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.


I am generally not a fan of formulaic books on investing, and this is particularly true of books that take unusual approaches to investing. This book is an exception because it does nothing unusual, and follows what all good quantitative investors know have worked in the past.  The past is not a guarantee of the future, but if the theories derived from past data make sense from what we know about human nature, that’s about as good as we can get.

The book begins with a critique of the abilities of financial advisors — their fees, asset allocation, and security selection.  It then shows how models of financial markets outperform most financial advisors.

Then, to live up to its title , the book gives simple versions of models that can be applied by individuals that would have outperformed the markets in the past.  You can beat the markets, lower risk, and “Do It Yourself [DIY].”  It provides models for asset allocation, stock selection, and risk control, simple enough that a motivated person with math skills equal to the first half of Algebra 1 could apply them in a moderate amount of time per month.  It also provides a simpler version of the full model that omits the security selection for stocks.

The book closes by offering three reasons why people won’t follow the book and do it themselves: fear of failure, inertia, and not wanting to give up an advisor who is a friend.  It also offers three risks for the DIY investor — overconfidence, the desire to be a hero (seems to overlap with overconfidence), and that the theories may be insufficient for future market behavior.

This is where I have the greatest disagreement with the book.  I interact with a lot of people.  Most of them have no interest in learning the slightest bit about investing.  Some have some inclination to learn about investing, but even the simple models of the book would make their heads spin, or they just wouldn’t want to take the time to do it.  Some of it is similar to seeing a Youtube video on draining and refilling your automatic transmission fluid.  You might watch it, and say “I think I get it,” but the costs of making a mistake are sufficiently severe that you might not want to do it without an expert by your side.  Most will take it to the repair garage and pay up.

I put a knife to my own throat as I write this, as I am an investment advisor, but there is more specialized knowledge in the hands of an auto mechanic than in an investment advisor, and the risk of loss is lower to manage your own money than to fix your own brakes.  That said, enough people after reading the book will say to themselves, “This is just one author, and I barely understand the performance tables in the book — if right, am I capable of doing this?  Or, could it be wrong?  I can’t verify it myself.”

The book isn’t wrong.  If you are willing to put in the time to follow the instructions of the authors, I think you will do better than most.  My sense is that the grand majority people are not willing to do that.  They don’t have the time or inclination.



The book could have been clearer on the ROBUST method for risk control.  It took me a bit of effort to figure out that the two submodels share half of the weight, so that when submodels A & B flash green — 100% weight, one green and one red — 50% weight, both red — 0% weight.

Also, the book is enhanced by the security selection model for stocks, but how many people would have the assets to assemble and maintain a portfolio with sufficient diversification?  The book might have been cleaner and simpler to leave that out.  The last models of the book don’t use it anyway.

Summary / Who Would Benefit from this Book

I liked this book, and I recommend it for those who are willing to put in the time to implement its ideas.  This is not a book for beginners, and you have to be comfortable with the small amount of math and the tables of financial statistics, unless you are willing to trust them blindly.  (Or trust me when I say that they are likely accurate.)

But with the caveats listed above, it is a good book for people who are motivated to do better with their investments.  If you want to buy it, you can buy it here: DIY Financial Advisor.

Full disclosure: I received a copy from one of the authors, a guy for whom I have respect.

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.


This book is written by an interesting man about another interesting man.  Tren Griffin writes a respectable blog called 25iq.  His main topics are the theory of value investing, and what he has learned from bright investors and businessmen.  One of his favorite businessmen/investors that he likes studying is Charlie Munger, and that’s why he wrote the book.

Why is Tren Griffin interesting, aside from his writing?  Well, he solved a practical problem of his own once using the ideas of Munger and Buffett.  As an executive at Microsoft, he had a large block of Microsoft stock during the dot-com bubble.  His dilemma: should he sell his stock or not?  After reading Munger particularly, he came up with a solution that I would endorse: he sold half of his holdings.  A lot of good investing is getting around psychological barriers so that you are happy with your results, and be able to sleep well at night.  Selling half is never the optimal solution, but it is a good one amid uncertainty, and allows you to stop sitting on your hands amid danger.

A lot of what goes into the thought processes of Charlie Munger involves how investors let fear or greed get the better of them, and cease to think rationally.  Learning these foibles has two advantages: you can try to train yourself to avoid these problems, and take advantage of the irrationality of others in business and investing.

