Photo Credit: Ian Sane || Many ways to supplement retirement income...

Photo Credit: Ian Sane || One of many ways to supplement retirement income…

Investing is difficult. That said, it can be harder still. Let people with little to no training to try to do it for themselves. Sadly, many people get caught in the fear/greed cycle, and show up at the wrong time to buy and/or sell. They get there late, and then their emotions trick them into action. A rational investor would say, “Okay, I missed that move. Where are opportunities now, if there are any at all?”

Investing can be made even more difficult.  Investing reaches its most challenging level when one relies on his investing to meet an anticipated and repeated need for cash outflows.

Institutional investors will say that portfolio decisions are almost always easier when there is more cash flowing in than flowing out.  It means that there is one dominant mode of thought: where to invest new money?  Some attention will be given to managing existing assets — pruning away assets with less potential, but the need won’t be as pressing.

What’s tough is trying to meet a cash withdrawal rate that is materially higher than what can safely be achieved over time, and earning enough consistently to do so.  Doing so as an amateur managing a retirement portfolio is a particularly hard version of this problem.  Let me point out some of the areas where it will be hard:

1) The retiree doesn’t know how long he, his spouse, and anyone else relying on him will live.  Averages can be calculated, but particularly with two people, the odds are that at least one will outlive an average life expectancy.  Can they be conservative enough in their withdrawals that they won’t outlive their assets?

It’s tempting to overspend, and the temptation will get greater when bad events happen that break the budget, whether those are healthcare or other needs.  It is incredibly difficult to avoid paying for an immediate pressing need, when the soft cost is harming your future.  There is every incentive to say, “We’ll figure it out later.”  The odds on that being true will be low.

2) One conservative estimate of what the safe withdrawal rate is on a perpetuity is the yield on the 10-year Treasury Note plus around 1%.  That additional 1% can be higher after the market has gone through a bear market, and valuations are cheap, and as low as zero near the end of a bull market.

That said, most people people with discipline want a simple spending rule, and so those that are moderately conservative choose that they can spend 4%/year of their assets.  At present, if interest rates don’t go lower still, that will likely (60-80% likelihood) work.  But if income needs are greater than that, the odds of obtaining those yields over the long haul go down dramatically.

3) How does a retiree deal with bear markets, particularly ones that occur early in retirement?  Can he and will he reduce his expenses to reflect the losses?  On the other side, during bull markets, will he build up a buffer, and not get incautious during seemingly good times?

This is an easy prediction to make, but after the next bear market, look for a scad of “Our retirement is ruined articles.”  Look for there to be hearings in Congress that don’t amount to much — and if they do amount to much, watch them make things worse by creating R Bonds, or some similarly bad idea.

Academic risk models typically used by financial planners typically don’t do path-dependent analyses.  The odds of a ruinous situation is far higher than most models estimate because of the need for withdrawals and the autocorrelated nature of returns – good returns begets good, and bad returns beget bad in the intermediate term.  The odds of at least one large bad streak of returns on risky assets during retirement is high, and few retirees will build up a buffer of slack assets to prepare for that.

4) Retirees should avoid investing in too many income vehicles; the easiest temptation to give into is to stretch for yield — it is the oldest scam in the books.  This applies to dividend paying common stocks, and stock-like investments like REITs, MLPs, BDCs, etc.  They have no guaranteed return of principal.  On the plus side, they may give capital gains if bought at the right time, when they are out of favor, and reducing exposure when everyone is buying them.  Negatively, all junior debt tends to return worse on average than senior debts.  It is the same for equity-like investments used for income investing.

Another easy prediction to make is that junk bonds and non-bond income vehicles will be a large contributor to the shortfall in asset return in the next bear market, because many people are buying them as if they are magic.  The naive buyers think: all they do is provide a higher income, and there is no increased risk of capital loss.

