (as of 3/31/09) and,
2) selling below the price that Warren Buffett paid.
There are several other Berkshire Hathaway holdings on this list but they don't have the 2nd thing going for them.
Stock/Maximum Price I'd Pay/Recent Price**
JNJ/65.00/59.23 - Buffett paid approx $ 62/share
COP/50.00/42.38 - Buffett paid approx $ 82/share...ouch
KFT/30.00/27.43 - Buffett paid approx $ 33/share
USB/24.00/17.96 - Buffett paid approx $ 31/share
BNI/80.00/74.80 - Buffett paid approx $ 75/share
WFC/28.00/25.00 - Buffett paid approx $ 32/share
BRKb/3000/2951
KO/55.00/50.32
PG/60.00/55.92
AXP/35.00/28.02
PEP/60.00/56.66
ADP/37.00/35.31
PM/45.00/44.00
DEO/60.00/57.95
---------------------
MO/16.00/17.34
LOW/19.00/20.42
MHK/30.00/37.78
HANS/25.00/29.48
RMCF/6.00/8.06
PKX/80.00/89.13
(Splits, spinoffs, and similar actions inevitably will occur going forward. Will adjust as necessary to make meaningful comparisons.)
Tactically, these may seem difficult to buy with the S&P 500 having moved from a recent low of 872 on 7/10/09 to 951 as of yesterday. Mr. Market's mood has improved a bit.
Many stocks have rallied so the risk of paying more than necessary in the short-term is there.
Yet, another risk, of course, is missing a stock entirely because it continues to rally. There is no perfect answer to this. The risk of missing something you like when a fair price is available (error of omission) can be more costly than suffering a short-term paper loss.
Here are some thoughts on errors of omission by Warren Buffett from an article in The Motley Fool.
And also...
"During 2008 I did some dumb things in investments. I made at least one major mistake of commission and several lesser ones that also hurt... Furthermore, I made some errors of omission, sucking my thumb when new facts came in." - Warren Buffett's 2008 Annual Letter to Shareholders
In other words, not buying what's still attractively valued to avoid short-term paper losses is far from perfect with your best long-term investment ideas.
To me, if an investment is initially bought at a fair price, and is likely to increase substantially in intrinsic value over 20 years, it makes no sense to be bothered by a temporary paper loss. Of course, make a misjudgment on the quality of a business and that paper loss becomes real (error of commission).
Bottom line: when highly confident that a great business is available at a fair price it's important to accumulate enough while the window of opportunity exists. Sometimes ignoring the risk of short-term losses is necessary to make sure a meaningful stake is acquired. Ending up with just the quantity of "an eyedropper" when I'd like a full glass is no fun.
Hey, investing is never easy.
Adam
* This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here are never a recommendation to buy or sell anything and should never be considered specific individualized investment advice. In general, intend to remain long the above stocks (at least those that at some point became cheap enough to buy) unless market prices become significantly higher than intrinsic value, core business economics become materially impaired, prospects turn out to have been misjudged, or opportunity costs become high.
** As of July 17, 2009
These are all intended to be long-term investments. A ten year horizon or longer. No trades here.
The stocks in bold have two things in common. They are:
1) currently owned by Berkshire Hathaway (as of 3/31/09) and,
2) selling below the price that Warren Buffett paid.
There are several other Berkshire Hathaway holdings on this list but they don't have the 2nd thing going for them.
Stock/Maximum Price I'd Pay/Recent Price**
JNJ/65.00/59.23 - Buffett paid approx $ 62/share
COP/50.00/42.38 - Buffett paid approx $ 82/share...ouch
KFT/30.00/27.43 - Buffett paid approx $ 33/share
USB/24.00/17.96 - Buffett paid approx $ 31/share
BNI/80.00/74.80 - Buffett paid approx $ 75/share
WFC/28.00/25.00 - Buffett paid approx $ 32/share
BRKb/3000/2951
KO/55.00/50.32
PG/60.00/55.92
AXP/35.00/28.02
PEP/60.00/56.66
ADP/37.00/35.31
PM/45.00/44.00
DEO/60.00/57.95
---------------------
MO/16.00/17.34
LOW/19.00/20.42
MHK/30.00/37.78
HANS/25.00/29.48
RMCF/6.00/8.06
PKX/80.00/89.13
(Splits, spinoffs, and similar actions inevitably will occur going forward. Will adjust as necessary to make meaningful comparisons.)
