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On Target Prices & Yields

I know that much of the money management business sets target prices for buying and selling, particularly value managers, and sell-side analysts.  I don’t set target prices.  Why?

Think of what a target price means.  It says that at a certain price you are willing to exchange securities for cash (sell), or vice-versa (buy).  The trade-off between an individual security and cash is difficult to calculate.  Even if you have a really good dividend discount model, the target prices are very sensitive to model inputs.  I think the question of whether I would rather have cash or an individual stock or bond is a difficult question.

So why don’t we focus on easier questions?  It is simpler to rank stocks versus other stocks at least in broad, and bonds versus bonds.  I am not saying that you have to optimize.  You can’t be exact in ranking the desirability of stocks or bonds, but if we can’t identify a group of stocks outside the portfolio that are better than a group of stocks inside the portfolio, there is not much sense in trading.  Same for bonds.

With bonds, the tradeoff is more obvious, because you can consult yield relationships, and make all of the adjustments necessary to decide whether a trade is a good one or not.  Even then, there had better be a good yield advantage after all adjustments, or the trad will not make sense.  As an example, back in the first half of 2002, I engaged in a wide number of trades that gave up some absolute yield, but improved the portfolio’s credit quality dramatically at a time when credit spreads were narrow.  Though overall yield went down, the portfolio was in better shape.  This was the opposite of what we did after 9/11 — buy distressed bonds while spreads were very wide, accepting more credit risks when it paid to do so.

Thus, most of my portfolio management is not so much “Aim for the best.”  I’m not sure I can do that.  “Aim for something better than what I currently have” is achievable.  In cases where I can find no clear improvements, sitting on my hands it the best strategy.  After all, time is on the side of a portfolio representing great relative value.

This is not to denigrate those that are better than me, like Seth Klarman.  He has a strong sense of when he would rather hold cash versus taking any risk, and so he manages value in an absolute sense, even giving back money to clients when  he doesn’t have anything to do with it.

I’m still finding some attractive assets to buy, though not many.  Later this month, I will do my formal quarterly reshaping of the portfolio, where I will trade away a few stocks I like less for those I like more.  And if I can’t find any that I like more, I don’t have to do anything, because if I’ve got a really good group of stocks, doing nothing may be the best idea of all.

PS — If you want more, some of the details are in Portfolio Rule Eight.






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Bonds, Portfolio Management, Quantitative Methods, Stocks, Value Investing | RSS 2.0 |

One Response to On Target Prices & Yields

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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