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Archive for January 9th, 2013

The Evaluation of Common Stocks

Wednesday, January 9th, 2013

Today, Tom Brakke of the Research Puzzle wrote:

“Go to it then. The field is wide open. The old masters have confessed their inability to determine value objectively. More investors than ever before are committing their capital to stocks. Very little has as yet been done in the field of stock evaluation by statistical organizations — and I say this with full awareness of our own efforts in the past 21 years. Here in the field of stock evaluation you will find a worthy challenge to your intelligence, and exciting adventure too.” — Arnold Bernhard, founder and editor of the Value Line Investment Survey.

The above excerpt is the last paragraph of Bernhard’s 1959 book, The Evaluation of Common Stocks. It is interesting to consider the changes since that time and to ponder the opportunities (or lack thereof) that exist now as a result of those changes.

Is the field still “wide open” for the enterprising investor?

When I was writing my Master’s Thesis at Johns Hopkins at the tender age of 21, I did a significant study on what did and didn’t work in stock investing.  My unpublished Master’s thesis anticipated momentum investing, but I did not get it at the time.  It also showed that value effects could make money, as well as tracking insider trading.

My life might have been quite different if I had started a hedge fund in my 20s off of my thesis… might have been richer, but my knowledge of of business was enriched by being an actuary for so many years… admittedly, I was not your normal actuary, but having to solve practical business problems does shape your views of many other things.

But Value Line, as created by Samuel Eisenstadt, discovered quantitative growth investing — price momentum, earnings momentum, and earnings surprise long before the rest of Wall Street caught on.  Once Wall Street caught on in the 90s, a lot of the excess profits got squeezed out, and Value Line lost its mojo.

As an aside, when I was running a set of multiple manager funds that did pretty well in the 90s, one manager had its methods and they were price momentum, earnings momentum, and earnings surprise.  I said to them, “Oh, you do what Value Line does.”  They were as offended as they could be without poisoning the possibility of being hired by us.

In another situation, I ended up hiring a value plus momentum manager in the mid-90s.  Very reliable outperformance.

But let’s go back a little further.  After the Great Depression, a lot of companies sold for considerably less than their net assets.  This diminished but held true until the 60s.  Ben Graham earned his living from arbitrage and net-net value investing.  Buffett, getting started later, did much the same, but being younger, reached a point where the easy opportunities were largely gone, but he had a lot of his investing life in front of him, unlike Graham, who picked that time to retire.

Value investing I do not think is tapped-out, though beating value indexes is difficult.

In the 80s, quantitative value came into existence, along with momentum and size as factors.  But throughout the 90s insider trading, net operating assets, distress and other factors began to be modeled. Now there are many quantitative factors, and it is hard to tell which are redundant.

With Graham, and Buffett and Eisenstadt in their early years, financial data did not flow easily… those who put in the hard work of gathering scarce data earned exceptional returns.  Today, with the internet, mere quantitative investing yields less of an advantage.  In order to do anything worthwhile some qualitative knowledge must be mixed in, or, proprietary data that few have.

Tom asks if the field is wide open.  I don’t know.  We’ve had a lot of discoveries over the past 50+ years, but discoveries are sometimes “forgotten” when they lose their punch.  There may be future discoveries, whether from technical or accounting measures.  I am reluctant to say everything that can be discovered is discovered, but I don’t want to say that there will be some earthshattering theory in the future… that may not happen.

What might happen is an economic disaster like the Great Depression that makes many flee stocks.  Then some of the older theories will work again for a time.  So I would answer Tom — is the field wide open?  No, but it is open somewhat, and with a lot of application and intelligence, it’s possible but not likely that you will do something amazing.

On the Platinum Coin

Wednesday, January 9th, 2013

Okay, so the Treasury mints a Platinum coin, and deems it to be worth One Trillion Dollars.  We have a fiat currency, so what is the problem?

There are fiat currencies, and there are fiat currencies.  Depositing something as collateral into the central bank where the “melt value” is decidedly less than one million, much less trillion dollars, is ridiculous.  I realize that many believe that the Fed can do whatever it wants, but eventually cash flows will catch up with a central bank as inflation rises.

The Trillion dollar coin would have value only because the taxation authority of the US Government stands behind it.  But that is not the way the government is behaving.  The taxation authority is not taking in as much and more so that they can redeem the promises inherent in the coin.  Instead, they are looking to the Fed to absorb losses in a stealth monetizing of the debt.

Monetizing government debt leads to inflation.  Receiving something worthless, and deeming it to be of high worth is the same as monetizing the debt.  Yes, the Fed can try to sterilize the effects, but it leaves the Fed with a problem — it will never be able to shrink its balance sheet to 2007 levels.  Thus inflation, eventually.

The platinum coin is a bad joke, and bad policy if eventually done.  This is what I wrote at Felix Salmon’s blog yesterday:

If they tried the platinum coin(s) once, Congress would legislate to eliminate the practice. The Purple party would take back their authority.

It is also possible that the Supreme Court would make them reverse the transaction, on the grounds that only Congress can regulate what is money. The executive may not. The minor exception made by Congress for platinum coins was only intended for numismatic coins — not anything large.

But yes, Felix, you are right. This would end the concept of the dollar as a reserve currency. Only banana republics monetize their debt. Hey, maybe even the Fed would develop a backbone, and refuse the coin, or tell them it is only worth $1000. They don’t want to be stuck with QE not of their own design. Their QE is bad enough, but the coin, which will be a hole in the Fed’s balance sheet for as long as it lasts will be far harder to reverse.

You can’t get something for nothing.  Monetary stimulus is garbage, it steals from savers to reward solvent debtors.  Insolvent debtors can rot.  As with all monetary policy, stimulus helps the solvent.

This is a huge advertisement to get the government out of the economics business.  It has never been good at it, and this is proof.  The government might be able to goose things in the short-run, but it never succeeds in the long-run.

As it is, our government is addicted to short-run policy, and as such, does not consider long-run solutions that might be painful in the short-run.

Too bad.  Your kids lose, while you don’t seem to lose much for now.  This is a lousy position to be in.  People play for short-term advantage while while inflation increases.

You can’t get something for nothing.  Either there will be inflation, or taxation to pay back the platinum coin.

Disclaimer


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.


Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.


Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

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