Checking Up on Value

Earlier this year I wrote about switching from a momentum based investment strategy to a valuation based investment strategy. How’s that working out for me.

I went back and calculated the YTD total returns of the portfolio I recommended and see that an equal weighted portfolio of these stocks from the beginning of the year would have returned just under 2%. This trails S&P 500 total returns by just under a point. However, when thinking about the move away from momentum, the strategy actually looks very smart.  Momo stocks have had a rough go of it so far this year.

Name Ticker Sector  Price  YTD
Symantec Corp SYMC IT  $            20.01 -14.6%
Apple Inc AAPL IT  $         539.10 -3.2%
Google Inc GOOG IT  $         568.17 1.9%
Garmin, Ltd. GRMN Discretionary  $            57.27 25.0%
GameStop Corp GME Discretionary  $            44.40 -9.1%
Coach, Inc. COH Discretionary  $            49.91 -10.4%
Valero Energy Corporation VLO Energy  $            55.79 11.2%
Tesoro Corporation TSO Energy  $            51.54 -11.5%
Diamond Offshore Drilling, Inc. DO Energy  $            48.24 -13.5%
NASDAQ OMX Group, Inc. NDAQ Financials  $            36.53 -7.9%
Moody’s Corporation MCO Financials  $            80.21 2.6%
Aon plc AON Financials  $            84.27 0.6%
L-3 Communications Holdings Inc LLL Industrials  $         119.88 12.8%
Republic Services Inc RSG Industrials  $            34.52 4.7%
General Dynamics Corp GD Industrials  $         110.82 16.7%
Nucor Corp. NUE Materials  $            51.51 -2.8%
Bemis Co Inc BMS Materials  $            40.18 -1.2%
Sealed Air Corporation SEE Materials  $            33.09 -2.4%
J.M. Smucker Co. SJM Staples  $            97.81 -5.1%
Monster Beverage Corp MNST Staples  $            68.09 0.3%
Avon Products Inc AVP Staples  $            14.67 -14.6%
WellPoint Inc WLP Healthcare  $            99.36 8.0%
UnitedHealth Group Inc UNH Healthcare  $            82.22 9.6%
Humana Inc HUM Healthcare  $         113.90 10.6%
NextEra Energy Inc NEE Utilities  $            94.53 11.3%
First Solar, Inc. FSLR Utilities  $            68.28 25.3%
SolarCity Corp SCTY Utilities  $            60.32 6.1%
Average 1.9%

Professional Management Fees

The Wall Street Journal’s Jason Zweig wrote a piece on shrinking management fees for professional asset managers a week ago. He introduced some very interesting services for retail investors that are looking to democratize investment management, increasing transparency, simplicity, access and control all while decreasing costs. Part of the reduction in costs comes from charging no management fees.

Decreasing management fees is a trend. I have seen this working in the asset management business through anecdotes, and quantitatively. And this trend is ultimately going to be your friend.

Ten Stack Commandments: Have fun (#10)

If you made it this far in the ‘Ten Stack Commandments’ readings, you are likely really, really into reading boring stuff. Hopefully you at least learned something about my investing philosophy. But here I want you to reflect on whether you want to make investing boring or fun? I think investing should be fun. If you get enjoyment out of reading then you should read as much as you can, and likely even now you’re not bored. I don’t expect anyone who doesn’t like to read has made it this far. Likewise, if you are someone who likes to day trade then this investing blog isn’t for you – there are plenty of other resources out there to help you be a successful day trader. Ultimately though, investing should be fun. Make it fun.

Buffet says ‘price is what you pay, value is what you get.’ My sister recently asked me whether she should buy Apple stock, simultaneously she was debating buying a new iPad. Since the price of an iPad and a share of Apple are the same, I told her she should definitely do both – only buy one less share of Apple and then she could afford to buy the iPad. Clearly a share of stock has value, but that value isn’t immediately tangible like an investment in a product that will educate you, or feed you, or house you. Always choose to invest in things that you want around your life to make it better. You will have more fun this way. If you have the resources, instead of buying a share of Williams-Sonoma (WSM), buy a cooking technique class if you’d get more value out of it then a share of stock. While this isn’t great advice to immediately grow your nest egg, it will certainly be a lot more fun and could certainly pay off in the long-run (maybe you’ll be the next Steve Ells).