In his book, Tren Griffin takes you through Munger’s thoughts on Value Investing.  Particularly interesting to me was how the concept of Margin of Safety changed, and what role Munger played in its development.  The key change was noting that businesses differ in quality, especially as to how long they can maintain above average returns on their invested capital, and how much of their profits would be free to be reinvested in the business.  An ideal business would be a natural monopoly with a high return on capital, and a need for continued capital investment somewhat less than its profits.

Tren Griffin also introduces you to the mental models of Munger.  Strong generalist knowledge in a wide number of areas can aid making business and investment decisions.  One drawback is that many of the mental models are clear and adequately described — the ones on human psychology.  The rest are more vague, and seem to be what a true liberal arts education should be, including math and science.  Munger is a lifelong learner, and given how much the world changes, if you want to be competitive, you have to continually update your knowledge.

For those who are familiar with the way that Munger thinks, this is old hat.  But for those that are new to it, this book is an excellent introduction, and is systematic in a slim 150+ small pages of information.  On that basis, I recommend the book strongly.

But, if you’re still not sure whether you would like the book or not, or whether it would be a good book for a friend of yours, you have an easy way to help you decide.  Just visit the author’s blog, and look at the topics page.  Scroll down and find the topic “Charlie Munger.”  Of the nine articles presently there, pick two of them and read them.  If you like them, you will like the book.


From my past dealings with authors, I know they don’t always control the title of the book, but this book is half about Munger and half about value investing generally, particularly the version of value investing practiced at Berkshire Hathaway.  There are ample quotations from Buffett and other value investors along with more from Munger.  If I had been structuring the book, I would have made it entirely about Munger, and might have included a biography if the book had not been long enough.

The appendices are a good example of that, in that they are less about what Munger thinks, and more about the way Berkshire Hathaway views value investing.  The last appendix doesn’t seem to mention Munger at all.

Summary / Who Would Benefit from this Book

If you’ve read a lot of Munger, this book will likely not benefit you.  If you are new to the thoughts of Charlie Munger, or want aid in clarifying his thoughts into a system, this book will help do that.  If you want to buy it, you can buy it here: Charlie Munger: The Complete Investor.

Full disclosure: I received a copy from a friendly 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.

Here is a recent question that I got from a reader:

I have a question for you that I don’t think you’ve addressed in your blog. Do you ever double down on something that has dropped significantly beyond portfolio rule VII’s rebalancing requirements and you see no reason to doubt your original thesis? Or do you almost always stick to rule VII? Just curious.

Portfolio rule seven is:

Rebalance the portfolio whenever a stock gets more than 20% away from its target weight. Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best. Keep about 30-40 names for diversification purposes.

This rule is meant to control arrogance and encourage patience.  I learned this lesson the hard way when I was younger, and I would double down on investments that had fallen significantly in value.  It was never in hope of getting the whole position back to even, but that the incremental money had better odds of succeeding than other potential uses of the money.

Well, that would be true if your thesis is right, against a market that genuinely does not understand.  It also requires that you have the patience to hold the position through the decline.

When I was younger, I was less cautious, and so by doubling down in situations where I did not do my homework well enough, I lost a decent amount of money.  If you want to read those stories, they are found in my Learning from the Past series.

Now, since I set up the eight rules, I have doubled down maybe 5-6 times over the last 15 years.  In other words, I haven’t done it often.  I turn a single-weight stock into a double-weight stock if I know:

  • The position is utterly safe, it can’t go broke
  • The valuation is stupid cheap
  • I have a distinct edge in understanding the company, and after significant review I conclude that I can’t lose

Each of those 5-6 times I have made significant money, with no losers.  You might ask, “Well, why not do that only, and all the time?”  I would be in cash most of the time, then.  I make decent money on the rest of my stocks as well on average.

The distinct edge usually falls into the bucket of the market sells off an entire industry, not realizing there are some stocks in the industry that aren’t subject to much of the risk in question.  It could be as simple as refiners getting sold off when oil prices fall, even though they aren’t affected much by oil prices.  Or, it could be knowing which insurance companies are safe in the midst of a crisis.  Regardless, it has to be a big edge, and a big valuation gap, and safe.

The Sense of Rule Seven

Rule Seven has been the rule that has most protected the downside of my portfolio while enhancing the upside.  The two major reasons for this is that a falling stock triggers a thorough review, and that if I do add to my position, I do so in a moderate and measured way, and not out of any emotion.  It’s a business, it is not a gamble per se.

