Aaah, yes.  This is the page for us to share our thoughts and ideas with you, whether you like it or not!  We want to make everyone, including your editor, think intelligently.  Not surprisingly, the topics will be mostly investment focused but don't be surprised if from time to time, we stray a little from that subject.  You can expect some bold and passionate statements with a dash of controversy and perhaps some humour sprinkled in too.   Oh and probably some sarcasm, I like sarcasm.

We want to hear back from you with intelligent input, rebuttals and other positive contributions, to keep us all thinking at an intelligent level.  Through this process, we can all learn things of value.

 

 
I thought so


July 21, 2012
Reasonable Expectations

Over paying through optimistic evaluation of the current hot stocks pushes them passed being "fully priced" as there is a feeling among market participants of not wanting to miss out.  "Fully priced" means that all the potential good news and good opinion has been factored into the current price.  If a firm then falls short of any of these lofty expectations its stock price will often fall significantly and in a very short period of time, despite the company announcing what many casual observers would say are ‘spectacular results'.  This is the markets twist on the adage "What have you done for me lately?" to become "What will you do for me next?".  Here is a good example of what I mean:

Shares of Apple Computer Inc., whose popular iPods led to higher-than-expected first-quarter results, nonetheless took a beating after hours, falling $3.27, or 4 percent, to $79.22 on INET.  The stock, which has been trading near its all-time high recently, earlier closed at $82.49 on the NASDAQ.

The Cupertino, Calif., company said it earned $565 million, or 65 cents per share, compared with $295 million, or 35 cents per share, in the year-ago quarter.  Analysts were expecting earnings of 61 cents per share.  Revenue totalled $5.75 billion.

But Apple provided a more muted outlook for the fiscal second quarter, and said it expects revenue of about $4.3 billion, below the $4.63 billion analysts are looking for.  The company added it expects earnings, excluding stock option expenses, of 42 cents per share.  Analysts are expecting earnings of 48 cents per share.

NEW YORK (AP)
Aftermarket Movers: Apple Falls  January 2006

So let's review the company's results.  They earned $0.65 per share versus $0.35 in the same period one year earlier.  That is an 85.7% increase in one year.  The analysts were expecting $0.61 per share surpassing expectations by 6.6%.  The company then said it estimated its total revenue would be $4.3 billion dollars in the next quarter compared to $4.63 billion analysts were expecting, a difference of -7%.  The company also estimated that their earnings would be $0.42 per share versus analyst expectations of $0.48, a difference of -12.5%.  And what was the result on the trading price of the stock?  On the previous day the stock was trading over $86 and two weeks later it traded below $66; a drop of over 23%.

People are prone to this over optimism and over paying for a variety of reasons.  One significant reason is the overwhelming amount of short-term news that is directed at us.  If you listen to or read the market headlines frequently, you are sure to be inundated with the current hot trends or biggest disappointments.  If you base your investment decisions on these daily gyrations, you will not only end up with poor performance and high commission fees but you will also have indigestion and a lot of anxiety over your portfolio.

The market participants are always trying to discount the future performance back to an appropriate price today.  The theory behind this approach is sound but where it falls apart is in the estimation and assumptions made of future performance along with the knee jerk reactions based on the most recent financial results.  Economists and analysts tend to fall in love with the story and believe their own hype too much.  They simply become too optimistic and then price securities for this best case scenario.  As the company in question grows at an amazing pace, the bar in the market gets set higher and higher.  All the while more and more investors fall in love with the story as people focus ever more on forced promises and lofty expectations and less and less on fundamental financial information and rational, conservative expectations.  This type of action is generally driven by people not wanting to ‘miss out' on this fabulous investment.  At this point, the stock has ceased to become an investment and is now a speculation.

If you are conservative in your estimates, allow a margin of safety in your evaluation rather than a ‘best case' scenario outlook, you will be less frequently disappointed and you will avoid many of the large price declines more often because this approach keeps you away from the speculations.  This conservatism means that you won't participate in the movement of a lot of the headline names because they are frequently fully priced at levels that can only be termed ‘speculative'. 

