Tag Archives: fn-end

The Worst Price And Long-Term Bargains

Originally published on Dec. 21, 2014 Professional investors and their political economies are very much interested in the price discovery functions of the securities and commodity markets. Prices translate into performance. Unfortunately, past performance leads to future individual investment decisions and asset allocations. In viewing the results for any given year, the last or terminal price plays an important role in the calculation of the resulting performance. Thus the December 31st (and to a much lesser extent June 30th) prices play a disproportionate role in the calculation that produces rankings, bonuses and job longevity. (Our actuarial friends would prefer multiple-date averaging calculations to “Last Trade on Last Day” as a better representative to what was happening.) For 2014 in particular, I suspect the quality of the last prices will be weak. Due to restrictions as to the size and deployment of capital on various trading desks, the normal capital absorption capacity will be limited. Further, many organizations have already determined the size of gains and losses that they wish to sustain for the year. Thus there will be less buying power available on the last trading day of the year. Remember, the absolute final price on the last increment of trading will determine performance. In some prior years we saw a concerted effort on the part of performance players to ramp up prices of what they held in the last hour of trading. In some extreme cases there were efforts through short sales and other techniques to lower important prices for securities owned by specific competitors. Ahead to December 31, 2014 At the moment I expect a slow year-end day, but I am prepared for a spike in either direction on the last day which could be well reversed on the first trading day of 2015. In a relatively dull performance year the level of distortion is likely to be 1% or under. From a performance analysis viewpoint I will pay more attention to year-to-date performance through November and/or the latest twelve month performance through the end of January, 2015. These mathematical machinations have some value in managing portfolios that have limited duration found in operational and some shorter-term replenishment portfolios. It should have no impact on decisions for endowment and legacy portfolios. These refer to our Timespan L Portfolios™, which are segmented by investment period focus. Better performance warnings After a week when some of our holdings from bottom to top gained 5%+, for example T Rowe Price (NASDAQ: TROW )*, I start to get nervous about rising volume sucking in sidelined cash. (NASDAQ OMX* stock volume almost tripled from 773,829 shares to 2,225,599 shares in two days.) These reactions need to be put into perspective. My old firm, now known as Lipper Inc., produces a daily index for each of 30 equity investment objectives. The components of these indices in the more numerous groups are the thirty largest funds. In the smaller groups the number of components can be as small as ten. Examining the performance roster I noticed the large-caps were up 10%, multi-caps 9-10%, mid-caps slightly under 8%, and the small-caps 1.7%. What this suggests to me is that in a period of declining liquidity, institutional investors continued their large-cap affection. Small-caps were the best performing investment objective asset based group in 2013, demonstrating their recovery potential. The first warning in terms of a possible blow off will be when small-caps become once again performance leaders and the investing public throws an extra $100 billion+ into small caps which can happen. The second warning is excessive focus on market capitalization as a screen for choosing investments. I note that on a five year compound annual growth rate basis there is little to separate the different investment objective groups’ performance; the entire range for these indices was a low of 13.92% for large-cap value, to a high of 15.77% for multi-cap growth funds. This narrow performance spread reminds me of one of the phrases that I learned at New York racetracks: one could throw a blanket over the leading horses at a heated finish line. In other words, even with all the traditional handicapping skills, the results of close races can not be successfully predicted. I would suggest that if in the future we have another five year like the last, investors should be pleased to be under the blanket of a 13.92% to 15.77% performance range, and not try too hard to pick the single best winner. Target Date funds may not be optimal There is another factor that may change the level of flows going into equities. The most popular inclusion in many 401(k) and similar plans are Target Date funds. The plans that are adopting these relatively new vehicles would be doing their beneficiaries a favor if they instead had chosen the mutual fund industry’s original product which was the Balanced fund where the managers made investment allocations between stocks, bonds and cash based on their outlook. Lipper Inc. has 12 indices of Target Date funds broken down largely by maturity or retirement dates with performance on a year-to-date basis of +4 to +5%. None of them has done as well as the Lipper Balanced Fund Index gain of +7.03%. In the right hands, most potential retirees would be better off in a Balanced fund. Often the better performance of a Balanced fund is due to its investment into reasonably high quality