Tuesday, October 30, 2012

Maximizing Per-Share Value

From this Barron's interview of Bill Nygren, co-manager of the Oakmark Fund:

"...something gets missed when people are talking about expectations of lower corporate profit growth and lower gross domestic product. What they are missing is how much excess cash companies have today and will continue to produce if the real-world economy isn't growing much."

These days, a much lower proportion of earnings are paid as dividends compared to historical norms. Since 1900, companies have, on average paid out something like half of earnings in dividends.* By comparision, the dividend-payout ratio in recent years has been more like 1/4 to 1/3 of profits. Nygren also added:

"There aren't many opportunities to invest in expanding capital expenditures, because there isn't growth there to be had."

For a variety of reasons, there is just fewer opportunities to intelligently deploy all the cash being generated in the current environment. Combine the current reduced capital needs with historically low dividend payout ratios and the net result is cash piling up on corporate balance sheets. This all makes for an environment where many businesses can easily afford to increase dividends and/or buyback shares.

Nygren points out that a company with a P/E of 14 and pays out as dividends one-third of its earnings has sufficient capital to buyback close to five percent of its stock every year. He goes on build on the assumption that ("the bears on the economy are right") there continues to be a subpar macro environment, maybe something like 1% real GDP growth (well below the historic norm) and 2% inflation:

"...that gets you to about 3% nominal GDP growth, which is a pretty good proxy for corporate profit growth. But that's on a share base that's shrinking 5% a year. Companies can still deliver upper-single-digit— if not double-digit—earnings-per-share growth rates, given how strong balance sheets are and how strong free-cash-flow generation is. So it is more important than ever for investors to align themselves with managers who think about not just maximizing value, but maximizing per-share value."

The next time someone tries to equate underwhelming GDP growth with subpar returns on marketable common stocks keep this in mind.

For good businesses, reduced economic growth likely means less capital (capital expenditures, other long-term investments) is necessary. Reduced capital requirements allows management more flexibility over what to do with the excess cash available.

"...the companies we are most interested in are the ones that are just as happy to use that capital to reduce their share base as they are to build a new plant or go make an acquisition."

For investors, it's not just key to buy cheap shares of companies with modest incremental capital requirements.

It's key to own small pieces of a business that can comfortably maintain (or ideally expand) its long-term competitive advantages when deploying only modest incremental capital.

The better businesses can do this but corporate managers need to be interested in "maximizing per-share value" instead of "expanding the empire" with per-share value creation a secondary consideration (or worse). Some are very clever about selling the idea that they're doing the former when it's actually more about the latter.

A weaker business, no matter what the macro environment happens to be, needs lots of incremental capital just to maintain competitiveness.** Even when the business has had enough ongoing investment to remain competitive, the returns on the capital that gets put to work isn't great. So these necessary capital expenditures, at best, produce just decent return on capital and, for the worst businesses, downright unattractive returns. Management has the option to underinvest (neglect necessary capital expenditures), allow competitiveness to suffer in the core business, while deploying the proceeds to some opportunities that generates better returns. The hope being that the new investments will pay off before the original business suffers too much (and shrinks in relative importance over time) and eventually leads to more attractive overall shareholder returns. This requires skilled management and is hardly easy to execute. At a minimum, figuring out how a situation like that will play out in advance is usually a pretty tough call.

Good businesses are the opposite. They need little capital to maintain competitiveness (and maintain attractive return on capital) but, when the opportunity to put additional capital to work arises, the incremental returns are attractive. In other words, the returns for shareholders end up being attractive whether there is impressive growth prospects or not.

This gets at the core of why exciting growth isn't necessary to achieve rather attractive long-term results. It's more important for a business to have durable competitive advantages than astonishing growth prospects. Those advantages allow shareholder to do well even if growth prospects remain fairly modest. Growth can, of course, be a good thing. Yet some assume it is always a good thing.
(The prior related posts below are meant to, at least, challenge that sometimes mistaken assumption.)

"Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive." - Warren Buffett in his 1992 Letter

The real question, at least for common shareholders, is whether the growth has a favorable impact on the per-share value created over a very long time. Sometimes it does. Sometimes it does not.

Growth, of course, will often have a favorable impact on value. 

It just happens to be a mistake to think that it always has a favorable impact. 

In fact, growth can actually reduce value if it requires capital inputs in excess of the discounted value of the cash that will be generated over time. Sometimes, the highest growth opportunities attract lost of capable competition and capital that ruins the long run economics. Sometimes, high growth requires expensive but necessary capital raising that dilutes existing shareholders and reduces per share returns.

Finally, even if growth that materializes does have favorable economics, some investors tend to pay a large premium upfront for those growth prospects. That hefty price paid may turn attractive long-term business results into not so attractive investment results.

Check out the full Barron's interview.

Adam

Related posts:
Death of Equities Greatly Exaggerated - Aug 2012
Stock Returns & GDP Growth - Jul 2012
Why Growth May Matter Less Than Investors Think - Jul 2012
Ben Graham: Better Than Average Expected Growth - Mar 2012
Buffett: Why Growth Is Not Necessarily A Good Thing - Oct 2011
Grantham: High Growth Doesn't Equal High Returns - Nov 2010
Growth & Investor Returns - Jun 2010
Buffett on "The Prototype Of A Dream Business" - Sep 2009
High Growth Doesn't Equal High Investor Returns - Jul 2009
The Growth Myth Revisited - Jul 2009
The Growth Myth - Jun 2009

* The real issue is whether the payout ratio allows the business to maintain competitiveness or, when applicable, expand the business in a high return manner for shareholders. For some businesses, a high payout ratio makes a lot of sense. For others, it certainly does not.
** The Berkshire Hathaway textile business comes to mind. If Buffett had just continued investing in the textile business instead of allocating capital elsewhere, Berkshire Hathaway would be a shadow of itself today. Check out the 1985 Berkshire Hathaway (BRKaShareholder Letter for more background.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Thursday, October 25, 2012

Buffett on Banks: CNBC Interview

CNBC's Becky Quick interviewed Warren Buffett yesterday.

Interview With Warren Buffett: CNBC Transcript

Earlier in the interview, Buffett said that:

"I think the stock market generally is the best place to have money..."

Then he added:

"...there's no question that worldwide there is some slowing down going on."