As a result I have had very few major losses since implementing the portfolio rules.  I probably have one more article to add to the “Learning from the Past Series,” and the number of severe losses over the past 15 years is around a half dozen out of 200+ stocks that I invested in.


Doubling down is too bold of a strategy, and too prone for abuse.  It should only be done when the investor has a large edge, cheap valuation, and safety.  Rule Seven allows for moderate purchases under ordinary conditions, and leads to risk reductions when position reviews highlight errors.  If errors are eliminated, Rule Seven will boost returns over time in a modest way, and reduce risk as well.

An investor can and should learn from the past.  He should never react to the recent past.  Why?  The past can’t be changed, but it can be known.  Reacting to the recent past leads investors into the valleys of greed and regret — good investments missed, bad investments incurred.

We’ve been in a relatively volatile environment for the last two weeks or so.  Markets are down, with a lot of noise over China, and slowing global growth.  Boo!

The markets were too complacent for too long, and valuations were/are higher than they should be, given current earnings, growth prospects and corporate bond yields.  It’s not the best environment for stocks given those longer-term valuation factors, but guess what?  The market often ignores those until a crisis hits.

The FOMC is going to tighten monetary policy soon.  Boo!

The things that people are taking on as worries rarely produce large crises.  They could mark stocks down 20-30% from the peak, producing a bear market, but they are unlikely of themselves to produce something similar to 2000-2 or 2008-9.

Let’s think about a few things supporting valuations and suppressing yields at present.  The overarching demographic trend in the market leads to a fairly consistent bid for risky assets.  It would take a lot to derail that bid, though that has happened twice in the last 15 years.  Ask yourself, do we face some significant imbalance where the banks could be impaired? I don’t see it at present.  Is a major sector like information technology or healthcare dramatically overvalued?  Maybe a little overvalued, but not a lot in relative terms.

There are major elections coming up next year, and a group of politicians harmful to the market will be elected.  This is a bad part of the Presidential Cycle.  Boo!

Take a step back, and ask how you would want your portfolio positioned for a moderate pullback, where you can’t predict how long it will take or last.  Also ask how you would like to be positioned for the market to return to its recent highs over the next year.  Come up with your own estimates of likelihood for these scenarios, and others that you might imagine.

We work in a fog.  We don’t know the future at all, but we can take actions to affect it, and our investing results.  The trouble is, we can adjust our risk profile, but our ability to know when it is wise to take more or less risk is poor, except perhaps at market extremes.  Even then, we don’t act, because we drink the Kool-aid in those ebullient or depressed environments.  We often know what we should do at the extremes, but we don’t listen.  There is a failure of the will.

This is a bad season of the year.  September and October are particularly bad months.  Boo!

I often say that there is always enough time to panic.  Well, let me modify that: there’s also always enough time to plan.  But what will you take as inputs to your plan?  Look at your time horizon, and ask what investment factors will persistently change over that horizon.  There are factors that will change, but can you see any that are significant enough for you to notice, and obscure enough that much of the rest of the market has missed it?

Yeah, that’s tough to do.  So perhaps be modest in your risk positioning, and invest with a margin of safety for the intermediate-to-long-term, recognizing that in most cases, the worst case scenario does not persist.  The Great Depression ended.  So did the ’70s.  Valuations are higher now than in 2007.  (Tsst… Boo!)  The crisis in 2008-9 did not persist.

That doesn’t mean a crisis could not persist, just that it is unlikely.  Capitalist systems are very good at dealing with economic volatility, even amid moderate socialism.  Go ahead and ask, “Will we become like Greece?  Argentina?  Venezuela?  Russia?  Spain?  Etc?”  Boo!

It would take a lot to get us to the economic conditions of any of those places.  Thus I would say it is reasonable to take moderate risk in this environment if your time horizon and stomach/sleep allow for it.  That doesn’t mean you won’t go through a bear market in the future, but it will be unlikely for that bear market to last beyond two years, and even less likely a decade.

Imagine that you are in the position of a high cost crude oil producer that has a lot of debt to service.  The price that you can sell your oil for is high enough that you make some cash over your variable cost.  The price is low enough that you are not recouping the cost of what you paid to buy the right to develop the oil, the development cost, and cost of equity capital employed.

