Just a reminder-- I'm blogging quite a bit less now since I started the Google Group "VictoriaContrarianInvesting" in February of this year.
If you're interested in joining up with like-minded beginner (mostly) value investors, send me an email at lporayko@gmail.com and I'll send you an invitation back. All of our discussions are kept on the VCIC website for future reference. There is a files section where I upload selected investing gems. When I have time, I throw together an informal newsletter with one or two stocks that I've been studying-- mostly for further discussion.
Most of us are not interested in "hot stocks" or buying the latest trend (gold?) so if that's your bent, you probably will find it frustrating. It's my experience that your brain is either wired to be a value investor or you are destined to follow the crowd as a momentum investor. This is why certain value gurus like Bruce Berkowitz, Warren Buffett and Seth Klarman (my 3 favourites, can you tell?) are so open about their analysis techniques and even concerning the stocks that they've bought recently.
From Klarman's "Margin of Safety":
"You may be wondering, as several of my friends have, why Iwould write a book that could encourage more people tobecome value investors. Don't I run the risk of encouragingincreased competition, thereby reducing my own investmentreturns? Perhaps, but I do not believe this will happen. For onething, value investing is not being discussed here for the firsttime. While I have tried to build the case for it somewhat differentlyfrom my predecessors and while my precise philosophymay vary from that of other value investors, a number of these views have been expressed before, notably by BenjaminGraham and David Dodd, who more than fifty years ago wroteSecurity Analysis, regarded by many as the bible of value investing.
That single work has illuminated the way for generationsof value investors. More recently Graham wrote The IntelligentInvestor, a less academic description of the value-investmentprocess. Warren Buffett, the chairman of Berkshire Hathaway,Inc., and a student of Graham, is regarded as today's most successful value investor. He has written countless articles andshareholder and partnership letters that together articulate hisvalue-investment philosophy coherently and brilliantly. Investorswho have failed to heed such wise counsel are unlikely to listento me."
People can make money using either approach. I think that you make a mistake when you develop "style drift" away from what suits you best, but that's a different whole discussion. I also think that momentum investing is too difficult for me. I'm just not smart enough to figure out group psychology, particularly on that scale. I'll leave that to George Soros, who obviously can.
I plan to track the performance of all the stocks that we discuss in a spread sheet every 6 months. Clearly, the best way to learn is to get continuous feedback- on our objective performance as well as from level headed colleagues that you respect.
One of my hypotheses for buying Seaboard SEB and Columbia Sportswear COLM was that a very high insider ownership (about 70% for each of them) would provide the following attractive investment features:
a strong incentive for management to align its interests with the minority shareholders
a limit to the downside of the share price during general market downturns as insiders tend to hold on to their shares when they are considered cheap and sell them when they are expensive (or they really need the money)
These advantages are offset by the potential for a complacent management that doesn't have to worry about activist shareholders stirring things up. When a company outgrows the skills and experience of the founders that are reluctant to give up control of the company, that bodes poorly for the business' prospects. The other downside is a legacy curse: rampant nepotism in family owned companies often leads to bad governance as children or grandchildren of the founders do not possess the gifts to lead a company forward, yet they maintain control. Wrigley was a prime example of this issue you need to watch for. SEB has mostly tracked the major indices pretty well-- particularly since Dec '08. It's price action doesn't support my hypothesis very well. On the other hand, COLM has definitely outperformed the markets. These are both family businesses that I believe are well run. I do wish SEB's executives were a bit more forthcoming with information, though. This is probably one of the main reasons it has been sidelined by Wall St.
Obviously looking at just 2 companies with a high degree of insider ownership over the short term is not even close to conclusive. I was impressed how well their stock prices held up compared to the rest of my portfolio and that's why I decided to look into it further.
Read this interesting and thought provoking study from Oxford that shows 9% excess returns v.s. the S&P 500 for firms where the CEO owns 10% of the outstanding shares or greater. This may indicate that choosing selected stocks with high insider ownership may also increase the upside potential in addition to limiting the downside.
IMHO, it's one of many important factors to consider when you're doing your research.
l
Sunday, May 3, 2009
As I've mentioned before, I'm slowly raising cash in order to exploit upcoming opportunities... I'm anticipating a large correction in the next 6-9 months. The market has become irrationally exuberant once again.
My estimate for AEO's intrinsic value is around $15-20/share, so I plan to sell it into strength.
SPLS, a company with management that I've admired and owned for the longer term, is also approaching my guess for its intrinsic value of around $25/share. I'll sell it too soon. I wouldn't hesitate to buy it back again at <$15/share.
Targets I'm monitoring closely, all trading at least 30% above my entry position:
Y (I already own some) CVL.UN BDI.UN PDLI FACT (I already own some) PFE URI KMX (own it, want more!) BBEP BBSI (I already own some) COP
There are others as well. Yes, I know that many of the above are ideas shamelessly stolen from the revered (for excellent reasons) Mr. Klarman and Mr. Berkowitz. Imitation is definitely the most sincere form of flattery. I also believe that I deeply understand their investment thesis in these companies and my conviction to own them comes along with that understanding.
Although the swine flu may turn out to just be a wake up call for developed nations' health authorities to dust off their "pandemic plans" and actually see if they are workable, there is little doubt in my mind that this event will stress test the world markets.