equities. Benefiting from discontinuous forecasting I have often said that I can and want to learn from smart people, thus I read Howard Marks’s letters. Howard is the very smart Chairman of Oaktree Capital and an old friend. He devoted his latest insightful letter to what can be learned from the current decline in the price of oil. He focuses on the failure of most forecasts of the price of oil. These failures created what Wall Street Journal columnist Jason Zweig has called the “Petro Panic” which dropped stock and bond markets globally. Howard focused on the fact that oil price predictions were extrapolations of the past, adjusted perhaps by plus or minus 20%. This is similar to most predictions coming out of the financial community. I would suggest that these are not really helpful on two grounds. Most often the impact of the forecast is already in the price of the stock or bond in question. In addition, big money is only earned or lost when the old model is disrupted. Three long-term items on my screen In our Time Span Portfolios approaches, the final portfolio which is the Legacy Portfolio is expected to include securities from various successful disruptors. While there is a place at the right time and price for investing in secular growers, they are not usually the sources of extraordinary gains. These are what I like to find. I do not have the same scientific background as many of my fellow Caltech Trustees; therefore it is unlikely that I will invest client money on the basis of what is in a laboratory. I need to enter into the process later when my reading and some of my contacts can guide me in the right direction. Let me share three examples that I am looking into: 1. The first is the global shortage of retirement vehicles. Almost no nation has sufficient retirement capital in private hands to meet the increasing retirement needs of large portions of its population. Europe is particularly troubled or should be with more people going into retirement, living longer, and fewer competent workers. I believe some of these needs can and hopefully will be met by mutual funds sold wisely to the public. Two of the investments in our financial services private fund portfolio address these needs. Both Franklin Resources (NYSE: BEN )* and Invesco (NYSE: IVZ )* have strong retail and institutional distribution in Europe as well as in Asia. Their current stock prices are based on the perceived value of their present business and are paying little to nothing for their potential. At some point I believe either or both will show more earnings power internationally than domestically. *Securities held personally and/or by the private financial services fund I manage 2. The second item is one that I have only a tiny direct exposure; it is an expected exponential growth in the service sector within China and some of its neighbors. 3. The third potential actually ties back to the concerns created by the Petro Panic that is the announced long-term strategy of Toyota to get rid of gasoline cars. I am trying to determine what else will be needed as people change their driving habits. Disclosure: Holdings in TROW, BEN, IVZ.

A Contrary Play For The Patient Investor In 2015

Summary For investors who are looking for inexpensively valued stocks that may be poised to benefit from mean reversion, energy stocks are now on the radar for a rebound in 2015. There are many factors that influence the outlook of energy stocks, but valuation and the price of oil are two places to start. Oil prices had a material decline in 2014. At the same time, energy stocks are showing inexpensive valuation based on their price-to-book-value ratio. By Nick Kalivas The recent plunge in oil prices has created a dramatic re-pricing of stocks in the energy sector. For investors who are looking for inexpensively valued stocks that may be poised to benefit from mean reversion (the theory that stocks move toward their average price over time), energy stocks are now on the radar for a rebound in 2015. Let’s take a look at historically large declines in the oil market and valuations in the energy sector to get some perspective. Examining historical price declines The energy sector is likely to find the most buying interest when the crude oil market is near a bottom, but picking a bottom in any market is never easy and may be a fool’s game. Over the past 10 years, the price of the S&P 500 Energy Sector has a 0.829 correlation to the price of West Texas Intermediate (NYSE: WTI ) crude oil. 1 Since the mid 1980s, there have been five times where the price of WTI has posted a decline of at least 40% from closing month high to closing month low. The table below compares those five historical periods with 2014’s price drop. (At the time of this writing, there were a few days left in December, so I used the Dec. 23 closing price of $56.52 to represent the month-end price.) Major Oil Market Declines Based on Monthly Closing Prices of WTI *Dec 23, 2014 price assumed as month-end close. Source: Bloomberg LP as of Dec. 23, 2014 Past performance is no guarantee of future results. The table indicates that the average and median durations for price declines are 10.3 and 8.0 months. If December 2014 were to mark a current low, the duration of the sell-off would be on the shorter side of history, at just six months. It seems like a bottom may be more likely in January or February 2015. The table highlights that the current decline of 46.4% (using the Dec. 23 close of $56.52) would be on