5) Leaving retirement behind for a moment, consider the asset accumulation process.  Compounding is trickier than it may seem.  Assets must be selected that will grow their value including dividend payments over a reasonable time horizon, corresponding to a market cycle or so (4-8 years).  Growth in value should be in excess of that from expanding stock market multiples or falling interest rates, because you want to compound in the future, and low interest rates and high stock market multiples imply that future compounding opportunities are lower.

Thus, in one sense, there is no benefit much from a general rise in values from the stock or bond markets.  The value of a portfolio may have risen, but at the cost of lower future opportunities.  This is more ironclad in the bond market, where the cash flow streams are fixed.  With stocks and other risky investments, there may be some ways to do better.

Retirees should be aware that the actions taken by one member of a large cohort of retirees will be taken by many of them.  This makes risk control more difficult, because many of the assets and services that one would like to buy get bid up because they are scarce.  Often it may be that those that act earliest will do best, and those arriving last will do worst, but that is common to investing in many circumstances.  As Buffett has said, “What a wise man does in the beginning a fool does in the end.”

6) Retirement investors should avoid taking too much or too little risk. It’s psychologically difficult to buy risk assets when things seem horrible, or sell when everyone else is carefree.  If a person can do that successfully, he is rare.

What is achievable by many is to maintain a constant risk posture.  Don’t panic; don’t get greedy — stick to a moderate asset allocation through the cycles of the markets.

7) With asset allocation, retirees should overweight out-of-favor asset classes that offer above average cashflow yields.  Estimates on these can be found at GMO or Research Affiliates.  They should rebalance into new asset classes when they become cheap.

Another way retirees can succeed would be investing in growth at a reasonable price – stocks that offer capital growth opportunities at an inexpensive price and a margin of safety.  These companies or assets need to have large opportunities in front of them that they can reinvest their free cash flow into.  This is harder to do than it looks.  More companies look promising and do not perform well than those that do perform well.

Yet another way to enhance returns is value investing: find undervalued companies with a margin of safety that have potential to recover when conditions normalize, or find companies that can convert their resources to a better use that have the willingness to do that.  After the companies do well, reinvest in new possibilities that have better appreciation potential.


8 ) Many say that the first rule of markets is to avoid losses.  Here are some methods to remember:

  • Always seek a margin of safety.  Look for valuable assets well in excess of debts, governed by the rule of law, and purchased at a bargain price.
  • For assets that have fallen in price, don’t try to time the bottom — buy the asset when it rises above its 200-day moving average. This can limit risk, potentially buying when the worst is truly past.
  • Conservative investors avoid the areas where the hot money is buying and own assets being acquired by patient investors.

9) As assets shrink, what should be liquidated?  Asset allocation is more difficult than it is described in the textbooks, or in the syllabuses for the CFA Institute or for CFPs.  It is a blend of two things — when does the investor need the money, and what asset classes offer decent risk adjusted returns looking forward?  The best strategy is forward-looking, and liquidates what has the lowest risk-adjusted future return.  What is easy is selling assets off from everything proportionally, taking account of tax issues where needed.

Here’s another strategy that’s gotten a little attention lately: stocks are longer assets than bonds, so use bonds to pay for your spending in the early years of your retirement, and initially don’t sell the stocks.  Once the bonds run out, then start selling stocks if the dividend income isn’t enough to live on.

This idea is weak.  If a person followed this in 1997 with a 10-year horizon, their stocks would be worth less in 2008-9, even if they rocket back out to 2014.

Remember again:

You don’t benefit much from a general rise in values from the stock or bond markets.  The value of your portfolio may have risen, but at the cost of lower future opportunities.

That goes double in the distribution phase. The objective is to convert assets into a stream of income.  If interest rates are low, as they are now, safe income will be low.  The same applies to stocks (and things like them) trading at high multiples regardless of what dividends they pay.

Don’t look at current income.  Look instead at the underlying economics of the business, and how it grows value.  It is far better to have a growing income stream than a high income stream with low growth potential.

Deciding what to sell is an exercise in asset-liability management.  Keep the assets that offer the best return over the period that they are there to fund future expenses.