Happy people are generally more successful. This might not necessarily be true, but I’d certainly like to think it is. I’d also like to think that people who have more fun with their investing will be better off. Please be smart about investing, but also have fun!

Ten Stack Commandments: Buy low sell high* (#9)

Obvious right? Unfortunately this is nearly impossible to accomplish one hundred percent of the time, therefore the *asterisk. However, you can accomplish this with most of your investing by holding onto your investments. Buy low, hold, hold, hold, … hold, sell high. But, even then, do you want to sell?

Time can cure lots of ills, including short term price corrections. Time leads to compounding (given prevailing interest rates). Generally when you have done your research, are diversified amongst assets that you know and understand, and hold for a long period of time you will have the opportunity to sell at a higher price then you bought. This holds for at least the majority of investments.

Always look to get a deal and find things that are cheap and selling for a ‘low price’. That’s great. But, don’t ignore great things that are more expensive either. Good things come in all shapes and sizes if you know what to look for. Again, I’d suggest reading some Graham & Dodd to understand investment moats as well as some of the other books in the resources page.

You don’t want to let market gyrations force your hand into selling investments you like. When you buy low and the investment goes lower, don’t sell – re-evaluate your view of the company and if it is still positive buy more to cost average down, then hold until it’s higher. And even then, hold. Traders try to take advantage of all kinds of psychological behavior for short term gains, including loss aversion (which I am telling you is generally a good thing – you’re not a trader and so do not need to harvest your losses) and endowment effects. Don’t be a trader looking for short term gains. Let the paid traders buy low and sell high, or vice versa – if they can. Over the long term by buying and holding good companies, you’ll be better off.

Ultimately you want to keep your portfolio as stable as possible. You want to buy assets that will always be increasing their value to the point that you know they will perform in-line or better than the market on average. If you are comfortable knowing this then you will never need to sell because the investment will always be increasing given the markets positive expected returns.

Please, next time you hear someone simply say buy low, sell high tell them there’s more to it and to stop thinking like a meat head day trader. You have to hold, and hold…and hold, and then the question will be whether to even sell higher at all.

 

Ten Stack Commandments: Don’t time the market (#8)

Trying to time the market will incur taxes, stress and ultimately cost you valuable stack-building compounding. You’re investing for your lifetime, not for the day, month or year. So be in it for the long haul and don’t wait to invest until that pullback happens that you think is likely. And definitely don’t sell ahead of that pullback that you think is likely.

Read Warren Buffet and Ben Graham. Even Goldman Sachs suggests trying to pick tops and bottoms in the market will lose you money. If you’re not invested, it’s better to leg into investing immediately by cost averaging into a full allocation over a year then to wait for a pullback to invest. This is a fact. An even better strategy when the market is trading in-line with historical valuation levels as it is doing right now.

If you are investing in a good swath of companies, which you’d be doing by investing in a S&P500 index ETF, you are better off buying and holding for a long time at any given point then trading around and stressing yourself out. I’ll say it again, even Goldman’s research shows this is quantitatively true. The last thing you want to do is sell when the market is cratering or buy when the market is peaking, but ultimately there are no crystal balls. The only certainty is time. And over time it pays not to try market timing, instead invest in great companies at good prices.

Keep it simple. Don’t try to time the market.

Ten Stack Commandments: Avoid complexity (#7)

Life is good. I’m neither rich, nor poor. But, if I had a dollar for every time I came across an investment or investment strategy I didn’t understand I’d definitely be rich. If instead I had actually invested in these things I’d probably be poor. Not to mention that the hucksters selling these complex investments would be getting richer. Don’t help wall street hucksters get richer. Avoid complexity in your investing.

My point here, if you didn’t get it already, is that you shouldn’t invest in things that are overly complicated. Leave the complicated investments for those who think they are smart enough to understand them. Like in commandment #4, know your investments, you need to at least understand what you’re investing in. Taking that a step further here, complexity adds risk and expense, and so frankly should be avoided and left to the ‘pros’.