I will say that there is nothing wrong with some speculating, as long as you are aware that you are doing exactly that!  Most investors don't know or don't believe they are speculating and that becomes a problem.  Speculating also requires you a lot more of your time and energy, not to mention your tolerance to wider swings in portfolio valuation.  Watching swings in the value of our holdings is an area of investing where many of us need serious coaching, but that topic is for another day.  In light of these factors, speculating should be avoided.

Investors on the other hand, who base their decisions on the values derived from the fundamentals of an investment, are the ones who achieve the best performance in the longer term and typically with less volatility.  Being content to stay out of these highflying headliners is a lot tougher to deal with than it sounds.  As human beings, we all feel more comfortable if we belong to a group, preferably the large, mainstream group.  Very few of us would be able to refrain from buying a high flying stock that's making headlines (think of Nortel) while watching all those other folks grin like a Cheshire cat as they watch their holdings skyrocket.

These same speculators will likely hold these securities to long on the down side to realize the huge gains they had at one point, albeit on paper.  For those of you who will be lured into the belief that you can trade and beat the market (while millions can't) remember that speculating is exactly like golf; it looks like fun, it seems simple and it feels great when you get it right.  But how many of us can actually play a par round?  If you can, how long did it take you to learn to consistently play that well?

The point here is simple; do not get carried away and pay too much for potential.  Stay focused on the price that you pay for what you are getting now and only a moderate valuation for what you are ‘reasonably likely' to get in the future.  What we really want to do is go bargain hunting for investments.  And why not!  Most of us shop around for a bargain on a TV or a car and we most certainly want a good deal on a house.  So why would you not be just as prudent about your stock investments?

 

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January 14, 2012
Personal Improvements

Only passions, great passions, can elevate the soul to great things.

Denis Diderot (1713 - 1784)

 

Do more than what is asked of you. 

Chronic underperformers provide the minimum amount of service that is asked or required.  Some do considerably less.  Average people generally provide just what is asked of them but seldom go that extra step.  Great people deliver more than what is asked of them and they generally do it with a contagious enthusiasm. 

We all know people that fit each of these descriptions in our personal lives as well as our business lives.  I have lived with someone who fit each of those categories at various times.  I see the silly bugger every morning, looking at me in the mirror.  On the days that I look back at him and wonder what I think and feel about him, I find I have the highest thoughts and greatest admiration for him when he has chosen to be an over achiever.  And being an over achiever is not that difficult when you really think about it.  It only requires you to be slightly above average.  We all have the ability to be above average. 

Many of us have heard of the expression “giving 110%”.  It’s impossible to give more than we can and I don’t think many us can work at maximum capacity all the time.  In fact, our goal is often to do just what is asked of us and no more.  I typically do just enough so I don’t get into too much trouble.  

What do you think would happen if we changed our ways just a little and reworked the “giving 110%” expression to mean; “I will give 110% of what is asked of me”.  This only requires minimally more effort with the outcome being above average results. 

Chronic underperformers are like water; always taking the path of least resistance.  Whenever they have a choice of tasks to do they inevitably do what is easiest because they are either lazy or more likely, just can’t see the benefit of putting out more effort.  The benefits are there, I assure you.  They just aren’t instantaneous.  Worthwhile achievements take substantial effort.  That may seem obvious to some but if it doesn’t, then read that last statement again.  

If you adopt this philosophy, your productivity and efficiency will increase in your personal and your business life.  By giving your manager, co-workers, friends and family just a little bit more than the basics, you will quickly come to be known as an above average achiever and held in high regard by those you have served.  You will be more likely to get that raise or praise you’ve been looking for at work and you’ll gain more admiration from the people in your personal life.  Something else you’ll notice as you make that tiny bit more effort; your opinion of yourself will increase too.  You will be prouder and more confident as you see the positive effects that this subtle change will have on all aspects of your life.

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January 11, 2012
Warren Buffett Quote

"Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway." - Warren Buffett

This is one of my all time favourite quotes from Warren Buffet.  He has great logic that has served him and Berkshire Hathaway shareholders well over these many years.  The point here is to remember that people you 'advise' you are often in a less enviable position than you and are frequently selling something to you disguised as advice. Caveat emptor.

 

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January 10, 2012
Buffett Quote...

Warren Buffett said: If a business does well, the stock eventually follows.