10) Will Social Security take a hit out around 2026?  One interpretation of the law says that once the trust fund gets down to one year’s worth of payments, future payments may get reduced to the level sustainable by expected future contributions, which is 73% of expected levels.  Expect a political firestorm if this becomes a live issue, say for the 2024 Presidential election.  There will be a bloc of voters to oppose leaving benefits unchanged by increasing Social Security taxes.

Even if benefits last at projected levels longer than 2026, the risk remains that there will be some compromise in the future that might reduce benefits because taxes will not be raised.  This is not as secure as a government bond.

11) Be wary of inflation, but don’t overdo it.  The retirement of so many people may be deflationary — after all, look at Japan and Europe so far.  Economies also work better when there is net growth in the number of workers.  It will be tempting for policymakers to shrink what liabilities they can shrink through inflation, but there will also be a bloc of voters to oppose that.

Also consider other risks, and how assets may fare.  Retirees should analyze what exposure they have to:

  • Deflation and a credit crisis
  • Expropriation
  • Regulatory change
  • Trade wars
  • Changes in taxes
  • Asset illiquidity
  • Reductions in reimbursement from government programs like Medicare, Medicaid, etc.
  • And more…

12) Retirees need a defender of two against slick guys who will try to cheat them when they are older.  Those who have assets are a prime target for scams.  Most of these come dressed in suits: brokers and other investment salesmen with plausible ways to make assets stretch further.  But there are other scams as well — retirees should run everything significant past a smart younger person who is skeptical, and knows how to say no when it is necessary.


Some will think this is unduly dour, but this is realistic.  There are not enough resources to give all of the Baby Boomers a lush retirement, without unduly harming younger age cohorts, and this is true over most of the developed world, not just the US.

Even with skilled advisers helping, retirees need to be ready for the hard choices that will come up. They should think through them earlier rather than later, and take some actions that will lower future risks.

The basic idea of retirement investing is how to convert present excess income into a robust income stream in retirement.  Managing a pile of assets for income to live off of is a challenge, and one that most people are not geared up for, because poor planning and emotional decisions lead to subpar results.

Retirees should aim for the best future investment opportunities with a margin of safety, and let the retirement income take care of itself.  After all, they can’t rely on the markets or the policymakers to make income opportunities easy.

Photo Credit: Insider Monkey || Carl never looked so good.

Picture Credit: Insider Monkey || Carl never looked so good.

I’ve written about this topic twice before:


Those were back in 2008, before the financial crisis.  I made similar comments at RealMoney earlier than that, but those are lost and gone forever, and I am dreadful sorry.

I’ve written a lot about AIG over the years, including my article that was cited by the Special Inspector General of the TARP in his report on AIG.  I’ve also written a lot about insurance investing.  I’d like to quote from the final part of my 7-part series summarizing the topic:

1) The first thing to realize is that diversification across insurance subindustries usually does not work.

Do not mix:

  • Life & P&C
  • Financial & Anything
  • Health & Anything

Maybe you can mix P&C, Mortgage & Title, after all Old Republic survived.  The main point is this.  Insurance is not uniform.  Coverages are sold and underwritten differently.  Generally, higher valuations will be obtained on “pure play” companies  Diversification is swamped by management inability.  These are reasons for AIG and Allstate to spin off their life operations.

2) Middle-sized companies tend to do best from a valuation standpoint: the large have nowhere to grow, and the small are always questionable on their viability.  With a few exceptions, I like sticking with focused mid-cap companies with my insurance names.

Both of these concepts augur in favor of a breakup of AIG — even without the additional capital needed for being a SIFI (which no insurance firm should be, they don’t collapse together, like banks do), large firms get a valuation discount, because they can’t grow quickly.

Synergies and diversification benefits between differing types of insurance tend to be limited as well.  Focus is worth a lot more in insurance than diversity, because managements are typically not good at multiple types of insurance.  They have different profit models, distribution systems, capital needs, and mindsets.  Think of it this way: if you can’t get personal lines agents to sell life insurance and annuities, why do you ever think there might be synergies?  They are very different businesses.

