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Book Review: The Little Book of Market Wizards

Tuesday, September 9th, 2014

9781118858691_MF5.inddOver time, I have reviewed a decent number of “Little Books.”  I have a theory as to why I like some of them, and not others.  I like the ones that take a relatively narrow concept and summarize it.  An example of that would be Mark Mobius’ book on emerging markets, or Vitaliy Katsenelson’s book on sideways markets.

But when a concept is broad and not friendly to summary, a “little book” is not so useful.  As examples, John Mauldin’s book on Bulls Eye  Investing went too many directions, and Scaramucci on Hedge Funds could not adequately summarize or describe a large topic.

There are other “Little Books” that I have read that did not even get a review… probably about 10% of the books I read in entire never get the review written because they were so bad, or just hard to decide what the book was.  (What do you want to be if you grow up dear? ;) )

Sorry, too much intro.  For those at Amazon, there are useful links at my blog.

Jack Schwager is generally a good writer, and expert at talking with clever investors in order to break down the main points of how they invest (without giving away the store).  In this “Little Book” he goes a different direction, and looks for commonalities among various clever investors, with each chapter covering a different topic.

My view is that most clever investors fall into one of a bunch of categories, much of which boils down to time horizon for the preferred investment.  Going down the continuum: day trader, swing trader, longer-term trader, momentum-oriented growth investor, growth investor, growth-at-a-reasonable-price investor, and value investor.  After that, you might differentiate between those that go for relative vs absolute returns.

As such, the book posits a bunch of topics that apply to different groups of clever investors.  I think it would have been better to have segmented the book by classes of investors, because then you could have a coherent set of commonalities for each main investor type.

As it is, the book relies heavily on anecdotes, which isn’t entirely a bad thing; nothing motivates a topic like a story.  But if you were reading this to try to develop your own philosophy of managing money in order to fit your own personality, you might have a hard time doing it with this book.  I think you would be better off reading one of Schwager’s longer books, and reading about each clever investor separately.  At least then you get to see the full package for an investor, and how the different aspects of investing in a given style work together.

Quibbles

Already expressed.

Summary

If you just want a taste of what a wide variety of different investors do to be effective, this could be the book for you.  For most other people, get one of Schwager’s longer books, and read about the different investors as individual chapters.  If you still want to buy it, you can buy it here: The Little Book of Market Wizards: Lessons from the Greatest Traders.

Full disclosure: I received a copy from the author’s PR flack.

If you enter Amazon through my site, and you buy anything, 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.

Goes Down Double-Speed (Update 2)

Saturday, September 6th, 2014

This is the third time I have written this article during this bull market.  Here are the other two times, with dates:

The first time, we had doubled since the bottom.  Second time, up 2.5x.  Now it is a triple since the bottom.  That doesn’t happen often, and this rally is getting increasingly unusual by historic standards.  That said, remember that every time a record gets broken, it shows that the prior maximum was not a limit.  If you think about that, after a bit you know that idea is obvious, but that isn’t the way that many people practically think about extreme statistics.

Let’s look at my table, which is the same as the last two times I published, except for the last line:

spx_31294_image002

Since the second piece, the gains have come slowly and steadily, though faster than between the first and second pieces.  As I said last time,

In long recoveries, gains first come quickly, then slowly, then near the end they often come quickly again.  Things are coming quickly again now, but who can tell how long it might persist.”

Indeed, and after the first piece, the market did nothing for about 16 months, after which the market started climbing again at a rate of about 1.5% per month for the last 27 months.  Though not as intense as the rally in the mid-’80s, this is now the third longest rally since 1950, and the third largest.  It is also the third most intense for rallies lasting 1000 calendar days or more.  This is a special rally.

 

spx_8180_image001

And now look at the cumulative gain:

spx_24509_image001

 

Does this special rally give us any clues to the future?  Sadly, no.  Or maybe, too much.  Let me spill my thoughts, and you can take them for what they are worth, because I encouraged caution the last two times, and that hasn’t been the winning idea so far.