the lower end of the distribution. The average and median declines are 55.2% and 54.1% respectively. The period most like the present (1985/1986, when the market was last awash in excess oil supply) saw a drop of 63.3%. The decline in 2008/2009 seems to be extreme as it was driven by a global economic and financial meltdown. Extrapolating based on historical examples is not without risk, but points 1 and 2 suggest that in 2015, we could see a close in the price of WTI in the $45 to $50 area in January or February, which could represent the bottom of the oil price plunge and lead to a cyclical recovery in energy shares. Examining energy sector valuations One way to examine the value of the energy sector is through the price-to-book-value ratio (P/B), which is affected not only by changes in companies’ stock price, but also by changes in the value of companies’ assets (book value). Monitoring this ratio over time helps to adjust for the impact of industry ups and downs. Oil properties and reserves are subject to impairment charges and changing values based on industry conditions – nonetheless, at some point the potential negatives are reflected in share prices. The P/B per share can shed light on when extremes are priced. Both the S&P 500 and the S&P SmallCap 600 Energy sectors appear to be approaching areas of perceived value based on their P/B ratios. At writing, the P/B of the S&P 500 Energy Sector was 1.78 and on the lower end of the range seen since 1990. The ratio had lifted from a low of 1.605 on Dec. 15, 2014. These P/B ratios compare to an average of 2.39 going back to 1990. 1 (The black dotted lines represent two standard deviations above and below the average price, which would be considered extreme pricing levels.) Source: Bloomberg LP as of Dec. 23, 2014. Past performance is no guarantee of future results. An investment cannot be made directly in an index. Valuation appears even more depressed looking at the S&P SmallCap 600 Energy sector where the price to book value ratio was 0.923. The ratio has lifted from a recent low of 0.78 on Dec. 15, 2014 and compares to an average of 2.02 going back to 1995. 1 Source: Bloomberg LP as of Dec. 23, 2014. Past performance is no guarantee of future results. An investment cannot be made directly in an index. Evaluating energy stocks There are many factors that influence the outlook of energy stocks, but valuation and the price of oil are two places to start. Oil prices had a material decline in 2014, although it is too early to say they have bottomed and history may argue for more weakness into the New Year. At the same time, energy stocks are showing inexpensive valuation based on their P/B ratio, and valuation suggests investors may want to put the energy sector on their shopping list for 2015. Investors seeking exposure to the energy sector may want to consider the PowerShares Dynamic Energy Exploration & Production Portfolio (NYSEARCA: PXE ) or the PowerShares DWA Energy Momentum Portfolio (NYSEARCA: PXI ).* PXE tracks an index that invests in exploration and production companies based on price momentum, earnings momentum, quality, management action, and value. PXI holds stocks that are displaying relative price strength. They are two smart beta solutions for investors looking for non-market-cap-weighted investment in the oil sector. Investors focused exclusively on the small-cap sector may want to consider the PowerShares S&P SmallCap Energy Portfolio (NASDAQ: PSCE ). 1 Source: Bloomberg LP as of Dec. 23, 2014 Important Information *Effective Feb. 19, 2014, changes to the fund’s name, investment objective, investment policy, investment strategies, index and index provider were made. Dorsey Wright & Associates, LLC replaced NYSE Arca, Inc. as the index provider for the fund, and the name of the index changed from Dynamic Energy Sector IntellidexSM Index to DWA Energy Technical Leaders Index. In addition, the name of the fund changed from PowerShares Dynamic Energy Sector Portfolio to PowerShares DWA Energy Momentum Portfolio. Important information The S&P 500 Energy Index is an unmanaged index considered representative of the energy market. The S&P SmallCap 600 Energy Index is a capitalization-weighted index that includes the energy sector companies within the S&P SmallCap 600 Index. Correlation indicates the degree to which two investments have historically moved in the same direction and magnitude. Price-to-book-value ratio (P/B ratio) is the ratio of a stock’s market price to a company’s net asset value. There are risks involved with investing in ETFs, including possible loss of money. Shares are not actively managed and are subject to risks similar to those of stocks, including those regarding short selling and margin maintenance requirements. Ordinary brokerage commissions apply. The fund’s return may not match the return of the underlying index. Investments focused in a particular industry or sector, such as the energy sector and the oil and gas services industries are subject to greater risk, and are more greatly impacted by market volatility, than more diversified investments. The momentum style of investing is subject to the risk that the securities may be more volatile than the market as a whole, or that the returns on securities that have previously exhibited price momentum are less than returns on other styles of investing. Investing in securities of small-capitalization companies may involve greater risk than is customarily associated with investing in large companies. Beta is a measure of risk representing how a security is expected to respond to general market movements. Smart Beta represents an alternative and selection index based methodology that seeks to outperform a benchmark or reduce portfolio risk, or both. Smart beta funds may underperform cap-weighted benchmarks and increase portfolio risk. The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE All data provided by Invesco unless otherwise noted. Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd. ©2014 Invesco Ltd. All rights reserved. blog.invesco.us.com

