I love Mr. Lewis's book "Moneyball", and his latest commentary from bloomberg is quite an entertaining one on some supposedly Goldman Sachs rumors.
Rumor No. 1: “Goldman Sachs controls the U.S. government.”
Rumor No. 2: “When the U.S. government bailed out AIG, and paid off its gambling debts, it saved not AIG but Goldman Sachs.”
Rumor No. 3: “As the U.S. government will eat the losses if Goldman Sachs goes bust, Goldman Sachs shouldn’t be allowed to keep making these massive financial bets. At the very least the $11.4 billion Goldman Sachs already has set aside for employees in 2009 -- $386,429 a head, just for the first six months -- is unfair, as the U.S. taxpayer has borne so much of the risk of the wagers that generated the profits.”
Rumor No. 4: “Goldman employees all look alike.”
Rumor No. 5: Goldman Sachs is “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”
I enjoy his explanation to rumor No. 2 the most.
The full article is at http://bloomberg.com/apps/news?pid=20601039&sid=a2X3hNaWcbeg
2009/07/28
Philip Fisher's 15 Points - Common Stocks and Uncommon Profits
I feel foolish for not reading this book earlier in my investing career. "Common Stocks and Uncommon Profits" by Philip Fisher is by far one of the best books on investment. The book was published in the 1950's, but honestly I could not tell a difference because the information in the book is just as relevant today as it was some 50 years ago.
I am borrowing the list from a Morningstar article about Mr. Fisher's 15 points on a worthwhile investment (I will go into more detail and apply the principles in future articles).
1. Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years? A company seeking a sustained period of spectacular growth must have products that address large and expanding markets.
2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited? All markets eventually mature, and to maintain above-average growth over a period of decades, a company must continually develop new products to either expand existing markets or enter new ones.
3. How effective are the company's research-and-development efforts in relation to its size? To develop new products, a company's research-and-development (R&D) effort must be both efficient and effective.
4. Does the company have an above-average sales organization? Fisher wrote that in a competitive environment, few products or services are so compelling that they will sell to their maximum potential without expert merchandising.
5. Does the company have a worthwhile profit margin? Berkshire Hathaway's BRK.B vice-chairman Charlie Munger is fond of saying that if something is not worth doing, it is not worth doing well. Similarly, a company can show tremendous growth, but the growth must bring worthwhile profits to reward investors.
6. What is the company doing to maintain or improve profit margins? Fisher stated, "It is not the profit margin of the past but those of the future that are basically important to the investor." Because inflation increases a company's expenses and competitors will pressure profit margins, you should pay attention to a company's strategy for reducing costs and improving profit margins over the long haul. This is where the moat framework we've spoken about throughout the Investing Classroom series can be a big help.
7. Does the company have outstanding labor and personnel relations? According to Fisher, a company with good labor relations tends to be more profitable than one with mediocre relations because happy employees are likely to be more productive. There is no single yardstick to measure the state of a company's labor relations, but there are a few items investors should investigate. First, companies with good labor relations usually make every effort to settle employee grievances quickly. In addition, a company that makes above-average profits, even while paying above-average wages to its employees is likely to have good labor relations. Finally, investors should pay attention to the attitude of top management toward employees.
8. Does the company have outstanding executive relations? Just as having good employee relations is important, a company must also cultivate the right atmosphere in its executive suite. Fisher noted that in companies where the founding family retains control, family members should not be promoted ahead of more able executives. In addition, executive salaries should be at least in line with industry norms. Salaries should also be reviewed regularly so that merited pay increases are given without having to be demanded.
9. Does the company have depth to its management? As a company continues to grow over a span of decades, it is vital that a deep pool of management talent be properly developed. Fisher warned investors to avoid companies where top management is reluctant to delegate significant authority to lower-level managers.
10. How good are the company's cost analysis and accounting controls? A company cannot deliver outstanding results over the long term if it is unable to closely track costs in each step of its operations. Fisher stated that getting a precise handle on a company's cost analysis is difficult, but an investor can discern which companies are exceptionally deficient--these are the companies to avoid.
