The Third Pig

I am writing today just to vent about a pet peeve of mine, two in fact. One of my pet peeves is when folks make uninformed declarations about any topic. I mean folks who take a position, an important position, with no qualified information, research or experimentation to back up their claim or position.

We see this all the time, especially when taking political positions. Someone takes the position that they don’t like or don’t care for the President (whomever the Prez happens to be at the time). When asked why they don’t like the President, the person lists so-called actions the President or his administration has taken. But many times the information they have is completely erroneous. What we find is that often times, the person had no idea what they were talking about and resorted to pulling so-called information out of the air.

The other pet peeve I have is when someone takes a position or makes a declaration based on very little information. This person, unlike the previous, has actually done some study. But that so-called study is so lacking thoroughness and depth, no rational person should or would ever draw any serious conclusion from it.

When it comes to investing both these approaches are not only bothersome to someone with my inclination for checking and cross-checking, it can be dangerous to the investor himself. Today I was perusing the CNBC website and noticed two articles about technical analysis. According to Investopedia, technical analysis is “A method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity.” However, anyone who has ever seriously studied the record of technical analysis knows it is of little value.

source: CNBC. Click picture to enlarge.

But that’s not what caught my attention on the CNBC site. Notice the headlines of the two articles circled in red. Each gives a totally opposing outlook of the future and both credit technical analysis as the method used to make the conclusion. Now an amateur investor, who is confident (falsely) but who isn’t necessarily vigilant in his research, might read either article and take a stance on the market that’s really ill-informed. Thus dangerous to his portfolio.

Venting over.

But here’s an approach I think is sound when it comes to investing on your own:

1. Don’t pay attention to the talking heads in the financial media.


2. Have some grounding in basic accounting.


3. Exercise a “lazy” approach.


4. Do your own research and make a habit of cross-checking your sources.

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Posted by Ben Taylor at 05:00 PM |
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Don’t be duped. Monday, after Standard and Poors downgraded the nation’s debt, for what seems to be highly political reasons instead of financial ones, the Dow Jones Industrial Average declined 634 points. The headlines the next morning in the Wall Street Journal read, “Downgrade Ignites Global Selloff”. Of course, there were similar headlines around the news-scape.

Now if you read these headlines with little to no context, you might be ready to cash in your 401k and bury your money in the back yard. You’d reason, “634 points?!?! The sky must be falling. Better get liquid!” In fact, I know some of your financial advisors have even advised you to move your long-term money to cash. Excuse me but this is really awful advice, especially for your long-term funds.

Context is what is needed. Although a 600+ point drop is significant, it hardly matters. The drop on Monday represented a 5.5% decline. That is not even close to making the top 20 percentage drops in the DJIA’s history. But the headlines would have you believe otherwise. It's percentages that matter, not points. The market, as a rule, goes up and down… daily. From 1926 to 2002, the S&P 500 was up 52% of the trading days and down 46%. There was little change the other 2% of the trading days. Like I said, up and down. Deal with it.

Your asset allocation decisions are important when it comes to managing the volatility in your portfolio. I won’t get into that much in this post except to say, your long-term money should typically be in stocks. Your short-term money should typically be in bonds and cash (treasuries). If you have that squared away, volatile days like these last few are buying opportunities and a chance to make money. Not sell out of misguided fear and lock in unnecessary loses.

Market:

"20 Largest Percentage Losses in DJIA History" by FoxBusiness.com

"The Revenge of the Rating Agencies" by Jeffrey Mann; New York Times

Portfolio:

One year chart of eBay (EBAY) vs. the iShares S&P 500 ETF (IVV)

"Stocks at 'fire sale' prices after bloodbath" by Hibah Yousuf; CNN Money

Life:

CrossFit Sports Series WOD-SUP Queens by CrossFit, Inc

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Posted by Ben Taylor at 02:00 PM |
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After finding my post about “lazy investing”, a reader of The Third Pig suggested following such an approach would eventually lead to financial ruin. The reader suggested to be a successful investor one had to be unnaturally gifted in analytic ability and/or spend countless hours researching and trading his portfolio. I cannot speculate on where this reader developed his point of view but what I can say is the evidence does not support him. Warren Buffett has often said that successful investing requires three things: a 5th grade understanding of mathmatics, a sound investment philosophy and the right temperament. Never does he say you have to be a genius or you have to stay up all hours a night trading your portfolio.