I got an e-mail the other day from a broker at one of the largest wealth management companies out there suggesting that Home Depot (HD) would likely report a better quarter than expected due to the recent string of bad weather. Ok, that’s relatively straight forward and makes sense because obviously people were shoveling and salting more, and having to make more emergency repairs. However, instead of simply suggesting I buy shares in Home Depot, they suggested a ‘long call spread’.  Yeah. So a few things. First, If I had put on a long-call spread it would have generated more money for the bank then simply buying the stock. Second, while it was a good call because HD did report a better quarter then expected this morning and the stock is up over 3.5% today, for each notional share of their suggested trade I would have made more money just purchasing the stock outright ($3 vs $0.66). In addition, regrettably, despite having an MBA and a background in finance I still had to google ‘long call spread’ to jog my memory.

Complexity does not make things easier.  And most of the times it ends up losing you money. Don’t let investing complicate your life any more than it already is. Financial products are sometimes set up certain ways so that the house always wins. That’s fine if it adds value for you as well, but that’s rare. Generally though, just avoid complexity. Own simple stakes in either debt or equity of good companies. Keep it simple, understand your investments and avoid complexity. Got it? Good.

Jackson Hole, Wyoming: Update

I just got back to NYC from a long weekend in Jackson Hole, Wyoming. While I was there to ski and snowshoe and do everything else one does in Jackson during the winter (drink whiskey, moose watch…), there was an ulterior motive, too. I was there with my partner to look at  real estate ahead of our move out west this spring. Yes, we are moving to Wyoming.

Not only is Wyoming a beautiful place for outdoor enthusiasts, but it is also a tax free state. Thanks to having the smallest population in the US and significant energy mining revenues (39% of all the coal mined in the US comes from WY, check out the Powder River Basin deposits) there is no state income tax, capital gains tax, or estate tax and a very low 4% sales tax.

Taxes aren’t the real reason for moving to Wyoming though. It’s a needed change, hopefully a healthy one. Having started an investment management business over two years ago I find that I spend a lot of time working and socializing, exercising by biking to work and running the same route up and down the east river. What’s missing is change – a different way to challenge myself in what has become a comfortable routine. Jackson will offer that change.

I’m hoping the move won’t affect my work. After all, the internet exists in Jackson and there are a number of hedge funds and family offices already based there. It could even help differentiate me from the New York crowd. Jackson is also home to many wealthy residents and potential clients.

I know the move will create a different quality of life. No longer will socializing revolve around a new restaurant or bar. A night out on the town might be ice fishing on Jackson lake or an open fire BBQ in the backyard. A working lunch might be preceded by a few aerial tram runs at Teton Village or a few casts on the Snake River. It’s exciting to think about.

While the Jackson Hole economy is seasonally driven by tourists, there is more to Wyoming than first meets the eye. I’ll have more to say about Jackson in the next few months. But in the meantime. “You speaking to me?” – Shane

Measured Reductions: Fed tapers another $10bpm (billionpermonth)

The key here is what does measured mean? Clearly the fed is going to be paying attention to economic signals, right? Well given some weaker economic data this month, the significant currency moves in certain emerging markets, and the negative market moves year to date following the Fed’s first cut of $10bn per month it seems like maybe the Fed isn’t going to pay as close of attention as we thought. As I’ve written before, the beginning of the end of QE has been written on the wall, and it seems they are “measured”ly  racing to unwind their market distortions – at least Bernanke is as likely he’s seen the distortions and is racing to set the FOMC on the right path prior to stepping down.

Don’t forget, in February the Fed will still be pumping $65bn a month onto the long end of the curve, but it seems if Bernanke had his way – and since 100% of the FOMC voted in favor – clearly they are going to be reducing this $10bpm further until August when they’ll be at $5bn per month and cut it altogether by September. Will Yellen allow all this ‘Sellin’? Stay tuned, but it’s likely to keep rates rising and markets in check here.

Ten Stack Commandments: Avoid debt (#6)

Debt will sink you. Not at first, but if you continue to hold debt, and let it pile up, it will eventually. Every dollar in debt, is more than a dollar of work to get out from. Just remember that.  And the longer you hold that debt the more work it becomes to pay it off (exponentially). Debt will increase uncertainty and instability. Getting into legally binding debt is like opening up a hole in the bottom of a boat, at first the rate of oncoming water is manageable (though challenging) for one person to bail, but overtime as the hole grows bigger with compounding pressure (more water in the boat = more pressure) it overwhelms you and sinks you.

