Succinct Summation of Week’s Events 8.24.18
Succinct Summations for the week
ending August 24th, 2018
Positives:
1. Jobless claims fell to 210k w/o/w, down from previous week’s
212k.
2. MBA homemortgage applications rose a seasonally
adjusted 3% w/o/w.
3.Order for core capital goods rose 1.4%
m/o/m, beating expected gain of .5%.
4. Same store sales rose 4.7% w/o/w, higher than the previous 4.5% rise.
2. MBA home
3.
4. Same store sales rose 4.7% w/o/w, higher than the previous 4.5% rise.
Negatives:
1. Existing home sales fell to an annualized rate of 5.340M,
missing expected 5.420M.
2. FHFA house price index showed a .2% increase for June, missing the expected .4%.
3. PMIU composite FLASH shows manufacturing at 54.5 for August, down from July’s reading of 55.5.
4. Kansas City Fed manufacturing index came in at 14 in August, 9points below what was expected.
2. FHFA house price index showed a .2% increase for June, missing the expected .4%.
3. PMIU composite FLASH shows manufacturing at 54.5 for August, down from July’s reading of 55.5.
4. Kansas City Fed manufacturing index came in at 14 in August, 9
Sun 8-26-18 BigPic: 10 Reasons Why It's Tough to be a True "Intelligent Investor" – Validea's Guru Investor Blog
August 22, 2018
Ben Graham’s tome The Intelligent Investor still sells over 100,000
copies a year as investors of all stripes look to learn the value-investing
way. But as Warren Buffett once said, value investing is “is simple, but not
easy”.
The truth is, the vast majority of investors will never be able
to become value investors as defined by Ben Graham for the reasons outlined
below. This is not a critique, but rather an exercise in illustrating the many
components of a value investing approach and mentality. While the list below is
by no means exhaustive, it captures some of the central tenets behind what
Graham believed contributed to successful value investing.
1 -Be an independent, critical thinker: Graham encouraged
investors to think for themselves. In his mind, an “intelligent investor” wasn’t
the smartest guy in the room, but instead one that used a fact-based
methodology and was able to control his or her emotions. Wall Street
Journal columnist Jason Zweig,
who updated and provided commentary for the 3rd edition of The
Intelligent Investor, neatly summarizes, “The components that are
needed in the character of an intelligent investor are
patience, independent thinking, discipline, eagerness to learn, self-control,
and self-knowledge”. By being an independent thinker there is a good
chance you won’t be influenced by the consensus and will come to your own
conclusion based on facts. The vast majority of investors rely on others to
form their opinions, and so-called market experts are busy giving their daily
market predictions. Graham preached forming conclusions based on the cold,
hard, numbers and believed that following the advice of forecasters was a bad
idea.
2 – Maintain a contrarian mindset: Seth Klarman, founder of
the value-oriented investment firm Baupost Group, called value investing “a
marriage between a contrarian and a calculator.” For Graham and most deep
value investors the contrarianism comes through in buying value stocks, which
are often stocks that investors are negative on for one reason or another. Look
at the top names driving the market today like Google, Amazon, Facebook and
Netflix –these may be great companies, but they are the furthest thing from the
type of unloved stocks that would fit the mold of being contrarian. As a
contrarian, you have the chance to find opportunities that may be mispriced,
where the market has potentially overreacted and become too negative but you
will likely need to endure significant pain to get there.
3 – Accept the future as
unknowable: Former Defense Security, Don Rumsfeld, once said, “… as we
know, there are known knowns; there are things we know we know. We also know
there are known unknowns; that is to say we know there are some things we do
not know. But there are also unknown unknowns – the ones we don’t know we don’t
know.” Graham understood the future was unknowable and that investing in the stock market came with
uncertainty. He wrote, “The future itself can be approached in two different
ways, which may be called the way of prediction (or projection) and the way of
protection.” By staying away from predicting and focusing on protection,
Graham gravitated toward stocks of companies that were so cheap that even if
the future was worse than expected, there was limited downside in the price…
4 – Find a margin of safety: Buying shares of companies that had a
“margin of safety” was a central concept in Graham’s investment approach. This
margin of safety was intended to provide some downside protection in the event
that future profits deteriorated for one reason or another. Because Graham
believed that the future was highly unpredictable and that the earnings power
of firms were also highly variable, he favored stocks of companies that could
be bought at or below their liquidation value. To determine the liquidation
value, he would take a firm’s current assets (cash, cash equivalents and some
of the liquid inventory) and net out the liabilities (Graham called these
qualifying stocks Net-Net stocks). This formula effectively gives you the price
a buyer would pay to in an event of a liquidation. For those companies valued
below this level, it is implied that there could be upside (as other investors
realized the value or as the business turns around) and also a limited
downside. [Note: For those interested in this Net-Net concept, there are two
very good articles here and here.]
5 – Be willing to put in the
work: If
you’ve ever picked up The Intelligent Investor, you know it’s a
daunting book – over 500 pages in small-type font. Security Analysis,
Graham’s first book, was even longer at 725 pages. The thoroughness in the
books reflect Graham’s thinking that to fully educate yourself on the markets
and investing takes lot of time, work and effort. Todd Combs, one of the
portfolio managers hand-picked by Warren Buffett to manage part of Berkshire
Hathaway’s public market investments, said earlier in this year that his daily work schedule
is “literally just reading about 12 hours a day.” The bottom
line: investing takes a lot of time, energy and continuously learning, and it’s
difficult for many to have the patience or interest in pursuing what takes to
become knowledgeable on the markets.