With the memory of SARS still fresh in the minds of Torontonians and in particular, the citizens of Hong Kong, fear will probably dictatet o the markets until the coast is clear. I think this will be particularly pronounced in highly populated Asian centres if the flu breaks out there.
Of course, there is no need to panic. You and your family should be prepared for this just like any other natural disaster such as an earthquake. Make sure you have a source of fresh water and lots of canned food. It might be nice to have a supply of N95 masks at home for when you need to enter public places with a high traffic rate of potentially infected people like a grocery store or an airport. Soap and water is plentiful in every home-- use it. A small container of hand disinfectant can be carried around and used each time doors are opened and hands are shook. All simple stuff.
When it comes to a financial strategy, I don't think changing tack makes sense to me. I've used the rally to sell my weaker positions into relative strength and consolidated my portfolio a bit. The majority of my holdings are debt free companies with prodigious free cash flows OR are net-net stocks with unlocked value (i.e. a pile of cash the management needs to be forced to distribute to shareholders...). I think that the game plan should not change one iota. If fear knocks down quality companies' market prices well below intrinsic value, then you should buy them, just like always.
It just so happens that Pharma stocks have been out of favour for a few years now and have some of the best balance sheets and cash flows of any sector. I've been accumulating shares in various companies (NVS, SNY, BMY) over the past 3 years and only sold one (SGP).
One could speculate that some of the Pharma companies will get a boost from world wide stockpiling of anti-viral agents and vaccines; however, I think that this is probably overblown. Roche and Glaxo-Smith-Kline have seen little boosts in their share price because they have Tamiflu and Relenza in their portfolio. Novartis' share price actually dropped a bit this morning despite being assigned the task (and being best positioned to do so) of developing a H1N1 vaccine by WHO and the CDC. This process takes 6 months using the "egg" technique, so they've been told to get cracking. I doubt very much that NVS (which I own, BTW) will profit much from this activity in the short term. I think that it is a great company with excellent prospects, but not because of the swine flu.
Pork producers could be hurt temporarily and irrationally by the pandemic. Russia has banned all pork products from North and Latin America and other countries are likely to follow suit. The virus is not spread by ingesting the meat or by dead animals; however, governments are likely to react in this fashion to garner political brownie points from their paranoid electorate. I'm watching SEB carefully for an opportunity to add to my position.
for this amongst many other reasons, I've been selling into strength-- mostly positions that I've either lost confidence in because of changing business dynamics or realizing that I made a mistake in my original analysis. Fortunately, with the 6 week bear market rally (is that what this is?) and the favourable forex, I've either broken even or made a modest profit on most of the positions.
I'm raising cash to exploit a few special situations that may present catalysts in the nearer term but I'm waiting for a market pullback before committing too deeply to them. I'm prepared to wait up to and including the fall if I have to.
My only mutual fund holdings are Chou Bond and Chou Associates. I've discussed in the past why I'm a fan of this modest but highly skilled capital allocator.
Like many (including the humbled author of this blog), he has suffered from premature accumulation syndrome. Jumping in too early is tough to avoid and one wonders if you're not just lucky if you don't. It's easy to confuse skill with luck until you look at long term track records-- Mr. Chou has one of the best.
Another lesson I learned the hard way is to only entrust your hard earned capital to a person of the highest integrity. Any red flags at all should make you run in the other direction. See below for why I have no plans to redeem my units despite short term underperformance:
News from globeandmail.com
The manager who gave back his fees
Thursday, April 2, 2009 ROB CARRICK
The mutual fund industry is going to hate this.
Investors will be angry that they don't see more of it.
Unhappy at the returns he has generated for clients, money manager Francis Chou is refunding almost all the management fees collected by his Chou Europe fund since it opened for business in September, 2003.
"We have not made money since inception," explained Mr. Chou, a widely respected investing figure whose financial career began in an investment club he formed in 1981 with six Bell Canada co-workers. "I don't like negative numbers long term. Short term - one year, two years or three years, if you do badly that's fine. But long term, you want to make sure you're making money for your unitholders."
What a difference there is between Mr. Chou's tiny, eponymous fund company and his big-boy competition. He looks out for unitholders. They look out for shareholders.
Investors are lax about understanding the cost of owning mutual funds, which means they may not realize that the fees charged by funds don't typically vary with results they produce for investors. Among the 15 largest equity and balanced funds by assets, losses for the 12 months to Feb. 28 range from 16 to 38 per cent. Don't waste your time waiting for fee rebates from any of them.
Mr. Chou's company, Chou Associates Management, has five funds in its lineup and their losses in 2008 ranged from a better-than-average 17.6 per cent for Chou Asia to a lower-than-average 44 per cent for Chou Europe.
As of the end of February, Chou Europe had lost a compound average annual 6.2 per cent since inception. This is the result that prompted him to ask the Ontario Securities Commission for guidance on how to do what may never have been attempted before by a fund company: Rebate all fees taken in by a fund throughout its history.
"It was the right thing to do," Mr. Chou said from his office in the Toronto suburb of North York, which is way off Bay Street.
In fact, Mr. Chou has rebated fees on a limited basis several times in the past. Most recently, he decided to waive roughly 77 per cent of the management fees collected last year from Chou Bond, a fund that holds high-yield corporate bonds. In the mid-1990s, he waived 19 months' worth of fees taken in by Chou RRSP. In 1990, he waived fees for Chou RRSP and his flagship fund, Chou Associates.