  1. To top the rally of the ’90s for total size, we would have to see 2700 on the S&P 500.
  2. It is highly unlikely that this rally will top the intensity of that of the ’50s or ’80s.  Gains from here, if any, are likely to be below the 1.7%/month average so far.
  3. For this rally to set a length record, it would have to last until 12/14/16 (what a date).
  4. Record high profit margins should constrain further growth in the S&P 500, but that hasn’t worked so far.  As it is, there are very good reasons for profit margins to be high, because unskilled and semi-skilled labor in the capitalist world is not scarce.
  5. Rallies tend to persist longer when they go at gradual clips of between 1-2%/month.  Still, all of them eventually die.
  6. At present the market is priced to give 5.5%/year returns over the next 10 years.  That figure is roughly the 85th percentile of valuations.  Things are high now, but they have been higher, as in the dot-com bubble.  We are presently higher than the peak in 2007.
  7. On the negative side, it doesn’t look like the market is pricing in any war risk.
  8. On the positive side, I’m having a hard time finding too many industries that have over-borrowed.  Governments and US students show moderate credit risk, as do some industries in the finance and energy sectors.
  9. Finally, the most unusual aspect of this era is how little competition bonds are giving to stocks.  In my opinion, that idea is getting relied on too heavily for a relative value trade.  Instead, what we may find is that if bond yields rise, stocks, particularly dividend paying stocks, will get hit.  By relying on a relative yield judgment for stocks, it places them both subject to the same risks.

I still think that we are on borrowed time, but maybe you need to regard me as a stopped digital clock with a date field, which isn’t even right twice per day.  Historically, if the rally persists, stock prices should only appreciate at a 8-9% annual rate with the bull this old.

That’s all for now.  I’m not hedging my equity portfolio yet, but maybe my mind changes near 2300 on the S&P 500, should we get there.

PS — the title comes from the fact that markets move down twice as fast as they go up, so be ready for when the cycle turns.  The first article in the series focused on that.

One Less Mentioned Reason for Stock Buybacks

Saturday, September 6th, 2014

Buybacks are not my favorite way to redeploy excess capital, in general.  But let me describe to you when they are useful and when they are not [taken from this article]:

 

  • Buybacks are preferred on a taxation basis to dividends.

  • But buybacks are especially good when the stock is trading below its franchise value, and especially bad the further above franchise value the stock is trading.

  • Using slack capital to improve operations, or do little tuck-in acquisitions is probably best of all.  Organic growth is usually the best growth, and small acquisitions can facilitate that.  Small acquisitions are usually not expensive.  Be wary of acquisitions to increase scale, they don’t work so well.

  • Paying a dividend makes management teams more cognizant of the cost of equity capital, which makes them more effective.

  • In the reinsurance business in Bermuda, companies with slack capital tend to buy back shares below 1.3x book value, and issue special dividends if they are above that level.

The whole article is worth a read, but there is one more factor that drives buybacks, especially illogical buybacks where they pay more than the per share intrinsic value of the company: they don’t want to get taken over by another company.  After all, the current management team may never have such nice jobs ever again.

Buying back stock at uneconomic prices temporarily keeps the stock price high, and removes cash from the balance sheet that an acquirer could use to help purchase the company.  We haven’t seen it in a while, but some companies under threat of a takeover would do a semi-LBO and borrow a lot of money to buy back stock, making a purchase of the company less attractive.

Thus, I’m not sure we could ever get rid of buybacks, even when they don’t make sense, except perhaps in the long run by selling the shares of companies that are too aggressive in the buybacks.

Closing Note

I rarely disagree with Josh Brown, but I did not find the HBR article he cited criticizing buybacks to be compelling.  I would find it really difficult to believe that management teams avoid projects offering organic growth at rates exceeding the implied yield from buying back stock.  Also, there are many different ways to run businesses in our country, and if public companies suffer from a buyback bias, then private companies might be able to think longer-term, and invest in profitable organic ventures.

Thus I would not blame buybacks for other problems in society; I might blame too much investment in residential housing and financial institutions, but even then, I would not be certain.  What we invest in as a society does affect future growth, but it is difficult to see where the end-investments take place.  Money from a stock buyback might get redeployed into a business startup.  It may be that public businesses are light on organic investing, and take less risk in investing via buybacks. But that is why we have startups, private equity, etc., much of successful of which go public or get acquired by public companies.

Anyway, just a few thoughts…

 

 

Enjoying Yahoo Finance Portfolio News

Friday, September 5th, 2014
Title: Neat and Tidy | Photo Credit: dolanh

Title: Neat and Tidy | Photo Credit: dolanh

I would like to thank Yahoo Finance for cleaning up their news stream that accompanies portfolios that are set up at their site.  It used to be that I would have to copy the news flow from Yahoo Finance, drag it into an Excel spreadsheet, and do some complex operations to separate the wheat from the chaff.  Eventually, I got good enough at doing so, that it only took me five minutes a day to do that.

