The Poor Investor

Investigatory Value Investing

Forecasting for Dummies

I recently attended the New Orleans Investment Conference and although I do not invest in mining companies and I’m not a “gold bug,” or a gold investor at all for that matter, I did take away a lot of useful information.

Though, perhaps the most useful piece of information was this:

Never forecast.

Now, admittedly, this was something I always knew, but the conference did help to solidify this thought some more in my mind. Watching people make big assertions about the price of gold going up, predicting stock valuations and movements in commodities only to see them be dead wrong two years later just made people look foolish. The people who made these forecasts and the people who followed them. All foolish. Imagine the hard-earned capital that was probably lost as well.

I worked at an investing research company for a short while and watched a seasoned analyst, who had been working there since the company’s inception, miss one of the most important calls in his industry.  One of the dozen or so companies he was following was bought out and he missed it completely.  It totally side-swiped him.  He even went as far as to say the company would never be bought out when another analyst brought up the prospect of the company being sold.  Talk about egg on the face.

Still not convinced? Well, think about this, do you even know what’s going to happen to you tomorrow? You know your life, your schedule, how many hours are in a day, etc. and I’ll bet you can’t accurately predict most of what happens to you tomorrow. You don’t know what your boss is going to say to you. You don’t know if you’ll get in a car wreck on the way to work. You don’t know if you’ll even wake up tomorrow. Test yourself. Try to predict a dozen or so things and see how many work out as planned.

So, if you can’t predict what’s going to happen to you, the person, or thing, you probably know the most about, how can you accurately predict what millions of investors are going to do? The bottom line is that you can’t. The best we can do as investors is look at the trees and forget about the forest. Will the market crash this week? I don’t know. Will it be down next year? No clue. However, I do have confidence that solid, well-managed companies trading for less than they are worth will most likely be trading at values higher than they are now. That’s the best we can do as investors. We take bets on stocks where the odds are in our favor and don’t when they’re not. And then we spread these bets out so we don’t bet the farm on one company because if there’s anything about this “not being able to forecast” thing it’s the whole “not being able to forecast” part.  You don’t know if “company X” will go to zero tomorrow. If “X” does go to zero, you want to have companies A, B, C, D, etc. to fall back on. Maybe it’s 20 companies, maybe it’s 100. That’s for you to decide. The point is to build your portfolio structure so that it won’t fall over if one brick crumbles. Keep the odds in your favor.

Examples of the “odds being in our favor” are things like companies trading at a discount to book value, or even cash value. Maybe it’s a company like BDCA Venture, Inc. trading below its NAV of $6.89 per share at $5.00 per share. Or maybe it’s a company like Electronic Systems Technology, Inc. trading at or near cash. Maybe it’s a management team that lowers the risk; management that’s honest about the direction of their company and can back up what they say with an excellent track record. People like Apple’s Tim Cook or Tibco Software’s Vivek Ranadivé. Perhaps it’s a catalyst on the horizon like a patent approval or a drug approval. Whatever it is, you put the odds in your favor in some way. If there’s nothing putting the odds in your favor, you’re no longer investing. You’re speculating; you’re gambling; you’re forecasting.

Never forecast.

Who You Know or What You Know?

I’ve recently finished my MBA and am now searching for employment opportunities. In this search I’m reminded, quite starkly, of the oft-quoted phrase, “It’s not what you know, it’s who you know.” The great thing about the stock market is that it works in exactly the opposite way. In the stock market, it’s not who you know that matters but what you know. The market, as Ken Fisher puts it, is “The Great Humiliator” and does not care who you are or who you know, “it wants to humiliate everyone.” In fact, who you know often works against you and may even entice investors towards illegal activities, as exemplified recently by a few well-known individuals.

The “what you know” I’m referring to here is your own analysis of individual companies and the markets in general. In fact, if you would have listened to common wisdom (the “who”) you might have sold in May, went away and missed out on a 2.1% gain in the S&P 500. You might have missed the boat on Apple at around $427 a share when everyone was claiming the sky was falling only to watch it rise to $633 a share, a lost opportunity of $206 per share. Once, when I was new to investing, I told a friend not to invest in Sirius XM when it was trading around $0.30 per share and he missed out on a potential 10-bagger. Or, you might have listened to friends who told you to buy Facebook when it first went public at $38 per share only to watch it drop to $18 in the first three months.