These moves are costly, even for a small firm like Mr. Chou's. About $700,000 extra will be available in Chou Bond so it can be invested for the benefit of unitholders, and a total of $547,000 will be put back into Chou Europe.
It's not only unique for a fund company to give back fees it has collected, it's also difficult because of the need for regulatory, legal and accounting advice. "When you go and give back money, you sometimes have to jump through hoops to get it done," Mr. Chou said.
What eased the way was an unusual clause in the prospectus for the Chou family of funds. It states that the matter of waiving management fees entirely or in part is reviewed annually at the discretion of the manager without notice to unitholders.
Management fees are what fund companies pay themselves from their mutual fund returns to cover the costs of running a fund. Some companies have fixed their management fees so they can't rise, others leave themselves the flexibility to charge more.
Mr. Chou's take: "I look at it more that you have to earn that fee rather than have it given to you. If I feel I earned it, I take it."
Here's something else Mr. Chou takes - responsibility for his investment returns, both good and bad. In 2008, the results were largely bad as a result of his value investing approach of seeking beaten-down stocks with the potential to rebound. In the financial crisis that blew up last year, these stocks have been pounded still lower.
In his annual report to clients, Mr. Chou wrote about how he was worried about irresponsible lending and the U.S. housing market, but did not foresee how severely the financial system would be hurt when the bubble burst.
"And so, based on the information we had in 2007, we purchased some stocks at prices that, in hindsight, were too high," Mr. Chou wrote. Go contrast that with the explanations you're going to be seeing from other fund companies as they explain the fiasco of 2008.
***
The Wisdom
of Francis Chou
THE MARKETS
"I think the economy may go south somewhat, but the stock market may not go along. The stock market tends to be a leading indicator by nine months to a year. So it could go up if the economy goes south."
PICKING SECTORS
"All sectors are cheap. Right now, we're just trying to wade into some financials."
FURTHER OPPORTUNITIES
"Everything is depressed, but corporate bonds are more mispriced than equities."
HOW LONG A COMMITMENT INVESTORS SHOULD MAKE TO HIS FUNDS
I look for "hot stocks" that are way overvalued on any objective basis and then wait to buy them when the market over reacts in the other direction. I think that ISRG is an example of such a company-- it's been thrown out in the bathwater.
All of you who spend some time in the OR are probably familiar with this company: they make the famous Da Vinci robot used for minimally invasive surgeries such as prostatectomies, hysterectomies and some cardiac indications.
Each unit costs the hospital $1.5 M and $120,000 p.a. to maintain the device. There's one at Vancouver General Hospital. We have a single surgeon on our staff who is trained to use the Da Vinci. He is threatening to leave for greener pastures (down South) if the hospital doesn't acquire one soon. (I hope he can speak American..... lol... I wouldn't hold my breath waiting for it to come).
The thing is that even in this depressed economic environment, double digit earnings growth is expected in this company for the next 5-8 years. The reasons for this are:
1. low market penetration so far 2. being designated "standard of care" for prostatectomies and probably soon for hysterectomies. (as you all know these procedures are demographically loaded! The expectation is that the number of procedures will undergo almost logarithmic growth over the next 20 years). 3. high barriers to entry-- regulation, difficult to learn and resistance to changing to new 'bots by surgeons
Other financial considerations:
1. no debt 2. very high and increasing free cash flows (215 M p.a. 2008) 3. "fat" net margins in the mid 30's 4. carrying $23/share of cash on the balance sheet to help it through the recession/downturn.
Downsides to consider:
1. competition will eventually arise and squeeze margins 2. political risk-- Obama has his eye squarely on big Pharma and the med device makers-- draconian legislation is not out of the question 3. pipeline? very expensive R&D
My approach will be do buy in the 80's and sell at $160 and above. I don't intend to hold for the very long term (over 5 years) as I prefer to invest in boring companies that are in slowly changing industries. Surgical robots sure don't fit that criterion, eh?
KSW Inc KSW.-- a microcap "value" engineering firm based in NYC that is highly profitable, holds 33% more cash than its market cap and pays a generous dividend (for now). Benjamin Graham would smile. I bought an original position at $2/share. A more detailed analysis will come out in our newsletter-- hopefully this week.
Fortress Paper Inc. FTP.TO-- I've covered this in detail in January and this was my first newsletter stock to study. Their Q4 numbers were strong, as expected. The balance sheet and valuations are highly favourable and management is executing their promised iniatives. The security paper segment is bottlenecked and FTP has had to politely turn away business to their competitors. An accretive acquisition or even a new build is likely in the offing and I believe the management has the experience and track record of good stewardship to pull it off without getting into trouble. Like many value investors, I'm very leary of M&A's as most don't go well, are not in the best interest of the shareholder and achieve only diworseification!. I plan to add to my small position at the company's 52 week low of $4.60/share.