He also made the following comments about Wells Fargo (WFC), U.S. Bancorp (USB), and banking in general:

"In the last week, I bought some Wells Fargo."

Then he later said...

"But we only have 430-something million shares, so I didn't feel we had enough."

Here's his explanation why banks won't be as profitable (and basically shouldn't be if you want a safe and sound financial system) as they were (or at least seemed to be) going forward.

"The profitability of banking is a function of two items. Return on assets and assets to equity.

And return on assets is not going to go up particularly. USB has done the very best on that. They're at about 1.7 percent. Wells is between 1.4 and 1.5 percent. But most banks are lower. Now, if you have 20 times leverage and you're getting 1.5 percent on assets, you're making 30 percent on equity.

And that was not lost on people a few years back. And they pushed balance sheets, and they're still pushing them in Europe. But they've cut back on that here. So they will not be having the leverage in the banking system. It'll be even more restricted among the bigger banks as part of the new rules, and you won't be able to earn more on assets than before, and so with less leverage in the same return on assets, you will have a lower return on equity. Banks were —banks were earning 25 percent on tangible equity not so many years ago. And really, that's kind of a crazy number. You know, for a basic semi-commodity business, you really don't want to allow that."

Yet it was allowed. Then we all had the great misfortune to see what happens when huge leverage is combined with the use of other people's money guaranteed, explicitly or not, by the government and a lack of sensible oversight. More from Buffett:

"...people got to push and push it and push it, and then the government says, 'Listen, we got a vested interest in this. You're using our credit, in effect, and if you want to play, you're only going to have 10-to-1, or some number like that.' So the returns on banks have come down. It's still a good business."

A well run bank can still be a good businesses. He added that "...Wells is very well run. And it's a good business."

A bank with 10x leverage* that can generate 1.4 or 1.5 percent return on assets (ROA) naturally has a mid-teens return on equity (ROE).

That math is simple but I think it is fair to say investing in most banks is far from easy to do. A bank that has mid-teens ROE bought near book value should**, in the long run, produce something like mid-teens returns for shareholders.

Should, that is, if (and it's a big IF) the bank can keep itself from getting into trouble down the road (unstable funding sources, insufficient liquidity, unwise investments/trades, dumb lending practices, foolish use of derivatives, etc.) that ends up wiping out all or part of the bank's per share value for common shareholders.

With leveraged institutions, an awful lot value can be destroyed in a very short amount of time (as we saw not all that long ago).

One of the weaknesses of some banks is that they lack the core earnings capacity of a Wells Fargo or U.S. Bancorp.

Wells Fargo's ROE in the most recent quarter was 13.4 percent.

U.S. Bancorp's ROE in the most recent quarter was 16.5 percent.

Whether they'll earn those kind of returns over the long haul can't really be known but it does provide some indication of relative capacity to earn.

In contrast, with similar leverage, some other banks seem likely to, post-financial crisis, have persistent below double-digit ROE (this starts with having inherently inferior ROA then not being able amplify with leverage as much). To me, that's generally an insufficient return for what are still, even if less so than before the financial crisis, by their nature rather leveraged institutions.

The problem isn't just that the returns are subpar considering the risks.

The problem is more that banks with lower returns have less capacity to absorb credit and other losses (lower pre-tax pre-provision earnings for every dollar of assets).

Once the next inevitable economic downturn or financial crisis occurs, those banks generating lower returns, all else equal, are likely the less durable institutions (from a common shareholder perspective that is). It takes less stress to begin weakening their balance sheet and more easily results in the need to raise capital (or worse). Since stressed financial institutions usually have to raise capital when the share price is quite cheap, it usually ends up being materially dilutive, and very expensive, for existing shareholders to say the least.

The returns of a bank should be considered in the context of their ability to withstand potentially severe economic and systemic stress. Like any investment, buying common shares of a bank requires a  margin of safety. Yet, with a weaker bank, simply adjusting the estimated intrinsic value lower by some percentage or buying with a bigger margin of safety to arrive at an appropriate price to pay is usually not enough. Eventually, it's more a go/no go decision. There's a threshold where it's just better to avoid the common stock of weaker banks altogether no matter how cheap they may seem.

A higher quality bank, though selling at a seemingly more expensive share price, may be intrinsically well worth the additional multiple of earnings or book value that must be paid.
(Only up to a point, of course. Margin of safety is still all-important.)

The bottom line is reduced earnings capacity relative to assets can significantly increase the risk of permanent capital loss for the common shareholders of a financial institution. Like any commodity/semi-commodity business, it's better to own the one's that will still be profitable in tougher environments when their weaker competitors are struggling to do so. The stronger banks are not just less likely to destroy intrinsic value during periods of economic stress (when credit losses are at their highest). The one's in a position of strength should also be able to make strategic moves that actually increase intrinsic value while weaker competitors are in retreat.

So it's not just that Wells or U.S. Bancorp generate higher returns, it's that they should be able to do so at less risk. It's their relative and absolute capacity to absorb losses from loans/ investments/ trades that go sour (and other liabilities that may arise). Ultimately, they earn superior returns (via various fees, gains, interest income) on their deposits (generally lower cost stable funding) than many competitors.

To a certain, but limited, extent those comfortable reading financial statements should be able to figure out if a bank has an advantage in this regard. Yet, annual/quarterly reports and other filings is unlikely to tell the whole story. Unfortunately, investing in any bank requires a subjective judgment (some might say a leap of faith) about the quality of management and the culture of the institution. In other words, there's no way that all the possible troubles a bank may get into will be obvious just from reading SEC filings. That's true of any enterprise but, considering the leverage involved, misbehavior or stupidity has the potential to be much more expensive for a bank shareholder.

Wells and U.S. Bancorp may not be as complex as some other large banks, but they are still hardly simple to analyze.***

Later in the interview, Buffett added this on the European banks:

"The European banks still are leveraged to an extraordinary extent... But they aren't earning 1.5 percent on deposits either."

Some European banks not only still have too much leverage but also don't earn nearly as much on their deposits (and some have funding that's of lesser quality). So they are not just riskier investments because of the excessive leverage. They are also riskier because their inherently inferior earnings provides them with less ability to absorb losses before the balance sheet, and eventually per share intrinsic value, takes a hit.