Invest In What You Know: Advice From Peter Lynch Is For Suckers

Summary Peter Lynch is the father of the very popular “invest in what you know” strategy that was very lucrative for him and has always enjoyed mass appeal. Today many names that are popular selections according to this strategy make terrible investments due to extremely overpriced stocks. Most people are not implementing the “invest in what you know” strategies the way Lynch intended. These days it may be more suitable to “invest in what you know” based on a personal edge gained from professional expertise. Peter Lynch is considered one of the greatest investors of all time because he managed the Fidelity Investments’ Magellan Fund in the 1980s, which was the best performing Mutual Fund in the world during that time. With average annual gains of over 29% it regularly more than doubled the yearly gains of the S&P 500. “Invest in what you know” is one of Lynch’s investment strategies that was not only very successful, but was easy to understand for the masses. He outlined his strategy in two highly popular and widely read books, One Up on Wall Street and Beating the Street , and many investors since have adopted the strategy. I also find this strategy very appealing simply for the fact that I can use the products and services that I already consume on a regular basis, but get the added satisfaction of contributing to the success of a company I partly own. However, today I find that Lynch’s philosophy is difficult, if not impossible, for many to profit from due to growth chasers and other investors who believe so strongly in a company that they are willing to pay any price for its stock. Buying a company simply because you like it is enticing and easy, but can lead to sideways performance, high volatility, or huge losses and as I will discuss in this article, is not the only way to “invest in what you know”. How Not to Invest In What You Know Many naive investors don’t know any better and will blindly make purchases of stock at insane multiples of potential future earnings simply because it is a company that they like. What’s worse is these purchases are made at times when reasonable growth is either already priced in or the company has reached its potential and future growth is limited. Three recent examples include: Amazon.com (NASDAQ: AMZN ) which has fallen 24% from a 52-week high of $408.06 to its current share price of $308.52. The stock still sports a very high stock price given the valuation of $145.85B, and the company is not profitable, with a loss of -0.47 per share in the last 12 months due to major expenses on infrastructure, customer subscription acquisition, and low margin contracts designed to gain market share. Netflix (NASDAQ: NFLX ) which has fallen 28% from a 52-week high of $489.29 to its current share price of $348.94. With a very lofty P/E multiple of 92.6, any potential future growth the company can receive is already priced into this stock, and then some. Tesla Motors (NASDAQ: TSLA ) which has fallen 24% from a 52-week high of 291.42 to its current share price of $219.31 These companies all have changed how industry operates and are forcing others to follow its lead by capturing the hearts, minds, and wallets of the public. I would jump at the chance to own NFLX or AMZN at a reasonable price because I love the services they provide and believe they have forced other companies to adopt a more consumer friendly business model to remain competitive. TSLA makes the only luxury electric car that is attractive and it has made huge strides in battery power storage, which makes it highly appealing to investors and consumers (I must confess I personally would not purchase stock in any company that relies on sales of vehicles over $70,000, a price I find ridiculous for any vehicle). The problem with investing in stocks like AMZN, NFLX, and TSLA is two-fold: Despite these companies being positioned for future growth and huge earnings, an investor’s risk of losing capital remains very high. Lofty investor expectations are priced into the current stock price and the risk of a huge drop in a short amount of time is dramatically increased if the company fails to meet the unrealistic expectations. Valuations continue to remain extremely lofty following the fall in share price that results from the company failing to meet unreasonable growth expectations. Even after the fall in stock price, there is no room for the investor to make money, and the investment becomes a speculation that the company will either beat lofty expectations repeatedly or you purchase based on technical analysis and the belief that other people (suckers) will be willing to pay a higher price in the future. I personally prefer to purchase stocks of good companies I believe will provide me a low risk of loss in the future due to a stock price below intrinsic value, and I don’t purchase stocks based on my belief that