Nothing works better in investing than coming up with your own conclusions. For one, you won’t have the conviction in the company you are buying if you go based off of someone else’s recommendation. Even if someone is spot on about a company’s valuation and tells you that company X will go from $5 a share to $15 a share—even if this person is absolutely right and has a compelling enough reason— are you going to be able to hold the company’s stock when it goes from $5 a share to $1 a share before it goes up to $15 a share? Will you really have that level of discipline and, more importantly, trust in someone else’s judgment? Only by doing your own analysis, coming up with your own valuation and buying a company that you have strong conviction in because you put in the hard work will you be able to hold through the downs (or buy more) and not sell too early during the ups. This person’s recommendation may be 100% accurate but you might be enticed to sell at $7 for a $2 gain because you just won’t have the commitment you would have had if you came up with the idea in the first place.

Secondly, if your investment is in a company someone else recommends, you probably won’t have any idea of what to look for when things are going south. Are insiders selling? Did a member of management leave? Is this good or bad? How do you know if you didn’t investigate the company thoroughly? Now, say, the company has to raise funds by issuing stock— is this good? Was this part of the company’s plan all along? If you weren’t following the company, if you didn’t do your homework, you wouldn’t have any idea on these questions or any others. There won’t be any tip-offs to tell you when things are going well or if the management is running the company into the ground when you don’t put in the long hours of work it takes to investigate a company thoroughly enough to have conviction in it.

These are just a few of the reasons why you need to think for yourself when it comes to investing. This is why I don’t like recommending companies, it takes away from a core part of what will make someone a successful investor. I like to use companies as examples to illustrate ideas and how to think about companies, not as advice for what to buy. And with that, I will leave you with a quote from the Oracle of Omaha himself:

“You have to think for yourself. It always amazes me how high-IQ people mindlessly imitate. I never get good ideas talking to other people.”  -Warren Buffett

Track Record is Everything

In a book by Peter Krass called The Book of Investing Wisdom, there is an essay by Warren Buffett entitled Track Record is Everything.  The crux of this essay is that past performance history, aka track record, is one of the best single guides as far as judging businesses and investments go.  With that in mind, I thought it’d be useful to show readers of this website what my track record has been thus far for recommendations made on this site.  This should help new readers judge whether the information they obtain from this site is useful.  Though, I should note, as most of my regular readers know, I do not often mention stock “picks.”  However, I do recommend some stocks from time to time to help illuminate some idea or point out glaring inefficiencies in the market (see my post on Apple).  Although, these recommendations come with the caveat that every investor should do his or her own research before coming to a conclusion.

So, let’s get right down to it.  Here is how my “picks” have performed:

Stocks Recommended Recommended
Date Symbol PPS at Date Current PPS Sell PPS Sell Date % Change
9/13/12 dell $10.63 N/A $13.85 2/24/13 30.29%
9/13/12 nvda $13.68 $15.21 N/A N/A 11.18%
9/13/12 atri $218.87 $269.40 N/A N/A 23.09%
3/11/13 aapl $431.72 $515.00 N/A N/A 19.29%
4/22/13 ntcxf $0.81 $1.07 N/A N/A 32.10%
Average= 23.19%
S&P Return (since 9/13/12)= 22.01%
Difference= 1.18%

So far, my “picks” have out-performed the S&P 500 by 1.18% (used the first pick start date for simplification purposes).  Only one sell recommendation, Dell, was given so far.  Now, as Warren Buffett clearly notes in his essay, a 5 – 10 year track record is much more important in making judgments.  However, this site has not been around that long to establish such a track record.   At that time, I will revisit this topic.

Natcore’s Latest PR- Black Silicon to Slash Solar Cell Production Costs by 23.5%

Reprint of Latest Press Release:

“Making plans to take our technology to market” -Provini

 Red Bank, N.J. — (October 30, 2013) — An independent study has concluded that Natcore Technology’s (NXT.V; NTCXF.PK; 8NT) black silicon technology could reduce silicon solar cell production costs by up to 23.5%.

The savings derive from a streamlining of the production process whereby a silicon wafer is processed into a black silicon solar cell.

To make solar cells, manufacturers typically acquire silicon wafers from an outside source. Since these wafers are cut from a large ingot, they usually have saw damage, which must be removed. To make a conventional solar cell, manufacturers must first remove the saw damage, then texturize the wafer surface, and then apply an antireflective coating.

To make a black silicon cell using Natcore’s proprietary process, manufacturers would be able to replace the texture etch with a black silicon etch which in itself would create a highly effective antireflective coating.

Thus the most expensive part of the solar cell process – the equipment and material costs associated with high-temperature chemical vapor deposition of a silicon nitride antireflective coating – is completely eliminated.

Natcore asked analysts at the country’s leading black silicon research facility to quantify the cost saving to be realized from omitting these steps. Using a “bottom up” manufacturing cost estimating methodology, the analysts calculate the production cost of a conventional silicon solar cell to be 17¢ per watt. In comparison, the study projected that cells made using Natcore’s black silicon process would cost about 13¢ per watt.