Tactically, these may seem difficult to buy with the S&P 500 having moved from a recent low of 872 on 7/10/09 to 951 as of yesterday. Mr. Market's mood has improved a bit.
Many stocks have rallied so the risk of paying more than necessary in the short-term is there.
Yet, another risk, of course, is missing a stock entirely because it continues to rally. There is no perfect answer to this. The risk of missing something you like when a fair price is available (error of omission) can be more costly than suffering a short-term paper loss.
Here are some thoughts on errors of omission by Warren Buffett from an article in The Motley Fool.
And also...
"During 2008 I did some dumb things in investments. I made at least one major mistake of commission and several lesser ones that also hurt... Furthermore, I made some errors of omission, sucking my thumb when new facts came in." - Warren Buffett's 2008 Annual Letter to Shareholders
In other words, not buying what's still attractively valued to avoid short-term paper losses is far from perfect with your best long-term investment ideas.
To me, if an investment is initially bought at a fair price, and is likely to increase substantially in intrinsic value over 20 years, it makes no sense to be bothered by a temporary paper loss. Of course, make a misjudgment on the quality of a business and that paper loss becomes real (error of commission).
Bottom line: when highly confident that a great business is available at a fair price it's important to accumulate enough while the window of opportunity exists. Sometimes ignoring the risk of short-term losses is necessary to make sure a meaningful stake is acquired. Ending up with just the quantity of "an eyedropper" when I'd like a full glass is no fun.
Hey, investing is never easy.
Adam
* This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here are never a recommendation to buy or sell anything and should never be considered specific individualized investment advice. In general, intend to remain long the above stocks (at least those that at some point became cheap enough to buy) unless market prices become significantly higher than intrinsic value, core business economics become materially impaired, prospects turn out to have been misjudged, or opportunity costs become high.
** As of July 17, 2009
Monday, July 20, 2009
When Genius Failed...Again
"'GIVE ME but one firm spot in which to stand,' Archimedes declared, 'and I will move the earth.' While the ancient Greeks discovered the principle of leverage some 2,200 years ago, it was John Meriwether and his Long-Term Capital Management LP that showed how far leverage could take you in financial speculation." - Forbes article by Robert Lenzner in 1998
John Meriwether, is closing his latest failed hedge fund (JWM Partners) after losing 44% in less than 18 months. Of course, Meriwether is best known for the Long-Term Capital Management (LTCM) disaster back in 1998. Back then, many feared LTCM's failure would threaten the stability of the global financial system without intervention. As a result, a bailout was organized by the Federal Reserve Bank of New York in order to prevent a wider collapse in the financial markets.
The book When Genius Failed tells the full story, but basically LTCM was an extremely leveraged outfit that gambled with various forms of arbitrage and lost a ton of money.
LTCM was made up of several former professors, including Nobel Prize-winning economists Robert Merton and Myron Scholes.
...its enormously leveraged gamble with various forms of arbitrage involving more than $1 trillion dollars went bad, and in one month, LTCM lost $1.9 billion. On the precipice of not only an American financial disaster, the fund's imminent collapse had significant international monetary implications, jeopardizing the financial system itself. - From Wikipedia on the book, When Genius Failed
From a recent Bespoke Investment Group post on his latest failed fund:
Only a little less than ten years after his first hedge fund [LTCM] blew up and threatened the stability of the financial system, John Meriwether has announced that his current fund, JWM Partners, will wind down operations after a loss of 44% from September 2007 through February 2009.
Bespoke also added...
...Bloomberg reported that, "For many investors, John Meriwether is by now just another hedge-fund manager." Just another hedge-fund manager? How many other hedge fund managers do you know with a resume that includes a US Treasury trading scandal, Long-Term Capital, and now this?
