IPO Process In The U.S.

The IPO process in the U.S. apparently needs an upgrade.

This Wall Street Journal article points out:

- Big investment banks don't like to be bothered with firms with less than $ 250 million in market value.
- There are 4,000 to 5,000 small companies in Silicon Valley that would like to raise capital (in the $ 10 million to $ 30 million range).

The article adds that "most banks can't be bothered with such piddly deals." 

 The above is just another example of how processes of capital formation and allocation is less than optimal. We need more capital to efficiently get in the hands of those with the best ideas (what the US historically excelled at) to encourage innovation and job creation.

More from the article:

If great oaks are to grow from acorns, the seedlings could surely use a little help.

Here are some previous posts with additional examples of capital development having evolved into something less than optimal over time:

Capital Productivity

Venture Capital

Capital Misallocation

Buffett & Bogle: Overcoming Short-termism

Addressing these weaknesses can't happen soon enough.

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.

Simple Stocks

"Stocks are simple. All you do is buy shares in a great business for less than the business is intrinsically worth, with managers of the highest integrity and ability. Then you own those shares forever." - Warren Buffett

Pricing Power

"...if you wanna know one question to ask in terms of determining whether somebody's got a good business or not, just ask 'em whether they can raise prices tomorrow." - Warren Buffett

Diversify or Focus?

It's the latter for Warren Buffett.

"A lot of great fortunes in the world have been made by owning a single wonderful business. If you understand the business, you don't need to own very many of them." - Warren Buffett

Ben Graham: Investing & Speculation

"The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator's primary interest lies in anticipating and profiting from market fluctuations. The investor's primary interest lies in acquiring and holding suitable securities at suitable prices." - Benjamin Graham in The Intelligent Investor

Klarman on Stocks

An excerpts from a Businessweek.com article on Seth Klarman:

The problem, he said, is that except for a brief time in March 2009, "stocks haven’t been at bargain prices for most of the last two decades." U.S. stocks reached a 12-year low in March 2009.

Klarman’s views on the U.S. stock market echo those of Jeremy Grantham, chief investment strategist at Boston-based Grantham Mayo Van Otterloo & Co., who recommended investors buy stocks in March 2009 after more than a decade of saying they were overvalued. Grantham’s latest forecast, posted on the firm's website, predicted U.S. large cap stocks would return 0.3 percent a year, adjusted for inflation, over the next seven years.

Klarman called Grantham "a very smart person" whose forecasts he watches carefully. In an e-mail, Grantham called Klarman "just about the smartest guy around."

High Quality

From Jeremy Grantham's 1st quarter letter:

The global equity markets taken together are moderately overpriced, and the U.S. part is now very overpriced but not nearly so bad as it could be. Surprisingly, within the U.S. the large high quality companies are still a little cheap, having been left totally behind in the rally. They are unlikely to do very well in a bubbly environment, however long it lasts, but should be great in declines and in the end should win. A potential plus for quality franchise stocks in the next few years is that they are far more exposed to emerging countries...

Many of best global businesses, especially those that make and distribute the great branded small-ticket consumer products (or fast-moving consumer goods: FMCG) on a big scale, tend to produce high returns on capital.

The best of them, while not necessarily extremely cheap, still seem priced to produce solid results in terms of risk and reward.

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.

Nassim Taleb: "Every Single Human Being" Should Be Short Treasuries

From this article in the most recent Barron's Magazine:

...Nassim Nicholas Taleb, author of The Black Swan: The Impact of the Highly Improbable...asserted earlier this year that "every single human being" should be short Treasuries.

Fantastic. As the article points out, at least so far, this hasn't worked so well. If followed, it actually would have been rather costly.

I'm no fan of Treasuries but -- even if the thinking is sound -- the idea of everyone being short anything is, well, possibly just a little extreme.

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.

A Crisis of Ethic Proportions

A little over a year ago John Bogle wrote this in the Wall Street Journal. In it, Bogle asserts that business ethics and professional standards have gone south in important ways.

Bogle points out that we've evolved from an "ownership society", where shares are owned directly by owners, to and "agency society", where financial institutions increasingly act as as agents. This change, in combination with what he calls a "spree of speculation" by the agents who should be acting as fiduciaries, has led us down an unfortunate path.

He also says:

Our money manager agents...fostered the crisis with superficial security analysis and research and by ignoring corporate governance issues. They also traded stocks at an unprecedented rate, engaging in a dangerous spree of speculation.

So what should be done? Bogle says we need to establish a "fiduciary society".

...where manager/agents entrusted with managing other people's money are required -- by federal statute -- to place front and center the interests of the owners they are duty-bound to serve. The focus needs to be on long-term investment (rather than short-term speculation), appropriate due diligence in security selection, and ensuring that corporations are run in the interest of their owners.

There are important and badly needed changes that unfortunately seem unlikely to happen anytime soon.

Read the entire opinion here.

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.

ETF Fail

Exchange Traded Funds (ETFs), another source of supposedly benevolent liquidity, were among the worst performers on the day of the May 6th, 2010 "Flash Crash".

According to this Barron's article, ETFs made up 70% of securities where the trades had to be cancelled.

Some assert that ETFs add liquidity and, as a result, reduce volatility. Well, they may actually be adding to volatility.

They certainly appeared to add to it on May 6th.