others will soon find it more desirable than it currently is. AMZN, NFLX, and TSLA are not the only examples of excellent companies with either a dominating market position, huge growth potential, or both, and sporting an extremely overvalued and unattractive stock price. Here are a variety of my favorite companies with overvalued stocks: Chipotle Mexican Grill (NYSE: CMG ) with a P/E of 52.9 The Habit Restaurants (NASDAQ: HABT ) with a P/E of 45.2 Starbucks (NASDAQ: SBUX ) with a P/E of 30.1 Visa (NYSE: V ) with a P/E of 30.8 Google (NASDAQ: GOOGL )(NASDAQ: GOOG ) with a P/E of 27.5 Don’t get me wrong, many investors have amassed huge returns from stocks in the above-mentioned companies and many will see huge returns in the future. However, I am trying to remain a disciplined investor, and the extreme valuations are more speculative to me considering the downside risk despite my natural attraction to stocks of companies I really like and I believe have excellent management and future growth potential. I was highly anticipating the recent IPO of HABT prior to its market debut on November 20th, because I love to eat at its restaurants, its casual dining atmosphere is appealing to customers, and management’s goal of growing from 99 to 2000 total restaurants. the growth potential is amazing, but I can only wait for the price to fall dramatically before I can even consider an investment. How did Peter Lynch do it? How to Properly Invest In What You Know First off, I don’t believe that Lynch’s investing advice is for “suckers” as my title suggests; in fact Lynch was living proof that when the strategy was used properly it was incredibly successful. It was so successful that he coined the term “ten bagger” to refer to investments that achieved a price 10-times greater than his purchase price. I doubt that Lynch would purchase the stocks discussed above at the current price, none of which have ten bagger potential at current prices. Lynch would purchase a stock when the company was small and had huge potential for growth before others in the investing community noticed. Getting in before others is really the key to making huge profits. As we have noticed recently with HBT and the amazing success of CMGs fast casual business model, most companies are good at touting future potential and attracting investors. This leaves little selection for value investors seeking to “invest in what we know” at a discount. Average holding time for one a Lynch investment was 6-7 years, which is how long it typically took for a company to reach its full growth potential, attract the full attention of the investing community, and reach overpriced status. Holding a stock for a long time is a place of common ground for value investors and growth investors, but takes extreme patience. Most investors have a difficult time holding losing stocks, and the volatility that can lead to boom and bust moments for high growth stocks can easily lead to huge losses for investors prone to emotional stock buying and selling, and let’s face facts, that is most of us. Buying companies whose products and services you like is not the only way to “invest in what you know”. Investing in companies or industries where you are a profession expert or you have indirect professional knowledge of can give you an edge. For example, I am a wildlife biologist and environmental impact analyst, and I consult for government agencies and large utilities and infrastructure developers regarding environmental impact avoidance and compliance with environmental laws. My understanding of environmental regulation gives me an edge regarding investments in industries such as solar energy, where solar panel developers may post huge profits in 2015 after prices fell considerably in recent months. The end of tax incentives for solar panel makers in 2016 will lead to increased profit in 2015 because many developers will rush to finish large project ahead of the deadline. My knowledge of environmental regulation and incentives I received from my job gives me an edge in this instance. Anyone can apply this same principle to their own profession and find many great companies that have excellent growth potential and attractive valuations. Closing Remarks I have great admiration for Peter Lynch as an investor, and I believe his philosophy has mass appeal, because it makes investing more personal and can be very lucrative if done well. However, many investors let emotions or naivety get the best of them and invest in what they know with purchases of stocks at the peak of popularity or at excessive earnings multiples and then hastily sell after the stock price drops when the company fails to meet unrealistic earnings goals. Successful purchases of stocks of companies that you like is done when the company is small and growth is ahead of the company, but most importantly before the masses are convinced that the company is the next CMG. Another way to “invest in what you know” is to invest in companies in industries you work in professionally. Knowledge of regulation, new product, successful internal business practices, and other hard to research information impacting companies’ future outlook can give you have an advantage over others. Don’t just look for the easy names of the new hot restaurant or the already established industry leader that commands a rich valuation, and be creative to find names that other investors may overlook or where you may have expert knowledge and information before it is widely known.