100 to 1 in the Stock Market

100 to 1 in the Stock Market

 

How can a book be largely true, but not be a good book?  By offering people a way to make a lot of money that is hard to do, but portraying it as easy.  It can be done, and a tiny number succeed at it, but most of the rest lose money or don’t make much in the process.  This is such a book.

Let me illustrate my point with an example.  Toward the end of every real estate bull market, books come out on how easy it is to make money flipping homes.  The books must sell to some degree or the publishers wouldn’t publish them.  Few actually succeed at it because:

  • It’s a lot of work
  • It’s competitive
  • It only works well when you have a bunch of people who are uneducated about the value of their homes and are willing to sell them to you cheap, and/or offer you cheap financing while you reposition it.
  • Transaction costs are significant, and improvements don’t always pay back what you put in.

You could make a lot of money at it, but it is unlikely.  Now with this book, “100 to 1 in the Stock Market,” the value proposition is a little different:

  • Find one company that will experience stunning compound growth over 20-30+ years.
  • Invest heavily in it, and don’t diversify into a lot of other stocks, because that will dilute your returns.
  • Hold onto it, and don’t sell any ever, ever, ever!  (Forget Lord Rothschild, who said the secret to his wealth was that he always sold too soon.)
  • Learn to mention the company name idly in passing, and happily live off of the dividends, should there be any. 😉

Here are the problems.  First, identifying the stock will be tough.  Less than 1% of all stocks do that.  Are you feeling lucky?  How lucky?  That lucky?  Wow.

Second, most people will pick a dog of a stock, and lose a lot of money.  If you aren’t aware, more than half of all stocks lose money if held for a long time.  Most of the rest perform meh.  Even if you pick a stock you think has a lot of growth potential, there is often a lot of competition.  Will this be the one to survive?  Will some new technology obsolete this?  Will financing be adequate to let the plan get to fruition without a lot of dilution of value to stockholders.

Third, most people can’t buy and hold a single stock, even if it is doing really well.  Most succumb to the temptation to take profits, especially when the company hits a rough patch, and all companies hit rough patches, non excepted.

Fourth, when you do tell friends about how smart you are, they will try to dissuade you from your position.  So will the financial media, even me sometimes.  As Cramer says, “the bear case always sounds more intelligent.”  Beyond that, never underestimate envy. 🙁

But suppose even after reading this, you still want to be a home run hitter, and will settle for nothing less.  Is this the book for you?  Yes.  it will tell you what sorts of stocks appreciate by 100 times or more, even if finding them will still be rough.

This book was written in 1972, so it did not have the benefit of Charlie Munger’s insights into the “Lollapalooza” effect.  What does it take for a stock to compound so much?

  • It needs a sustainable competitive advantage.  The company has to have something critical that would be almost impossible for another firm to replicate or obsolete.
  • It needs a very competent management team that is honest, and shareholder oriented, not self-oriented.
  • They have to have a balance sheet capable of funding growth, and avoiding crashing in downturns, while rarely issuing additional shares.
  • It has to earn a high return on capital deployed.
  • It has to be able to reinvest earnings such that they earn a high return in the business over a long period of time.
  • That means the opportunity has to be big, and can spread like wildfire.
  • Finally, it implies that not a lot of cash flow needs to be used to maintain the investments that the company makes, leaving more money to invest in new assets.

You would need most if not all of these in order to compound capital 100 times.  That’s hard.  Very hard.

Now if you want a lighter version of this, a reasonable alternative, look at some of the books that Peter Lynch wrote, where he looked to compound investments 10 times or more.  Ten-baggers, he called them.  Same principles apply, but he did it in the context of a diversified portfolio.  That is still very tough to do, but something that mere mortals could try, and even if you don’t succeed, you won’t lose a ton in the process.

Quibbles

Already given.

Summary / Who Would Benefit from this Book

You can buy this book to enjoy the good writing, and learn about past investments that did incredibly well.  You can buy it to try to hit a home run against a major league pitcher, and you only get one trip to the plate.  (Good luck, you will need it.)

But otherwise don’t buy the book, it is not realistic for the average person to apply in investing.  if you still want to buy it, you can buy it here: 100 to 1 in the Stock Market.

Full disclosure: I bought it with my own money.  May all my losses be so small.

If you enter Amazon through my site, and you buy anything, including books, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

Photo Credit: Tony Webster || Bridges can collapse -- so can leverage...

