Advice to a Friend, Again

A friend of mine asked me the following:

I read an article or a comment from a blog that inked to your sight.  the statement was akin to this. ” The market is dead.  The lack of growth over ten years shows the deadness of the market.  If the market had kept pace with inflation over the last ten years it would be at 32,000 not the 11,000 we see today.”

I am not all that concerned that this is a true statement, nor am I convinced that their is any better long term investment then a good market strategy.  but I do not have the wisdom to know how to answer this sort of claim in my mind.

The Other Question also comes from a blog that linked to your site:

“Whitney Tilson’s latest monthly letter provides us with some insightful lessons for the current market environment.  Regular readers will know that I believe there is no such thing as a one size fits all investment strategy or a holy grail approach.  Instead, investors must understand the macro environment and apply the correct strategy to fit that particular environment.  That micro approach could involve buy and hold, trading, value investing, etc.  But the likelihood of success using one strategy in all environments is unlikely. The current turmoil and unusual asset class correlation is making for a very difficult environment for value investors.  Tilson explains (thanks to Zero Hedge):”

Later on he states the following: “Value investing might not be dead (it’s certainly not dead for those who have the ability to implement it in the actual way that Warren Buffett implements it – no, not the “buy and hold” myth that Wall Street has sold to everyone), but we can be almost certain that it’s more important than ever to understand the macro.  If there’s one great lesson to learn from the recent turmoil that should be it….”

Is the above author stating the difficulty of being a value investor, or is this a man trying to validate his own lack of plan or strategy in a difficult market?  Besides a difficult month for some value investors what is their augment against it.  Would your “bloodless” strategy of quarterly trading be the answer their the accusation of the “buy and hold myth.”

With respect to the tripling of the index level due to inflation, that seems really high to me, akin to a 10% inflation rate.  I think that government inflation statistics are biased low, but by 1-2%/year not 6-8%/year.

On value investing, I rely on Ben Graham’s dictum that the stock market is a voting machine in the short run, and a weighing machine in the long run.  Periods of high correlation where the voting machine dominates eventually go away, and when they go away the weighing machine comes back and patient holders of cheap quality stocks get rewarded.

Value investing has gone through far deeper periods of underperformance such as the one in the late ’90s where many famous value investors got fired, just before the paradigm was about to shift, and value outpace growth by more than the underperformance.

“Buy and hold” is always lionized in a bull market, and castigated in a bear market.  That’s normal.  I grew up in the ’70s watching Wall Street Week with Louis Rukeyser, and at that time, traders were dominant in a static market.  That was not true in the ’80s and ’90s.

My quarterly trading strategy strikes a balance between too-frequent trading that most mutual fund managers do, and the never trade strategies that those who misunderstand value investing do.  Most investors trade at the wrong times, giving up on a stock merely due to bad performance, or buying because it is fashionable.  But if the business is fundamentally sound, it can be held through periods of weakness, and even add to the position.

That’s what I do, and it has worked well for me.  May it work so well for my clients.

I lead a finance class for church.  I think we have talked of it before.  I do not deal much with investing. Mostly I work with cleaning up the personal finances of the families.  Paying down debt, increasing savings, Setting and living below your income, budget, basic investing, using your tax shelters, and avoiding risky investments.

I have a family who some years ago purchased $8000 worth of Microsoft stock.  This has over the course of their holdings dropped between $8-10 a share.  Their financial situation requires cash, cash they do not have.  They need to pay off debts, and their current income gives them very little wiggle room to pay extra on debts.  They asked me what to do with the Microsoft stock, that is now down about $1500 from when they purchased it.  Microsoft stock has remained at a price of $23-29 a share for over a year now.  with the average being somewhere around $24-27 My thoughts have been: That the stock has corrected for the time being and

$25 is probably the true value.  IF $6500  would make a big diffrence in you budget, let you pay down alot of debt and free up some extra cash in your budget to pay off other debts, then sell the stock now.  $1500 is a cheap price to pay for a not so wise investment decision, if it can be use to improve your overall financial standing.  I told him he might ask his broker to sell as soon as it hits $26.

I have however read that Microsoft is a company that has put up good sales and profits in the past few years and that their stock price might be well undervalued.  should I encourage him to hold or sell.  Not asking you to predict the future, simply wanting to get counsel on the advise I have given.

If you think this is good advice let me know.  He is able to get by without the funds immediately, but it will be best if he sell them and use them eventually.

Microsoft is a test for value investors.  What do you do with a company that is cheap on a price-to-earnings basis, but tends to waste free cash flow on foolish acquisitions, investments, and stock buybacks?  My view is that you reject Microsoft; there are better things to buy.

But what of the decision of Microsoft versus cash?  Look, one of the first principles of investing is never invest what you can’t afford to lose.  If you might need the money to spend in the near term, don’t invest it in stocks.

Reconsider my article, Build the Buffer.  Until someone can meet all cash needs easily, including small disasters, he should not be investing in stocks.

With that, I would say that he should sell the stock to the degree that he needs liquidity.  Ability to pay cash in advance is worth far more than equity market returns.