The resulting savings of 3¢/watt – 4¢/watt represent a production cost reduction of up to 23.5%. “When solar companies are scrambling to save fractions of a cent, a saving of 3¢ – 4¢ per watt is momentous,” says Dr. Dennis Flood, Natcore’s co-founder and Chief Technology Officer.

In addition to the dramatic cost reduction, Natcore’s test, which was conducted using monocrystalline silicon, had an important environmental benefit: it eliminated the need for silane, a highly toxic gas that combusts upon exposure to air. Natcore may plan a similar test using polycrystalline silicon at a later date.

“We knew there would be a cost saving,” says Chuck Provini, Natcore’s president and CEO. “We were surprised that it was so large. In fact, production-cost savings of this magnitude will likely overshadow any power gains of black silicon and will make Natcore’s technology a must-have for the world’s solar cell manufacturers.

“To put it into perspective,” he notes, “a recent article by Shyam Mehta, senior solar analyst of GTM Research (‘Technology not materials to drive down Chinese solar costs,’ August 2013), predicts that Chinese manufacturers will be able to cut prices by only one cent in the next year or so. We could quadruple those savings in one fell swoop. We feel so optimistic about this development that we’ve begun making plans to take our technology to market.”

“The full cost of a solar cell is the sum of two parts: the cost of the silicon wafer and the cost of the processing steps required to turn the wafer into a working solar cell,” says Flood. “Cell manufacturers have no control over the cost of the silicon wafers they buy. As a result they are always looking for ways to control their production costs, but with a very important caveat:  cost cutting must not lower cell performance in any way.  Natcore’s black silicon processing technology results in solar cells that meet or exceed the industry’s requirement and at the same time provide a spectacular reduction in finished cell cost. Natcore’s technology can easily be retrofitted into existing solar cell production lines and can just as easily be incorporated into a new line. Black silicon seems poised to become the industry’s standard approach.”

Would You Invest in Yourself?

First off, no, I am not talking about saving for retirement. I am asking, would you literally invest in yourself?

This may appear to be a rather silly question, although, I think it is an important one, whether you’re an investor or not. However, in essence it boils down to the oft-heard Plato quote, attributed to Socrates, “the life which is unexamined is not worth living.” And to take it one step further, if you would invest in yourself, how much? Are there people you know you’d rather invest more in? Why? Lastly, if you wouldn’t invest in yourself, why not?

A few reasons you might want to invest in yourself are: you have a good job, you have a good income, you’re a person of integrity, you’re healthy and you’re wise beyond your years. If you wouldn’t want to invest in yourself, maybe it is because: you’re an alcoholic, you spend all your free time watching TV, you have a low income, you have too much debt, you’re in poor health or you’re not that smart.

The good news is, whether you would invest in yourself or not, you can still increase your personal brand equity. And why not? Why wouldn’t you want to be a good investment? You can increase your knowledge and educate yourself, strengthen your integrity and start becoming a better person, get off the couch and start exercising more. Whatever it is, you can improve it. Even if you already consider yourself a great investment, as a human, there is always room for improvement. You can always be a better person, more friendly, more knowledgeable, more wise. Think bigger.

Odds are, there is probably someone you’d invest in more than yourself. So why is this? You’re the one in control of your life, yet you’d rather put your hard-earned money in another person? This, logically, seems absurd. Your investment is out of your control. Yet, I bet there are many people who would rather invest in others than themselves. Are these people more generous? Are they more friendly? More virtuous? Have more integrity? Are they smarter? What is it that they have that you admire so much? Take that person, subtract yourself, and what are you left with? Become those things you find you’re missing.

Reverse engineer your life. What is it you want to be and how do you plan on getting there? No one knows how many days they have, but on average, there are about 30,000 days to make this life into something great. How many of those days have you already wasted? Do the math. How many of those days do you have left to turn yourself into the greatest investment on the planet? Calculate it out. Plan. Use each of those days you have left wisely.

Are you content with mediocrity?

You only get one trip around this Earth. You should be the kind of person you, as well as others, would want to invest in.

Become that person.

Notes: Growing your wealth is a great thing but means nothing if you don’t grow your internal wealth. Like your external investments, internal investments grow exponentially. As more and more external success comes to you, there is greater and greater need for internal enrichment. The internal and external must be balanced or the external will slip away. There’s a good chance that externally you aren’t where you expected to be because internally you weren’t ready. By investing in your internal self you can ensure that your external success doesn’t slip through your fingers or go wasted.