Adam

Long positions in WFC and USB established at much lower than recent market prices.

* 10x is far more reasonable leverage for a sound bank (those with lots of stable deposits, outstanding liquidity, high quality equity capital, sound underwriting practices, etc.) compared to what was often the norm before the financial crisis.

** Assuming the market price of the shares in the very long run can be sold at or above book value. That's not an unreasonable assumption for a well run bank. The intrinsic value of the better banks should be comfortably higher than book value. Wells and U.S. Bancorp are no longer selling below book value and certainly not below tangible book value. There were, however, a number of occasions in recent years when shares of both banks were selling for less than their per share tangible book value. Also, any share repurchases, especially if comfortably below intrinsic value, will boost returns above what their ROE suggests.
*** There are many simpler investment alternatives with less difficult to gauge risks and reduced likelihood of big mistakes. Investing in a bank's common stock certainly require a lot more work than, say, one of my favorite minimally leveraged consumer businesses. The question is whether there's a good chance they will produce materially greater long-term risk-adjusted returns considering all that extra work. An investment with greater complexity that requires more effort should be plainly worth the trouble. For me, sometimes they have been worth the additional effort but it's often a closer call than I'd like it to be. In other words, considering the alternatives, I'm not sure investments in even the highest quality financial institutions frequently pass the "plainly worth the trouble" test. There are many other, relatively unleveraged, potentially sound investments available. With that in mind, it seems unwise for an investor to put capital at risk in the common stock of a bank unless they're highly confident in their ability to judge financial institutions.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Monday, October 22, 2012

Chasing "Rearview-Mirror Performance"

In this interview, Bill Nygren, co-manager of the Oakmark Fund, says that investors are "chasing the rearview-mirror performance" of bonds.

Barron's: Why Stocks Beat the Alternatives

He also later added the following:

"...investors are looking at equities saying, 'It's not like they've returned much recently,' and everybody is telling them that the world economic outlook isn't as good as it used to be."

There is, unfortunately, a general tendency for investors to sell or avoid buying what's out of favor (and possibly more attractively valued) and, instead, own what has worked more recently.*

Of course, that leads investors too often to accumulate the asset classes that happen to now be relatively expensive (and maybe sell/avoid what's rather cheap). These days, it's bonds that are in favor. In the late 1990s, it was equities. They seem (or seemed) safe, at least in the near-term but, with a longer term risk-adjusted returns perspective, they are (were) not.
(Price action may even continue to reinforce the actions of the herd for quite some time. Well, at least it tends to do so until it doesn't. Generally speaking, just long enough to cause even more pain. Social proof can be a powerful thing.)

What seems safe is priced in a way that's unlikely to produce anything close to satisfactory enough long-term returns to compensate for the risks.

It happens all too frequently, and even, predictably.

Lou Harvey, president of DALBAR, provided a good explanation of what happens with fund investors back in 2009:

"...investor returns lag what performance reports and prospectuses would lead one to believe is achievable. While those returns are, in fact, theoretically achievable, the reality is that investors are not rational, and make buy and sell decisions at the worst possible moments," he said.

One major reason so many market participants underperform long-term comes down to this reliable pattern of investor behavior. I'm guessing most don't think they are susceptible to it.

Not everyone is susceptible, no doubt, but the evidence suggests more participants are than may be obvious or expected. Chances are that means quite a few who think they immune to the pattern are, in fact, not immune at all.

As a result, the returns of fund investors suffer in a very big way.

More on that subject in just a bit. First, according to Vanguard founder John Bogle, from 1984 to 2002 the average mutual fund delivered a 9.3% annual return compared to the S&P 500's return of 12.2% a year.

So the average mutual fund performance wasn't great compared to the broader index.

Here's what Jack Meyer, who managed the endowment, pension, and other assets as President and CEO of the Harvard Management Company from 1990 to 2005, had to say: **

"Most people think they can find managers who can outperform, but most people are wrong. I will say that 85 percent to 90 percent of managers fail to match their benchmarks. Because managers have fees and incur transaction costs, you know that in the aggregate they are deleting value."

Even worse, during that same period the average fund investor, according to DALBAR, earned just 2.6% a year. This comes down to investor behavior. The reliable tendency to make poor buy/sell decisions. Less action and a focus on longer investing horizons often lead to improved returns.

What's popular isn't necessarily expensive, but chances are pretty good it's not cheap.

Similarly, what's less popular -- and likely faces near-term or longer very real headwinds -- isn't necessarily cheap, but it's not a bad place to start looking for value.

"Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well." - Warren Buffett

If an investor habitually buys (sells) what's popular (unpopular), and tends to do so during bull (bear) markets, returns are likely to suffer. It certainly not tough to understand why the opposite of this behavior will generally improve long-term results. Yet, the fact is quite a few studies more than just suggest that a whole lot of fund investors, in fact, do their buying/selling at rather unfortunate times. That seems to at least imply this is less an intellectual challenge, more about temperament and discipline.

My own view is that an awareness of the tendency is just one step but an important one. Establishing, proactively, one's own simple policies or rules ("never sell if...", "only buy when...") can at least partially counteract the tendency in certain challenging market environments. In other words, better to think it through beforehand when fewer emotions are involved. Then, the policies and rules can be more routinely applied -- using objective factors to guide actions in the moment -- when the challenging and sometimes quite emotionally charged environment arises (whether a bubble/near bubble or a crash/near crash...either extreme). Even if there's no way to entirely eliminate every costly mistake, developing an effective trained response goes a long way toward reducing the cumulative adverse portfolio impact of poor buy/sell decisions made over many years.

In the long run, returns are driven by price paid and value. No matter what the near-term market environment happens to be, it's the price paid for sound investments relative to their intrinsic worth that matters.***
(Consistently buy shares of businesses with durable advantages at a discount and good things are likely to happen. The same is true for a broad-based index fund even if there are different specific risks involved. Usually the time to buy is when it feels pretty awful and the time to maybe sell some shares is when there seems to be no economic storm clouds whatsoever.)

John Bogle, in The Little Book of Common Sense Investing, also estimated that in the 25 years ending in 2005 the average mutual fund investor earned 7.3% compared to the 12.3% for the benchmark. Once again, investor ill-timed buy/sell behavior accounts for the gap in performance.