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T Bill

Jan-11 10:26pm

The point being, buy a good company and the results in the form of the stock appreciating are sure to develop!


January 10, 2012
Things I like to read.

At the end of this paragraph is a link to a site that I find incredibly insightful.  It is an intelligent, rational and logical business-like assessment of the markets, valuations and investment approaches given various conditions.  This link is to a page of a very helpful report where you will bluntly be told by Ed Easterling that you will not find investment success if you go sailing when the forecast is for no wind.  After you read “The P/E Report” by Ed Easterling of Crestmont Research, you will be adequately informed about the approach you currently need to take with your investments and why we take the approach to investing that we do.  Enjoy learning.  http://www.crestmontresearch.com/docs/Stock-PE-Report.pdf

-       Lars Borghardt

 

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January 5, 2012
What have I done?

I am writing this blog as much for my sake as I am for yours. I figure that if I write out my observations then I will benefit and learn as much as anyone.  This particular note is because I recently didn’t hedge a position after some reasonable gains as I had planned because...........I “hoped” for a little more upside before I hedged.

One of the reasons I prefer a hedging strategy is because of my emotional make up; I don’t like to lose money.  While I may limit my upside potential by hedging I also reduce my downside pain, which to me, is far more important.

This morning my position lost some value but more importantly, I noticed how that made me feel; crappy.  I didn’t follow my strategy.  I got that uncomfortable feeling in my stomach and realized that I messed up, more so emotionally than monetarily.  My biggest loss was that of my mental capital which is a resource more scarce than my monetary capital.  To confirm what I mean and to see if this applies to you then do this simple test; write down how you feel about your portfolio when it goes up in value and then when it goes down in value.  For many of us, the discomfort of having our portfolio’s value decrease far outweighs the comfort we feel when our portfolio’s value appreciates.  You can take this observation one step further for hedging; observe how you feel when you missed out on further gains versus when you lost more than you needed to.  Which feelings are more intense? The satisfaction of seeing more gains in your portfolio or the pain of seeing avoidable losses?  This exercise will help you be more comfortable with your investments.

As many before me have written, when we invest, our emotions swing like a pendulum between levels of greed and fear.  And of the two, fear is much more powerful and therefore harder on us emotionally.  This is a key non-monetary benefit to hedging; it’s easier on us emotionally.

Try not to make this same mistake and I will do the same.

 

Cheers.

-Lars Borghardt

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January 3, 2012
Is buy & hold dead? Should I be trading?
 

This is an enjoyable article with some very interesting facts.  A little bit astonishing regarding the insider trading by politicians and a good section about whether or not you should be active and trade your portfolio or be lazy and use the 'buy & hold' approach.  I have my own thoughts on this subject but most of you can guess my choice.  Read this article to help enlighten yourself further on this subject.

http://www.marketwatch.com/story/lazy-portfolios-lose-to-senators-hedge-fund-2012-01-03?pagenumber=2 

 

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December 28, 2011
Diversification

 

Diversification – Definition 

1.     To give variety to; vary: diversify a menu.

2.     To extend (business activities) into disparate fields.

3.     To distribute (investments) among different companies or securities in order to limit losses in the event of a fall in a particular market or industry.  (http://dictionary.reference.com/)

A portfolio strategy designed to reduce exposure to risk by combining a variety of investments, such as stocks, bonds, and real estate, which are unlikely to all move in the same direction. The goal of diversification is to reduce the risk in a portfolio. Volatility is limited by the fact that not all asset classes, industries, or individual companies move up and down in value at the same time or at the same rate. Diversification reduces both the upside and downside potential and allows for more consistent performance under a wide range of economic conditions.  (http://www.investorwords.com/)
 
Diversification.  We all know what it is and the fact that we need it but many of us are uncertain when we need to decide how much we need for our portfolios.  If your subscription to BOTD is your sole source of investment advice and you follow the guidance provided, will you have a prudent amount of diversification?  After all, we are only selecting form a list of 30 companies.  Fair question.  The answer is a resounding, yes!  I can say that with complete confidence because, what you must realize, is that the list of thirty companies we are choosing from has already been analyzed and met investment quality and diversification requirements.  The complete list is a proxy for the US market, at least for the large capitalized companies.  From that list of investment quality companies, we are recommending the top companies for you to invest in based on their intrinsic value relative to their quoted price.
 