Photo Credit: Tony Webster || Bridges can collapse — so can leverage…

This is the last article in this series… for now.  The advantages of the modern era… I went back through my taxes over the last eleven years through a series of PDF files and pulled out all of the remaining companies where I lost more than half of the value of what I invested, 2004-2014.  Here’s the list:

  1. Avon Products [AVP]
  2. Avnet [AVT]
  3. Charlotte Russe [Formerly CHIC — Bought out by Advent International]
  4. Cimarex Energy [XEC]
  5. Devon Energy [DVN]
  6. Deerfield Triarc [formerly DFR, now merged with Commercial Industrial Finance Corp]
  7. Jones Apparel Group [formerly JNY — Bought out by Sycamore Partners]
  8. Valero Enery [VLO]
  9. Vishay Intertechnology [VSH]
  10. YRC Worldwide [YRCW]

The Collapse of Leverage

Take a look of the last nine of those companies.  My losses all happened during the financial crisis.  Here I was, writing for RealMoney.com, starting this blog, focused on risk control, and talking often about rising financial leverage and overvalued housing.  Well, goes to show you that I needed to take more of my own medicine.  Doctor David, heal yourself?

Sigh.  My portfolios typically hold 30-40 stocks.  You think you’ve screened out every weak balance sheet or too much operating leverage, but a few slip through… I mean, over the last 15 years running this strategy, I’ve owned over 200 stocks.

The really bad collapses happen when there is too much debt and operations fall apart — Deerfield Triarc was the worst of the bunch.  Too much debt and assets with poor quality and/or repayment terms that could be adjusted in a negative way.  YRC Worldwide — collapsing freight rates into a slowing economy with too much debt.  (An investment is not safe if it has already fallen 80%.)

Energy prices fell at the same time as the economy slowed, and as debt came under pressure — thus the problems with Cimarex, Devon, and to a lesser extent Valero.  Apparel concepts are fickle for women.  Charlotte Russe and Jones Apparel executed badly in a bad stock market environment.  That leaves Avnet and Vishay — too much debt, and falling business prospect along with the rest of the tech sector.  Double trouble.

Really messed up badly on each one of them, not realizing that a weak market environment reveals weaknesses in companies that would go unnoticed in good or moderate times.  As such, if you are worried about a crushing market environment in the future, you will need to stress-test to a much higher degree than looking at financial leverage only.  Look for companies where the pricing of the product or service can reprice down — commodity prices, things that people really don’t need in the short run, intermediate goods where purchases can be delayed for a while, and anyplace where high fixed investment needs strong volumes to keep costs per unit low.

One final note — Avon calling!  Ding-dong.  This was a 2015 issue.  Really felt that management would see the writing on the wall, and change its overall strategy.  What seemed to have stopped falling had only caught its breath for the next dive.  Again, an investment is not safe if it has already fallen 80%.

There is something to remembering rule number 1 — Don’t Lose Money.  And rule 2 reminds us — Don’t forget rule number 1.  That said, I have some things to say on the positive side of all of this.

The Bright Side

A) I did have a diversified portfolio — I still do, and I had companies that did not do badly as well as the minority of big losers.  I also had a decent amount of cash, no debt, and other investments that were not doing so badly.

B) I used the tax losses to allow a greater degree of flexibility in investing.  I don’t pay too much attention to tax consequences, but all concerns over taking gains went away until 2011.

C) I reinvested in better companies, and made the losses back in reasonably short order, once again getting to pay some taxes in the process by 2011.  Important to note: losses did not make me give up.  I came back with vigor.

D) I learned valuable lessons in the process, which you now get to absorb for free.  We call it market tuition, but it is a lot cheaper to learn from the mistakes of others.

Thus in closing — don’t give up.  There will be losses.  You will make mistakes, and you might kick yourself.  Kick yourself a little, but only a little — it drives the lessons home, and then get up and try again, doing better.

 

Full disclosure: long VLO — made those losses back and then some.

 

I’m still working through the SEC’s proposal on Mutual Fund Liquidity, which I mentioned at the end of this article:

Q: <snip> Are you going to write anything regarding the SEC’s proposal on open end mutual funds and ETFs regarding liquidity?

A: <snip> …my main question to myself is whether I have enough time to do it justice.  There’s their white paper on liquidity and mutual funds.  The proposed rule is a monster at 415 pages, and I may have better things to do.   If I do anything with it, you’ll see it here first.

These are just notes on the proposal so far.  Here goes:

1) It’s a solution in search of a problem.

After the financial crisis, regulators got one message strongly — focus on liquidity.  Good point with respect to banks and other depositary financials, useless with respect to everything else.  Insurers and asset managers pose no systemic risk, unless like AIG they have a derivatives counterparty.  Even money market funds weren’t that big of a problem — halt withdrawals for a short amount of time, and hand out losses to withdrawing unitholders.