Now Carl Icahn is arguing the same thingsize and diversification are harming value at AIG, as well as a high cost structure.  I think his first argument is right, and a breakup should be pursued, but let me mention four complicating factors that he ought to consider:

1) Costs aren’t overly high at AIG, and there may not be a lot to cut.  Greenberg ran a tight ship, and I suspect those who followed tried to imitate that.  I would try to double-check cost levels.

2) ROEs are low at AIG likely because many life insurers have low embedded margins and those can’t be changed rapidly because of the long duration nature of the contracts.  The accounting for DAC [deferred acquisition cost] assets can be liberal at times — writedowns are not required until you are deferring losses.  I would analyze all intangible assets, and try to estimate what they returning.  I would also try to look at the valuation of life insurers comparable to those at AIG, which are high complexity beasties.  You might find that a breakup won’t release as much value as you think, at least initially.

3) Pure play mortgage insurers are fodder for the next financial crisis.  If one of those gets spun off, it won’t come at a high valuation, particularly if you give it enough capital to maintain its credit ratings.

4) There are a variety of cross-guarantees across AIG’s subsidiaries.  I’m assuming Icahn read about those when he looked through the statutory books of AIG.  That is, if he did do that.  They are mentioned in the 10K, but not in as much detail.  Those would probably be the most difficult part of a breakup of AIG, because you would have to replace guarantees with additional capital, which reduces the benefit of breaking the companies up.


Breaking up AIG would be difficult, but I believe that focused insurance companies with specialist management teams would eventually outperform AIG as it is currently configured.  Just don’t expect a quick or massive initial benefit from breaking AIG up.

One final note: it would pay Carl Icahn and all of the others who would be interested in breaking up AIG to hire some insurance expertise.  Insurance is a set of complex businesses, and few understand most of them, much less all of them.  It would be easy to naively overestimate the ability to improve profitability at AIG if you don’t know the business,  the accounting, and how free cash flow emerges, if it ever does.

They might also want to have a frank talk with Standard and Poors as to how they would structure a breakup if the operating subsidiaries were to maintain all of their current ratings.  Icahn and his friends might be surprised at how little value could initially be released, if any.


Full disclosure: long ALL


Before I start on this tonight, let me say that I never begrudge any salesman a fair commission.  When I was a bond manager, I made a point of never letting my brokers “cross bonds” to me, i.e., at no commission.  I would raise my purchase price a little to compensate them.  Had my client known that I did that, he might have objected, but it was in his best interests that I did it.  As a result of that and other things that I did, my brokers were very loyal to me, and worked to give my client excellent executions whether buying or selling.  They were also more frank with me about bonds they thought I should sell.  Fairness begets fairness under most conditions, and suspicion and tightness also have their way of breeding as well.  Consider that in all of your dealings.

My main reason for writing tonight is to remind investors to think about how the parties you transact with are compensated.

  • If they are compensated on transactions, expect to see a lot of buying and selling.
  • If they are compensated on asset-based fees, expect them to try to get business, and then retain it.
  • If they are compensated on profits, they will try to get profits.  Be wary of how much control they might have over the accounting, they will be incented to be liberal if they have any control.  They will also be incented toward volatility, because volatile assets offer the best possibility of a big score, even if the probability is moderate at best.

The greater the potential compensation, the greater the tendency to act along the incentives offered.  As a result, if a life insurance salesman has a product offering a high commission, and one offering a low commission, he may act in the following way:

  • Figure out if you are price-sensitive or not.
  • Figure out if you are willing to accept a product that has a long surrender charge.  Long surrender charges lock in business, and allow for high commissions to be paid.
  • Also analyze how much complexity you are willing to accept — more complex permanent policies and especially ancillary riders are far more profitable because even external actuaries would have a tough time analyzing them.
  • If you are price-sensitive, bring out the low commission policy that is more competitive.
  • If you are price-insensitive, bring out the high commission policy that is less competitive.

(Note: there are state laws in every state that constrain this behavior for life insurance agents, but it can never be eliminated in entire.)