DOW Diamonds Trust DIA , an ETF that buys all 30 DOW Industrial companies, weighted according to their market cap-- I was able to buy in near the short term bottom at $67/share. The dividend yield of the basket is just under 5%, providing incentive to sit on it for the intermediate term rather than play trader and try to time the market (which frankly, I suck at). I realize that the components of the DOW will be changing soon as it casts off some of the uber-dogs like GM and possibly Citigroup. This is a play on historically low valuations (except for McDonalds), cheap diversification and global exposure leading the recovery. I've mentioned before that the DOW companies should not be thought of as "American". Many of the larger components (i.e. IBM) get over 50% of their revenue from overseas. I'll buy (cautiously) again if DIA drops to 6000 and again at 5000. If it drops lower than that, we will be in interesting times, indeed! It's pretty tough to pin a fair market value on DIA as it would be even more of a moving target than its components' FMVs. To simplify matters, I'll take Graham's approach of selling (part or whole of a position, depending on the fundamentals at the time) after a 50% capital appreciation and/or 2-3 years pass by, whichever comes first. I could be persuaded to wait as long as 5 years-- the 2-3 year rule seems pretty arbitrary to me.
Belzberg Technologies BLZ.TO-- I've touched on this company in the past. In short, it provides secure, turn-key brokerage systems for trading equities and options for banks and the big brokers. It's in a hated sector, debt free and trading below its cash holdings ($1.50/share cash v.s. $1.33/share trading on Friday). Last quarter Q4 reported a small loss/share for the year due to restructuring charges. I think it represents another asymmetric intermediate term bet, with the catalyst being the eventual and inevitable return of Wall St. along with the European trading centres that represent BLZ's customer base.
Douglas Adams (author of "The Hitchhiker's Guide to the Universe")
My wife bought me a copy of the 6th edition of "Security Analysis" by Dodd and Graham for my birthday--- with forewards by Warren Buffett, Seth Klarman, Bruce Berkowitz and the like. I'm going to digest every word... I can hardly wait.
On the more sobering matter concerning the markets and our hemorrhaging portfolios, I've been slowly and methodically changing my positions in the following securities, while reflecting what I've done wrong and reasonably well:
LYG Lloyd's TSB: SELL (for a 90% loss)-->Pro forma results of Lloyds pre-merger business were very decent ($1 B profit) considering the toxic atmosphere for banks, particularly of the UK sort. Not that this matters a whit, as the hasty and politically motivated deal went through without much discussion with shareholders. The share price was quite rationally sliced to ribbons (<$3/share from over $20) as it became clear to investors that HBOS' aggressive corporate bond and mortgage portfolio was going to bring on eye-popping losses for an extended period. The combined entity has become semi-nationalized with the UK gov't owning 65% of equity in the company as it required more and more funding to cover these losses.The dividend was terminated about 6 months ago, of course. Where I made the error was not in assuming that LYG was "too big to fail"; it was in not realizing that the government needs to protect the interests of the national economy, often to the detriment of shareholders. I was impressed by Lloyd's track record of conservative management and their very good balance sheet. In the past, they have always been very careful about costs (to the point of having a reputation for being stingy) and I figured that this good stewardship would pay off down the line when the competitors gave up market share to LYG during the meagre times we're in now. After the HBOS merger was announced, I was lulled into complacency by the CEO's message that the new company would emerge from the crisis as a largely unchallenged semi-monopoly of the mortgage market in the UK. In retrospect, when management makes uncharacteristically risky moves (particularly a merger or acquisition), I should sell-- even if it means taking a loss. Lesson #12322, engraved into my eyeballs for posterity. UNH United Health (an HMO)-- sold for 30% profit due to difficulty of assessing political risks. For much the same reasoning, (I read Obama's budget carefully) I'm not entering a position in SYK Stryker or IHI (med device ETF) although I find the investment profile very appealling of those stocks. You just can't ignore the political aspects. Thanks To Steven Friedman for his insight here.
DELL-- SELL -half of my position was sold after digesting the last quarter's results, for a loss of 35%. I'm not certain that this company still isn't very undervalued and the balance sheet is very strong indeed; however, the key profile that brought me in in the first place isn't as compelling-- the cash flow/share.
PCs, laptops and netbooks are becoming commodities, pure and simple. Dell made its name for being the lowest cost producer and a reliable, quality product. It will now face fierce and probably insurmountable competition from Chindian firms. Its franchise has been deeply eroded due to austere product lines (albeit, better lately) and damage to its reputation by providing poor support for its products (outsourcing and poorly executed quality control of that support network). Insider and guru buying is mixed. This company has confounded me. What I am most certain of is that there are better businesses with fatter margins and wider moats to deploy capital into. We'll see if I'm wrong.
SGP Schering-Plough- SELL- a great company with a great pipeline of products that I was lucky to get in at $12/share after the Vytorin media spin knocked the stock down irrationally. The impending acquisition of SGP by Merck was announced today and the share price appreciated 14% just today. I plan to take profits, hopefully in the mid 20's. I have no interest in owning Merck and even less interest in owning a mega-mega cap combined company with all the execution risk involved in such a large deal and the hostile political exposure to big Pharma evident in the Obama administration's budget. I am interested in the smaller non-US companies who have excellent balance sheets, strong pipelines and generic exposure like SNY, NVS and NVO.