Remember this. Whatever you do, before you start investing use whatever spare savings you can muster to start paying off debt. Especially if you are young, just out of college with crushing student loans to pay off. Work as hard as you can to get out of debt. Don’t even think about investing yet. Keep working until you owe nothing.

This is the same for mortgages. If you need a mortgage to buy your first house, no problem. Just do whatever you can to pay it off and put as much down as possible to begin with (literally liquidating your investment portfolio if you need to).

Long-term debt is bad. In fact any debt over 1month is bad. I do believe Credit Cards are a good thing – at the expense of merchants having to pay a fee to the card company for every transaction. But essentially you get floated the money (negative working capital) for the month. Just make sure you pay off your credit card bills in full or as thoroughly as possible at the end of every month.

Now this advice is probably not for everyone. Some people thrive on debt. They love taking risks and going on margin in their brokerage accounts, taking mortgages to invest the capital in the stock market, borrowing money to live lavish lifestyles. Almost always this turns out badly for them, ending in bankruptcy court.

Avoid debt. Invest only what you can afford to invest and don’t leverage yourself. You only amplify risks. Even though companies use debt as a tax shield, and according to theories on optimal capital structures it’s efficient to hold some debt, the legal ramifications when times are uncertain (say you lose your job in a recession) are not worth the risks. Pay your debts as soon as possible….

Ten Stack Commandments: Cash is king (#5)

Show me the money! This investing commandment has two very distinct directives. First, you must always know what the cash on cash returns of the investment you are making look like. Second, you must not be afraid to hold cold hard cash in your portfolio. Ever. But especially during periods of uncertainty.

As part of knowing your investments and skimming through the prospectus or the most recent SEC filing, make sure you pay particular attention to the financial statements or terms of the investment. What you specifically should care about is how much cash your investment is going to be generating for you. There are a number of ways to look at this.

As an equity investor, the way I like to look at cash returns is through the Free Cash Flow Yield of the business. First, approximate the market cap of the company by taking the most recent share price and multiplying it by the number of total shares outstanding found from the front page of the most recent 10-K/Q.  Shares can be tricky. You don’t want to rely on the shares line on the financial statements because those are averages between periods. Also it won’t include vested unexercised options and other shares with a diluting impact. Also, there can often be multiple share classes which you’ll want to find out more about. Once you have a rough estimate of the market cap, then go to the Consolidated Statement of Cashflows. An approximation of FCF is taking the total Operating Cashflows line item and subtracting the Capex line (within the Investing Cashflows). I generally want to get a good picture of the annual cashflows over 3 to 5 years to spot outliers. Dividing FCF by the Market Cap you’ll get a FCF yield expressed in percentage terms. This is the cash on cash return of the equity investment.

If FCF is negative, no need to worry, it just means that you have to believe in growth of the business over time to justify the purchase today and know that the investment is riskier. Also some will say that this isn’t an appropriate measure given it doesn’t take into account the cost of capital, or it doesn’t actually represent actual ‘cash on cash’ returns given not all FCF is returned to shareholders in the form of dividends or buybacks. But, I believe it is a great way to look for value. Companies that have a solid history of generating significant FCF and strong fundamental underlying drivers as well as trade at very high FCF yields relative to their history are generally good investments.

Bonds and other investments will also offer a series of cash flows or expected returns that when discounted can be used to understand value. Bottom line, the cash that an investment is going to generate for you either as a bond holder getting paid a fixed coupon, or an equity owner entitled to the cash flows generated from the ongoing operations of the business are what you want to be paying attention to, not non-GAAP adjustments and the Income Statements accounting gimmicks.

Finally, I don’t think there is anything wrong with having a portion of you portfolio in cash. Especially during times of uncertainty. Keeping some dry powder for new compelling investment opportunities, or to add to existing positions that have become more compelling, is important. It also gives your portfolio a natural hedge to the market. I like to think of holding cash as the best hedge to the markets volatility. It also has the added benefit of being useful to live life off of. Afterall, you can’t exchange bonds, stock certificates or gold for goods & services (at least that I know of) but cash will always work.