A more recent study by DALBAR reached a similar conclusion.

According to DALBAR's Quantitative Analysis of Investor Behavior (QAIB), the S&P 500 returned 8.35% over the 20 years that ended in 2008 while, on average, equity fund investors earned just 1.87% (less than the inflation rate of 2.89%).


Investors in bond funds revealed a similar pattern and, of course, results. The bond fund investors earned 0.77% compared to 7.43% for the index.

So it's not difficult to find evidence that investors can be their own worst enemy. In the long run, an awareness of the damage this pattern of behavior does to portfolio returns is only useful if wise steps are taken to counteract the tendency.

Not seriously considering the implications of this in the context of one's own investing approach seems a bit foolish and certainly, well, expensive.

It's worth keeping the following front of mind:

- Investors have a reliable tendency to buy and avoid/sell at the wrong times; it's an expensive pattern.

- Index funds have a not insignificant likelihood of outperforming a large number of market participants especially if trading is minimized and they're held long-term. It's a relatively simple approach. When a simple approach produces the same or better results than the more complex one, the simpler approach obviously wins. The added complexity needs to be worth the trouble. In other words, there's a cost to complexity and the benefits of a less straightforward approach should be apparent and easy to justify.

- More investors, due to overconfidence in (or overestimation of) their own abilities, seem to believe they can outperform an index than appears to be justified based upon available evidence.

- Investors who buy marketable stocks need to realistically assess their own ability outperform an index long-term and on a risk-adjusted basis. Similarly, investors who buy an actively managed fund need to realistically assess whether they can identify the particular fund (or funds) that will outperform in the future. I mean, knowing who did well after the fact doesn't really help a whole lot. Studies seem to more than suggest too many investors overestimate their own ability to either pick stocks or active managers.

I've used this quote recently but it bears repeating:

"By periodically investing in an index fund..... the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when 'dumb' money acknowledges its limitations, it ceases to be dumb." - Warren Buffett in the 1993 Berkshire Hathaway Shareholder Letter

Buffett goes on to say, in effect, the
"know-something investor" who's able to identify "five to ten sensibly-priced" enterprises with sound business economics that possess long-term competitive advantages need much less diversification than what is offered by an index fund. As I said in this recent post, there's a big difference between it being not possible and it being not likely to achieve attractive results buying individual stocks. So it's not likely that many equity investors will do better than an index fund. Yet, as I said in this recent post, there's a big difference between not possible and not likely. Attractive results can be achieved buying individual stocks but some seem to think long-term outperformance is easier than it actually is.

Still, if the results of these studies are any indication, a rather daunting number of market participants will end up doing worse by buying individual stocks. It'd be folly to ignore the results from the studies noted above and others.

The added risk and complexity of owning individual stocks works against long-term returns unless the investor: 1) truly knows business economics, 2) is able to identify those with sustainable advantages, 3) judges value well, then 4) buys with an appropriate margin of safety. The right temperament and no small amount of discipline is necessary.

The evidence supporting the idea that index funds are often the way to go is not insignificant. Yet, that doesn't mean no one should invest in individual stocks. Some are really very good at it but, as always, it's about knowing one's own limits.

Check out the full Barron's interview.

Adam

Related posts:
Index Fund Investing
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Halo Effect & Rear-View Mirror Investing
The Illusion of Skill
Buffett's Bet Against Hedge Funds, Part II
Buffett's Bet Against Hedge Funds
The Illusion of Control
Rear-View Mirror Investing
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
Recent Study on Investor Returns
When Genius Failed...Again
Best Performing Mutual Funds - 20 Years

* Certain bonds may be generally expensive but that doesn't mean, near current levels, the major equity indexes are at extraordinarily low valuations. Best case, the major indexes seem to be annoyingly neither cheap nor expensive, though certain individual stocks appear rather attractively priced.
(In general, my own approach is to buy shares of businesses with durable economics below what their worth then ideally "never" but, at least, rarely sell once I own part of a quality enterprise at a fair or better price.)
** Index funds don't just outperform the average mutual fund. It's much worse than that: "The statistical evidence proving that stock index funds outperform between 80% and 90% of actively managed equity funds is so overwhelming that it takes enormously expensive advertising campaigns to obscure the truth from investors." - The Motley Fool
John Bogle makes a similar point here. There are some very good actively managed funds. The problem is it's difficult to pick those that will outperform a broad-based market index over a long time frame into the future.
*** And how much intrinsic worth will change, for better or worse, over time. Investing in individual stocks starts and ends with knowing how to judge value and paying an appropriate discount. Those that don't feel they can judge value certainly shouldn't be buying individual stocks (even if you are a buyer of index funds, having a good sense of price versus value is hugely useful). Naturally, a lousy market environment often produces attractively priced assets while a euphoric market produces the opposite. What's more important, at least for those building an equity portfolio with long-term results in mind, is whether shares can be bought (via an index fund or well understood, ideally higher quality individual stocks) at a plain discount to value no matter what the market environment is. For long-term investors, it's first and foremost about consistently buying shares at a discount to value not the near-term (or even somewhat longer term) price action or mood of the equity markets. Very bullish/bearish market environments just usually (though not always) provide a larger number of mispriced assets and more extreme individual mispricings. Understandably, a trader looks at this in an altogether different manner if for no other reason that his/her time horizon is vastly shorter.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Thursday, October 18, 2012

DJIA Stocks With the Highest and Lowest P/Es

According to this, the five stocks in the Dow Industrials with the highest P/Es based upon 2013 earnings estimates:

Barron's - Dow Industrials Consensus Earnings

Stock                                     | P/E
Home Depot (HD)            | 17.5
Coca-Cola (KO)                 | 17.4
Procter & Gamble (PG)  | 16.4
Verizon (VZ)                     | 16.0
McDonalds (MCD)           | 15.5

Naturally, these look a bit more expensive based upon 2012 earnings.