Now, many agents will act in your interests in spite of their own interests, but some won’t, so be aware.  Always ask a question like, “This seems expensive.  Don’t you have another policy that is less expensive that accomplishes only the main goal that I am shooting for?”

You could always ask them what commission is that they will earn.  Most won’t answer that.  First, it’s kind of offensive, and second, they will argue that it is not material to your decision.

But it is material to your decision.  Here’s why:

  • The size of the commission directly affects the size of the premium that you pay.
  • It also directly affects the length and size of the surrender charge that you would pay if you terminate the policy early.
  • After all, the actuaries or other mathematical businessmen are trying to avoid the risk of paying a commission that they can’t recover under ALL circumstances.  They will get their fees from you to recoup the commission cost.  They will either get it from you coming or going, but they WILL get it from you, at least on average.

If the salesmen disagree with you after mentioning this (or showing them this), you can say to them that every actuary knows this is true, don’t argue with the actuaries, they know the math.  (And its why we tend to buy term and other simple policies.  Shhh.)

I’ve seen more than my share of ugly products in my time.  I’m happy I never designed any.  I did kill a few of them.  That said, one of the most unpleasant duties I ever had as a life actuary was about 18 years ago when I inherited a department to clean up, and I got the responsibility of talking to the clients that were the most irate, demanding to talk to the man in charge.  I never created those products, but I was nominally in charge of the division as I cleaned up the pricing, reinsurance, reserving, accounting, and asset-liability management.

I’ll tell you, it is no fun talking to people who conclude that they have been had.  It is even less fun to be the one who has been had.  Thus I would tell you to view all salesmen of financial with skepticism.  It is hard to assure a good result with intangible products that are hard to compare.  Thus aim for simplicity and lower surrender charge and commission products.

Now, I used life insurance as my example here because I know it best, and it excels in complexity.  But this applies to all financial products, especially illiquid ones.  Be wary of:

  • Brokers who make money off of commissions
  • Those who sell private REITs and structured notes
  • Any product where you have a limited ability to liquidate or sell it.
  • Any product that you can’t understand how the company and salesman are making money off it.
  • Any product where you can’t understand what the legal form of the investment is (Stock, bond, mutual fund, partnership, derivative, insurance, etc.)

Here are some final bits of advice:

  • Look for advisers who are fiduciaries, and are responsible to look out for your interests (but still be wary)
  • Look at the fee structures, and look for lower cost alternatives.
  • Seek competing products, salesmen and companies.
  • Negotiate lower compensation where possible.
  • Remember that higher yields are almost never free… what yields more typically has more risk.  Yield is the oldest scam in the books.

Remember, regardless of what laws exist, you are your own best defender when it comes to your own economic interests.  Be aware of the economic incentives of those who seek your business with financial products, and be reasonably skeptical.

financial tales

This financial book is different from the 250+ other financial books that I have reviewed, and the hundreds of others I have read.  It tells real life stories that the author has personally experienced, and the financial ramifications that happened as a result.  Each of the 60+ stories illustrates a significant topic in financial planning for individuals and families.  Some end happy, some end sad.  There are examples from each of the possible outcomes that can result from people interacting with financial advice (in my rough large to small probability order):

  • Followed bad advice, or ignored good advice, and lost.
  • Followed good advice, and won.
  • A mixed outcome from mixed behavior
  • Followed bad advice, or ignored good advice, and won anyway.
  • Followed good advice, and lost anyway.

The thing is, there is a “luck” component to finance.  People don’t know the future behavior of markets, and may accidentally get it right or wrong.  With good advice, the odds can be tipped in their favor, at least to the point where they aren’t as badly hurt when markets get volatile.

The stories in the book mostly stem from the author’s experience as a financial advisor/planner in Maryland.  The stories are 3-6 pages long, and can be read one at a time with little loss of flow.  The stories don’t depend on each other.  It is a book you can pick up and put down, and the value will be the same as for the person who reads it straight through.