Many investment professionals will have different answers regarding the required level of portfolio diversification.  You must keep in mind why you are diversifying.  For that answer, go back and read definition 3.  As with many things, the devil is in the details.  You are diversifying to reduce risk.  BUT what type of risk?  Keep in mind that no matter what you do, you cannot diversify away all risk.  Simply put, business and investing, like life, is full of risks and all different kinds.  There are absolutely no guarantees anywhere, regardless of what the ads say.  What you need to focus your energies on is increasing your chances of success by investing in companies that  are simple to understand, have a good operating history and favorable prospects with good management and can be purchased at a significant discount to their intrinsic value.   If this is done successfully then you will have reduced the risk of investing in a business failure. Other risks will still likely be very real.  Decide what risks you are prepared to accept and avoid the ones you are not.  Sorry if that seems blunt but there is no magic answer.

When you are deciding how much to diversify, we would suggest some basic questions for you to answer:

How many different investments can I competently follow?

    • Do I understand what I invested in?
    • How much overlap is there in my investment positions?
    • Do I have enough diversification to spread out risk?
    • Do I have too much diversification to realize favourable results?

This is not a definitive list but simply some key points for your consideration.

If you listen to or read the money managers in the various general media outlets and try to follow their advice then you will find yourself investing in everything!  Do you think that is necessary?  I sure don’t.  It’s not practical either. 

Your initial ideas of investing likely included investing mutual funds, stocks, bonds and real estate.  As your research expanded, you probably learned about commodities like gold and silver.  That realization expanded your knowledge to include other precious metals, rare earth metals, pork bellies, orange juice, coffee, wheat, etc..  Whoa! That may have seemed a bit to exotic and overwhelming for you, so you went back to deciding about bonds. 

That’s simple, right?  There are T-Bills, commercial paper, government and corporate bonds.  Seems simple.  Did you include the high yield category and having to decide what duration of bonds you need?  And of course there are still convertibles to consider.

So now you’re thinking you’ll stick to just stocks and mutual funds.  Ok, but of course your research will guide you to include large, mid and small caps.  Then you’ll need to make sure you cover of the various sectors; consumer discretionary, consumer staples, energy, financials, health care etc.. 

And last but not least, you’ll be told to diversify away currency risk.

In case your thinking it’s all to confusing and you’ll do nothing and be safe, think again.  There is always inflation risk.  Ignoring inflation will make certain that you will have less later than what you have now.

While I have just provided you with a broad list of choices and corresponding risks, it is by no means all-inclusive.  It does illustrate that you need to make some decisions.  Since you can’t cover all the choices I suggest that you construct a simple portfolio that you can understand, have the time to monitor and lets you sleep comfortably.

It’s right to diversify your investments, because if you only hold one investment and it turns out poorly then you are in big trouble.  If that poor investment is only one of several then it becomes less troublesome and less of a serious concern to your total portfolio performance.  No matter how much research and analysis is done, you can’t be completely certain of any one single investment turning out favorably and statistics show that everyone is bound to end up with the occasional underperformer in their portfolio.  If Warren Buffet and Charlie Munger have bought some stinkers then the rest of us are likely to buy some not so great investments as well.

So how much diversification is the right amount?  That depends. A terribly safe answer, isn’t it?  In my humble opinion, the amount only depends on your level of comfort and confidence in your investments. 

It is a fact that the lower the number of investments you have in your portfolio the more volatile it is likely to be.  However, volatility is not necessarily a bad thing.  Warren Buffet, in many of his letters to shareholders has frequently stated “I would much rather earn a lumpy 15% over time than a smooth 12%”.  If you are confident in your purchases then the dips present a nice buying opportunity.  Besides, volatility is only the measure of the movement of a security’s quoted price, not its actual value.  And if you are holding a stock for the income that it generates for you then the price movement of that stock should concern you even less. 

Benjamin Graham said that you should have a minimum of ten and a maximum of perhaps thirty common stocks in your portfolio.  Consensus amongst modern finance authors and instructors is that the majority of market risk is diversified at a level of approximately twenty holdings and that anything over forty holdings provides no measurable benefit regarding diversification.  There is much written on this subject but despite the all efforts there is no definitive answer. 