Legg Mason Capital Management performed a study in an attempt to find the common characteristics of mutual funds that beat the S&P 500 Index during the period of 1992 to 2002. What was found was a few common attributes of the outperformers which are strickingly similar to a lazy investing approach. Those funds were/are/have:

• Portfolio concentration: These portfolios have, on average 37% of assets in their top-10 holdings, versus 24% for the S&P 500 and a 28% median for all U.S. equity funds.
• Portfolio turnover: As a whole, this group of investors had about 30% turnover, which stands in stark contrast to turnover for all equity funds of 110%. They are truly, lazy investors (how we like to define it).
• Value Investment Style: Most if not all of the funds listed seek stocks with prices that are less than their value. These fund managers recognize that price and value are not the same, often diverge and then converge again. They take advantage of this consequence of investing in the stocks of companies.
• Off Wall Street: Only a small fraction of high-performing investors are located in the financial centers of New York or Boston. There location allows them to quiet the noise of Wall Street, dampening the temptation to trade frequently or with reckless abandon. They can take a more methodical and rational approach.

The chart below shows how some of those funds have fared against the S&P 500 in the 10 years ending September 30, 2009. As you can see, most of them beat the market and had positive returns in a period that experienced the worst economic times since the great depression. Oakmark Select in particular had a bad run as a result of owning a large piece of Washington Mutual during the subprime crisis (article) but it hardly mattered over the long term. The funds that didn't have been a little more volatile than the market and measured over different but similarly long periods, also outperformed the market. Although I cherry-picked the funds I follow most, the sample is representative of the group listed in the Legg Mason white paper.

Following this approach, our Core Model Portfolio Average has performed well over a similarly long period of nearly 7 years (ending 9/30/2009) returning an annualized 10.7% versus the S&P 500's 3.8%. Bottom line, it pays to be lazy when it comes to investing.

Disclosure: I and the clients of Brick Financial Management, LLC did not own shares in any of the the companies or funds mentioned in this post at the time of this writing. But positions may change at any time.

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Posted by Ben Taylor at 03:00 PM |
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source: Cordoza Life

This past January, about the time of Obama's inauguration, Warren Buffett gave an interview to PBS corresspondent, Susie Gharib. In the interview Buffett was asked to give his greatest and most important business lesson. He responded:

The most important investment lesson is to look at a stock as a piece of business not just some thing that jiggles up and down or that people recommend or people talk about earnings being up next quarter, something like that, but to look at it as a business and evaluate it as a business. If you don't know enough to evaluate it as a business you don't know enough to buy it. And if you do know enough to evaluate it as a business and its selling cheap, you buy.

When thinking of stocks as more than just pieces of paper, but actual representations of underlying businesses, the investor is led to a more sensible approach. If as an investor you were considering buying a business that you would own, operate and would provide the majority of your income, it is likely you would not contemplate selling that business within seconds of purchasing it. Just as you would not think of buying a home in the morning and selling it in the evening, if your intent was to live in it.

A great example is Google (GOOG). Google is the dominant player in the search engine world commanding more than 64% of internet searches and is rapidly becoming a threat to longtime tech behemoth, Microsoft (MSFT). Google also produces and obnoxious amount of free cash flow and seems to grow that cash at will (see chart).

With market dominating performance and consistent operating results, it is safe to assume Google's business value is stable and steadily growing. But if you were to look at the stock price, you'd never know it. In the past 52 weeks, Google's shares have gone from a high of $510 to a low of $247 and now sit at around $430. Do these wild fluctuations make any sense given Google's performance? Nope. But for those of us who are more concerned with the underlying business, we can just sit still and only move when to buy when the market greatly undervalues our business and sell when they overvalue them. This is why I don't trade very often and prefer the "lazy" approach to investing.

Disclosure: I and the clients of Brick Financial Management, LLC owned shares of Google at the time of this writing but positions may change at any time.