CX Cemex- SELL- for a 65% loss- a potentially great company that was crushed by its debt load. I made the mistake of expecting historic nadir cashflows (the bottom of previous business cycles and other recessions Cemex has weathered through) to be sufficient to meet Cx's debt covenants. I then realized that I wasn't aware of the massive derivative holdings of the company (other than the hedges held for feedstock) and the largely unhedged forex risk. This was poor research on my part and I can blame no one other than myself.
p.s. I've put in a bid for the DIA ETF at $70/share. I currently have a bid that will probably be filled soon for $40/share of NVS, one of my favourite pharm companies. I've been waiting to buy NVS for a long time this cheap.
When the general market rises on a hope and a dream rather than any tangible fundamentals, I use the opportunity to sell some of the companies I've been holding that meet any of the following criteria:
the share price is at or near the target (usually 90% my estimated fair market value)
the management, business plan or prospects for the business has changed materially and most likely, permanently
Mea culpa--->I identify a mistake I made in the original analysis that either significantly diminishes the FMV of the company or makes it too difficult to determine.
With the recent rally (and even more recent crushing of that rally), I had a good, long look at my portfolio and decided which positions I should pare down or exit completely.
PHG-- Royal Phillips Electronics-- I sold my entire stake for a loss of 40% (not including dividends collected over 18 months). Compelling valuations, a generous dividend and the "green" angle (the LED arm) were more than offset by the inherent complexity of a large conglomerate, onerous competition (like GE and Siemens), a deteriorating balance sheet and a management that had a questionable record of execution. Although I liked what I saw initially when I first evaluated this business, I overlooked how complicated its corporate structure was and I certainly didn't have a feel for the committment and long term goals of the management. Mason Hawkins obviously doesn't agree and has increased his stake to 28M shares in December
UNH-- United Health Group (an HMO)-- I sold my entire stake for a gain of 30%, not including dividends. Very attractive valuation and what I thought was a overblown market reaction to political risk lead me to take a position. I sold because of a continuously deteriorating medical cost ratio, management with shaky ethics (I value reputation and this is one of the most hated companies in the world... hated by its customers!) and increasing competition from UNH's not-for-profit peers who will likely be more favourably treated in the upcoming reform measures (if they actually happen). I notice that many of my favourite gurus have sold recently as well including Warren Buffett, Seth Klarman, David Einhorn and Jean-Marie Eveillard.
LYG Lloyd's TSB Group and HOG Harley Davidson have both been thoroughly trashed but I continue to hold on to my stakes (despite the termination of the dividend in LYG and the cut in Harley's) as I remain to be convinced that either business will completely fail and instead emerge down the line in even a more dominant position than prior to the crisis. I am considering adding carefully to both positions although I'm more likely to do so for HOG than LYG. Buffett's almost usurious loan to HOG makes it less likely that their financial division will drag down their rather decent balance sheet. LYG's fate seems to be less to do with the market and what a solid, conservative bank it used to be and more to do with backroom deals with the UK government who pushed them into the HBOS merger and then on to the possibility of nationalization down the line. It's really impossible to have an edge in this kind of situation so I'm going to have to think long and hard about what to do about LYG.
Recent new positions:
LUK Leucadia National at $14
BLZ.TO Belzberg Technologies at $1.75
FTP.TO Fortress Paper Ltd. at $4.60
Addition to existing positions:
BBSI at $9.00
I'm actively researching:
IIC.TO Ing Canada JOE St. Joe Company BIP Brookfield Infrastructure Partners KSW KSW Inc. BNI Burlington North Santa Fe railroad
See the article in Barron's below. One thing you can say about Jim Cramer is that very few people who watch him feel neutrally about his abilities and his attitudes. In other words, either you hate him or you love him.
I have to admit that I do enjoy watching the show.... that is, when my wife lets me watch it (his antics give her a headache). I certainly don't pay much attention to his specific buy and sell advice which changes wildly over very short periods of time... something he readily admits to. I have been surprised by calm, rational and independent insight he very occasionally offers. It's usually near the end of the show. The CEO interviews are definitely worth listening to. Jim will often ask them very tough and surprisingly incisive questions.
Unfortunately, the rest of the material he offers is as inconsistent as the market. I believe that Todd Kenyon referred to him as actually being the insane "Mr. Market" Graham refers to in "The Intelligent Investor". I think that this is spot on. Mr. Cramer and his support staff are obviously well informed and very intelligent. The problem is that he is obviously a very emotional man and this extends into his investment psyche. If you don't know what I mean, see the video below. It doesn't bode well for his followers.
He often refers to himself as a "value investor" (sorry, I just can't keep a straight face typing that) who chooses stocks because of their "fundamentals" and compared himself earlier this week to Warren Buffett and Benjamin Graham! Hmmm.... I wonder if he realizes that he is a momentum investor who almost routinely buys high and sells low?
When I research potential companies, I try to take on the same sort of psychological approach that I find is optimal in my medical practice: a cool, mostly detached and perpetually skeptical tack. If I feel myself getting excited or depressed about a particular position I will force myself to invert (along the lines of Charlie Munger's advice) the feeling, usually by presenting both sides of the argument to an intelligent but uninformed person. Just articulating the bull and bear case to an interested party who has no bias on the subject (otherwise this may influence you) will often clear your head of irrational, emotionally based noise.
In other words.... you want to be the Anti-James J. Cramer.