Now, here's the stocks that currently have single-digit P/Es among the Dow Industrials:

Stock                                     | P/E
Chevron (CVX)                 | 9.0
Microsoft (MSFT)            | 8.9
Cisco (CSCO)                      | 8.8
Caterpillar (CAT)             |  8.2
JP Morgan (JPM)             | 8.1
Hewlett-Packard (HPQ) | 3.8

Adjusting for net cash and investments on the balance sheet, Microsoft (MSFT) and Cisco (CSCO) actually sell at an even lower multiple of earnings.*

Unfortunately, many of Cisco's earnings estimates are made on a non-GAAP basis. In my view, that creates an optimistic view of the company's earnings power over the long haul. The inflated earnings picture come primarily from not including stock-based compensation. Some might be willing to disregard stock-based compensation as an expense. I'm not. It's true that it often makes sense when valuing a company to ignore non-cash expenses. Not in this case. The cost of stock-based compensation is economically very real for long-term shareholders (i.e. have a material impact on per share intrinsic value) even if difficult to estimate precisely ahead of time and not an immediate hit to free cash flow.

Cisco - Adjusting for net cash and investments while using a more conservative estimate of earnings the net result is still a stock with a P/E around 7 or so.**

Microsoft - Sells for less than 8 times earnings after adjusting for net cash and investments.

Clearly, Hewlett-Packard is priced as earnings are going to continue sinking. In fact, that multiple implies the expectation is that it's going to happen rather quickly. The problem, of course, is understanding the company's prospects far into the future. Does it have a sustainable business with at least decent economics even if at a substantially lower than current level of earnings? That's all it needs to prove at this point with that kind of P/E. Alternatively, will earnings power just continue to take hits until there's little, if any, intrinsic business value left? We'll see. The range of outcomes seems pretty wide. It'll be a rocky road until the answer to questions like this become at least somewhat more apparent.

Keep in mind certain stocks among the Dow Industrials have a substantial range of earnings estimates. Alcoa (AA) and Bank of America (BAC) come to mind. So the so-called "consensus" may not mean a whole lot. Those with the broadest ranges likely have difficult to judge business prospects (at least in the near-term and maybe longer). A wide range of estimates may not necessarily indicate a low quality business (though it often does), but describing the estimates as "consensus" seems like more than a slightly flexible use of that word.

Also, as far as I'm concerned, it's better to pretty much ignore the consensus and come up with my own estimate of current intrinsic value*** -- and how much it seems likely to change over time -- based on conservative numbers for future earnings power (and long run expected return on capital). To me, how the business performed over the previous business cycle should be weighed heavily. If current prices seem likely to produce a nice long-term risk-adjusted return based upon conservative estimates, there'll be no complaints if the business ends up having even more earnings power than assumed. Whether management can be trusted to allocate capital intelligently and, most importantly, whether the business has a sustainable economic moat need be judged well, of course.

Those less economically sensitive (Coca-Cola is one example) businesses are likely to have rather modest drops in earnings even if the global economy slows (though it would certainly at least temporarily throttle growth). The financial crisis provided some pretty good evidence of Coca-Cola's earnings persistence. Even if there were a temporary reduction in the Coca-Cola's earnings, it would do little damage the company's per share intrinsic value (and how it increases over the long haul) in my view.

Too bad the stock has gotten a bit pricey.

In contrast, expect the more economically sensitive businesses to have meaningful adjustments in earnings estimates in periods of severely reduced economic activity. A business more sensitive to economic activity requires earnings to be normalized across a complete business cycle to get a good read on its true P/E.

Finally, five years ago, back in October of 2007, the DJIA was just over 14,000. According to this Barron's article, at that time the forward P/E of the stocks that made up the index was 16.1.

Five years later, with the DJIA now at roughly 13,500, the forward P/E is more like 11.7.

So the Dow Jones Industrial Average may not be higher than it was five years ago, but it's not because the underlying per share intrinsic value of the company's in that index hasn't increased.

Adam

Long positions in KO, PG, CVX, MSFT, CSCO established at much lower than recent market prices. Small long position in HPQ established when it was more expensive than where it has traded recently.

* Enterprise value = market capitalization minus cash and investments plus debt. The substantial amount of net cash and investments these two companies have results in an enterprise value that's far lower than market value. Roughly 1/4 of Microsoft's market value is made up of net cash and investments. Nearly 1/3 of Cisco's market value comes from its net cash and investments. Naturally, the result is lower enterprise value to earnings for both companies.
** I use GAAP earnings so stock-based compensation expense -- admittedly a crude estimate of what ultimately will be the true expense -- is taken into account. Using GAAP is a conservative estimate of earnings since the GAAP numbers also include expenses related to amortization of acquisition-related intangible assets. Unlike stock-based compensation, those non-cash amortization expenses aren't necessarily material in an economic sense looking forward. A company that regularly overpays for the assets they acquire will adversely impact intrinsic value. One reason to include amortization expenses when valuing a company is to build in additional margin of safety in case the company ends up doing just that in the future. Still, those willing to be less conservative in estimating value have a reasonable argument in not counting amortization of acquisition-related intangible assets.
*** Estimates of intrinsic value is actually more a range of likely values and certainly is not a precise number. There's little room for false precise when estimating value. 
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice.

Monday, October 15, 2012

Buffett: Buying Businesses "Through The Purchase Of Marketable Stocks"

From The Superinvestors of Graham-and-Doddsville:*

The common intellectual theme of the investors from Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market...Incidentally, when businessmen buy businesses, which is just what our Graham & Dodd investors are doing through the purchase of marketable stocks -- I doubt that many are cranking into their purchase decision the day of the week or the month in which the transaction is going to occur. If it doesn't make any difference whether all of a business is being bought on a Monday or a Friday, I am baffled why academicians invest extensive time and effort to see whether it makes a difference when buying small pieces of those same businesses.

While the influence of Graham and Dodd is significant, these successful investors put the theory to work in very different ways. It's no secret (and it's been covered on this blog more than a few times) that Warren Buffett and Charlie Munger prefer portfolio concentration over diversification.** Well, Walter Schloss, one of the "superinvestors", was known to diversify a whole lot and has an incredible long-term record. So each investor finds what works (or doesn't) for them even if they've built upon ideas that have a common origin.

Buffett contrasted the investing style of Walter Schloss with his own in "Superinvestors":

Walter has diversified enormously, owning well over 100 stocks currently. He knows how to identify securities that sell at considerably less than their value to a private owner. And that's all he does...He simply says, if a business is worth a dollar and I can buy it for 40 cents, something good may happen to me. And he does it over and over and over again. He owns many more stocks than I do -- and is far less interested in the underlying nature of the business; I don't seem to have very much influence on Walter. That's one of his strengths; no one has much influence on him.