11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition? Fisher described this point as a catch-all because the "important clues" will vary widely among industries. The skill with which a retailer, like Wal-Mart WMT or Costco COST, handles its merchandising and inventory is of paramount importance. However, in an industry such as insurance, a completely different set of business factors is important. It is critical for an investor to understand which industry factors determine the success of a company and how that company stacks up in relation to its rivals.
12. Does the company have a short-range or long-range outlook in regard to profits? Fisher argued that investors should take a long-range view, and thus should favor companies that take a long-range view on profits. In addition, companies focused on meeting Wall Street's quarterly earnings estimates may forgo beneficial long-term actions if they cause a short-term hit to earnings. Even worse, management may be tempted to make aggressive accounting assumptions in order to report an acceptable quarterly profit number.
13. In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders' benefit from this anticipated growth? As an investor, you should seek companies with sufficient cash or borrowing capacity to fund growth without diluting the interests of its current owners with follow-on equity offerings.
14. Does management talk freely to investors about its affairs when things are going well but "clam up" when troubles and disappointments occur? Every business, no matter how wonderful, will occasionally face disappointments. Investors should seek out management that reports candidly to shareholders all aspects of the business, good or bad.
15. Does the company have a management of unquestionable integrity? The accounting scandals that led to the bankruptcies of Enron and WorldCom should highlight the importance of investing only with management teams of unquestionable integrity. Investors will be well-served by following Fisher's warning that regardless of how highly a company rates on the other 14 points, "If there is a serious question of the lack of a strong management sense of trusteeship for shareholders, the investor should never seriously consider participating in such an enterprise."
I am borrowing the list from a Morningstar article about Mr. Fisher's 15 points on a worthwhile investment (I will go into more detail and apply the principles in future articles).
1. Does the company have products or services with sufficient market potential to make possible a sizable increase in sales for at least several years? A company seeking a sustained period of spectacular growth must have products that address large and expanding markets.
2. Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited? All markets eventually mature, and to maintain above-average growth over a period of decades, a company must continually develop new products to either expand existing markets or enter new ones.
3. How effective are the company's research-and-development efforts in relation to its size? To develop new products, a company's research-and-development (R&D) effort must be both efficient and effective.
4. Does the company have an above-average sales organization? Fisher wrote that in a competitive environment, few products or services are so compelling that they will sell to their maximum potential without expert merchandising.
5. Does the company have a worthwhile profit margin? Berkshire Hathaway's BRK.B vice-chairman Charlie Munger is fond of saying that if something is not worth doing, it is not worth doing well. Similarly, a company can show tremendous growth, but the growth must bring worthwhile profits to reward investors.
6. What is the company doing to maintain or improve profit margins? Fisher stated, "It is not the profit margin of the past but those of the future that are basically important to the investor." Because inflation increases a company's expenses and competitors will pressure profit margins, you should pay attention to a company's strategy for reducing costs and improving profit margins over the long haul. This is where the moat framework we've spoken about throughout the Investing Classroom series can be a big help.
7. Does the company have outstanding labor and personnel relations? According to Fisher, a company with good labor relations tends to be more profitable than one with mediocre relations because happy employees are likely to be more productive. There is no single yardstick to measure the state of a company's labor relations, but there are a few items investors should investigate. First, companies with good labor relations usually make every effort to settle employee grievances quickly. In addition, a company that makes above-average profits, even while paying above-average wages to its employees is likely to have good labor relations. Finally, investors should pay attention to the attitude of top management toward employees.
8. Does the company have outstanding executive relations? Just as having good employee relations is important, a company must also cultivate the right atmosphere in its executive suite. Fisher noted that in companies where the founding family retains control, family members should not be promoted ahead of more able executives. In addition, executive salaries should be at least in line with industry norms. Salaries should also be reviewed regularly so that merited pay increases are given without having to be demanded.
9. Does the company have depth to its management? As a company continues to grow over a span of decades, it is vital that a deep pool of management talent be properly developed. Fisher warned investors to avoid companies where top management is reluctant to delegate significant authority to lower-level managers.