You can read the Barron's article below. As always, take it with a grain of salt as I suspect the author's objectivity isn't exactly up to my standard.
from Barrons - SATURDAY, FEBRUARY 7, 2009 Cramer's Star Outshines His Stock Picks By BILL ALPERT
JIM CRAMER'S CELEBRITY IS BIGGER THAN EVER. As financial markets came apart in October, more than 600,000 viewers turned to his Mad Money show -- the biggest crowd since the Nielsen Company started tracking the CNBC series. He is giving advice to huge audiences on NBC's Today Show and getting awestruck coverage in Esquire magazine.
And why not? An earthquake has hit Wall Street, and the 53-year old broadcaster has spent more time there than most any TV journalist. The guy is a hardworking genius with a word of advice for everyone...many words of advice, actually. He dispenses thousands of Buy/Sell recommendations a year and has declared that those stock picks will help you get rich.
In 2007, when we questioned Cramer's performance, he told viewers we were know-nothings and assured them his Mad Money picks had "killed" the S&P 500. The only regrettable thing about any of this is that CNBC and Cramer won't meaningfully discuss how his advice pans out.
Cramer's recommendations underperform the market by most measures. From May to December of last year, for example, the market lost about 30%. Heeding Cramer's Buys and Sells would have added another five percentage points to that loss, according to our latest tally.
To his credit, Cramer's Sells "made money" by outperforming the market on the downside by as much as five percentage points (depending on the holding period and benchmark). His Buys, however, lost up to 10 percentage points more than the market.
These batting averages represent his stock-picking over a stretch of time, but Cramer is wildly inconsistent, and the performance of individual picks varies widely. So widely, in fact, that it is impossible to know with confidence that any sample of Cramer's recommendations will enable you to outperform the market.
These facts don't mean that viewers should avoid his informative and entertaining show -- they should just be wary of his stock picks.
OTHER CAREFUL, HONEST EXAMINATIONS of the CNBC star showed the same underperformance -- including several independent studies by finance researchers, and a 2007 review by Barron's that found the only way to reliably profit from Cramer's stock picks was to short them (see "Shorting Cramer," Aug. 20, 2007).
That seems to be what smart traders have done, from the evidence of options-market activity examined by a finance professor, who found that betting against Mad Money's Buy recommendations can yield 25% in a month.
The recent performance of Mad Money's stocks resembles past periods in another striking way. Our research reveals that the stocks Cramer picks as Buys have been rising versus the market for several days in advance of his show, while his Sells have been falling. This doesn't prove there is a leak in the tight security surrounding CNBC's show. It could merely mean that Cramer and his staff are heavy-footed in their research. Or it could mean that his stocks are primarily momentum plays. That is the network's explanation. "Jim likes to recommend 'what is working'," said CNBC communications vice president Brian Steel in a written response Friday. "So it is no surprise there would be movement in these stocks prior to Jim mentioning them."
In any event, these pre-show moves are the probable cause of Cramer's underperformance. As the stocks revert to the market's trend in the weeks after the show, Cramer's followers get hurt [See chart below]. Like any active-investing strategy, Cramer's advice must always be measured against the market return that his viewers could get in an index fund.
IT IS RARE THAT ANYONE BEATS the market over time, so there is no disgrace in the underperformance of Mad Money's stocks. The stocks featured in Barron's bullish stories did even worse than the market last year. ("Oops! We Missed the Mark in '08," Jan. 19)
Yet the last time Barron's inquired about Cramer's stock-picking, CNBC responded with cherry-picked success stories; lawyers; calls to Dow Jones executives; and an end to Barron's regular presence on CNBC. Cramer shouted to his viewers that we were know-nothings and assured them that his Mad Money picks had "killed" the Standard & Poor's 500 index. This time around, CNBC wouldn't let us near their headliner and said our questions were aimed at helping CNBC's less-watched rival, Fox Business News (owned by News Corp. , as is Barron's).
"You wrote a premeditated hatchet job to curry favor with your new bosses at News Corp.," said CNBC's Steel on Friday. "[Cramer] doesn't consider you a journalist."
The pre-show moves made by Mad Money stocks relative to the market were first observed by doctoral students at Northwestern's Kellogg School in a 2006 working paper. After hearing from an indignant CNBC, co-author Joseph Engelberg stopped labeling the moves "information leakage." When Barron's asked in 2007 about the pre-show moves we had found in Mad Money stocks, CNBC scrambled $100,000 worth of lawyers and sternly explained the broadcast lockdown procedures at the Mad Money set.
In the recent seven-month period, the pre-show runs are still the most dramatic thing about Cramer's stocks. We found that his bullish picks had risen 4% against the S&P in the two weeks ahead of his recommendation, while his bearish selections had dropped more than 7%. This action looks all the more interesting when compared with the pre-show activity in stocks that Cramer considers only when asked by a caller during the show's "Lightning Round." As the chart below shows, there are almost no market-excess moves before he tells a Lightning Round caller to Buy, while the Lightning Round Sells make but a fraction of the pre-show moves of previously prepared Sells.
MEASURING SUCH MOVES was easy, thanks to the tools available at EventVestor.com, a startup created by Wharton Business School and Merrill Lynch alumnus Anju Marempudi, with the advice of finance professors. Hedge funds and investor-relations firms are using EventVestor to study the returns of stocks around events like dividend cuts and earnings preannouncements.