Most successful investors are independent thinkers. Buffett further made this point:

[Stan] Perlmeter does not own what Walter Schloss owns. He does not own what Bill Ruane owns. These are records made independently. But every time Perlmeter buys a stock it's because he's getting more for his money than he's paying. That's the only thing he's thinking about. He's not looking at quarterly earnings projections, he's not looking at next year's earnings, he's not thinking about what day of the week it is, he doesn't care what investment research from any place says, he's not interested in price momentum, volume, or anything. He's simply asking: what is the business worth?

In my view, two of the big benefits of owning shares in fewer businesses ideally for a very long time is: 1) surprises become less likely as familiarity grows, and 2) there's less chance of getting the value very wrong.

Yet there's clearly many other ways that work. Each investor has to find their own independent "recipe" that fits them. That's why I happen to think that no investor in marketable stocks should buy something just because some other investor -- even someone who has a very good track record -- has bought it.

The specific approach put into practice (and the specific stocks bought and sold) matter much less than the common theme here:

Buying shares when they happen to sell at a price comfortably below one's own appraised per share value of a business.

Mason Hawkins, Chairman and Chief Executive Officer Southeastern Asset Management, recently answered questions for readers of GuruFocus. He had this to say:

Because of the short investment time horizons in the markets today, we often get the chance to buy businesses that we have previously owned. Generally, companies and managements that we have lived with successfully in the past come with fewer unknowns and therefore less appraisal risk. 

I think jumping in and out of too many stocks can lead to mistakes that wouldn't otherwise get made but, whatever the approach, it all gets back to sound judgment of value and always paying a meaningful discount to it.

Adam

* The "superinvestors" mentioned by Warren Buffett include: Walter Scloss, Tom Knapp (Tweedy Browne), Ed Anderson (Tweedy Browne), Bill Ruane (Sequoia Fund) , Rick Guerin, Stan Perlmeter and, of course, Charlie Munger.
** The Berkshire Hathaway (BRKa) equity portfolio itself is, to this day, very concentrated. Yet as Berskhire has grown in size and complexity it has become impossible for them to concentrate the entire portfolio (i.e. including all the operating businesses they control). Their equity portfolio frequently has 60-70 percent and, at times, even more allocated to just five stocks. It remains roughly constructed that way.

The Superinvestors of Graham-and-Doddsville
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Thursday, October 11, 2012

Wal-Mart's Share Repurchases

GuruFocus recently interviewed Steve Romick, the Portfolio Manager of FPA Crescent (FPACX):

According to Morningstar, here's how FPACX has performed recently and, more importantly, over the long haul. Also, here's a link to the Top 25 holdings in the fund.

In the interview, Steve Romick points out that Wal-Mart's (WMT) shares were selling for around $ 50/share last fall and, at the time, a multiple of earnings that was roughly 10 and a half. The stock has rallied almost 50% since then.

Romick also said the following about Wal-Mart:

The margins of Walmart don't move very much over time. In fact, of any company I've ever seen, the rate between the high margin and low operating margin is only 50 basis points. We're talking about an earnings growth that should be pretty close to revenue growth.

Then he later added:

...in addition to that we're getting the benefit of share repurchases. In the last decade they bought back more than 20% of the shares outstanding. It's like a creeping buyout for the largest retailer in the world. And we believed that they would continue to use their free cash flow to repurchase their shares at a rate of 2.5% or so per year. That added to our growth in earnings. And then we said they have a dividend on top of that. We added that to what we thought we could earn. By the time we were all done, we had an expected outcome, assuming no change in the P/E – which at the time was a lot lower than it is today – the expected outcome was going to be in a range of returns of anywhere from, call it 7% to 13%. We felt that we'd rather own this than bonds or cash. And we believed that it would be quite likely that we couldn't lose money, over time.

Back in July of 2011, this Michael Santoli article in Barron's pointed out that investors were effectively selling Wal-Mart back to the Walton family.

Related posts:
Selling Wal-Mart Back to the Walton Family: Part 1 - July 2011
Selling Wal-Mart Back to the Walton Family: Part 2 - July 2011

Well, with the shares having rallied so much, each buyback dollar now goes a whole lot less far. So the higher share price makes future buybacks less wealth enhancing for long-term Wal-Mart investors. The fact that the shares having rallied so much also assures that the process of selling of Wal-Mart back to the Walton family has been slowed.

Buying back the shares is now less effective though hardly ineffective. Shareholders, at least those in it for the long haul, benefit as long as shares are bought when selling below per share intrinsic value.*

The shares may no longer be exceptionally cheap, but they're not particularly expensive either at slightly more than 15 times earnings.

Still, the margin of safety that existed last year is no longer there.

Wal-Mart is as good a recent example as any why no long-term investor should cheer when the stock of a great durable franchise, especially those run by capable capital allocators, has rallied.

Adam

Long position in WMT established at much lower than recent market prices

* As long as the company is financially strong, has no other strategic need for corporate cash, and the necessary investments are being made that maintain, or ideally enhance, the size and strength of its economic moat.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Monday, October 8, 2012

Six Stock Portfolio Performance

It has now been roughly 3 and a 1/2 years since I first mentioned the Six Stock Portfolio. At that time, I considered those stocks attractive long-term investments, at the then-prevailing price levels, for my own portfolio.*

Back then, I felt the share price of each represented a very nice discount to likely intrinsic value a few years out (and beyond) and said as much. No estimate of value can be perfect, of course, but each seemed oddly cheap back then compared to even the most conservative estimate of their intrinsic worth.

None are now selling at much, if any, discount to my judgment of their value. To me, at the very least, the margin of safety is now insufficient.

As a group, the six stocks have obviously done just fine since they were first mentioned.

Stock                                                | Total Return**
Wells Fargo (WFC)                                    91%
Diageo (DEO)                                           187%
Philip Morris (PM)                                 189%
Pepsi (PEP)                                                 52%
Lowe's (LOW)                                             67%
AmEx (AXP)                                             230%

Since April of 2009, the combined total return is 136 percent (including dividends) for these six stocks while the SPDR S&P 500 (SPY) returned 82 percent (also including dividends).