In general, I thought the author advocated good advice for his clients, family and friends.  Most people could benefit from reading this book.  It’s pretty basic, and maybe, _maybe_, one of your friends who isn’t so good with financial matters could benefit from it as a gift if you don’t need it yourself.  The reason I say this is that some people will learn reading about the failures of others rather than being advised by well-meaning family, friends, and professionals.  They may admit to themselves that they have been wrong when they be unwilling to do it with others.

I recommend this book for readers who need motivation and knowledge to guide themselves in their financial dealings, including how to find a good advisor, and how to avoid bad advisors.


The book lacks generality because of its focus on telling stories.  It would have been a much better book if it had one final chapter or appendix where the author would take all of the lessons, and weave them into a coherent whole.  If nothing else, such a chapter would be an excellent review of the lessons of the book, and could even footnote back to the stories in the book for where people could read more on a given point.

I know this is a bias of mine regarding books with a lot of unrelated stories, but I think it is incumbent on the one telling the stories to flesh out the common themes, because many will miss those themes otherwise.  In all writing, specifics support generalities, and generalities support specifics.  They are always stronger together.

An Aside

I benefited from the book in one unusual way: it gave me a lot of article ideas, which you will be reading about at Aleph Blog in the near term.  I’ve never gotten so many from a single book — that is a strength of reading the ideas in story form.  It can catch your imagination.

Summary / Who Would Benefit from this Book

You don’t need this book if you are an expert or professional in finance.  You could benefit from this book if you want to improve what you do financially, improve your dealings with your financial advisor, or get a good financial advisor.  if you want to buy it, you can buy it here: Financial Tales.

Full disclosure: The author sent a free copy to me directly.  Though we must live somewhat near to one another, and we both hold CFA charters, I do not know him.

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: TexasEagle || A: Do you see any prey? B: No, I don't. Do *you* see any prey?

Photo Credit: TexasEagle || A: Do you see any prey? B: No, I don’t. Do *you* see any prey?

I was surprised to find that I wrote another piece with the same title — 8.5 years ago, before the housing bubble crashed.  It was a short piece (with dead links).  Here it is:

I had a cc post over at RealMoney called Too Many Vultures, Too Little Carrion . The idea was that there’s too much money ready to rescue dud assets at present. Yesterday, Cramer had his own blog entry suggesting that the absorption of subprime assets at relatively high prices implied that the depositary financial sector is a sound place to invest. I disagree. In the early phases of any secular change, there are market players who snap up distressed assets, and later they find out that they could have gotten a better bargain had they waited.

The good sale prices for subprime portfolios is not a sign of strength, but a sign that there is a lot of vulture capital looking for deals. The true problems will surface when the vulture capital gets burned through or scared away.

That last paragraph is the “money shot.”  When there is too much vulture capital waiting to invest in distressed securities, marginal business concepts don’t get destroyed, clearing the way for a reduction in capacity, and healthy firms pick up the pieces.  At such a time, you have to wait until the distressed players get hosed, or get smart.

Today’s topic is the debt and equity of companies producing energy, or providing services to them, all of which get hurt by a lower oil price.  In the recent past, you have had marginal energy companies able to get financing amid decreasing opportunities for decent profits.  Thus the article at the Wall Street Journal talking about hedge funds losing money on recently placed bets on energy.

Aiding the financing of marginal companies can pay off if the companies will be profitable within a reasonable window of time, or, if you are trying to buy assets cheap for a reorganization.  But if there is too much capacity, and thus low prices for products, the profits after financing may never emerge, and the value of the assets may sag.

Let me talk about another group of oil companies on the global scene.  They are relatively high cost players with large-ish balance sheets that are presently pushing to recover market share.  Yes, I am talking about OPEC countries.  Not the national oil companies of those countries, but the countries themselves.

Think of the countries as the companies, because the companies themselves fund the government of these countries.  Consider this quotation from the Bloomberg article to which I linked, regarding one of the stronger OPEC countries, Saudi Arabia:

Saudi Arabia, the main architect of OPEC’s new strategy, will have a budget deficit of 20 percent of gross domestic product this year, the International Monetary Fund estimates. While the kingdom has been able to tap foreign currency reserves and curb spending to cope with the slump, financial assets may run out within five years if the government maintains current policies and prices stay low, the IMF said Wednesday.