The problem the SEC is trying to deal with seems to be that in a crisis, mutual fund holders who do not sell lose value from those who are selling because the Net Asset Value at the end of the day does not go low enough.  In the short run, mutual fund managers tend to sell liquid assets when redemptions are spiking; the prices of illiquid assets don’t move as much as they should, and so the NAV is artificially high post-redemptions, until the prices of illiquid assets adjust.

The proposal allows for “swing pricing.”  From the SEC release:

The Commission will consider proposed amendments to Investment Company Act rule 22c-1 that would permit, but not require, open-end funds (except money market funds or ETFs) to use “swing pricing.” 

Swing pricing is the process of reflecting in a fund’s NAV the costs associated with shareholders’ trading activity in order to pass those costs on to the purchasing and redeeming shareholders.  It is designed to protect existing shareholders from dilution associated with shareholder purchases and redemptions and would be another tool to help funds manage liquidity risks.  Pooled investment vehicles in certain foreign jurisdictions currently use forms of swing pricing.

A fund that chooses to use swing pricing would reflect in its NAV a specified amount, the swing factor, once the level of net purchases into or net redemptions from the fund exceeds a specified percentage of the fund’s NAV known as the swing threshold.  The proposed amendments include factors that funds would be required to consider to determine the swing threshold and swing factor, and to annually review the swing threshold.  The fund’s board, including the independent directors, would be required to approve the fund’s swing pricing policies and procedures.

But there are simpler ways to do this.  In the wake of the mutual fund timing scandal, mutual funds were allowed to estimate the NAV to reflect the underlying value of assets that don’t adjust rapidly.  This just needs to be followed more aggressively in a crisis, and peg the NAV lower than they otherwise would, for the sake of those that hold on.

Perhaps better still would be provisions where exit loads are paid back to the funds, not the fund companies.  Those are frequently used for funds where the underlying assets are less liquid.  Those would more than compensate for any losses.

2) This disproportionately affects fixed income funds.  One size does not fit all here.  Fixed income funds already use matrix pricing extensively — the NAV is always an estimate because not only do the grand majority of fixed income instruments not trade each day, most of them do not have anyone publicly posting a bid or ask.

In order to get a decent yield, you have to accept some amount of lesser liquidity.  Do you want to force bond managers to start buying instruments that are nominally more liquid, but carry more risk of loss?  Dividend-paying common stocks are more liquid than bonds, but it is far easier to lose money in stocks than in bonds.

Liquidity risk in bonds is important, but it is not the only risk that managers face.  it should not be made a high priority relative to credit or interest rate risks.

3) One could argue that every order affects market pricing — nothing is truly liquid.  The calculations behind the analyses will be fraught with unprovable assumptions, and merely replace a known risk with an unknown risk.

4) Liquidity is not as constant as you might imagine.  Raising your bid to buy, or lowering your ask to sell are normal activities.  Particularly with illiquid stocks and bonds, volume only picks up when someone arrives wanting to buy or sell, and then the rest of the holders and potential holders react to what he wants to do.  It is very easy to underestimate the amount of potential liquidity in a given asset.  As with any asset, it comes at a cost.

I spent a lot of time trading illiquid bonds.  If I liked the creditworthiness, during times of market stress, I would buy bonds that others wanted to get rid of.  What surprised me was how easy it was to source the bonds and sell the bonds if you weren’t in a hurry.  Just be diffident, say you want to pick up or pose one or two million of par value in the right context, say it to the right broker who knows the bond, and you can begin the negotiation.  I actually found it to be a lot of fun, and it made good money for my insurance client.

5) It affects good things about mutual funds.  Really, this regulation should have to go through a benefit-cost analysis to show that it does more good than harm.  Illiquid assets, properly chosen, can add significant value.  As Jason Zweig of the Wall Street Journal said:

The bad news is that the new regulations might well make most fund managers even more chicken-hearted than they already are — and a rare few into bigger risk-takers than ever.

You want to kill off active managers, or make them even more index-like?  This proposal will help do that.

6) Do you want funds to limit their size to comply with the rules, while the fund firm rolls out “clone” fund 2, 3, 4, 5, etc?

Summary

You will never fully get rid of pricing issues with mutual funds, but the problems are largely self-correcting, and they are not systemic.  It would be better if the SEC just withdrew these proposed rules.  My guess is that the costs outweigh the benefits, and by a wide margin.

Photo Credit: Vladimir Pustovit || But do they have compatible credit scores?