Great Speech by Former PNC CEO

Jim Rohr speaks at CMU

Few Highlights:

On success:
-Showing up, working hard is a key to success
-Luck is also a big part of success
-Innovation and forward-thinking is key to any business succeeding

On banking/finance:
-Dodd-Frank has WalMart clause
-Money, virtually none is physically at banks
-”Too big to fail” or not big enough to protect itself?
-Deficit is a huge problem, the US dollar could no longer be the global currency soon

On society:
-Uses the internet the most: less than 30 and greater than 70 year-olds
-Every $1 spent on early childhood education gives society back $17-$27
-Biggest predictor of ending up in jail, 3rd grade literacy level
-Next “Pearl Harbor” will be a cyber attack

Message from Natcore’s CEO

Last post I wrote about Natcore Technology. The president wrote a message to shareholders on the website that I thought was important enough to share considering my previous post. Here it is below:

I think it was the 1970s when I first realized that it was no longer possible to buy a television set that was made in America.
As time went on, I began to notice other products that had suffered a similar fate: stereo equipment, digital cameras, and small appliances immediately come to mind. I’m sure you could add to the list.
And I realized this: Whoever owns the technology owns the industry.
We at Natcore are determined that the solar industry will not go the way of the transistor radio. For that reason, much of our time is spent in developing and protecting our solar technology. We are determined that the solar industry will be based on our home soil.
We’ll soon convene a series of meetings with our scientific brain trust, whom we believe are the greatest solar scientists in the world today. This distinguished cadre includes:
Dr. Dennis Flood, Natcore co-founder and Chief Technology Officer. A NASA veteran, with more than 30 years’ experience in developing solar cell and array technology for both space and terrestrial applications.
Dr. Andy Barron, Natcore co-founder. The Charles W. Duncan, Jr.-Welch Chair of Chemistry and Professor of Materials Science at Rice University, as well as a visiting Professor at the University of Wales.
Dr. David Levy, Natcore Director of Research & Technology. A Chemical Engineering PhD, with a minor in Electrical Engineering, from MIT, then 20 years as a research scientist at Eastman Kodak.
Dr. Daniele Margadonna, Chairman, Natcore advisory board. Chief Technology Officer of MX Group SpA in Villasanta, Italy. An international expert in the solar photovoltaic industry with extensive experience in the planning and construction of turnkey photovoltaic plants.
Dr. David Carlson, Natcore advisory board. Until his recent retirement, the chief scientist of BP Solar, for whom he managed future technology programs and the intellectual property system. He invented the amorphous silicon solar cell at RCA Laboratories
Our multitalented technicians—Ted Zubil, Rich Topel and Wendy Ahearn– will participate, too. They’re an impressive bunch: they have 26 patents among them.
The meetings will be held at our Research and Development Center in Rochester, NY. Their purpose can be expressed in these questions: What are the strengths of our technology? What are the weaknesses? How can we maximize the strengths and fix the weaknesses? How can we most quickly move our technology from the lab to the production line?
Incidentally, we’ve finally consolidated all of our R&D work in Rochester. So there will be no more need for routine travel to university labs in Ohio, Arizona, and Texas. (Just to let you know how much money this will save us, we’re paying for Dr. Margadonna’s flight from Italy with airline miles accumulated from our past travel.)
In my next President’s message, I’ll report on the results of these meetings.
Sincerely,
Chuck Provini, President, CEO & Director


Disclosure: Long NXT.V

The Paradox of Penny Stock Investing

A lot of investors keep a portion of their portfolios for speculating in the stock market, often referred to as “fun money” by many.  This percentage generally ranges from 1-5% of an investor’s portfolio.  This is the portion of a portfolio that you’d use to bet on stocks that usually have more potential than actual substance; this often times means betting on penny stocks or stocks trading on the OTC market or pink sheets.  Keeping a portion of your portfolio dedicated to this endeavor is like having a release valve for your portfolio.  Many investors may find it to be quite cathartic.  It should be noted, however, that this is not for everyone.  You still have to remain extremely disciplined and, in a sense, compartmentalize the speculative portion of your portfolio to some extent.

Now, you’re not going to read about how to invest speculatively in “The Intelligent Investor” or “One Up on Wall Street,” two of my favorite books, as you might recall from this post.  However, this does not mean that speculative investing shouldn’t be part of your portfolio and shouldn’t be taken just as seriously as your overall investing philosophy.  A sound philosophy should be developed for the “fun money” portion as well.  The goal, just as with the larger portion of the portfolio, should be to minimize risk.  Just because you are speculating with this small part of your portfolio doesn’t mean you want to lose the money any more than you normally would.