In this awkward situation you continue to produce oil, because it may keep you from defaulting on your debts, even though you are not earning what is needed to justify the GAAP book value of your firm.  You’re destroying value by producing, but because of the debt, you don’t have the option of waiting because not surviving loses more money than pumping oil and seeing if you can survive.

Where there is life, there is hope.  Who knows, one of three things could “go right:”

  1. Enough competitors could fail such that global industry capacity reduces and prices rise.
  2. Demand for oil could rise because it is cheap, leading prices to rise.
  3. You could get bought out by a more solvent competitor with a longer time horizon, who sees the assets as eventually valuable.

Trouble is with #1, you could fail first.  With #2, the process is slow, and who knows how much the Saudis will pump.  With #3, the price that an acquirer could pay might not be enough for shareholders, or worse, they could buy out your competitors and not you, leaving you in a worse competitive position.

One more thought: think of the Saudis, the Venezuelans, etc… all of the national oil companies.  They’re not in all that different a spot than you are.  They need cash to fund government programs or they may face unrest.  For some like the Saudis, who assets in reserve, the odds are lower.  For the Venezuelans, who have had their economy destroyed by the politics of Chavez, the odds are a lot higher.

There will be failures among energy producers, and that could include nations.  Failures with each will be temporary as debts get worked through/compromised and new management takes over, and high cost supply gets shut down.  The question is: who will fail and who won’t.  The job of the hypothetical firm that I posited at the beginning of this article is to survive until prices rise.  What will a survivor look like?

  • Relatively high contribution margins (Price – variable cost per barrel)
  • Relatively little debt
  • Debt has long maturities and/or low coupons.

Now, I’m going to give you 40% of the answer here… I’m still working on the contribution margin question, but I can give you a useful measure regarding debt.  My summary measure is total debt as a ratio of market capitalization.  It’s crude, but I think it is a good first pass on debt stress, because the market capitalization figures carry an implicit estimate of the probability of bankruptcy.

Anyway here’s a list of all of the oil companies in the database that have debt greater than their market cap:

CompanyCountrytickerMkt capDebt / Market Cap
Energy XXI LtdBermudaEXXI17126.93
SandRidge Energy Inc.United StatesSD26416.63
Comstock Resources IncUnited StatesCRK1469.45
Linn Energy LLCUnited StatesLINE1,1728.81
EXCO Resources IncUnited StatesXCO2137.2
Cosan Limited(USA)BrazilCZZ1,0156.34
W&T Offshore, Inc.United StatesWTI2456
Halcon Resources CorpUnited StatesHK6205.89
BreitBurn Energy Partners L.P.United StatesBBEP6145.05
Magnum Hunter Resources CorpUnited StatesMHR1885.05
California Resources CorpUnited StatesCRC1,3254.92
Sanchez Energy CorpUnited StatesSN3684.74
Crestwood Equity Partners LPUnited StatesCEQP5434.64
Rex Energy CorporationUnited StatesREXX1714.51
Penn West Petroleum Ltd (USA)CanadaPWE4034.19
Atlas Resource Partners, L.P.United StatesARP3654.09
Gastar Exploration IncUnited StatesGST1083.8
Petroleo Brasileiro PetrobrasBrazilPBR35,7483.71
Stone Energy CorporationUnited StatesSGY2923.59
Bill Barrett CorporationUnited StatesBBG2523.19
EP Energy CorpUnited StatesEPE1,5523.15
Memorial Production Partners LUnited StatesMEMP5993.05
Premier Oil PLC (ADR)United KingdomPMOIY8282.95
Triangle Petroleum CorporationUnited StatesTPLM2862.88
Ultra Petroleum Corp.United StatesUPL1,2812.68
Bonanza Creek Energy IncUnited StatesBCEI3332.55
Northern Oil & Gas, Inc.United StatesNOG3592.47
Denbury Resources Inc.United StatesDNR1,4792.37
Jones Energy IncUnited StatesJONE3542.36
Chesapeake Energy CorporationUnited StatesCHK4,9172.35
Vanguard Natural Resources, LLUnited StatesVNR8332.27
LRR Energy LPUnited StatesLRE1282.23
Pengrowth Energy Corp (USA)CanadaPGH7052.21
Legacy Reserves LPUnited StatesLGCY4612.1
Aegean Marine Petroleum NetworGreeceANW3911.85
GeoPark LtdChileGPRK2021.8
Mitsui & Co Ltd (ADR)JapanMITSY23,7271.74
Oasis Petroleum Inc.United StatesOAS1,3901.69
Santos Ltd (ADR)AustraliaSSLTY3,8131.59
Whiting Petroleum CorpUnited StatesWLL3,5931.46
Midcoast Energy Partners LPUnited StatesMEP5581.45
Paramount Resources Ltd (USA)CanadaPRMRF1,0061.35
Encana Corporation (USA)CanadaECA5,9441.33
Clayton Williams Energy, Inc.United StatesCWEI5971.25
Clean Energy Fuels CorpUnited StatesCLNE4681.23
EV Energy Partners, L.P.United StatesEVEP4051.23
WPX Energy IncUnited StatesWPX1,6601.2
Baytex Energy Corp (USA)CanadaBTE1,0681.19
ONEOK, Inc.United StatesOKE7,4531.18
SunCoke Energy Partners LPUnited StatesSXCP5051.18
TransAtlantic Petroleum LtdUnited StatesTAT1261.13
Global Partners LPUnited StatesGLP1,0711.12
NGL Energy Partners LPUnited StatesNGL2,6591.12
Sprague Resources LPUnited StatesSRLP4951.11
Amyris IncUnited StatesAMRS2661.07
Sunoco LPUnited StatesSUN1,6051.06
SM Energy CoUnited StatesSM2,3601.05
Solazyme IncUnited StatesSZYM2021