Here's an excerpt from an article about John Meriwether that was published earlier this year:
"Some people really do live a cartoon life. They blow themselves up, and for a second, there they are, all charred and burned. But then in the next frame, they've got a fresh stick of dynamite in their hands and they're good as new. Such is the fanciful tale of John Meriwether, the mad genius behind Long-Term Capital Management, the original hedge-fund disaster story. There are some analysts who now see the 1998 government bailout of LTCM as planting the seeds of our current predicament — the moment when sophisticated financial managers learned that causing systemic risk was something they didn't really have to worry about, because the government would be there to have their backs." - From John Meriwether, The Wile E. Coyote of Hedge Funds by Hugo Lindgren
We've seen this movie:
1) Excess leverage,
"Leverage is the only way a smart guy can go broke." - Warren Buffett on The Charlie Rose Show
2) complex formulas,
"Beware of geeks bearing formulas." - Warren Buffett in the 2009 Berkshire Hathaway Shareholder Letter
3) and overconfidence based on high IQ.*
"We'd argue that what's taught is at least 50% twaddle, but these people have high IQs. We recognized early on that very smart people do very dumb things, and we wanted to know why and who, so we could avoid them." - Charlie Munger at the 2007 Berkshire Hathaway Shareholder Meeting
"If you have a 150 IQ, sell 30 points to someone else. You need to be smart, but not a genius. What's most important is inner peace; you have to be able to think for yourself. It's not a complicated game." - Warren Buffett at the 2009 Berkshire Hathaway Shareholder Meeting
When all three are combined, it's smart to keep hard earned money as far away as possible.
Adam
Related posts:
Smart Money?
The Madness of Crowds
Max Planck: Resistance of the Human Mind
* From John Kenneth Galbraith's book, A Short History of Financial Euphoria: "...the investing public is fascinated and captured by the great financial mind. That fascination derives, in turn, from the scale of the financial operations and the feeling that, with so much money involved, the mental resources behind them cannot be less.
Only after the speculative collapse does the truth emerge. What was thought to be unusual acuity turns out to be only a fortuitous and unfortunate association with the assets. Over the long years of history, the result for those who have been thus misjudged (including, invariably, by themselves) has been opprobrium followed by personal disgrace or a retreat into the deeper folds of obscurity. Or it has been exile, suicide, or, in modern times, at least moderately uncomfortable confinement. The rule will often be here reiterated: financial genius is before the fall."
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
John Meriwether, is closing his latest failed hedge fund (JWM Partners) after losing 44% in less than 18 months. Of course, Meriwether is best known for the Long-Term Capital Management (LTCM) disaster back in 1998. Back then, many feared LTCM's failure would threaten the stability of the global financial system without intervention. As a result, a bailout was organized by the Federal Reserve Bank of New York in order to prevent a wider collapse in the financial markets.
The book When Genius Failed tells the full story, but basically LTCM was an extremely leveraged outfit that gambled with various forms of arbitrage and lost a ton of money.
LTCM was made up of several former professors, including Nobel Prize-winning economists Robert Merton and Myron Scholes.
...its enormously leveraged gamble with various forms of arbitrage involving more than $1 trillion dollars went bad, and in one month, LTCM lost $1.9 billion. On the precipice of not only an American financial disaster, the fund's imminent collapse had significant international monetary implications, jeopardizing the financial system itself. - From Wikipedia on the book, When Genius Failed
From a recent Bespoke Investment Group post on his latest failed fund:
Only a little less than ten years after his first hedge fund [LTCM] blew up and threatened the stability of the financial system, John Meriwether has announced that his current fund, JWM Partners, will wind down operations after a loss of 44% from September 2007 through February 2009.
Bespoke also added...
...Bloomberg reported that, "For many investors, John Meriwether is by now just another hedge-fund manager." Just another hedge-fund manager? How many other hedge fund managers do you know with a resume that includes a US Treasury trading scandal, Long-Term Capital, and now this?