10. How good are the company's cost analysis and accounting controls? A company cannot deliver outstanding results over the long term if it is unable to closely track costs in each step of its operations. Fisher stated that getting a precise handle on a company's cost analysis is difficult, but an investor can discern which companies are exceptionally deficient--these are the companies to avoid.
11. Are there other aspects of the business, somewhat peculiar to the industry involved, which will give the investor important clues as to how outstanding the company may be in relation to its competition? Fisher described this point as a catch-all because the "important clues" will vary widely among industries. The skill with which a retailer, like Wal-Mart WMT or Costco COST, handles its merchandising and inventory is of paramount importance. However, in an industry such as insurance, a completely different set of business factors is important. It is critical for an investor to understand which industry factors determine the success of a company and how that company stacks up in relation to its rivals.
12. Does the company have a short-range or long-range outlook in regard to profits? Fisher argued that investors should take a long-range view, and thus should favor companies that take a long-range view on profits. In addition, companies focused on meeting Wall Street's quarterly earnings estimates may forgo beneficial long-term actions if they cause a short-term hit to earnings. Even worse, management may be tempted to make aggressive accounting assumptions in order to report an acceptable quarterly profit number.
13. In the foreseeable future will the growth of the company require sufficient equity financing so that the larger number of shares then outstanding will largely cancel the existing stockholders' benefit from this anticipated growth? As an investor, you should seek companies with sufficient cash or borrowing capacity to fund growth without diluting the interests of its current owners with follow-on equity offerings.
14. Does management talk freely to investors about its affairs when things are going well but "clam up" when troubles and disappointments occur? Every business, no matter how wonderful, will occasionally face disappointments. Investors should seek out management that reports candidly to shareholders all aspects of the business, good or bad.
15. Does the company have a management of unquestionable integrity? The accounting scandals that led to the bankruptcies of Enron and WorldCom should highlight the importance of investing only with management teams of unquestionable integrity. Investors will be well-served by following Fisher's warning that regardless of how highly a company rates on the other 14 points, "If there is a serious question of the lack of a strong management sense of trusteeship for shareholders, the investor should never seriously consider participating in such an enterprise."
2009/07/20
Diversification is the golden rule?
When it comes to investing, people often question whether they have enough diversification.
"Concentration to create wealth" and "Diversification to preserve wealth" is my usual response. I am not sure where I got those ideas from, but the following from Warren Buffett's letter to shareholders in 1991 is an excellent illustration on this topic.
The true question then becomes how strong is your willingness to create wealth, and do you understand the implications behind that. In addition, how do you know that your full confidence is not a sense of illusion. The principle of "Margin of Safety" is really the best discipline tool one can use (Simple example: buy asset for 50 cents when it is worth a dollar).
With a margin of safety, the probability of investment success is at a higher percentage but by no mean a guarantee. Just as someone who holds a pair of aces before the flop in a poker game does not guarantee him/her a winner of that round. But by being selective, over the long term, concentrating on good starting hands will eventually pay off more significantly than trying to pick the pots with many marginal hands.
"Concentration to create wealth" and "Diversification to preserve wealth" is my usual response. I am not sure where I got those ideas from, but the following from Warren Buffett's letter to shareholders in 1991 is an excellent illustration on this topic.
If my universe of business possibilities was limited, say, to private companies in Omaha, I would, first, try to assess the long-term economic characteristics of each business; second, assess the quality of the people in charge of running it; and, third, try to buy into a few of the best operations at a sensible price. I certainly would not wish to own an equal part of every business in town. Why, then, should Berkshire take a different tack when dealing with the larger universe of public companies? And since finding great businesses and outstanding managers is so difficult, why should we discard proven products?
John Maynard Keynes, whose brilliance as a practicing investor matched his brilliance in thought, wrote a letter to a business associate, F. C. Scott, on August 15, 1934 that says it all: "As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one's risk by spreading too much between enterprises about which one knows little and has no reason for special confidence. . . . One's knowledge and experience are definitely limited and there are seldom more than two or three enterprises at any given time in which I personally feel myself entitled to put full confidence."