So that's a ~54% performance gap achieved in 3 and a 1/2 years with no portfolio turnover and little, if any, trading abilities required (well, actually none). It's always a focus on paying a price that's comfortably below my best estimate of intrinsic value (necessarily more of a range of values than a precise number).

The fact that shares of good businesses like these were that inexpensive back in April of 2009 still seems amazing.

Since none are particularly cheap at this point, some might ask why not switch from these somewhat expensive stocks (or, at least, a whole lot less cheap) into something a bit less expensive.

On rare occasions, I'll consider a switch if: valuation becomes extreme on the high side, I've lost confidence in/significantly misjudged the long-term prospects of the business, or I understand an equal or better quality alternative investment pretty much as well that is clearly much cheaper.
(Something that is just plainly a superior investment alternative. I mean, it generally has to be just screaming at me.)

Otherwise, I'm just not that smart. Each move is just another chance to make a mistake. Buying and selling isn't just a chance to improve results, it's a chance to hinder them. It's all too easy to overweight the likelihood that a move will improve portfolio performance while not considering the possibility it might do just the opposite. It's an illusion of control. Of course, each move also creates unnecessary frictional costs.

I own these because my judgment is that they have durable advantages that support attractive business economics and it was, at one time, possible to buy the shares comfortably below my conservative estimate of intrinsic value. Once I own shares of a good business at the right price (at least those that I understand), my bias is to not sell for a very long time. That means sometimes holding onto shares of a business I like even if, due to increased market prices, the stock might temporarily no longer be a bargain relative to current estimated per share intrinsic value.
(As long as my expectation is that intrinsic value will still increase over the long haul at an attractive rate.)

I don't expect most to adopt this way of thinking and apply it in their own way but it's, if nothing else, a recognition of my own limits. We'll see how these six perform over many years compared to the S&P 500. If I'm an idiot it will clear over time.

The blog is here to make sure of that.

This concentrated portfolio is meant to be an example of how attractive results can be accomplished with minimal to no trading. I'd imagine it takes a fair amount of energy to learn trading techniques and become proficient (though I don't plan to find out). My interests lie elsewhere. Instead, my energy and focus has always been on judging business quality and value, being disciplined about buying shares at a substantial discount to that value, and minimizing frictional costs of all kinds.

Returns are driven by the economics of each business and always buying with a margin of safety, not some unusual talent for trading.

Of course, many investors -- depending on the circumstances -- will want or need to own more than six stocks but portfolio concentration can make sense.***

At least for me, it's not possible to get a good understanding of 50-100 businesses.

Some may be able to do just that, but I can't.

I suspect there are a few who are kidding themselves that they understand so many businesses well enough to risk their capital.

So I think attractive results can be achieved without some unusual acuity for trading but, instead, via paying the right price per share (buying with a nice margin of safety) for good businesses with sound economics and owning them for a very long time.

At some point each of these businesses (and maybe their stocks) will almost certainly not perform well for a period of time. Yet, considering both the quality of the businesses and the price that shares could be purchased for in April 2009, I'd expect this portfolio's overall results to be just fine over the very long haul.

Of course, as noted above, if my view of future prospects were to change action might be necessary. For example, if the economic moat of one of these businesses became materially impaired (or if capital allocation decision-making by management became a serious concern), I will certainly consider switching one of these out.

It's probably obvious for those who've read some of my previous posts that I don't view it as a good thing this portfolio has doubled in value so quickly. Right now, I am comfortable with these six stocks long-term but, at current prices, neither I nor these companies can buy shares at an extreme discount to value.

In the long run, as Buffett pointed out using the IBM example in the most recent Berkshire letter, that will reduce returns for long-term owners. So it makes no sense to be happy the stocks have run up this much.

It does, in fact, actually hurt relative and absolute long-term performance.

The gap in performance more recently shouldn't be sustainable. If it does continue, then price action will certainly outrun increases to intrinsic value. Not a good thing. At the end of 2011, these six stocks combined, since April 9th, 2009, had a ~33% performance advantage over the S&P 500. Less than a year later, it is now already up to a ~54% advantage. It seems improbable these stocks will continue expanding the gap over the S&P 500 at such a rate over the longer haul.

These are good businesses, in my view, but their capacity to increase per-share intrinsic value is far more modest than that.

In other words, it seems likely some underperformance is overdue for maybe even an extended period of time.

I certainly hope so.

So, while I'm not surprised that these six are doing well compared to a broad-based index (and might look very solid over a 10-20 year and longer horizon), the extent of the more recent outperformance continuing simply is not likely at all.

Still, if they do produce nice risk-adjusted returns over the very long haul, it will because these six enterprises continued to have sound core business economics and were bought at a discount to per share value in the first place.

Finally, I'd add that 3 and a 1/2 years is still not really long enough to make a meaningful judgment on relative performance.

Adam

Long position in WFC, DEO, PM, PEP, LOW, and AXP

* This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here are never a recommendation to buy or sell anything and should never be considered specific individualized investment advice. In general, intend to be long the positions noted unless they sell significantly above intrinsic value, core business economics become materially impaired, prospects turn out to have been misjudged, or opportunity costs become high.
** Includes dividends and based upon closing price on April 9th, 2009 compared to this past Friday.
*** It comes down to reliably judging business economics. Index funds will be, of course, the more logical alternative for many investors. Portfolio concentration is a disaster waiting to happen for anyone not able to reliably judge business economics. As always, awareness of individual limits is key.

Friday, October 5, 2012

Index Fund Investing

"The statistical evidence proving that stock index funds outperform between 80% and 90% of actively managed equity funds is so overwhelming that it takes enormously expensive advertising campaigns to obscure the truth from investors." - The Motley Fool

From The Little Book of Common Sense Investing by John "Jack" Bogle:

"Of the 355 equity funds in 1970, fully 233 of those funds--almost two thirds--have gone out of business. Only 24 outpaced the market by more than one percentage point a year--one out of every 14. Let's face it: These are terrible odds!."

That excerpt, and others from the book, can be found here.

This recent CNBC article, written by Dan Solin, added this view:

"Nothing gets my attention quicker than the perpetuation of what I call 'the big lie.' 