This isn’t a complete analysis by any means. Personally, I would be skeptical of holding any company twice as much debt as market cap without a significant analysis.  Have at it your own way, but be careful, there will be a lot of stress on oil companies with high debt.

Photo Credit: edkohler || Buy Now and smile!

Photo Credit: edkohler || Buy Now and smile!


One of my clients asked me what I think is a hard question: When should I deploy capital?  I’ll try to answer that here.

There are three main things to consider in using cash to buy or sell assets:

  • What is your time horizon?  When will you likely need the money for spending purposes?
  • How promising is the asset in question?  What do you think it might return vs alternatives, including holding cash?
  • How safe is the asset in question?  Will it survive to the end of your time horizon under almost all circumstances and at least preserve value while you wait?

Other questions like “Should I dollar cost average, or invest the lump?” are lesser questions, because what will make the most difference in ultimate returns comes from  the above three questions.  Putting it another way, the results of dollar cost averaging depend on returns after you put in the last dollar of the lump, as does investing the lump sum all at once.

Thinking about price momentum and mean-reversion are also lesser matters, because if your time horizon is a long one, the initial results will have a modest effect on the ultimate results.

Now, if you care about price momentum, you may as well ignore the rest of the piece, and start trading in and out with the waves of the market, assuming you can do it.  If you care about mean reversion, you can wait in cash until we get “the mother of all selloffs” and then invest.  That has its problems as well: what’s a big enough selloff?  There are a lot of bears waiting for rock bottom valuations, but the promised bargain valuations don’t materialize because others invest at higher prices than you would, and the prices never get as low as you would like.  Ask John Hussman.

Investing has to be done on a “good enough” basis.  The optimal return in hindsight is never achieved.  Thus, at least for value investors like me, we focus on what we can figure out:

  • How long can I set aside this capital?
  • Is this a promising investment at a relatively attractive price?
  • Do I have a margin of safety buying this?

Those are the same questions as the first three, just phrased differently.

Now, I’m not saying that there is never a time to sit on cash, but decisions like that are typically limited to times where valuations are utterly nuts, like 1964-5, 1968, 1972, 1999-2000 — basically parts of the go-go years and the dot-com bubble.  Those situations don’t last more than a decade, and are typically much shorter.

Beyond that, if you have the capital to spare, and the opportunity is safe and cheap, then deploy the capital.  You’ll never get it perfect.  The price may fall after you buy.  Those are the breaks.  If that really bothers you, then maybe do half of what you would ultimately do, but set a time limit for investment of the other half.  Remember, the opposite can happen, and the price could run away from you.

A better idea might show up later.  If there is enough liquidity, trade into the new idea.

Since perfection is not achievable, if you have something good enough, I recommend that you execute and deploy the capital.  Over the long haul, given relative peace, the advantage belongs to the one who is invested.

If you still wonder about this question you can read the following two articles:

In the end, there is no perfect answer, so if the situation is good enough, give it your best shot.