Fortunately, that only lasted for 18 months.  Now I can just look at the news flow on the portfolio pages, because almost all of the news-clutter is gone.  I’m not asking for perfection from Yahoo Finance.  It’s good enough that I can skip over the few remaining low-quality news sources.

I say this with some hesitation, because after writing for enough time on the web, I have friends in many publishing organizations on the web.  Thus, I would rather not publicly mention names of those excluded, or those who possibly should be excluded from those still allowed into the feed at Yahoo Finance.  I will only say to avoid robotic content.  Yes, we can create programs that can fully or partially automate the writing of certain news stories, but from my experience, those stories are low value, and frequently contain errors that a human specialist could have culled out.

To close: Thanks to Yahoo Finance for making the portfolio news feeds far more useful!

Ranking Industries by Range

Thursday, September 4th, 2014

As part of a continuing quest to turn up stock ideas in the midst of a market hitting new highs, I wanted to trot out a less commonly used statistic called “range.”  Range is the distance that a company’s stock price is between its 52-week low and 52-week high.  0% means the current price is at the 52-week low, and 100% means the current price is at the 52-week  high.  So far, simple, right?  How might industries look if their weighted average range statistics were calculated, weighted by market cap?

RANGE_16247_image002The top zone, which is shaded light red, are industries that are above the median range statistic in the market which is around 78.5% (average is around 72.2%).  The industries shaded yellow represent industries where the stocks are closer to their 52-week high than their 52-week low, but are have average range statistics lower than the median of the market.  Finally, the industries shaded green, what few there are, their current prices are closer to their 52-week low on average.

Personally, I would be inclined to look through the industries toward the bottom of the list, looking for misunderstood companies that have good potential of future outperformance.  That said, someone thinking that this rally would have a long way to go would be incented to look for companies at the top of the list who have trends that are underdiscounted.

As it is, this is where the industries are priced in terms of the past 52 weeks.  You could look at the industries with the view of finding things that are out of place, and prices could shift in the future to reflect it.

If nothing else, this is food for thought.  Technology, Utilities and Healthcare look strong.  Basic materials, Capital Goods, and Consumer Durables look weaker.

All for now.  Be careful.

My Time on RT America’s Boom Bust

Wednesday, September 3rd, 2014

You can never quite tell where blogging may take you.  I know that if I lived near New York City, some opportunities would open up that presently aren’t likely.  Living near Baltimore/DC has had its share of opportunities, though.

In general, if I get asked to appear somewhere, I’ll try to make time on my schedule for doing so, whether it is:

  • Internet TV
  • Internet Radio
  • Local Radio
  • Fox Business News (with Cody Willard)
  • Speaking at a local High School
  • Speaking to a local College
  • Speaking to meetings of the Society of Actuaries, local Actuarial Societies, local CFA Societies, etc.
  • Talking to the staff at SIGTARP, giving a lesson on how insurance companies work
  • And more… if someone had told me all of the things that I would do as a result of saying “yes” to Jim Cramer’s invitation to write for RealMoney.com eleven years ago, I would have been surprised.  The thing I would have been most surprised at would have been the total amount of words that I have written.  I viewed myself eleven years ago as a mathematical businessman, but not a writer.

About five days ago, I was invited to appear on RT America’s show Boom Bust.  What I did not know at the time was that Ed Harrison of Credit Writedowns was behind getting me onto the show.  I’ve known Ed for some time — he was one of the original attendees at the only Aleph Blog Lunch.

I also didn’t know what I would be talking about on the show, so when I got pulled into the makeup room (me?) ten minutes prior to airtime, I was saying to myself, “I guess I have to ‘wing it.'”  Then Ed popped his head through the door and said “Hi,” and explained everything to me.  What a relief!  I went back to the Green Room, scribbled out a few notes — not that I could take it with me, but just to get my mind in order for what I *might* be asked about.

As it was, it went fast, like every other time that I have been on live TV or radio.  What was eight or so minutes felt like two.  Are there things I would have said differently with more composure?  Yes.  But that’s part of the fun of it: thinking on your feet, because I knew little about what the actual questions would be.

If you want to, enjoy watching the video of RT America Boom Bust.  My particular portion is on from 3:30 to 12:00 or so.  Ed Harrison is on at the end.  I stayed to watch that segment live, and talk with Ed and the charming host Erin Ade afterwards.  It was a fun end to my workday.

Q&A with Guy Spier of Aquamarine Capital

Tuesday, September 2nd, 2014

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In the near future, I will be writing a a review of Guy Spier’s The Education of a Value Investor, which will be released next week.  Until then, to whet your appetite, here is an 11 question Q&A that I did with Guy, for which I give him thanks, because his time is valuable.