Photo Credit: Vladimir Pustovit || But do they have compatible credit scores?

Unlike many commentators, I tend to think credit scores are a good thing. In a big world, it is difficult for large financial institutions to figure out the most import “C” of the four Cs of Credit — Character.  Credit scores offer an imperfect but generally useful shortcut in what is often an anonymous world.

In my last article on the topic, I noted that in addition to lending, credit scores are used in renting, insurance, employment, and a wide number of other areas.  One new place where credit scores could prove useful is analyzing a prospective spouse.  An academic paper suggests the following:

  • Birds of a feather flock together — in general, people tend to enter into long-term relationships those with similar credit scores.
  • Relationships with higher credit scores tend to last longer.
  • Those with larger gaps in the credit scores have a higher probability of the relationship ending sooner.

Though the paper is more broad than marriage, I am going to shift over to marriage for the rest of this article.  Why?  Every now and then, I get called in to do marriage counseling, typically along with my pastor and fellow elders.  I’m not perfect, so my marriage isn’t perfect, but it is very good.

Marriages tend to fail because the husband and wife disagree on goals or methods for the partnership that they have entered into.  Common disagreements and problems involve:

  • Money
  • Sex
  • Children — number, methods of raising
  • Lack of companionship — shared goals, responsibilities, etc.
  • Bad communication patterns
  • Sins that need to be repented of — anger & abuse, adultery & related, laziness, substance abuse, disdain, lying, etc.
  • And more — there are more ways to get it wrong than to get it right, just as there are more wrong answers on tests than right answers.

I’m only going to handle the money issue here, though laziness, lying, bad communication, and lack of clearly specifying and agreeing to goals play a large role in money problems.  Going back to my earlier article on credit scores, you might recall that I said that credit scores were a moderately accurate measure of moral tendency on average.  Quoting:

Honoring agreements that you have entered into is an important indicator of your personality.  Those who do not repay are on average less moral than those that repay.  Those that are net creditors on average made efforts that net debtors did not.

Credit scores are important.  In a specific way, they measure your willingness to keep your word.  Anytime you enter into a debt contract, you make a promise to repay.  If you fulfill your promise to repay, you impress others as one of good moral character.  If you don’t repay, it is vice-versa, you appear to be of low moral character.  (Note: I am excluding those that got hoodwinked by lenders that defrauded borrowers in a variety of ways.  That said, if you can be hoodwinked, that says something else about you, and that may have an impact on your creditworthiness as well.)

Now, before I continue, these concepts work on average, and not always in particular.  I have helped some at the edge of society with gifts and loans.  In some cases there is a cascade of bad events that the most intelligent would have a hard time facing.  Being wise helps, but there are some situations that would tax the soul of anyone, and be difficult to claim that they were blameworthy; it’s just the way things happened.

The “keeping your word” part is important for marriage.  After all, marriage begins with a simple public promise of mutual fidelity between a man and a woman.  If you can’t keep your word in one area, i.e., paying off a debt, your ability to keep your word in another area, marital fidelity, may be less likely as well.  As such, it shouldn’t be too surprising that those with higher credit scores tend to have longer lasting relationships on average.  They keep their word better, and will tend to have fewer money problems, because they manage their finances well.

As for the couples that have dramatically different credit scores between the two of them, there is the possibility that the more responsible one will get fed up with the lack of discipline on the part of his/her spouse.  Or, the one with less self-controlled spouse will grow to disdain the one trying to bring order.  If not handled properly, it can lead to a breakup — no one wants to feel their resources are being wasted, and no one likes constant criticism.

No Determinism Here

For those that do have difficulties here, I can tell you that you can change.  It is not a question of ability, but of willingness to do so.  The same is true in saving any marriage.  Ask, “Is this the way I wanted things to end up?  Didn’t I have better goals than this?”  and then get to: “Am I willing to give up my bad habits, my purely personal interests, my pride, for the good of my spouse?  Am I willing to work in the best interests of the both of us, even if I don’t get everything I want?”

Tough stuff.  It’s a wonder that any marriages hang together.  But change is possible, and it usually begins with a shared commitment to agree on goals, execute those goals faithfully, leaving behind laziness, overspending and over-committing (taking on too much debt).  Dave Ramsey and many others are good counselors in this area.

If you have never budgeted before, it will be time to do so.  Again, there are many good guides on the Internet, and at bookstores.  Find one that fits your personality and go with it.  (I have never kept a budget in my life, so I would have a hard time advising there.  I don’t spend much on myself, and neither does my wife.)