ETF volumes have exploded over the past decade and, in just the past few years, a bunch of leveraged ETFs that allow any investor to go 2x and 3x short or long using derivatives have been launched. These new tools have been controversial for good reason:

1. They do not function as some might expect over a longer time horizon. I use the term longer time horizon loosely here (i.e. more than a day). Using that criteria for longer time horizon probably speaks volumes about how crazy this has all become. In 2009, Bespoke Investor Group pointed out that the 3x Leveraged Long Financial (FAS) ETF had dropped -63% ytd through July 16th while 3X Leveraged Short Financial ETF dropped -88%. During that period, the Russell 1000 Financial Sector Index was down only -2%. Wow.
2. Margin requirements are there to keep the amount of leverage used to buy stocks within acceptable limits. These ETFs are designed to get around those rules. How does this kind of liquidity reduce volatility?

Excerpt from the Bespoke Investment Group post:

In a period when the Financial sector is down 2%, not only is the 3x bearish ETF down, but with a decline of 88%, it is also down more than the leveraged long ETF! So even if you correctly anticipated the direction of the Financial sector at the start of the year, you would have lost your shirt if you used these ETFs to implement your strategy.

Saying these extreme ETFs don't function properly seems quite an understatement. They should probably be reined in but that's probably not going to happen anytime soon.

In this Bloomberg article, John Bogle had the following to say about extreme ETFs:

Bogle...says these complex securities subvert the discipline of buy-and- hold investing and encourage investors to chase market-beating returns by speculating like day traders.

In the article, Bogle added...

"It's insanity," says Bogle, 81, the founder of Vanguard Group Inc. "This is a classic case of Wall Street trying to capitalize on the worst instincts of investors."

Traditional ETFs, bought when prevailing equity values are fair and held for long periods of time are excellent low cost ways of investing. The problem is they are predominantly not being used that way.

On the other hand, extreme ETFs seem to just increase volatility. They seem to encourage the renting of stocks over ownership.

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.

Volatility Villains

This article, in the most recent issue of Barron's Magazine, says that "the biggest floating crap game" is run on Wall Street. 

In the article, there's a good graph in the article that illustrates how much volatility has changed in recent times compared to the past twenty years. Later in the article, Kevin Cronin, director of Global Equity Trading at Invesco asks a key question:

"Do we want a casino, or do we want something that fosters longer-term investment and capital formation?"

The primary argument for all this extreme trading has been that it adds liquidity.

As a result - the argument goes - this supposedly benevolent added liquidity will make stocks less volatile. I think there's evidence that this is not necessarily the case. One thing that isn't in question, all this liquidity adds a bunch of frictional costs that, by definition, hurts investor returns in the aggregate over the long run.

It also reduces confidence in the stability of the system which almost certainly leads investors to get out of the market at just the wrong time out of fear and vice versa.

Check out the full article.

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.

Growth & Investor Returns

I've revisited the "growth myth" from time to time. Stocks with high growth prospects are routinely given huge multiples of earnings until that growth becomes more subdued. At that point, the multiple collapses and it's look out below.

"Obvious prospects for physical growth in a business do not translate into obvious profits for investors." - Benjamin Graham

In the long run it is durable return on capital and the price that you pay relative to intrinsic value that matters...not necessarily growth. Now, it's true that growth will often have a favorable impact on value. 

It just happens to be a mistake to think that it always has a favorable impact. 

In fact, growth can actually reduce value if it requires capital inputs in excess of the discounted value of the cash that will be generated over time. Sometimes, the highest growth opportunities attract lost of capable competition and capital that ruins the long run economics. Sometimes, high growth requires expensive yet necessary capital raising that dilutes existing shareholders and reduces per share returns.

Finally, even if growth that materializes does have favorable economics, some investors tend to pay a large premium upfront for those growth prospects. That hefty price paid may turn attractive long-term business results into not so attractive investment results.

Adam

Related posts:
Buffett on "The Prototype Of A Dream Business" - Sep 2009
High Growth Doesn't Equal High Investor Returns - Jul 2009
The Growth Myth Revisited - Jul 2009
The Growth Myth - Jun 2009
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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.

The Difference 12 Years Makes

12 years ago yesterday, June 2, 1998, the S&P 500 closed at 1,093. We are currently at 1,094 as I write this.

Consider the following:

• Investor A starts investing on June 2, 1998 and continues investing yesterday. That investor saw no durable lift, other than dividends, in the stock market for all 12 years (there has, of course, been a wide trading range) of his career.

Anyone planning on the historic 9-10% annual equity returns in 1998 has been disappointed. Stocks were overvalued and only became more so going into 1999 and 2000.

• Investor B was lucky enough to start a similar career exactly 12 years earlier on June 2, 1986 and manages money for the same amount of time, 12 years, getting out of the business on June 2, 1998. In sharp contrast, Investor B saw the S&P go from 245 to 1093 during his career. A 15%+ annualized return including dividends could have been achieved just buying the Vanguard Index 500 fund during that time frame.

Quite a bit of wind at your back. Investor A managed money in an entirely different world than Investor B. Some of the best have shown they can make money in either period...but many prove otherwise.

10%/year long-term returns in equities has been the norm. That fact masks the following: the market historically goes through long periods of going sideways (often 15-20 years) before embarking on periods of explosive growth like the 80's and 90's. Examples of long-term sideways markets include 1965-1982 and possibly 2000-????*.

So the long-term average return of 10% doesn't tell you much if your investing horizon is not truly very long-term.

Adam

* In just over 80 years we've essentially had the following: [~1929-1946 sideways market], [~1946-1965 bull market], [~1965-1982 sideways], [~1982-2000 bull market], and [~2000-??? sideways].
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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.

Graham: Smallest Possible Sums

"There is a great advantage for the young capitalist to begin his financial education and experience early. If he is going to operate as an aggressive investor he is certain to make some mistakes and to take some losses. Youth can stand these disappointments and profit by them. We urge the beginner in security buying not to waste his efforts and his money in trying to beat the market. Let him study security values and initially test out his judgment on price versus value with the smallest possible sums." - Benjamin Graham