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Posted by Ben Taylor at 06:19 AM |
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Articles that appear on The Third Pig occasionally appear on the Seeking Alpha website and are regularly picked up by the general financial media outlets including Yahoo Finance, Reuters and other financial blogs. I have listed some of the latest entries and other locations they can be found:

Asset Allocation in 2009: Best to Go with the Devil You Know at:
Yahoo Finance: http://finance.yahoo.com/q/h?s=SBUX and http://finance.yahoo.com/q/b?s=BRK-A
Fav.or.it: http://fav.or.it/post/953406/asset-allocation-in-2009-best-to-go-with-the-devil-you-know

Coach: Luxury on the Cheap at:
Guru Focus: http://www.gurufocus.com/forum/read.php?2,42620
Fav.or.it: http://fav.or.it/post/929527/coach-luxury-on-the-cheap

Five Things to Be Thankful for in This Market at:
Reuters: http://www.reuters.com/finance/stocks/marketViews?symbol=COH.N
Yahoo Finance: http://finance.yahoo.com/q/b?s=COH&t=2008-12-15T03:55:28-05:00

GM Bailout Would Be Agony For Taxpayers at:
Yahoo Finance: http://biz.yahoo.com/ic/news/330.html?time=1226885400 

Obamanomics and the Stock Market at:
Stock Shoot: http://stockshoot.com/content/view/6602 

Buffett and Cramer Agree: It’s Time to Buy Stocks at:
AOL Finance in the Headlines area: http://finance.aol.com/related/berkshire-hathaway-inc-cl-b/brk.b/NYS?topic=144012971&tab=3 

Greed, When Others Are Fearful, Is Good at:
Wall Street Oasis: http://www.wallstreetoasis.com/newswire/greed-when-others-are-fearful-is-good

If you would like to share some of the above articles with your friends, family or associates just click any one of the icons below for the various websites including ShareThis, Digg.com and Facebook. Here is to a wonderful 2009 in the market.

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Posted by Ben Taylor at 05:28 PM |
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The stock market ended the year of 2008 posting one of its worst annual price performances ever. The Standard & Poor's 500 index dropped 38.5% for the year marking its worst performance since 1937’s 39% drop in the index. In fact it was the first time the index saw a 30% or more drop in price in those 71 years. So if you survived this year, give yourself a pat on the back.

Investors over the past year made many wrong moves, paralyzed by fear, they drove down stock market prices to unreasonable levels. One bright spot is patient investors could invest in stocks very cheaply. Valuation levels had not been at those levels since the early 1980’s. Although the S&P 500 has advanced more than 20% from its low of November 20^th, there remain bargains to be had.  

With so many bargains to choose from, some investors may experience paralysis because of greed. Which stock does one pick? In such an instance, it is best to invoke the spirit of Charles Munger, co-chairman of Berkshire Hathaway. In an Outstanding Investor Digest article some years back Munger was quoted as saying:

“For an ordinary individual, the best thing you already have should be your measuring stick. If the new thing isn’t better than what you already know is available then it hasn’t met your threshold. This screens out 99 percent of what you see.”

Although I picked up a few new positions for myself and my clients’ portfolios, in following Munger’s advice I found that the positions already in the portfolios were of solid companies that were similarly beat down as the market. Every nook and crannie of the market was hurt this year. It couldn't be avoided. And the potential of being hurt further is still present. However, when choosing where to allocate funds, sometimes it is best to go with "the devil you know".

Instead of scouring the investment universe for the new thing, I simply averaged down. The following chart marks the return of a few positions from the beginning of the year to the S&P 500’s low on November 20^th and then the return to the end of the year from that November date compared to the market’s return.

Although as a group the stock of these companies declined to a similar degree as the market, their rebound so far as been nearly 50% greater. Although it is too soon to say, I believe superior companies will bounce back to a greater degree than the average stock. I think this is what we are seeing in the chart above.

Disclosure: I and the clients of Brick Financial Management, LLC owned shares in all the companies mentioned in this post at the time of this writing. But positions may change at any time.

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Posted by Ben Taylor at 06:10 PM |
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Every now and again we are presented with a choice to buy a new something or buy into a new idea. Often times these decisions are not the easiest to make. Do I buy the silver coupe or the red convertible? Sometimes the decisions are slightly easier. Do I accept the job working long hours for minimum wage or accept the million dollar inheritance from Uncle Ralph?

We at Brick Financial are often faced with the decision to add new positions to our clients’ portfolios. But our decision of whether to buy or not is often made easier by utilizing a simple technique. We simply compare the new position under consideration to what we already own. If we find after this comparison, that the new investment does not make our clients better off, we pass. This mental exercise saves of tons of time and effort. It eliminates 99% of the investments in the marketplace. Most just will not be up to snuff.