  1. What company have you owned the past that was the most surprising to you? (In prospect or in retrospect)

I think that many have surprised me in one direction or another, but one of the more memorable was Duff and Phelps Credit rating – which I purchased in the mid-1990’s at a 7 Price to Earnings ratio. The company proceeded to increase in value by seven times over 2-3 years before being purchased by Fimalac, the owner of Fitch. I had expected the stock to double, but I did not understand that I had purchased a super high quality business with a manager who was committed to devoting every cent of free cash, which was in excess of reported earnings, to repurchasing shares.

  1. Which rule(s) of your checklist would surprise average investors the most, if any?

I actually think that none of them would. They are common sense items that anyone would look over and say, “yes – that makes obvious sense”. What is key is not that they are surprising, but that in the wrong state of mind, I might easily skip over a particular factor in evaluating an investment.

  1. Would you advise young people to get a CFA charter or an MBA or is there a better way to become an investor?

I don’t think that either is necessary in order to become a good investor. Attending the Berkshire Hathaway meetings, studying Warren Buffett and reading the Berkshire Annual Reports, along with Poor Charlie’s Almanack are an absolute necessity, in my view.

  1. Would you ever consider setting up your own holding company like Buffett did? (Permanent capital has its attractions…)

Yes. It’s a no brainer to do it if you have the skills. I hope that I have the skills, but I don’t think that the time has been ripe for me. Mohnish Pabrai has recently launched Dhandho Holdings which I think will be an extraordinarily successful enterprise over the years. It’s one to watch.

  1. What would you say is the most common mistake that value investors make? Does this matter if the value investor is amateur or professional?

I think that all-too-often, we feel like we are forced to take a decision. Warren Buffett has often said that, unlike baseball, there are no “called strikes” in investing. That is a truism, but the point is that too many of use act like it is not true. Amateur investors, investing their own money, have a huge advantage in this over the professionals. When you are a professional, there is a whole system of oversight that is constantly saying, “What have you done for me lately!” or in baseball terminology, “Swing you fool!”

 Amateur investors who are investing unlevered funds that they don’t need any time soon have no such pressures.

  1. Financial companies are usually a big part of the portfolio of value investors, because they seem cheap to industrials and utilities. But every now and then financials wipe out in a credit crisis. Why don’t many value investors pay attention to credit conditions?

Yes, that’s absolutely true. Many value investors love the financial industry: Probably because, in a certain way, we are in it ourselves. And yes, value investors probably pay far too little attention to the credit cycle. In my case, I think that I was utterly convinced that my stocks were sufficiently cheap, such that I could invest without regard to financial cycles. But I learned my lesson big time in 2008 when I was down a lot. I now subscribe to Grant’s Interest Rate Observer so as to help me track the credit cycle.

  1. Are your wife and children happier as a result of the changes to your life since becoming a value investor in the style of Warren Buffett?

Absolutely. I spend more time with them. I am simply around more, although that can come with its own irritations. You might have to ask them.

  1. I appreciate your “investing tools,” and I do things mostly like that, but isn’t the main goal of them to be reasoned, dispassionate, independent-minded, etc.? The actual form of the rules is less important than the effect it has on our personalities in making decisions rationally, yes?

Yes – I 100% agree and thus a different personality might have a very different set of rules to guide them. That’s why the book is about my education as a value investor. It’s personal and idiosyncratic. I would fully expect someone else to come up with different rules of behavior.  I do hope though that it will allow people to see that getting to a reasoned, dispassionate, independent minded state is a struggle for this investor, at least and that thinking about our meta environment and making good decisions about that is just as, if not more important than the actual investment decisions.

  1. How do you balance keeping an independent view versus interacting with respected professional friends who have their views?

I try to switch off, or distance myself from people who I think communicate in a way that is not productive for me. The key is to have the kind of discourse that allows other people to come to their own conclusion. Asking open ended questions and not telling someone what to do are important aspects of that. When I come across people who do that, I try to build closer relationships with them. If they don’t I might still keep them in my circle, but I would not allow myself to interact with them too often – because I don’t want to be swayed.

  1. How do you feel about those who use 13F filings to generate ideas?

Mohnish Pabrai taught me to be a cloner. In the academic world, plagiarism is a sin. In business, copying other people’s best ideas is a virtue, and it is no different in investing. I would go further. In the same way that if I wanted to improve my chess, I would study the moves of the grandmasters, if I want to improve my investing, I need to study the moves of the great investors. 13F’s are a great way to do that.