Here's an excerpt from an article about John Meriwether that was published earlier this year:
"Some people really do live a cartoon life. They blow themselves up, and for a second, there they are, all charred and burned. But then in the next frame, they've got a fresh stick of dynamite in their hands and they're good as new. Such is the fanciful tale of John Meriwether, the mad genius behind Long-Term Capital Management, the original hedge-fund disaster story. There are some analysts who now see the 1998 government bailout of LTCM as planting the seeds of our current predicament — the moment when sophisticated financial managers learned that causing systemic risk was something they didn't really have to worry about, because the government would be there to have their backs." - From John Meriwether, The Wile E. Coyote of Hedge Funds by Hugo Lindgren
We've seen this movie:
1) Excess leverage,
"Leverage is the only way a smart guy can go broke." - Warren Buffett on The Charlie Rose Show
2) complex formulas,
"Beware of geeks bearing formulas." - Warren Buffett in the 2009 Berkshire Hathaway Shareholder Letter
3) and overconfidence based on high IQ.*
"We'd argue that what's taught is at least 50% twaddle, but these people have high IQs. We recognized early on that very smart people do very dumb things, and we wanted to know why and who, so we could avoid them." - Charlie Munger at the 2007 Berkshire Hathaway Shareholder Meeting
"If you have a 150 IQ, sell 30 points to someone else. You need to be smart, but not a genius. What's most important is inner peace; you have to be able to think for yourself. It's not a complicated game." - Warren Buffett at the 2009 Berkshire Hathaway Shareholder Meeting
When all three are combined, it's smart to keep hard earned money as far away as possible.
Adam
Related posts:
Smart Money?
The Madness of Crowds
Max Planck: Resistance of the Human Mind
* From John Kenneth Galbraith's book, A Short History of Financial Euphoria: "...the investing public is fascinated and captured by the great financial mind. That fascination derives, in turn, from the scale of the financial operations and the feeling that, with so much money involved, the mental resources behind them cannot be less.
Only after the speculative collapse does the truth emerge. What was thought to be unusual acuity turns out to be only a fortuitous and unfortunate association with the assets. Over the long years of history, the result for those who have been thus misjudged (including, invariably, by themselves) has been opprobrium followed by personal disgrace or a retreat into the deeper folds of obscurity. Or it has been exile, suicide, or, in modern times, at least moderately uncomfortable confinement. The rule will often be here reiterated: financial genius is before the fall."
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Friday, July 17, 2009
Buy a Stock...Hope the Price Drops?
An investor buys Coca-Cola (KO) today and it immediately drops 50%.
The stock then stays at that 50% discount to the price he paid for 5-10 years. As a result, that investor becomes substantially richer in the long run.
The longer it stays undervalued the higher the long-term return.
What's going on?
Well, for starters, this works best when:
Loss aversion is a powerful force that's difficult to manage even when you are aware of it.
So, even with a decent understanding of loss aversion, my initial instinctive response to a price drop after purchase is sometimes still negative but, over time, it's been possible to develop a trained more rational response.
To celebrate.
Naturally, in the long run, an investor wants the shares that were bought to be materially higher. Yet, unless a shareholder intends to sell shares soon, a drop in price* in the near to intermediate term works to the investor's advantage.
The math, of course, is simple.
A 50% drop in price may be terrible to stare at on a computer screen or monthly statement, but it allows 2x as many shares to be bought back with the same amount of dollars. Do that consistently over time and it creates a ton of wealth for remaining long-term shareholders.
Let's say shares of a good business are bought at 10x free cash flow and the shares then drop 50%.
In that situation, even if the earnings do not grow, share count would be reduced by 50% over two and a half years using just free cash flow (even if free cash flow shrunk somewhat the returns are clearly very favorable for the owners that hang on for the long haul).
The key again is that the shares are, in fact, being bought below intrinsic value. Too often with buybacks that is not the case. Using a company's dividend to buy more shares when selling below intrinsic value can accomplish a similar thing.**
The difference in returns is not academic. Consider the case of Philip Morris/Altria where $ 10,000 invested in 1957 grew to more than $ 80 million (incl. reinvested dividends) over roughly 50 years -- an annual return of nearly 20%. Philip Morris shareholders had frequent undervaluation and, of course, the durable superior core economics of the business itself working for them over those years.