The beauty of this technique is that it can be applied to every day life. In managing your “life portfolio” you simply compare the new thing to what you already have in your possession. If you have children in a good school it might not be worth taking them out of the school they’re in unless the new school you’re considering produces Rhodes Scholars left and right. If you’re married, it’s probably not worth the headache and expense of divorce for a short-lived affair with the new office hottie. Well, maybe if it’s Angelina Jolie. Even then it’d be a close call.

The point is, your decisions become substantially easier to make if you are thinking about how they will improve your life. If it’s close, why bother. Your time is better spent relaxing with a Mai Tai than worrying about all the choices and decisions you need to make in life. Life is too short. Enjoy it.

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Posted by Ben Taylor at 03:41 PM |
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Financials are doing well even with news that would have normally sent the shares of companies in the sector on a downward spiral.  The earnings of banks are off by a long shot even in comparison to just last year. We're also seeing write offs left and right.  Last month when Bear Stearns basically went out of business and calamity was predicted, the market barely budged (the S&P 500 was down less than 1%). Lehman Brothers announced to the market that it had taken action to sure up its liquidity by raising $4 billion in capital. Why would the firm have done this if it wasn’t in trouble? With all the bad news coming in and undoubtedly more bad news in the near future it's interesting that the stocks of financial companies have actually done well. What one might garner from this is the sector has turned a corner. So does this mean we should all go out a buy a bunch of financial stocks? Quick answer: NOPE!  

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Posted by Ben Taylor at 08:44 AM |
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In case you haven’t heard the old saying, “Don’t put all your eggs in one basket”, the collapse of Bear Stearns (BSC) is a great example of why the phrase exists. As you may recall, last month Bear’s stock plummeted to less than $3 per share from a 52-week high above $150. Although Bear employees seemed to be a little better off than the former employees of Enron and Worldcom whose retirement savings were obliterated by the collapse of those companies, as Bear’s employee stock ownership plan accounts for only 3% of total shares.

However this belies the point. About 1.5 million Americans are invested heavily in their employer's stock and another 11 million Americans participate in employee stock ownership plans and the like. Should these companies fail, and the stock of those companies fall significantly, you’ll see a lot of folks working in their golden years. Although I believe in prudent concentration in one’s investment portfolio, there is such a thing as too much of a good thing. The best actions an employee can take is not to make their own company’s stock more than 10-15% of their overall portfolio.

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Posted by Ben Taylor at 06:17 PM |
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"We believe that according the name 'investors' to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a 'romantic."

- Warren Buffett

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Posted by Ben Taylor at 03:05 PM |
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Excerpt from Brick Finanacial's June 2007 Client Letter: 

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Posted by Ben Taylor at 10:13 AM |
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A sound selling discipline is an oft-neglected part of a sound investing approach. A sell discipline will get the investor out of situations that show little promise and allow him to be available for situations that do. One of the sell criteria we employ at Brick Financial imparts us to sell a stock if “we have made a mistake in calculation or judgment.” Last August the clients of Brick Financial saw the criteria at work.

In August I wrote,

"We were cautious when we bought JetBlue: JBLU back in the spring of 2003… at the time it was trading at about 35x earnings which we thought was expensive… What we did not fully appreciate were some of the challenges that JetBlue faces. One was its vulnerability to rising oil prices. Although all transportation businesses were affected, airlines seemed to be especially so, and JetBlue was no exception. The other issue was the realization that although JetBlue’s operating and labor costs are presently low - as planes age, as employees become unionized, as new markets become more scarce – the company’s costs are bound to rise... We made several mistakes on this purchase... [ultimately] we did not provide ourselves a wide enough margin of safety [and] we should have weighed JetBlue’s rich valuation more heavily in our analysis…”

Since then, JetBlue has declined from a split-adjusted price of $12.71 to $9.69 at today’s (May 2nd) close. That move represents about a 24% decline. The company’s last two quarters were net losses, with the latest loss reaching $32 million. I would not say that I am clairvoyant, but some of the concerns I covered last summer have come to fruition. Larger competitors are pilfering the company’s business model and the company’s costs are catching up to it. The company, though nimble compared to other carriers, could not escape the ever-increasing rise in oil prices. It has also been forced to scale back on its expansion plans, sell some of its planes and shorten many of its routes.

A recent Wall Street Journal article underscores the company’s difficulty:

“ ‘We haven't done a good job at managing our business’ with aviation fuel costing more than $2 a gallon, said David Neeleman, JetBlue's founder and chief executive officer. The company's fuel bill rose 85% in the first quarter compared with a year earlier, and the average cost per gallon jumped 43% to $1.86. But the ‘silver lining’ in the record fuel price is that it is ‘helping us focus on becoming a better company,’ he said.”