I would suggest to you that the answer depends on several factors including; the size of your portfolio, your comfort level concerning volatility, the amount of time and ability you have for research and monitoring of investments as well as the level of confidence you have in your investments.

But does that mean that any more is counterproductive?  Does that mean that less is irresponsible? 

There are valid points in the debate over diversification.  There are some, like Philip A. Fisher, another extremely successful and highly regarded investor, that believe that you should not have more than about 10 investments in your portfolio for some very sound reasons.  One main argument is that Mr. Fisher believes investors use diversification as an attempt to cover up their level of guesswork in constructing their portfolios.  The argument is that an investor should be more thorough and rational in his/her decision and only invest when they are completely confident in the quality of the investment.  Once the investor is confident in the prospects of the investment, he/she should invest heavily in the few investments that they are so confident about rather than sprinkle their funds over a larger number of investments that they are guessing about.  Mr. Fisher strongly believes that large diversification is a sign of incompetence.  Warren Buffet’s long time partner Charlie Munger, concurs by investing in a concentration of well-chosen holdings that he knows very well.  Charlie has on occasion stated that the quantity of an investor’s holdings rises in proportion with his/her level of uncertainty and incompetence.

The time argument is one of a fairly practical nature; it is increasingly more difficult and time consuming to properly learn about the business of each company, monitor their operations and evaluate their performance and valuation as you include more and more companies in your portfolio.

As a polar opposite example, Peter Lynch, a famous and successful mutual fund manager at Fidelity Investments, managed his fund to an average annual return of 29.2% from 1977 to 1990.  When he resigned, his fund had over 1000 individual positions.

Please remember that you can’t diversify all risk and nor do you want to.  The risk you should take on is that of any other business owner, since your investment has now made you a part owner of that business.

One other seemingly obvious point about diversification must be mentioned.  Simply having a large number of investments does not provide you with adequate diversification.  If an investor has holdings in thirty-two clothing store chains then, despite the number of holdings, they are not adequately diversified.  Diversification means not only holding investments in a broad number of investments but also that those investments are from a broad range of different industries.  Most investors are aware of the fact that different industries perform better at different times and so it would benefit you to hold a range of investments across a number of industries at any given time.  This will allow you to benefit from these favorable conditions when they arise.  So if you know someone who has six mutual funds and they are all invested in USA Blue Chip equities then you can confidently explain to then that they are not properly diversified and wisely recommend they should have a look at one of Helden Wealth’s services at www.heldenwealth.com to address the problem and save money too.  What a brilliant and shameless plug!

So what should an intelligent investor do?  Do what you’re comfortable with.  The central point is that you don’t need to (and you physically can’t) invest in everything.  When you read the attached copy of “The Superinvestors of Graham and Doddsville”, you will have excellent guidance to your answer. 

 

And from the best...

Theory of Diversification 

                ' There is a close logical connection between the concept of a safety margin and the principle of diversification.  One is correlative with the other.  Even with a margin in the investor’s favor, an individual security may work out badly.  For the margin guarantees only that he has a better chance for profit than for loss – not that loss is impossible.  But as the number of such commitments is increased the more certain does it become that the aggregate of the profits will exceed the aggregate of the losses.  That is the simple basis of the insurance underwriting business. 

                Diversification is an established tenet of conservative investment.  By accepting it so universally, investors are really demonstrating their acceptance of the margin of safety principle, to which diversification is the companion.  This point may be made more colorful by a reference to the arithmetic of roulette.  If a man bets $1 on a single number, he is paid $35 profit when he wins – but the chances are 37 to 1 that he will lose.  He has a “negative margin of safety”.  In his case, diversification is foolish.  The more numbers he bets on, the smaller his chances of ending with a profit.  If he regularly bets $1 on every number (including 0 and 00), he is certain to lose $2 on each turn of the wheel.  But suppose the winner received $39 profit instead of $31.  Then he would have a small but important margin of safety.  Therefore, the more numbers he wagers on, the better his chances of gain.  And he could be certain of winning $2 on every spin by simply betting $1 each on all the numbers. '

The Intelligent Investor, Benjamin Graham

Page 282-283

 

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