(Attractive risk and reward characteristics, if bought at the right price, may still exist but it seems very unwise to expect anything close to these kind of returns going forward. There are a number of reasons that's simply not likely to happen even if it's still an otherwise sound investment. Now, if it turns out to be better than expected there'll surely be no complaints.)
This works best for well-financed (strong balance sheet, lots of liquidity) businesses with durable core economics that can reliably produce far more capital than it ever needs to run the business. Those with superior economics and durable competitive advantages are the best candidates.***
Interestingly, even though Coca-Cola has been a great investment over the past twenty years, one of the reasons the stock did not perform as well as it would have otherwise was its extremely high valuation in the 1990s (particularly the late 1990s). It became way overvalued and stayed that way for years. This prevented Coca-Cola management from reducing shares outstanding on the cheap.
The bad news is that the stock of quality businesses like Coca-Cola do not often sell at a large discount to value. The good news is even a slightly undervalued stock price bought back consistently can make a meaningful difference over time.
Naturally, when someone buys a stock they want to see it go up but that high price actually does reduce long-term returns. Seeing a stock sell below the price paid for an extended period is difficult for some investors to tolerate. Quite a few end up bailing out before the benefits of shares bought at cheap prices has really had an impact.
Shares of a good business bought consistently below intrinsic value has powerful long-term effects. This works whether it is the individual investor (through additional share purchases or dividend reinvestment) or the company itself that is doing the buying.
None of this works, of course, if value is misjudged or shares of what turns out to be a lousy business were purchased.
Also, the investor must have a truly long-term investing horizon.
Otherwise, it just isn't very likely to work out all that well.
Adam
Long positions in KO, MO, and the recent spin-off of PM
* Of course, eventually an investor wants the stock to go up. It's just that an investor is better off if market participants misjudge intrinsic value on the low side for as long as possible. It only matters if the investor decides to sell many years later. Until a stock is sold ideally many years down the road, a low price, even if it sells below the price paid for an extended period, is in fact an advantage. What's an exception to this? Here's one scenario to consider. Unfortunately, there's the very real risk that a buyout offer comes in at a premium to market value but a discount to intrinsic value. If enough owners are okay with the gain that will have occurred compared to the recent price action, the deal may be approved. If too few have conviction about longer run prospects, the deal may get approved. When too many owners of shares are in it for the short-term or, at least, primarily to profit from price action, the chance of this happening increases. Well, those that became owners because of the plain discount to intrinsic value and the company's long run prospects will likely get hurt in this scenario.
** Economically a stock buyback vs dividend reinvestment are similar. Yet there is a potentially a difference from a tax standpoint since, depending on the type of account, one has to pay taxes on those dividends. That's not the case for buybacks. So, if management is a good capital allocator (a big if), the investors are generally better off if the company repurchases the shares. Other than the tax differences, buybacks and dividend reinvestments, implemented at reasonable or better valuation levels (i.e. discount to value), similarly benefit long-term owners; the former reduces overall share count, while the latter increases the number of shares owned.
*** First and foremost, the amount of capital required to run the business and how much the free cash flow generation can grow over time are the crucial factors in long-term value creation. After that it comes down to how well management allocates capital.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
The stock then stays at that 50% discount to the price he paid for 5-10 years. As a result, that investor becomes substantially richer in the long run.
The longer it stays undervalued the higher the long-term return.
What's going on?
Well, for starters, this works best when:
- The investment horizon that is at least 5-10 years and ideally even longer
- Comfortably financed businesses (strong balance sheet/lots of liquidity) with ample free cash flow and high return on capital are purchased
- Shares are bought below (ideally well below) intrinsic value
Loss aversion is a powerful force that's difficult to manage even when you are aware of it.
So, even with a decent understanding of loss aversion, my initial instinctive response to a price drop after purchase is sometimes still negative but, over time, it's been possible to develop a trained more rational response.