The true question then becomes how strong is your willingness to create wealth, and do you understand the implications behind that. In addition, how do you know that your full confidence is not a sense of illusion. The principle of "Margin of Safety" is really the best discipline tool one can use (Simple example: buy asset for 50 cents when it is worth a dollar).
With a margin of safety, the probability of investment success is at a higher percentage but by no mean a guarantee. Just as someone who holds a pair of aces before the flop in a poker game does not guarantee him/her a winner of that round. But by being selective, over the long term, concentrating on good starting hands will eventually pay off more significantly than trying to pick the pots with many marginal hands.
2009/07/03
Behavioral Finance 001
Here is an interesting chart from a study done in 2002 where two groups of professionals are asked to predict some near-term future outcome. One group of analysts are asked to predict the level of S&P 500 in the next month and half. Another group of weather men are asked to predict the average temperature in April for a location (about same one month and half time frame).
Each group are given three mutually exclusive and collectively exhaustive selections of greater than X, between X and Y, and less than Y. A sensible human being, from a mathematical perspective would have a confidence level of 33% (1/3 chance to be correct). Yet, the average level of confidence was about 58% for analysts and 49% for weather men, suggesting overconfidence in our ability may be a nature tendency.
What's more interesting is from the group of respondents that incorrectly predict the outcome. As a side note, about 1/3 of the analysts made the correct choice and about 2/3 of weather men did so as well. Participants who made incorrect forecast are asked for a reason for their inaccuracy. Interestingly enough, none of the analysts mentioned the outcome as lack of experience or insufficient data. Most attributed to the "single prediction" and “ceteris-paribus” defense mechanisms (definition below).
To be a better investor, I think it's more important to understand one's own emotional strengths and stay honest to one's own action than to crunching analysis. The issues mentioned here seems trivial but are very difficult to overcome. The following is a good checklist to remind our brain every once in awhile.
Optimism and Overconfidence:
- Optimism
Well documented trait among young individuals who feel the odds of something bad occurring in their lives are very low or even non-existent. Example: Young adults are far more likely to become disabled than they are of dying, yet the vast majority does not carry disability insurance.
- Overconfidence
People tend to place too much confidence in their ability to predict. They tend to systematically underestimate the risk, which lead to higher probability of surprises.
- Increased Trading
Belief that you can interpret information better than the average investors and often leads to undiversified portfolios.
- Overconfidence in Forecasters
Primary factor leading to overconfidence in professionals is knowledge (education or experience). They feel their forecasts are based upon skill (i.e., an illusion of knowledge)
Forecast defence mechanisms
1. The “if-only” defence.
2. The “ceteris-paribus” defence.
3. The “almost-right” defence.
4. The “it hasn’t happened yet” defence.
5. The “single predictor” defence.
Examples from financial-education.com:
“The “if only” defense says their forecast would have been correct if the advice or analysis they had provided had been followed. This defense is popular because it cannot be proven wrong since historical events will seldom follow a specific analysis. However, the basis of the original forecast was presumably to predict the likely outcome, not the outcome if a certain set of actions occurs. A conditional forecast should also outline the consequences of conditions varying from those set out.
The “ceteris paribus” defense says something interfered with the original forecast. “They would have gone bankrupt but their competitor bought them out.”
The “I was almost right” defense says the forecast almost happened. This applies primarily to averted catastrophes. “Long-term Capital Management’s collapse almost brought down the entire financial system.” If one was predicting the collapse of the financial system, close doesn’t count.
The “it just hasn’t happened yet” defense says the next hedge fund collapse will be the one that brings down the financial system. Either that, or the one following it.
The “single prediction” defense acknowledges that the conditions of the forecast were met but the prediction was still incorrect. However, forecasts are pointless so don’t hold it against the analysis that led to the forecast.”
Loss Aversion:
Individual’s reluctance to accept a loss. A stock may be down considerable from its purchase price, but the investor holds on to it hoping that it will recover. Loss aversion can also lead to risk-seeking behavior.
Reference:
Hersh Shefrin, Portfolios, Pyramids, Emotions, and Biases
James Montier, Behavioural Investing
Schweser CFA Level III Notes
http://financial-education.com/2007/09/09/ego-defense-mechanisms/
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