  1. How do you feel about quantitative value investors?

I am not sure that I understand the way that you are using the term. If you mean to use statistical methods to uncover value, Ben Graham style, then I’m all for it. That is what I did when I created my Japan basket. That said, I found it hard and monotonous work. Monotonous because, in the case of Japan it did not lead to greater knowledge or wisdom about the world, because there was a limit on the degree to which I could drill down. But that said, I do run screens for value on S&P CapitalIQ from time to time, and then drill down on some of what comes up.

Again, thanks to Guy Spier for taking time to answer some questions for us… his book is being released on September 9th.  Look for it.

Full disclosure: The Author and some PR flack asked me if I would like a copy and I said “yes.”

If you enter Amazon through my site, and you buy anything, 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.

Book Review: Deep Value

Tuesday, September 2nd, 2014

deep-value-front-coverThis is a book that starts with a simple premise: buy stocks at a fraction of the per share intrinsic value of the company, conservatively calculated.  Neat idea, huh, and it is called value investing.

The author starts by giving a preview of where he will end — with Carl Icahn when he was much younger, where he was buying closed-end funds at large discounts, and pressuring managers to liquidate the fund.  Eventually he started doing the same with overcapitalized companies trading a discount to the net worth of the company.

Then the author takes us on a trip through history, starting with Ben Graham buying the shares of companies at prices lower than the net liquid assets of the company, net of the debt.  It was easy money while it lasted, but eventually many of those companies were bought up and liquidated, and many of the rest had the stock price bid up until the value was no longer compelling.

Then we get to travel along with Warren Buffett and Charlie Munger, who note that the easy pickings are gone, and begin investing in companies that are inexpensive relative to their growth prospects.  This is more complicated, because these companies must have an advantage that will sustain their effort versus their competition.

Then we visit Joel Greenblatt, where he analyzes buying good companies at cheap prices, analyzing them the way an acquirer might do, but also looking for high returns on invested capital.  Lo, but it works, and furthers the efforts of those trying to obtain excess returns.

Then the book gets gritty, and looks at mean reversion of companies that have done poorly over the last four years.  Surprise! The worst tend to do quite well on average.  Also, raw application of simple valuation ratios tend to work on average in stock selection.  People undervalue the boring crud of the market, and overvalue the glamorous stocks, leaving an investment opportunity.

Then it tells a story that is personal to me, that of Litton Industries.  Litton Industries was one of two stocks I owned as a boy — gifts from relatives.  Litton Industries was a company that in the ’50s and ’60s used its highly valued stock to buy up companies that were not highly valued, and made Litton look like its earnings were growing rapidly, which propelled the value of Litton stock still higher.  So long as Litton could keep acquiring cheap-ish companies, the idea kept working, but eventually that ended, and the stock price crashed.  When did my relatives buy me shares of Litton?  Near the end, natch, when everyone know how wonderful it was.

Quite a lesson for an eight year old to see the stock price down by 80% in a year.  The other stock, Magnavox, did that also, so it is a testimony to my mother’s own clever investing that I ended up in this business… my story aside, the point of the Litton chapter was to point out that not all earnings growth is real, and that it is far better to focus on boring companies than what seems glamorous and successful.  Untempered optimism tends not to be rewarded.

The book then moves onto investors large enough to effect change outright, buying enough of a company to force change in a management team that is lazy, incompetent, or overly conservative.  The book goes through the experiences of Ronald Brierly, T. Boone Pickens, and Carl Icahn.  The art of spotting an undervalued company, and gaining enough influence to buy the company and fix it, or see the company sold to another company that will fix it, can lead to great gains.

Here the trail ends.  It started with Ben Graham buying companies that would be good investments regardless, moves to companies that will be good investments if you analyze them more closely, and ends with companies that good be good investments if you could influence a change in corporate behavior.  The same principles are being applied, but with much more analysis and potentially threat of a takeover.

In closing, the book talks about what can be a way of measuring moats, which is gross profits as percentage of assets.  It also reviews what factors activist investors look for when they invest, which may give the clever a guide into what stocks to pursue.

Quibbles

I liked the book, and I recommend it, but in one sense the book is a  statement of how tough the value investing game has become.  Ben Graham could sit back and do simple analyses, pursuing artistic endeavors and the good life in his spare time.  We have to analyze far more closely, and be aware of whether what companies larger activist players may consider.  Value investing still has punch for amateurs, but there is a lot more work and analysis to do.