6 – Think like a business
owner: In
Berkshire’s Hathaway’s 2013 Annual Letter to shareholders (see excerpt
from Fortune here) Warren Buffett wrote about two small real estate
investments he had made — an investment in a farm in Iowa and building in New
York City. Both have proved to be profitable investments, as Buffett points
out, but his main objective in sharing this information was to emphasize the
importance of considering asset purchases, such as stocks, more like buying a
piece or all of a business. Buffett writes, “Stocks provide you minute-to-minute valuations for
your holdings, whereas I have yet to see a quotation for either my farm or the
New York real estate.” The concept of looking at stocks as pieces of
businesses was something Graham emphasized continuously, and Buffett credits
Graham for helping him think of investing as a business owner rather than just
a stock certificateholder. In The Intelligent
Investor, Graham wrote, “Investment is most intelligent when
it is most businesslike … every corporate security may best be
viewed, in the first instance, as an ownership interest in, or claim against, a
specific business enterprise.” Although they should, most investors
will never think of investing this way.
7 – Maintain discipline and a
systematic process: Graham specifically promoted a “quantitative” approach to
investing. A quantitative method provides more protection in Graham’s mind
because it offered a disciplined, unemotional way to buy a group of value
stocks that over time would have the potential to perform well. “Qualitative”
investing approaches, according to Graham, involved forecasts and predictions,
which he believed represented a speculative way to invest that would lead to
poor results. In chapters 14 & 15 of The Intelligent Investor,
Graham outlines two investment strategies using specific fundamental criteria.
The first was the Defensive Investor method, for investors who wanted to buy a
set of diversified value stocks as a basket or portfolio. I’ve outlined these
criteria below, and it’s this model that powers the Value Investor quant model we run at Validea. Graham
looked for the following:
**Adequate Size – mostly mid-sizedand larger companies.
**A Sufficiently Strong Financial Condition – a firm’s current ratio and debt compared to net working capital.
**Earnings Stability – long-term profitability.
**Dividend Record – a long-term dividend history.
** Earnings Growth – modest amount of past earnings growth.
** Value – as defined by price-to-earnings ratio and also the price-to-book ratio. Graham would only consider stocks that were trading cheaply based on these two metrics.
**A Sufficiently Strong Financial Condition – a firm’s current ratio and debt compared to net working capital.
**Earnings Stability – long-term profitability.
**Dividend Record – a long-term dividend history.
** Earnings Growth – modest amount of past earnings growth.
** Value – as defined by price-to-earnings ratio and also the price-to-book ratio. Graham would only consider stocks that were trading cheaply based on these two metrics.
8 – Realize stocks prices are there for your
convenience: Graham wrote that stock prices, or quotes, were there “to be
taken advantage of or to be ignored”. Investors, he wrote, should never buy a
stock because it has gone up or sell a stock because it has gone down. Rather,
they should determine the price they are willing to pay, based on the
underlying value of the business, then make a rational decision on whether to
buy or sell a stock. Buffett drove this point home with his famous
saying, “Price Is What You Pay, Value Is What You Get.” The
price of a stock can fluctuate wildly based on the latest headlines and flow of
money, but in the long run it’s the value of the underlying business that will
reward you as a shareholder as long as you bought the shares at a sensible
price and didn’t overpay.
9 – Invest, don’t speculate: Graham considered himself
an investor. He wanted to find companies with certain fundamentals and buy
their stocks for the long run. Speculators, as Graham labeled them, didn’t care
about the value of the business–their only concern was whether the price was
headed up. Graham also believed that anyone who was making a business out of
forecasting the market and/or company earnings in the future was engaging in a
type of speculation, and this would manifest itself in terms of poor returns.
In Chapter 1, Graham differentiates investing and speculating this way: “An investment operation is
one which, upon thorough analysis, promises safety of principal and an adequate
return. Operations not meeting these requirements are speculative.”
10 – Be skeptical of the Wall
Street marketing machine: Although it may be tempting to listen to arm-waving pundits that
sing the praises of certain companies while trashing others, understand that it
is impossible to predict what stocks will do from one moment to the next. In a
video posted last year by The Motley Fool, analyst David Kretzmann put it this way: ”
Build your portfolio around the understanding that market drops will happen,
but invest in such a way that you won’t let those drops get to you, that you’ll
continue to stay focused on the underlying businesses behind the stocks in
your portfolio, because the long-term performance of those businesses
is, in the end, what will drive the performance of those stocks.”
Value investing is a layered process that commands certain
psychological attributes and some hard-to-follow techniques, but I believe it
can lead to good outcomes for those investors willing to dig in and embrace the
philosophy. Simple may not mean easy, but sticking to a well-structured value-investing process can reap
rewards in the long run.
Justin J. Carbonneau is
Partner at Validea Capital Management and Validea.com. You can follow Justin on
Twitter @jjcarbonneau.
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