The following may be controversial. It also may be dull to the point that you might not care. Here’s why you should care: quarterly reporting is a useful and productive use of corporate resources, and it would be a shame to lose it because some people with a patina of intelligence think it is harmful. Who knows? Losing it might even make you poorer.

The cause for tonight’s article is a piece from the Wall Street Journal, Time to End Quarterly Reports, Law Firm Says.  Here’s the first two sentences:

Influential law firm Wachtell, Lipton, Rosen & Katz has an idea that may be music to the ears of its big corporate clients and a nightmare for some investors and analysts: end quarterly earnings reports.

Wachtell on Tuesday called on the Securities and Exchange Commission to consider allowing U.S. companies to do away with the obligatory updates, one of the most important rituals on Wall Street and in corporate America, suggesting that they distract executives from long-term goals.

The basic case is that quarterly earnings lead companies to behave in a short-term manner, and underinvest for longer-term growth, thus hurting the US economy.  I disagree. There are at least four things that are false in the arguments made in the article, and in books like Saving Capitalism from Short-Termism:

  • Quarterly earnings don’t produce value in and of themselves
  • Quarterly earnings cause most corporations to ignore the long-term.
  • Ending quarterly earnings will end activism, buybacks, and dividends.
  • Buybacks and dividends are bad uses of capital, and more capital investment, especially for long-dated projects, is necessarily a good thing.

Why Quarterly Earnings are Valuable

I’ve written a number of articles about quarterly earnings and estimates of those earnings: Earnings Estimates as a Control Mechanism, Flawed as they are, and Earnings Estimates as a Control Mechanism, Flawed as they are, Redux.  The basic idea is this: quarterly earnings results give investors an idea as to whether the companies remain on their long-term growth path or not.  As I wrote:

Most of the value of a Corporation on a going concern basis stems from the future earnings of the company.  Investors want to have an estimate of forward earnings so that they can gauge whether the company is growing at an appropriate rate.

Now, it wouldn’t matter if the system were set up by third-party sell side analysts, by buyside analysts, by companies themselves, or by a combination thereof.  The thing is investors are forward-looking, and they want a forward-looking estimate to allow them to estimate whether the companies are doing well with their current earnings or not.

Don’t think of the quarterly earnings in isolation.  A good or bad quarterly earnings number conveys information not about the current period only, but about all future periods.  A bad earnings number lowers the estimates of all future earnings, telling market players that the long-term efforts of the company are not going to be so great.  Vice-versa for a good number.

Now, in some cases, that might not be true, and the management team will say, “But we still expect our future earnings to reach the levels that we expected before this quarter.”  That still leaves the problem of getting to the high future earnings, which if missed will lead the market to reprice the stock down.

They might also use a non-GAAP measure of earnings to explain that earnings are not as bad as they might seem.  In the short-run the market may accept that, but if you do that often enough, eventually the markets factor in the many “one-time” adjustments, and lower the earnings multiple on the stock to reflect the reduced quality of earnings.

In addition, having shorter-term targets causes corporations to not get lazy in managing expenses and capital.  When the measurement periods get too long, discipline can be lost.

Quarterly Earnings Don’t Cause Most Firms to Neglect the Long-Term

Firms aren’t interested in only the current period’s earnings, but about the entire future path of earnings.  Even if the current period’s earnings meet the estimates, the job is not done.  If there aren’t plans to grow earnings for the next 3-5 years, eventually earnings won’t meet the expectations of investors, and the price of the stock will fall.  The short-term is just the beginning of the long-term.  It is not either/or but both/and.  A company has to try to explain to investors how it is growing the value of the firm — if present targets aren’t being met, why should there be any confidence that the future will be good?

Think of corporate earnings like a long-term project which has a variety of things that have to be done en route to a significant goal.  The quarterly earnings measure whether the progress toward completing the goal is adequate or not.  Now, the measure is not perfect, but who can think of a better one?

Ending Quarterly Earnings Would Not End Activism, Buybacks, and Dividends

I can think of an area in business where earnings estimates don’t play a role — private equity.  Are the owners long-term oriented? Yes.  Are they short-term oriented?  Yes.  Is capital managed tightly?  Very tightly.  All excess capital is dividended back — it as if activists run the firms permanently.

If there were no quarterly earnings in the public equity markets, firms would still be under pressure to return excess capital to shareholders.  Activists would still analyze companies to see if they are badly managed, and in need of change.  If anything, when companies would release their earnings less frequently, the adjustments to the market price of the stock would be more severe.  Companies that disappoint would find the activists arriving regardless of the periodicity of the release of earnings.