Less wealthy OPEC members have even fewer options. The threat of political unrest is mounting in the “Fragile Five” of Algeria, Iraq, Libya, Nigeria and Venezuela, according to RBC Capital Markets LLC.

Think of the budget deficits that the OPEC countries have to fund in the same way you think about the debt service of a US E&P company.  The deposits of oil being produced may be low cost in and of themselves, but any profits go to cover debt service of the greater enterprise, and whatever is not covered, more will be borrowed, should the markets allow it.

What’s the longest that this game could be played?  Never say never, but I would be shocked if this could continue  to 2020.  That said, there are a lot of OPEC countries that won’t make it that far, and a lot of E&P and services businesses that won’t make it that far either.  Now, the countries could face severe political turbulence, but eventually, they will have to reduce what they borrow and spend.  That doesn’t mean the oil stops flowing, though a new government could decide to cut spending further, and save the patrimony (crude oil) for a better day.

The free market oil producers are another matter… they can go under, and production would likely stop.  The question is what side of the solvency line you end up on when enough production capacity is eliminated.  If you are still solvent, you will reap some reward for your fiscal rectitude as prices rise again, and the Saudis breathe a sigh of relief, congratulating themselves for winning a very expensive game of “chicken,” or, a Pyrrhic economic war.

As such, be careful playing in heavily indebted companies that benefit from higher energy prices.  That they are limping along should be no comfort, because those that they presently rely on for financing will eventually have to give up, much as those snatching up bargains in subprime had to give up when the financial crisis hit.

And for those watching the price of crude oil, this is yet another reason why Brent crude should remain near $50/bbl, for a few years.  It is the uneasy equilibrium where producers are both entering the market and giving up.  The Saudis don’t want it much lower — there are limits to the pain that they want to take, as well as impose on the rest of OPEC.

Photo Credit: Tony & Wayne || Do we PEG the growth of pretty flowers?

Photo Credit: Tony & Wayne || Do we PEG the growth of pretty flowers?

I was looking through an article to see if it had any decent stock ideas, and noted that most of the companies featured were growth stocks.  As such, my first pass for analysis is the PEG ratio, which is the ratio of the Price-Earnings ratio divided by the growth rate expressed as a percentage (e.g. 8% => 8 for this calculation.).

I’ve written about the PEG ratio a long time ago, and it is a classic article of mine.  The PEG ratio is a valid concept for “growth at a reasonable” price investors.  It does not work well for value investors or aggressive growth investors.  My rule for implementation comes to this: if the current P/E ratio is 12 or higher and the PEG ratio is lower than 1.5, that stock might be worth a look.  Better to find the PEG ratio below one, though.

I went through the article and concluded that maybe Becton Dickinson and Hanesbrands might be worth a look.  But then I thought, “What if I applied the formula to propose overvalued stocks?”

I set my screener for a 2016 PE higher than 12 and a PEG higher than 2.0x, with failing momentum, where the stock was down more than 20% in the nine months prior to the current month.  Here were the 50 stocks that resulted:

What I find fascinating here is the mix of hot companies, basic materials and energy names, and limited partnerships.

This is only a start for analysis, so don’t run out and short these.  Not that I am big on shorting, but high earnings valuations, and failing price momentum could be a good place to start.  I have no positions in any of these companies, and I rarely if ever short.  I just thought this would be an interesting exercise.

Picture Credit: Insider Monkey

Picture Credit: Insider Monkey || Isn’t Jamie Dimon handsome?

Recently Jamie Dimon was interviewed by Bloomberg, and commented that companies should stop giving earnings guidance. This is out of character for me, but I will explain why companies should offer earnings guidance. (Why is it out of character? Previously I have said that I don’t personally care whether firms that I own give earnings guidance or not… that still remains true.)