It is usually presented like this: Index based investing is fine if you are not too bright, or lazy and don't have the time to do the research, or if you are willing to settle for "average" returns. Otherwise, you should include actively managed mutual funds..."

The evidence more than just suggests that quite the opposite is true. Solin later added:

"There is no reliable way to predict which actively managed funds are likely to outperform their designated benchmarks in the future."

So...

"Don't be misled by statements indicating there is some way you can identify actively managed funds that will outperform their benchmarks prospectively."

John "Jack" Bogle was once asked this question during an "Ask Jack" Q&A:

Mr. Bogle, 

"In researching your work I don't understand one point. 

If everything you say is true regarding the relationship of fees to investment performance, where did you come up with the statistic that "passive" investing beats 90% of the active managers? 

I would think it would beat 99% of the managers!!!!!!!!"

His reponse:

"Thanks for writing. The percentage of managers outperformed by the broad market index is, well, time-dependent. On a given day, it's likely about 55%; over a year maybe 60-65%, over a decade perhaps 75-80%, and over 50 years...well, there's no data (yet!) on that!

But the probability statistics suggest that over a 50-year period, some 98% of managers will lose to the market index."

He also said this on Page 177 of Bogle on Mutual Funds:

"There is one final problem in selecting a winning manager. According to Richard A. Brealey, '...you probably need at least 25 years of fund performance to distinguish at the 95% significance level whether a manager has above average competence.'"

Some are convinced that the market is so efficient that pretty much no one can outperform. From an interview with Eugene Fama:

Question: "When is the market likely to be inefficient or to misprice securities?" 
Fama: "When it's closed..."

I'm no fan of the efficient market hypothesis (EMH), but the advantage of index funds does not come down to, as some seem to believe, how efficient markets happen to be. An index fund investor earns the market's return minus expenses whether the market is generally mispriced or not.

Passively managed index funds are just a convenient way for an investor to capture the return of a broad-based index while incurring minimal costs. Well, at least that's true if the investor doesn't attempt to trade in and out of the index. That way mistakes and frictional costs remain minimized.

Of course, there is plenty of evidence that fund investors tend to do their buying and selling at just the wrong time.*

Unfortunately, too many investors buy when stocks are expensive (when the outlook is rosiest and the good times seem likely to continue, indefinitely). They also tend to sell under the opposite conditions. In a remarkably reliable manner that's what many investors do. As a result, real world returns usually suffer materially compared to what the funds themselves deliver on an absolute and relative basis.

To me, the idea that markets are always efficient is more than a little flawed. Markets aren't necessarily efficient but they don't have to be for index based investing to make sense. Index funds do seem the right choice for many investors. The evidence is too strong to ignore or suggest otherwise.

Yet some, especially those who believe that EMH has few or no flaws, seem to take the wisdom of owning index funds to an extreme. They don't just suggest it is very difficult to do better than a market as a whole. They go further and seem to imply or assert outright it's effectively not possible to do so.

Well, those that think this way are conveniently ignoring things like what Buffett wrote in The Superinvestors of Graham-and-Doddsville and his own long-term track record. The list of investors with a long enough track record of outperformance may be a short one, but it's certainly not non-existent.

Buffett himself has expressed support for the wisdom of owning index funds as a way to gain exposure to equities.

"Most investors, both institutional and individual, will find that the best way to own common stocks (shares) is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) of the great majority of investment professionals." - From the 1996 Berkshire Hathaway Shareholder Letter

Peter Lynch has said much the same:

"Most individual investors would be better off in an index mutual fund." - Peter Lynch

Accumulating shares of a very low expense index fund over time makes a ton of sense for many investors. It's an investing approach that does tend to beat most alternatives. Yet, that reality doesn't logically lead to the conclusion no investors would be better off buying individual equities. It's a matter of knowing one's own limits.

"By periodically investing in an index fund..... the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when 'dumb' money acknowledges its limitations, it ceases to be dumb. 

On the other hand, if you are a know-something investor, able to understand business economics and to find five to ten sensibly-priced companies that possess important long-term competitive advantages, conventional diversification makes no sense for you." - Warren Buffett in the 1993 Berkshire Hathaway Shareholder Letter

It's not likely, over the long haul, that many investors will do better than low cost index funds. Yet there's a big difference between not possible and not likely.

Also, consider that buying individual stocks adds complexity to the investing process. Added complexity ought to offer a clear benefit or else that complexity is not worth the trouble. Those not realistic about whether they gain a real advantage by owning individual equities will see their returns suffer quite a lot. (Adding complexity with not only no clear benefit, but possibly even reduced returns.)

No matter what kind of investment vehicle is used, it's generally best to buy when the headlines are pretty awful. That's, of course, when the largest margin of safety is likely to be available to investors. Too many investors do just the opposite.

Whatever the right long-term investment vehicle(s) might be (it's necessarily different for each individual) the key is always to avoid the temptation to trade excessively.

Based upon trends in recent decades, it seems fair to say not many market participants will be easily convinced they should minimize their trading activities.

Adam

Related posts:
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Illusion of Skill
Buffett's Bet Against Hedge Funds, Part II
Buffett's Bet Against Hedge Funds
The Illusion of Control
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
When Genius Failed...Again

* Unfortunately, the returns investors in mutual funds achieve in the real world ends up being even worse than the funds themselves. That's not the fault of the funds. It's the result of investor behavior. Here's a good explanation by Lou Harvey, president of DALBAR, back in 2009: "...investor returns lag what performance reports and prospectuses would lead one to believe is achievable. While those returns are, in fact, theoretically achievable, the reality is that investors are not rational, and make buy and sell decisions at the worst possible moments," he said. Professional money managers certainly do, on average, underperform the S&P 500 index over the long haul. According to Vanguard founder John Bogle, from 1984 to 2002 the average mutual fund delivered a 9.3% annual return compared to the S&P 500's return of 12.2% a year. Even worse, during that same period the average fund investor, according to DALBAR, earned just 2.6% a year. 
(The average fund investor does much worse largely due to ill-timed buy/sell decisions and fund selection. In other words, a timing penalty and a selection penalty. Bogle adds why he thinks the DALBAR study might actually overstate the annual returns. See his explanation under the Is the DALBAR Study Accurate? section for more details.)
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and are never a recommendation to buy or sell anything.
 
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