On the Use of Excess Capital

Investing, particularly for the long-term, is not risk-free.  In an environment where there is rapid technological change, like there is today, it is difficult to tell what investments will not be made obsolete.  In such an environment, it can make a lot of sense to focus on shorter-term investments that are more certain as to the success of the project.  It is also a reason why dividends and buybacks are done, as capital returned to shareholders is associated with higher stock prices, because the capital is used more efficiently.  Companies that shrink their balance sheets tend to outperform those that grow them.

As an example, large acquisitions tend not to benefit shareholders, while small acquisitions that lead to greater organic growth do tend to benefit investors.  The same is true of large versus small investments for organic growth away from M&A.  Most management teams can adequately estimate and plan for the growth that stems from incremental action. Large revolutionary investments are another thing.  There is usually no way to estimate how those will work out, and whether the prospects are reasonable or not.

In one sense, it’s best to leave those kinds of investment projects to highly focused firms that do only that.  That’s how biotech firms work, and it is why so many of them fail.  The few winners are astounding.

Or, think about how progressive Japanese firms were viewed to be in the 1980s, as they pursued long-term projects that had very low returns on equity.  All of that failed, to a first approximation, while the derided American model of shareholder capitalism prospered, as capital was used efficiently on projects with high risk-adjusted returns, and not wasted on speculative projects with uncertain returns.  The same will prove true of China over the next 20 years as they choke on all of their bad investments that yield low returns, if indeed the returns are positive.

Remember, bad investments are just expenses in fancy garb — it just takes the accounting longer to recognize the losses.  Think of Enron if you need an example, which brings up one more point: good investing focuses on accounting quality.  Accrual items on the asset side of the balance sheets of corporations get higher valuations the shorter the accrual is, and the more likely it is to produce cash.  Most long term projects tend to be speculative, and as such, drag down the valuation of the stock, because in most cases, it lowers the long-term earnings of the company.


If quarterly earnings are abolished, intelligent corporations won’t change much.  Investment won’t go up much, and the time horizon of most management teams will not rise much.  If you need any proof of that, look at how private equity and large mutual insurers manage their firms — they still analyze quarterly results, and are conservative in how they deploy capital.

The only great change of eliminating quarterly earnings will be a loss of quality information for equity investors.  Bond investors and banks will still require more frequent financial updates, and equity investors may try to find ways to get that data, perhaps through the rating agencies.

Other Aleph Blog Articles for Consideration

Excess Returns

Suppose you wanted a comprehensive book on all of the ways that there are to get excess returns from the stock market as a type of value investor (as of year-end 2013), and you wanted it in one slim volume.  This is that book.  As with most desires there is the “be careful what you wish for, you just might get it” effect.  This book is not immune.

At Aleph Blog, I try to write book reviews that always include what sort of reader might benefit from a given book.  Because this book packs so much into such a small space, it is not a book for beginners unless they are prodigies.  If you are a beginner, better to warm up with something like The Intelligent Investor, by Ben Graham.  Beginners need time to see concepts described in greater detail, and more slowly.

Though it is a book on value investing, it is expansive in what it considers value investing.  It includes topics as varied as:

  1. Behavioral Economics
  2. Market-timing from a valuation standpoint
  3. Growth at a reasonable price [GARP] investing
  4. Private investing
  5. Shorting
  6. Event-driven investing
  7. Barriers to considering investments that keep others from buying them at attractive prices
  8. Studying informed investors (insiders & 13F filings
  9. Catalysts that may unlock value
  10. Emerging markets
  11. Financial statements
  12. Competitive Analysis
  13. Analyzing Growth Potential
  14. Analyzing Management
  15. Valuation techniques
  16. Common mistakes; why most average investors go wrong
  17. Understanding different types of industries and companies
  18. Attitudes — Modesty, Patience & Independent Judgement
  19. And more…

In a book of around 300 pages, this is ambitious.  It gives you one or two passes over important topics, so you are only getting a taste of the ideas involved.  This is also predominantly a book on qualitative investing.  Pure quantitative value investing doesn’t get much play.  Non-value anomalies don’t get much coverage.

The other thing the book lacks is a way to pull it all together in a practical way.  Yes, the last chapter tries to pull it all together, but given the breadth of the material, it gets pulled together in terms of the attitudes you need to do this right, but less of a “how do you structure an overall investment process to put these principles into practical action.”  Providing more examples could have been useful, and really, the whole book could have benefited from that.