So we got a record of the Mad Money recommendations from a source that Cramer endorses as the definitive way to track his performance. It is a trailing six-month database updated daily at TheStreet.com, the Website that Cramer brought public in the dot-com boom (see it yourself at MadMoney.TheStreet.com).
We then poured Cramer's data into EventVestor. Event-study tools like EventVestor aren't hard to understand. They simply track the performance of stocks over identical periods; for example, 10 trading days before through 45 trading days after each Mad Money show (as illustrated in the chart). You can leave out the impromptu advice he gives callers during the Lightning Round -- which Cramer has said shouldn't count toward his performance, even though the next-day stock moves show that Lightning Round watchers take him at his word when he tells them to Buy.
Looking at just the 650-odd recommendations Cramer prepared for the show's Discussion or Feature blocks between June and December, his bullish picks underperformed the S&P by about 3.5 percentage points over the 45 trading days after each show. His bear calls turned a slim profit of one point versus the market -- with all of the profit coming the day after broadcast, so viewers would do well to ignore Cramer's occasional urging that they wait five days before following his calls. You can even isolate the stocks of companies whose executives Cramer interviews and usually endorses -- those endorsed stocks dropped six points versus the S&P in the 45 days following the interviews. Considered separately, Cramer's Lightning Round Sell recommendations did better than those he prepared, while his Lightning Buys did even worse than those he prepped. [For charts of these results, and others, see Barrons.com.] It is reasonable to measure Cramer's stocks over such a relatively brief interval because -- as CNBC points out -- he isn't running a fund in which he reviews each position daily.
But the network and Cramer have alternatively argued that his picks are meant as long-term investments, so we also measured their performance from each show date through the end of the year. On that basis, Cramer's Buys finished five percentage points behind the Nasdaq and 10 points behind the Dow, while his Sells were one point less profitable than the Nasdaq but five points more profitable than the Dow.
Cramer bashers and acolytes typically argue in anecdotes. His critics remind you that he scolded a caller "No! No! No! Bear Stearns is fine! Do not take your money out!" just days before the firm collapsed in March. But boosters brag of his Oct. 6 market call on the Today Show, when he said: "Whatever money you may need for the next five years, please take it out of the stock market. Right now!"
That Oct. 6 advice saved investors "millions," said CNBC's Steel, by allowing folks to escape the market's 15% plunge through December. In fact, says Steel, that single piece of advice means Cramer beat the market, if you credit the 15% to his performance through Oct. 6. Of course, Cramer went on to make 800 more recommendations through December -- most of them Buys. Cramer would have saved investors even more, said Steel, had they put 20% of their assets in cash on Sept. 19, as he suggested. "Jim made two of the greatest prepared bearish calls of all time," crowed Steel.
We gamely worked through the details of CNBC's argument: Ending the measurements on Oct. 6 makes Cramer look worse, with his recommendations losing eight percentage points against the S&P. If you then spot him the Today Show 15%, as Steel insists, Cramer would finish the year seven points ahead of the market.
If readers don't buy CNBC's complicated argument, it has others. "Jim's advice is nuanced, complex and often qualified on either a future price or a specific market event," said Steel, who says that even Cramer's official Mad Money database misses nuances. It is kind of bizarre to hear the network impugn the Website that carries Cramer's endorsement as the record of "exactly what I say, when I said it, and how I feel about each stock now." He urges -- "passionately" -- that his show's performance be measured with those data.
When Barron's asked CNBC for their own preferred database of Mad Money recommendations, we heard something equally strange: The investment news channel keeps no track record of its stockpicker's Buys and Sells. "The show as it is currently produced," said Steel, "isn't set up to track every stock Jim mentions every day as if it was a fund."
Instead, Steel demanded that Barron's join him in watching six months of recorded shows so that he could decide whether Cramer really meant that viewers should buy or sell a stock. He said Cramer's Website had misinterpreted recommendations on four dates- for example, putting down a Buy recommendation when Cramer meant it sarcastically.
The Bottom Line
By most measures, Jim Cramer did worse than the market, but CNBC and the TV journalist have taken few steps to clarify his exact performance for his show's growing audience.In other words, CNBC wanted to debate its horse bets after knowing how the races ended. There is no way such a post hoc selection could be as credible as the record made at the time of each show (and before the recommendation's outcome is known) by Cramer's official Website. That would also be the time for Cramer to correct confusion in the record he tells viewers to rely on. Still, we recalculated Mad Money's returns without the four dates that Steel says had errors: Cramer's performance was precisely as bad without them.
The finding that Mad Money lags the market has been replicated using other records of Cramer's picks, too. University of Dayton finance professor Carl Chen used the third-party Website called MadMoneyRecap.com to study options-market trading in stocks that Cramer recommended. Chen found signs that the smart money bets against Cramer's Buy recommendations by using short-term in-the-money puts. Those bets could earn over 25% in a month, Chen concludes, at the expense of Cramer's fans.
CNBC's evasiveness about Mad Money's performance can't be attributed to Cramer, since the network wouldn't let us talk to the star. We were scolded that we didn't understand the mind of a genius. "Barron's and News Corp.'s repeated attempts to take Jim down have been a complete and utter failure," said spokesman Steel.
