Tag Archives: pro

Choose The Game You Play Wisely

Expert decision making, especially in the stock-picking world, is not reliable. Stock picking by speculators is not a skill that can be mastered. Value investing needs to be thought of in the context of playing the long-term odds. Daniel Kahneman’s remarkable work, ‘ Thinking Fast and Slow ‘, discusses in detail overconfidence in the professional world and when experts can be trusted in their predictions. He had collaborated with psychologist Gary Klein on a project that researched this very question, as Klein was prone to believe that expert intuition was to be trusted when a decision had to be made, while Kahneman had concluded that algorithms are more trustworthy than human intuition. Their work was interesting, to say the least. Kahneman felt that algorithms could drown out the noise that human emotion brought to the decision-making process, but Klein laughed at the very thought of a machine making a critical decision in the heat of the battle. After numerous discussions and long debates, the question was asked what type of “expert” they were analyzing? Klein had in mind nurses and fire fighters and the like; people who had to make split-second decisions because lives depended on it. However, Kahneman had been thinking of political science forecasters and stock pickers. Kahneman had earlier done studies at a financial firm, analyzing the company’s stock advisors. His findings were not encouraging. Kahneman had been given data on the firm’s advisors and their records over the course of an 8-year period. When the rankings of the advisors were compared year by year, Kahneman found a correlation .01 – basically showing that the stock-picking skill was non-existent within the firm. Those who did well one year were likely to do worse the following year and vice versa; regression to the mean prevailed. He notes that the executives at the firm as well as the advisors basically swept the findings under the rug. They were collecting fees from their clients anyway, right? Kahneman and Klein concluded that stock picking occurs in a low-validity environment. There are no set rules to play within, like a grandmaster would encounter in a game of chess. Intuition can be trusted in such a high-validity world, proven by Gary Kasparov’s success against IBM’s (NYSE: IBM ) Deep Blue in a number of man vs. machine chess matches. The stock-picking world is different, with too many variables and moving parts to ever become “skilled” or “expert”. Stock picking is more like the roll of the dice than a game of poker, according to Kahneman. This is why mutual funds, with their fees and transaction costs, constantly underperform the overall markets. Just ask Jack Bogle! However, anyone who has been around the investing world for more than about 10 minutes is familiar with Warren Buffett’s ‘ The Superinvestors of Graham-and-Doddsville ‘. Mr. Buffett eloquently refutes the idea that the stock market is efficient and discredits the belief that success in investing comes down to a coin flip. It is hard to argue with Mr. Buffett’s logic, backed by his exceptional and illustrious decades-long performance. Buffett fits Kahneman’s description of the former in the “hedgehog and the fox” parable. The hedgehog is good at one thing. He believes himself to be an expert and, so, is overconfident in his predictions. The fox is a more global thinker and opened-minded. He is mindful of the black swan and concedes that he will be wrong on occasion. He constantly questions his position and looks for flaws in his logic. While the hedgehog’s ego prevents him from admitting his mishaps, the fox looks at mistakes as learning opportunities. The fox has historically outperformed the hedgehog. So, what can we conclude from all of this? Many have gone into great detail on the differences between speculating and investing. I categorize Kahneman’s group of stock advisors as speculators, as I do many money managers of today. They have little incentive to outperform the indexes, but their careers are on the line if they make a wrong call. Due to the structure and competitiveness of corporate America and the “instant gratification” mindset that characterizes today’s “investors”, money managers don’t have 5 years to wait for an investment to pan out. Status quo keeps them employed. The proven way is the long-term, value investment strategy employed by Buffett and his skulk of foxes. A true poker player knows that he’ll succeed eventually, if he continues to play the odds. Know that you will occasionally be wrong, keep an open mind, learn from your mistakes, and don’t listen to the pundits of mass media. Speculating is a game of roulette; invest like you’re playing Texas Hold ’em for the long term.