Additional Resources

Now, if you want a greater taste of the book without buying it, I’ve got a deal for you: this is a medium-sized slide presentation that summarizes the book.  Pretty sweet, huh?  It represents the book well, so if you are on the fence, I would look at it — after that you would know if you want to buy it.


Summary / Who Would Benefit from this Book

This is a good book if you understand qualitative value investing, but want to get an introduction to all the nuances that can go into it.  If you want to buy it, you can buy it here: Excess Returns: A comparative study of the methods of the world’s greatest investors.

Full disclosure: I received a copy from the author.

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.



I’m not going to argue for any particular strategy here. My main point is this: every valid strategy is going to have some periods of underperformance.  Don’t give up on your strategy because of that; you are likely to give up near the point of maximum pain, and miss the great returns in the bull phase of the strategy.

Here are three simple bits of advice that I hand out to average people regarding asset allocation:

  1. Figure out what the maximum loss is that you are willing to take in a year, and then size your allocation to risky assets such that the likelihood of exceeding that loss level is remote.
  2. If you have any doubts on bit of advice #1, reduce the amount of risky assets a bit more.  You’d be surprised how little you give up in performance from doing so.  The loss from not allocating to risky assets that return better on average is partly mitigated by a bigger payoff from rebalancing from risky assets to safe, and back again.
  3. Use additional money slated for investing to rebalance the portfolio.  Feed your losers.

The first rule is most important, because the most important thing here is avoiding panic, leading to selling risky assets when prices are depressed.  That is the number one cause of underperformance for average investors.  The second rule is important, because it is better to earn less and be able to avoid panic than to risk losing your nerve.  Rule three just makes it easier to maintain your portfolio; it may not be applicable if you follow a momentum strategy.

Now, about momentum strategies — if you’re going to pursue strategies where you are always buying the assets that are presently behaving strong, well, keep doing it.  Don’t give up during the periods where it doesn’t seem to work, or when it occasionally blows up.  The best time for any strategy typically come after a lot of marginal players give up because losses exceed their pain point.

That brings me back to rule #1 above — even for a momentum strategy, maybe it would be nice to have some safe assets on the side to turn down the total level of risk.  It would also give you some money to toss into the strategy after the bad times.

If you want to try a new strategy, consider doing it when your present strategy has been doing well for a while, and you see new players entering the strategy who think it is magic.  No strategy is magic; none work all the time.  But if you “harvest” your strategy when it is mature, that would be the time to do it.  It would be similar to a bond manager reducing exposure to risky bonds when the additional yield over safe bonds is thin, and waiting for a better opportunity to take risk.

But if you do things like that, be disciplined in how you do it.  I’ve seen people violate their strategies, and reinvest in the hot asset when the bull phase lasts too long, just in time for the cycle to turn.  Greed got the better of them.

Markets are perverse.  They deliver surprises to all, and you can be prepared to react to volatility by having some safe assets to tone things down, or, you can roll with the volatility fully invested and hopefully not panic.  When too many unprepared people are fully invested in risky assets, there’s a nasty tendency for the market to have a significant decline.  Similarly, when people swear off investing in risky assets, markets tend to perform really well.

It all looks like a conspiracy, and so you get a variety of wags in comment streams alleging that the markets are rigged.  The markets aren’t rigged.  If you are a soldier heading off for war, you have to mentally prepare for it.  The same applies to investors, because investing isn’t perfectly easy, but a lot of players say that it is easy.

We can make investing easier by restricting the choices that you have to make to a few key ones.  Index funds.  Allocation funds that use index funds that give people a single fund to buy that are continually rebalanced.  But you would still have to exercise discipline to avoid fear and greed — and thus my three example rules above.

If you need more confirmation on this, re-read my articles on dollar-weighted returns versus time-weighted returns.  Most trading that average people do loses money versus buying and holding.  As a result, the best thing to do with any strategy is to structure it so that you never take actions out of a sense of regret for past performance.

That’s easy to say, but hard to do.  I’m subject to the same difficulties that everyone else is, but I worked to create rules to limit my behavior during times of investment pain.

Your personality, your strategy may differ from mine, but the successful meta-strategy is that you should be disciplined in your investing, and not give into greed or panic.  Pursue that, whether you invest like me or not.