 A sound sell discipline, and the ability to admit I was wrong, saved some money.

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Posted by Ben Taylor at 04:41 PM |
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Those of you who have read our Client Letters and are familiar with our services know that we are proponents of concentrated portfolios. Of course this belief runs contrary to most of the discourse that exists in the investing public today. Most investors and investment professionals are devout followers of modern-portfolio-theory (MPT) and the efficient-market-hypothesis (EMH). MPT holds that the more diversified a portfolio, the less risk (in terms of volatility) from each of its individual positions. EMH states that stock market prices reflect the collective knowledge and judgment of all investors and thereby reflects the correct price. In other words, no individual investor can gain an advantage over the stock market by selecting specific stocks.

We think that both MPT and EMH are (mostly) bunk. We indeed think that it is possible to beat the market and at less volatility risk by choosing just a few stocks. Two recent articles support our view. A New York Times article about the record of concentrated portfolios points out that:

"...concentrated funds come out slightly ahead (of diversified funds). They returned 8.9 percent a year, on average, over the last 10 years, versus 8.7 percent for the diversified funds, according to Morningstar."

"A low-risk concentrated portfolio may sound like a contradiction in terms. After all, the belief in diversification as a way to reduce risk is sacrosanct, and the average domestic equity fund holds 175 stocks. But academic studies show that as few as 50 stocks can give a portfolio volatility levels equal to those of the Standard & Poor's 500-stock index. And many funds get by with less. A screen of those with fewer than 50 stocks on fund tracker Morningstar's database found that more than half had lower betas -- a measure of risk -- than the S&P 500. One-third had lower standard deviations -- which Morningstar measures as the month-to-month variation in the price of fund shares. What's more, according to a 2004 Morningstar study, some 80% of concentrated funds -- also known as focused funds -- outperformed their peers from 1993 through 2003."

An advantage of running concentrated portfolios not addressed in either article is the tendency for such funds to have much lower than average turnover ratios. The turnover ratio is the percentage of a fund's assets that have changed over the course of a given time period, usually a year. The turnover ratio for a mutual fund is calculated by dividing the average assets during the period by the lesser of the value of purchases and the value of sales during the same period.

Portfolios with high turnover ratios (i.e. high levels of buying and selling) tend to have a higher degree of taxable events. Managers that run concentrated portfolios usually create fewer of these events as they tend to buy and sell much less often. Concentrated funds also tend to have much lower trading costs than the average fund. A perusal of the Morningstar database shows that mutual funds with 40 or fewer stocks have an average turnover ratio of 40.7% while the average mutual fund is closer to 100%.

In other words, even if concentrated funds didn't outperform more diversified funds on an outright basis, once costs are considered concentrated funds would come out ahead anyway. Bottom line we tend to agree with the conclusion of a study on concentrated funds presented in The Journal of Finance:

"We find that funds with concentrated portfolios perform better than funds with diversified portfolios."

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Posted by Ben Taylor at 01:55 PM |
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Another nice little tidbit is that while the Relative Value portfolio has returned 104.9% since December 31, 2002, the Russell Midcap (using the iShares Russell Midcap Index ETF [symbol: IWR] as a proxy) return was 77.3%. So the portfolio has done extremely well over the last 2.5 years compared to its closest benchmark.

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Posted by Ben Taylor at 02:56 PM |
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From Brick Financial's April 2005 Client Letter: 

...Although we just told you that the short term doesn’t matter much, it is interesting to see how other highly concentrated (less than 40 positions) value-oriented portfolios are performing.  These types are portfolios are extremely rare in the mutual fund world (they are little more popular among hedge funds).  The list below represents nearly all the mutual funds that fit that description. All of these funds and their managers have been able to beat the stock market over any period greater than 5 years. But let’s take look at the one year returns of these funds compared to our portfolios:

source: Foliofn

Take note of a couple of things.  First, the range in returns from port to port is very wide (from our port Relative Value at 14.84% to White Oak Growth’s -12.93%).  The second thing you should take note of is that none of these outstanding managers are beating their respective indexes (represented by the iShares ETF funds).  Does this serve as evidence that each manager has lost his/her investment muster? Doubtful.  It is just the economic climate we find ourselves in.

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Posted by Ben Taylor at 01:40 PM |
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