Stock Picking Or Index Investing: Comparing Average And Median Price To Cash Flow Ratios Globally

Summary When looking at country level stock market valuation ratios, it is always useful to look both at median and average statistics. Wide valuation dispersion allows stock pickers to find relative value plays within a country index. Narrow valuation dispersion tends to top-line calls on the overall country index. When looking at country level stock market valuation ratios, it is always useful to look both at median and average statistics. If you only look at average statistics, the resulting valuation ratios can sometimes be very skewed . When several companies are dramatically re-rated lower it drags down the average ratio statistics and can make an entire countries stock market look a lot cheaper than it actually is. A good example of this can been seen when looking at MSCI Brazil. The average price to cash flow ratio for MSCI Brazil is just 4.6x. If an investor just looks at this than one might think that market looks as cheap as it has at any point since 2009. However, the median price to cash flow ratio is still 8.6x which is right in the range that valuation ratios have been since mid-2012. Therefore, there most be a wide dispersion of valuations among individual stocks for investors to choose from. On the other hand, you have a situation like MSCI Hong Kong where the spread between average and median valuations is just 14 basis points. With average and median valuations so close, most likely there isn’t a lot of variation among valuation levels among individual stocks within the country index. In the charts below, we are going to group various country indexes into two baskets: large valuation spreads and small valuation spreads. (click to enlarge) (click to enlarge) Large Spreads – Potential For Individual Security Analysis (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) Small Spreads – Index Investing May Make More Sense (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) Its tough to make an investment decision purely on valuation spreads. However, there are a couple of investment conclusions that I think we can make. First, when the spread between average and median valuations is large this means most likely that there is a wide dispersion of valuation levels among individual stocks within a country index. This would seem like an environment for stock pickers to be able to find opportunities to apply individual security analysis to unearth stock ideas. Second, when the spread between average and median valuation is small than it would seem that it would be tougher to find very many individual security ideas, at least from a relative valuation stand point, and investors would be better off buying or selling the entire country index (or ETF). Relevant Tickers: MCHI , EDEN , EWG , EWQ , EWH , EWJ , EWW , EWM , EPHE , EWS , ERUS , EWP , EZA , EWD , TUR , ICOL , EWA , EWC The original posting of this article can be found here . All data was created by the author and sourced from Gavekal Capital, MSCI and FactSet.

Consider Taking Tax Losses Now – Beat The Year-End Bounce Rush

Recent stock market volatility has resulted in portfolio losers. NOW is the time to consider tax-loss selling to beat the year-end bounce rush. There are several questions to ask when considering taking a stock tax loss. With all the volatility in the stock market this year, many investors probably find themselves holding some stocks in which they have sizable losses. By selling those losers and realizing those losses, you can use the losses to offset taxable gains that you may have realized during the year. Most individual investors think about this strategy in December, which means that this tax-loss selling could push the price of some of these stocks even lower. This means that you probably don’t want to be selling your losers then, and may in fact want to consider buying some of these beaten down stocks to take advantage of this tax-generated downward pressure that goes away on January first. I’ll discuss this in more detail in the December issue of my investment newsletter . Moreover, under the U.S. tax code you can buy a stock back 31 days or more after selling and still recognize the loss. (If you sell in 30 days or less, the IRS will not allow the loss). This way you can take the tax loss and still participate if the stock eventually rebounds. When considering taking a tax loss in a particular stock, there are several questions you need to ask yourself: “Do I really want to own this stock anymore?” If not, you should just sell it and move on to other stocks with better gain potential. If you do want to own the stock for the long haul, there are other considerations: “How likely it is to rebound sharply in the next 30 days?” If you think the likelihood is high, you probably should not take the tax loss. Similarly, if you have a sizable position, you need to consider whether there is enough trading volume in the stock to get out and then back in 31 days later without significantly affecting the stock price. If you are concerned about the volume in the stock, it may be better to look elsewhere for your losses. Read more of my most recent investing advice and turnaround stock picks . Share this article with a colleague