A little demonstration of what an intensely emotionally guy he is:
(although in retrospect he appears to have been right on this one):
Published: January 30 2009 18:26 | Last updated: January 30 2009 18:26
Over the 42 years that Warren Buffett has been in charge of Berkshire Hathaway, the company has earned an average compound rate of return of 20 per cent per year. For himself. But also for his investors. The lucky people who have been his fellow shareholders through all that time have enjoyed just the same rate of return as he has. The fortune he has accumulated is the result of the rise in the value of his share of the collective fund.
But suppose that Buffett had deducted from the returns on his own investment – his own, not that of his fellow shareholders – a notional investment management fee, based on the standard 2 per cent annual charge and 20 per cent of gains formula of the hedge fund and private equity business. There would then be two pots: one created by reinvestment of the fees Buffett was charging himself; and one created by the growth in the value of Buffett’s own original investment. Call the first pot the wealth of Buffett Investment Management, the second pot the wealth of the Buffett Foundation.
How much of Buffett’s $62bn would be the property of Buffett Investment Management and how much the property of the Buffett Foundation? The – completely astonishing – answer is that Buffett Investment Management would have $57bn and the Buffett Foundation $5bn. The cumulative effect of “two and twenty” over 42 years is so large that the earnings of the investment manager completely overshadow the earnings of the investor. That sum tells you why it was the giants of the financial services industry, not the customers, who owned the yachts.
So the least risky way to increase returns from investments is to minimise agency costs – to ensure that the return on the underlying investments goes into your pocket rather than someone else’s.
The effect of these costs on returns depends on the frequency with which you deal. Online trading is so inexpensive and easy that you may be tempted to trade often. But only one thing eats up investment returns faster than fees and commissions, and that is frequent trading. Do not succumb. Do not accept the invitation to subscribe to level two platforms or direct market access. The total costs of running your own portfolio should be less than 1 per cent per year.
Investing in actively-managed funds will cost you more. The choice of funds, both open and closed-end, is unbelievably wide. There are more funds investing in shares than there are shares to invest in. This situation doesn’t make sense, and is both cause and effect of the high charges. Costs need to be high to recover the expenses of running so many different, mainly small, funds that all do much the same thing. At the same time, the high level of charges encourages financial services companies to set up even more funds.
The proliferation of funds means that choosing a fund may be no easier than choosing individual investments. The problem seems to multiply itself, as do the fees. The fees attract more advisers, and so on. This plethora of choice would be less confusing if all funds, managers and advisers were excellent, but most are not.
The underlying problem is one of information asymmetry. The marketing of financial services emphasises quality, not price, and for good reasons. It would be worth paying more – a lot more – to get a good fund manager. But since it is hard to identify a good fund manager, good and bad managers all charge high fees, with the consequences described above.
If you own a mainstream British unit trust for five years, it is likely that the direct and indirect costs and charges you incur in buying, holding and selling that investment will total 3 per cent a year. Other investment funds may cost you more. The total charges on a fund of hedge funds are such that it might yield less than a government bond even if the underlying investments returned more than 10 per cent per year.
There may be hope of better value from funds. In the US, the Vanguard Group, a not-for-profit company with a messianic founder, John Bogle, has become market leader in retail fund management with charges substantially lower than the norm.
The most attractive equity-based funds for small investors are generally indexed funds, exchange traded funds, and investment trusts (closed-end funds) with low charges and significant discounts to underlying assets. These funds provide more than sufficient choice for normal purposes. All of them can be accessed through your online execution-only share-dealing account.
Extracted from John Kay’s new book ‘The Long and the Short of It: Finance and Investment for Normally Intelligent People who are not in the Industry’, published by Erasmus Press. Next week: Diversifying
if you don't have time to watch it the summary is:
equities are historically cheap but not "dirt" cheap
investors with a long term horizons (7 years +) can start to buy quality "blue chip" companies now, but should take their time over then next year and one half
keep cash on hand-- the more likely you are to freak out when volatility occurs, the higher your cash holdings should be
Jeremy Grantham has been amongst the most negative of market prognosticators I've ever bothered reading---as long as I've ever can remember! I've dreaded reading his commentaries, particularly in the last 3 years.
Of course, the last year and a half have vindicated his viewpoints. Unfortunately, I notice that he's still losing his client's money in his mutual funds. It seems almost everyone has not escaped unscathed.
With all due respect to a very, very smart man... if you predict that something bad is going to happen for long enough, well of course, one day you're going to be right. So take that in consideration before you read his latest here. I'm so anti-macro prognostication, it's not funny. I just don't think it's possible. It's fun to do with your buddies over a few drinks but it DEFINITELY shouldn't be taken too seriously (i.e. put your hard earned money into a idea based on a macro economic guess).
The only thing you can do is find good companies run by good management (and only history will tell you that) and buy them when they are cheap. This usually means you have to buy them when everyone else thinks you're crazy to do so, unfortunately.
Note that Mr. Grantham is finally recommending buying stocks now, but carefully. I was pleasantly surprised to see that he suggested US blue chip stocks and "emerging equities". My point would be that if you look at the list of blue chips in the Dow 30 below, you'll find that most of them qualify as emerging equities as a significant number obtain more of their revenues overseas than in the US! IBM is just one example. An easy way to buy all 30 is with the DIA ETF. It's the only ETF I own currently.
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