To celebrate.
Naturally, in the long run, an investor wants the shares that were bought to be materially higher. Yet, unless a shareholder intends to sell shares soon, a drop in price* in the near to intermediate term works to the investor's advantage.
The math, of course, is simple.
A 50% drop in price may be terrible to stare at on a computer screen or monthly statement, but it allows 2x as many shares to be bought back with the same amount of dollars. Do that consistently over time and it creates a ton of wealth for remaining long-term shareholders.
Let's say shares of a good business are bought at 10x free cash flow and the shares then drop 50%.
In that situation, even if the earnings do not grow, share count would be reduced by 50% over two and a half years using just free cash flow (even if free cash flow shrunk somewhat the returns are clearly very favorable for the owners that hang on for the long haul).
The key again is that the shares are, in fact, being bought below intrinsic value. Too often with buybacks that is not the case. Using a company's dividend to buy more shares when selling below intrinsic value can accomplish a similar thing.**
The difference in returns is not academic. Consider the case of Philip Morris/Altria where $ 10,000 invested in 1957 grew to more than $ 80 million (incl. reinvested dividends) over roughly 50 years -- an annual return of nearly 20%. Philip Morris shareholders had frequent undervaluation and, of course, the durable superior core economics of the business itself working for them over those years.
(Attractive risk and reward characteristics, if bought at the right price, may still exist but it seems very unwise to expect anything close to these kind of returns going forward. There are a number of reasons that's simply not likely to happen even if it's still an otherwise sound investment. Now, if it turns out to be better than expected there'll surely be no complaints.)
This works best for well-financed (strong balance sheet, lots of liquidity) businesses with durable core economics that can reliably produce far more capital than it ever needs to run the business. Those with superior economics and durable competitive advantages are the best candidates.***
Interestingly, even though Coca-Cola has been a great investment over the past twenty years, one of the reasons the stock did not perform as well as it would have otherwise was its extremely high valuation in the 1990s (particularly the late 1990s). It became way overvalued and stayed that way for years. This prevented Coca-Cola management from reducing shares outstanding on the cheap.
The bad news is that the stock of quality businesses like Coca-Cola do not often sell at a large discount to value. The good news is even a slightly undervalued stock price bought back consistently can make a meaningful difference over time.
Naturally, when someone buys a stock they want to see it go up but that high price actually does reduce long-term returns. Seeing a stock sell below the price paid for an extended period is difficult for some investors to tolerate. Quite a few end up bailing out before the benefits of shares bought at cheap prices has really had an impact.
Shares of a good business bought consistently below intrinsic value has powerful long-term effects. This works whether it is the individual investor (through additional share purchases or dividend reinvestment) or the company itself that is doing the buying.
None of this works, of course, if value is misjudged or shares of what turns out to be a lousy business were purchased.
Also, the investor must have a truly long-term investing horizon.
Otherwise, it just isn't very likely to work out all that well.
Adam
Long positions in KO, MO, and the recent spin-off of PM
* Of course, eventually an investor wants the stock to go up. It's just that an investor is better off if market participants misjudge intrinsic value on the low side for as long as possible. It only matters if the investor decides to sell many years later. Until a stock is sold ideally many years down the road, a low price, even if it sells below the price paid for an extended period, is in fact an advantage. What's an exception to this? Here's one scenario to consider. Unfortunately, there's the very real risk that a buyout offer comes in at a premium to market value but a discount to intrinsic value. If enough owners are okay with the gain that will have occurred compared to the recent price action, the deal may be approved. If too few have conviction about longer run prospects, the deal may get approved. When too many owners of shares are in it for the short-term or, at least, primarily to profit from price action, the chance of this happening increases. Well, those that became owners because of the plain discount to intrinsic value and the company's long run prospects will likely get hurt in this scenario.
** Economically a stock buyback vs dividend reinvestment are similar. Yet there is a potentially a difference from a tax standpoint since, depending on the type of account, one has to pay taxes on those dividends. That's not the case for buybacks. So, if management is a good capital allocator (a big if), the investors are generally better off if the company repurchases the shares. Other than the tax differences, buybacks and dividend reinvestments, implemented at reasonable or better valuation levels (i.e. discount to value), similarly benefit long-term owners; the former reduces overall share count, while the latter increases the number of shares owned.