Summary

This book would be good for investors looking to understand value investing better, and how it has changed over the years.  It would not likely be good for novices.  If you still want to buy it, you can buy it here: Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations (Wiley Finance).

Full disclosure: The PR flack asked me if I would like a copy and I said “yes.”

If you enter Amazon through my site, and you buy anything, 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.

Using Mean Reversion and Momentum for Possible Advantage

Saturday, August 30th, 2014

One of the challenges of fundamental investing is trying to find decent ideas that are off the radar. There are a number of ways to try to do that by looking at:

  • smaller foreign companies
  • companies that have made some significant losses.
  • companies where the relative performance is so awful that no manager benchmarked to an index would dare touch the company.
  • small companies with modest insider buying.
  • companies in boring industries that you know can’t have any significant growth.  (This excludes “buggy whip” industries.)
  • companies where insiders own so much of the company, that it can’t easily be taken over.
  • complex companies that are difficult to understand.

Okay, tall order.  That said, I’ll do a few articles over the next two months that try to unearth companies that might be suitable candidates for analysis.  Tonight’s article follows up on what I wrote in my last article, where I said:

Sometimes I like to run a screen for stocks have done badly over the last four years, but have begun to outperform over the last year.  This can point out areas that are still ignored by most of the market, but where trend may have shifted.  I’ll post that screen after my software has its weekly update on Saturday.

I’m going to show you the list, with some additional data to give some context, but remember this: the only reason these stocks are here is that they underperformed the market massively for the last four years, and have had a turn in performance in the last year.  Anyway, here is the list:

 

 

BADTHENGOOD_21692_image002

I’ve been analyzing stocks for over 20 years… out of the 49 companies listed here, I recognize 24 of them.  I own none of them at present, though I have owned four of them in the past [AKS, DYN, TNP & YRCW].  That said, four years of lousy relative performance likely means that few are actively looking at these companies.

As with any analysis on the internet, purchasing or selling shares of companies like this is at your own risk.  I’m planning on looking through this list for ideas, and if I find one good enough to buy for my clients and me, I will do a write-up after we have established our position.

In order to get there, I would have to be satisfied about a number of things regarding any one of these companies:

  • What went wrong over the last four years?
  • Has management fixed what was wrong?  (Or, is there a new management with better ideas?)
  • Is the business adequately capitalized?
  • Is the accounting likely honest/conservative?
  • Do they have a large area where they can earn money sustainably, or are they up against stronger competition almost everywhere?
  • If they are in a tough industry, are they one of the few that could survive if conditions got markedly worse?
  • Does management seem intelligent in using excess cash?

The question is to look for a margin of safety, and then see whether the company will earn a return on its business that is attractive at your entry price.  This is a challenge, but maybe one or two companies out of 49 could make it.

Or not.  Be careful.

 

Two Portfolios. Pick One.

Friday, August 29th, 2014

I’m going to show you two portfolios — I’m not initially going to tell you much about either one, but then you can consider which one you might like better.  Here’s portfolio A:

LOSERS_9447_image002

And here is portfolio B:

WINNERS_3286_image002

There is one obvious difference in the two portfolios: portfolio B has gone up more than portfolio A in the past year.  But the hidden story is that portfolio A’s stocks have had price returns of -85% or worse over the past four years, whereas portfolio B’s stocks have has price returns of 1000% or better.  They are the only stocks with current market caps of over $100 million that meet those criteria.

Now, which one would you choose, if you had to hold one portfolio for the next year? The next four years?

Oddly, the right answer might be portfolio A.  Currently, I am reading through a book called Deep Value, which I will review in a week or two, and they cite in Chapter 5 some research by Thaler and De Bondt which indicates that portfolios that have gone through extreme failure tend to outperform portfolios that have gone through extreme success.

Though the momentum anomaly (weak as it has been recently) usually favors portfolios with stronger price momentum, the relationship breaks down over longer periods of time, and more severe moves, where mean-reversion tends to take over.  One thing that I can tell looking at the two portfolios — the expectations are a lot, lot higher for portfolio B than portfolio A.  Things only have to stop getting worse for there to some positive price action there.

Sometimes I like to run a screen for stocks have done badly over the last four years, but have begun to outperform over the last year.  This can point out areas that are still ignored by most of the market, but where trend may have shifted.  I’ll post that screen after my software has its weekly update on Saturday.  Until then.

PS — as an aside, it will be fun to review the relative performance of these portfolios.

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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