From the interview:

JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said corporate leaders shouldn’t give earnings guidance because they can’t predict the future and should focus instead on long-term performance.

Some CEOs “start making promises they shouldn’t make,” Dimon, 59, said Monday in a Bloomberg Television interview with Stephanie Ruhle. “Don’t make earnings forecasts. You don’t know what’s going to happen every quarter. I don’t even care about quarterly earnings.”


While many JPMorgan shareholders “completely appreciate” long-term investing, other market participants overreact to short-term results, Dimon said. The New York-based firm last week reported third-quarter profit that missed analysts’ estimates as a slump in trading and mortgage banking drove revenue lower from a year earlier.

Dimon is mostly right, as far as he goes, particularly when you think about a complex bank, where the accounting for profits over a short period is less than an exact science.

I’ve written at least two articles on earnings estimates:

In general, I think you have to have something like [adjusted non-GAAP (ANG)] earnings estimates in order for shareholders to have some measure of how corporations are tracking in their goals of building value.  That doesn’t mean that corporations have to facilitate that, because the sell side will do it themselves if the company is big enough, the shares trade enough, or it raises capital often enough.

Dimon and other CEOs can sit back and let the earnings estimates be their own little sideshow.  Still, there is a reason to give forward guidance.  It lowers your cost of capital on average.

Forward guidance gives investors (and sell side analysts comfort that there is a business model there that is predictable in building value.  I’m not talking about GAAP earnings, but ANG earnings because in principle they should reflect the true increase in the per share value of the firm after eliminating accounting entries that distort that effort.

Now don’t get me wrong.  Not all companies craft their ANG earnings so honestly — they may even adjust differently period to period to make things look good.  As with all things in the market, buyer beware.

But if companies can show that they have adequate control over their financial results such that they forecast future earnings and they honestly come to pass, investors will think the place is better managed than most, and reward it with a higher P/E multiple.

That is my simple argument.

I have my list of concerns for the economy and the markets:

  1. Unexpected Global Macroeconomic Surprises, including more from China
  2. Student Loans, Agricultural Loans, Auto Loans — too much
  3. Exchange Traded Products — the tail is wagging the dog in some places, and ETPs are very liquid, but at a cost of reducing liquidity to the rest of the market
  4. Low risk margins — valuations for equity and debt are high-ish
  5. Demographics — mostly negative as populations across the globe age
  6. Wages in the “developed world” are getting pushed to the levels of the “developing world,” largely due to the influence of information technology.  Also, technology is temporarily displacing people from current careers.

But now I have one more:

7)  Nonfinancial corporations, once the best part of the debt markets, are beginning to get overlevered.

This is worth watching.  It seems like there isn’t that much advantage to corporate borrowing now — the arbitrage of borrowing to buy back stock seems thin, as does borrowing to buy up competitors.  That doesn’t mean it is not being done — people imitate the recent past as a useful shortcut to avoid thinking.  Momentum carries markets beyond equilibrium as a result.

If the Federal Reserve stimulates by duping getting economic actors to accelerate current growth by taking on more debt, it has worked here.  Now where is leverage low?  Across the board, debt levels aren’t far from where they were in 2008:

As such, I’m not sure where we go from here, but I would suggest the following:

  • Start lightening up on bonds and stocks that would concern you if it were difficult to get financing.  How well would they do if they had to self-finance for three years?
  • With so much debt, monetary policy should remain ineffective.  Don’t expect them to move soon or aggressively.
  • Fiscal policy will remain riven by disagreements, and hamstrung by rising entitlement spending.
  • Long Treasuries don’t look bad with inflation so low.
  • Leave a little liquidity on the side in case of a negative surprise.  When everyone else has high debt levels, it is time to reduce leverage.

Better safe than sorry.  This isn’t saying that the equity markets can’t go higher from here, that corporate issuance can’t grow, or that corporate spreads can’t tighten.  This is saying that in 2004-2006, a lot of the troubles that were going to come were already baked into the cake.  Consider your current positions carefully, and develop your plan for your future portfolio defense.

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.


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, 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.