*** First and foremost, the amount of capital required to run the business and how much the free cash flow generation can grow over time are the crucial factors in long-term value creation. After that it comes down to how well management allocates capital.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
Stocks & Gravity
I think of the overall stock market returns as the equivalent of gravity for an investor.
On Earth, a person with a four foot vertical leap would be considered a world class athlete. On the Moon (with gravity at 1/6 the Earth's), obviously a person could jump a lot higher with no additional skills or effort.
The same is true for investing. From 1982-2000 suddenly even below average investors seemed to get good results. When a market goes up 10x everyone feels pretty smart. As an investor, moving from the 1966-1982 era to the 1982-2000 era was like moving from the Earth to the Moon. Investor "gravity" changed dramatically. Those that gauged their investment returns from the 80's and 90's without this in mind overestimated their talents.
"I would consider a year in which we declined -15% and the [Dow Jones Industrial] Average -30%, to be much superior to a year when both we and the Average advanced 20%." - Warren Buffett in his 1960 Partnership Letter
The -30% market return is, for investing purposes in the short run, that years functional equivalent of gravity. Sometimes over the short run, sometimes very much longer. So "leaping" twice as high as the, in this case, declining average is more than a solid performance.
"You make most of your money in a bear market, you just don't realize it at the time." - Shelby Davis
Being down -15% won't feel good with all those red arrows and paper losses but people felt great buying at the height of financial euphoria in 1999; the worst possible time to buy.
From an investor perspective, we have been back to the Earth's gravitational pull (and then some) for a while. When you have excess returns over a long period like 1982-2000 the following period is a painful process of normalizing returns. That process historically takes a long time. Whether it is, as Art Cashin says, a 17.6 year cycle or not, the relevant point is it usually take more than a decade. Mr. Market is a bit like Jerry Seinfeld, annual returns end up "even Steven", or around 7-10% annualized, over the long haul.
So the everyone feels like a genius market of the 80's and 90's has been replaced in the past 10 years with the I'm starting to feel like George Costanza market:
Kramer: "You're wasting your life! George: "I am not. What you call wasting, I call living. I'm living my life!" Kramer: "OK, like what? No, tell me. Do you have a job?" George: "No." Kramer: "You got money?" George: "No." Kramer: "Do you have a woman?" George: No. Kramer: Do you have any prospects? George: "No." Kramer: "You got anything on the horizon?" George: "Uh...no." Kramer: "Do you have any action at all?" George: "No." Kramer: "Do you have any conceivable reason for even getting up in the morning?" George: "I like to get the Daily News!"
No doubt we will eventually enter a period like 1982-2000 where everyone begins to feel smart again.
"Let it be emphasized once more, and especially to anyone inclined to a personally rewarding skepticism in these matters: for practical purposes, the financial memory should be assumed to last, at a maximum, no more than 20 years. This is normally the time it takes for the recollection of one disaster to be erased and for some variant on previous dementia to come forward to capture the financial mind. It is also the time generally required for a new generation to enter the scene, impressed, as had been its predecessors, with its own innovative genius." - John Kenneth Galbraith in his book: A Short History of Financial Euphoria (Page 87)
Of course, many will probably actually believe it thanks to Galbraith's 20 years of financial memory.
Adam
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
On Earth, a person with a four foot vertical leap would be considered a world class athlete. On the Moon (with gravity at 1/6 the Earth's), obviously a person could jump a lot higher with no additional skills or effort.
The same is true for investing. From 1982-2000 suddenly even below average investors seemed to get good results. When a market goes up 10x everyone feels pretty smart. As an investor, moving from the 1966-1982 era to the 1982-2000 era was like moving from the Earth to the Moon. Investor "gravity" changed dramatically. Those that gauged their investment returns from the 80's and 90's without this in mind overestimated their talents.