Telling you that you can raise your credit score is superfluous.  That’s a symptom, not the disease.  If you manage household finances well, and keep your word on paying debts on time, that will take care of itself.  The harder thing is changing the bad habits of spending incautiously.

Now, in the short run, for couples where the two parties are different with willingness to manage money well, there is another solution if both parties are willing to do it.  The one that is less disciplined with money should cede management of finances to the one that is more disciplined.  The one that is more disciplined then gives the one that is less disciplined a regular allowance (mutually agreed upon).  To husbands I would add that if the wife is the one who is better the money, cede that to her, and don’t let your pride get in the way.  Be grateful that you have a bright and responsible wife, and take delight in it.  Far better to have an orderly and well-run household than to have a household that is failing.

This is up to both parties to the marriage to make it work.  It is easy to be selfish, and hard to accept the fact that we are flawed in the way that we handle relationships.  Once humility comes (something that I need too), and communication improves, then real progress can be made in repairing household finances, and hopefully bigger things as well — life isn’t all about money.  But when money is badly handled, it is an engine of relationship destruction.

Thus, if you have money problems in marriage, choose wisely, be humble and unselfish, and do what is best for the one that you pledged to love till death do you part.

81WYYrgZEkL

Some books are better in concept than they are in execution.  Ironically, that is true of “The Art of Execution.”

The core idea of the book is that most great investors get more stocks wrong than they get right, but they make money because they let their winners run, and either cut their losses short or reinvest in their losers at much lower prices than their initial purchase price.  From that, the author gets the idea that the buy and sell disciplines of the investors are the main key to their success.

I know this is a book review, and book reviews are not supposed to be about me.  I include the next two paragraphs to explain why I think the author is wrong, at least in the eyes of most investment managers that I know.

From my practical experience as an investment manager, I can tell you that your strategy for buying and selling is a part of the investment process, but it is not the main one.  Like the author, I also have hired managers to run a billion-plus dollars of money for a series of multiple manager funds.  I did it for the pension division of mutual life insurer that no longer exists back in the 1990s.  It was an interesting time in my career, and I never got the opportunity again.  In the process, I interviewed a large number of the top long-only money managers in the US.  Idea generation was the core concept for almost all of the managers.  Many talked about their buy disciplines at length, but not as a concept separate from the hardest part of being a manager — finding the right assets to buy.

Sell disciplines received far less emphasis, and for most managers, were kind of an afterthought.  If you have good ideas, selling assets is an easy thing — if your ideas aren’t good, it’s hard.  But then you wouldn’t be getting a lot of assets to manage, so it wouldn’t matter much.

Much of the analysis of the author stems from the way he had managers run money for him — he asked them to invest on in their ten best ideas.  That’s a concentrated portfolio indeed, and makes sense if you are almost certain in your analysis of the stocks that you invest in.  As such, the book spends a lot of time on how the managers traded single ideas as separate from the management of the portfolio as a whole.  As such, a number of examples that he brought out as bad management by one set of managers sound really bad, until you realize one thing: they were all part of a broader portfolio.  As managers, they might not have made significant adjustments to a losing position because they were occupied with other more consequential positions that were doing better.  After all, losses on a stock are capped at 100%, while gains are theoretically infinite.  As a stock falls in price, if you don’t add to the position, the risk to the portfolio as a whole gets less and less.

Thus, as you read through the book, you get a collection of anecdotes to illustrate good and bad position and money management.  Any one of these might sound bright or dumb, but they don’t mean a lot if the rest of the portfolio is doing something different.

This is a short book.  The pages are small, and white space is liberally interspersed.  If this had been a regular-sized book, with white space reduced, it might have taken up 80-90 pages.  There’s not a lot here, and given the anecdotal nature of what was written, it is not much more than the author’s opinions.  (There are three pages citing an academic paper, but they exist as an afterthought in a chapter on one class of investors. It has the unsurprising result that positions that managers weight heavily do better than those with lower weights.)   As such, I don’t recommend the book, and I can’t think of a subset of people that could benefit from it, aside from managers that want to be employed by this guy, in order to butter him up.

Quibbles

The end of the book mentions liquidity as a positive factor in asset selection, but most research on the topic gives a premium return to illiquid stocks.  Also, if the manager has concentrated positions in the stocks that he owns, his positions will prove to be less liquid than less concentrated positions in stocks with similar tradable float.

Summary / Who Would Benefit from this Book

 

Don’t buy this book.  To reinforce this point, I am not leaving a link to the book at Amazon, which I ordinarily do.

Full disclosure: I received a copy from a PR flack.

If you enter Amazon through my site, and you buy anything, including books, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.