"I would consider a year in which we declined -15% and the [Dow Jones Industrial] Average -30%, to be much superior to a year when both we and the Average advanced 20%." - Warren Buffett in his 1960 Partnership Letter
The -30% market return is, for investing purposes in the short run, that years functional equivalent of gravity. Sometimes over the short run, sometimes very much longer. So "leaping" twice as high as the, in this case, declining average is more than a solid performance.
"You make most of your money in a bear market, you just don't realize it at the time." - Shelby Davis
Being down -15% won't feel good with all those red arrows and paper losses but people felt great buying at the height of financial euphoria in 1999; the worst possible time to buy.
From an investor perspective, we have been back to the Earth's gravitational pull (and then some) for a while. When you have excess returns over a long period like 1982-2000 the following period is a painful process of normalizing returns. That process historically takes a long time. Whether it is, as Art Cashin says, a 17.6 year cycle or not, the relevant point is it usually take more than a decade. Mr. Market is a bit like Jerry Seinfeld, annual returns end up "even Steven", or around 7-10% annualized, over the long haul.
So the everyone feels like a genius market of the 80's and 90's has been replaced in the past 10 years with the I'm starting to feel like George Costanza market:
Kramer: "You're wasting your life! George: "I am not. What you call wasting, I call living. I'm living my life!" Kramer: "OK, like what? No, tell me. Do you have a job?" George: "No." Kramer: "You got money?" George: "No." Kramer: "Do you have a woman?" George: No. Kramer: Do you have any prospects? George: "No." Kramer: "You got anything on the horizon?" George: "Uh...no." Kramer: "Do you have any action at all?" George: "No." Kramer: "Do you have any conceivable reason for even getting up in the morning?" George: "I like to get the Daily News!"
No doubt we will eventually enter a period like 1982-2000 where everyone begins to feel smart again.
"Let it be emphasized once more, and especially to anyone inclined to a personally rewarding skepticism in these matters: for practical purposes, the financial memory should be assumed to last, at a maximum, no more than 20 years. This is normally the time it takes for the recollection of one disaster to be erased and for some variant on previous dementia to come forward to capture the financial mind. It is also the time generally required for a new generation to enter the scene, impressed, as had been its predecessors, with its own innovative genius." - John Kenneth Galbraith in his book: A Short History of Financial Euphoria (Page 87)
Of course, many will probably actually believe it thanks to Galbraith's 20 years of financial memory.
Adam
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Art Cashin: The 17.6-Year Market Cycle
Whether Art Cashin turns out to be correct or not, it's often worthwhile for an investor to step back and think about longer time horizons for some perspective.
Consider the following from CNBC:
Cashin revisited his theory of "the 17.6-year cycle".
"It's like the Biblical story of the fat and lean years. During the fat, you can throw a dart at the wall, and anything you buy goes up."
Stocks may go up 7-10% per year on average in the long run but historically extended periods when markets move sideways (within a wide range) followed by long periods of returns well in excess of normal. For example:
We are almost a decade into one of those possible 15-20 year sideways grinds that Art Cashin describes.
Being roughly half way through would be the good news I guess.
Of course, the way it plays out might be a whole lot different this time around.
What really matters in the longer run is whether shares of good businesses can be bought at a nice discount to value.
Adam
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Consider the following from CNBC:
Cashin revisited his theory of "the 17.6-year cycle".
"It's like the Biblical story of the fat and lean years. During the fat, you can throw a dart at the wall, and anything you buy goes up."
Stocks may go up 7-10% per year on average in the long run but historically extended periods when markets move sideways (within a wide range) followed by long periods of returns well in excess of normal. For example:
- 1966-1982 the market went bounced around but essentially went nowhere
- 1982-2000 the market went up more than 10 fold
We are almost a decade into one of those possible 15-20 year sideways grinds that Art Cashin describes.
Being roughly half way through would be the good news I guess.
Of course, the way it plays out might be a whole lot different this time around.
What really matters in the longer run is whether shares of good businesses can be bought at a nice discount to value.
Adam
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Subscribe to:
Posts (Atom)