There are many types of ways to speculate in the stock market but generally I tend to think of this as focusing on stocks at the low range of the micro cap world, or penny stocks (those interested in options trading, commodities, currency speculation, and other activities such as these should look elsewhere).  These are companies usually trading for a market cap less than $100 million.  Although these stocks should be analyzed just like other stocks in your portfolio there are several particular areas you really need to go over using a fine-toothed comb:

  • Legitimacy
  • Management
  • Growth

The first portion is business legitimacy.  This means that you should be scouring the SEC (or other) filings of the company and looking for any red flags.  It means that you should be evaluating the company as if you were going to start working there the next day.  If you wouldn’t work there, you wouldn’t want to buy the company, surely.  This means you should be asking questions like:

  • Has this company been around for at least 3 years?
  • Does the product/technology/business make sense?
  • Does the company keep issuing shares only to line executives’ pockets and dilute existing shareholders?
  • Is there an inordinate amount of outstanding shares?
  • How is the company financing itself?
  • Does the company carry too much debt?
  • Do insiders own a large portion of the company?
  • How does the company treat its employees?
  • Is the company hiring a lot of new employees?
  • Does the company have reputable partners or do business with those of high repute?
  • Does the company provide sufficient information/transparency to its shareholders?
  • Are the small shareholders valued?

This is by no means an exhaustive list.  But questions along these lines should be asked and the answers you get to them should make you feel comfortable.  If you don’t find an answer you like, find out why and see if it makes sense.  If you find too many red flags in this portion of the process, don’t even move on to next examination step, just move on to the next company.

The next portion is management.  Many times with small companies it’s good to see management that has been around since the company’s inception.  It’s not necessarily a red flag if they haven’t, or the green light if they have, but as a general rule of thumb this should be the case.  Lots of times, with small companies, you can actually call the management and ask questions that concern you.  When speaking to the management try to get a sense of whether or not these are people you can trust.  You should ask yourself several questions after speaking to management:

  • Are they open to honest inquiry?
  • Do they evade or avoid certain questions?
  • Do the answers they give make sense?
  • Do the answers correlate with what you’ve read about the company?
  • Does what they say actually pan out? (wait a bit and see if what is said comes to fruition)

Other factors to consider when looking into the management of such companies are:

  • Have they invested their time, money, blood, sweat, and tears into the company?
  • Do they own a lot of the stock so that they eat their own cooking?
  • What are their credentials?
  • Are they accountable to anyone?
  • What is the track record of management, especially the CEO?
  • Is there sufficient diversity on the management team and BOD?

Again, this is not an exhaustive list, but gets you thinking along the lines you need to be thinking when looking into more speculative companies.  Act like you are a detective looking for any signs or hints of fraud and steer clear when things start to smell funny.

In the back of your head, you should have already considered the growth prospects of the company in question or it wouldn’t have even be worth looking into in the first place.  However, it should be noted that many micro cap or penny stock companies might look like good growth opportunities but the growth could actually be very limited.  For instance, the company could be in an extremely high growth market such as biotech or pharmaceuticals, but markets such as these mean that competition is going to make it very difficult for the company to actually succeed.  This means that the growth prospects should be tremendous (if you’re going to speculate, don’t speculate with a company that’s going to hit a home-run,  instead, think multiple grand slams).  Some aspects of growth you might want to look into are:

  • What are the odds of market penetration?
  • Are the competitive advantages big enough and sustainable?
  • Does the company have multiple patents? How solid are the patents?
  • Are there large partners aiding the company’s growth/penetration?
  • Does the company operate in a niche market within the growing market?
  • How does the company plan on funding growth?
  • Does the company have an expansion plan in place so that it can grow successfully?
  • If growth/market penetration has been proven already, how likely is it to continue?

Once again, this is not an exhaustive list, but how you should be thinking about the growth of the company.  Also, you should be comfortable with the answers to these questions and any other questions you decide are pertinent.  Above all, don’t make excuses for the company!  If you get answers that don’t jive with you, move on.

Last but not least, try to attend at least one shareholder meeting of the company.  This will give you a chance to get up-close and personal with management as well as bounce questions off of other shareholders.

A good example of an interesting speculation from my portfolio is Natcore Technology, a solar company headquartered in New Jersey.  While I won’t go into laborious detail about the company and how it fits the criteria mentioned above, I will mention some highlights.   The company was founded in 2009 when it bought out a company of the same name— thus clearing my 3-year hurdle.  The company trades on the TSX Venture exchange, a very well-regulated exchange, in Canada and the company reports regularly.  The company is headed by Chuck Provini, a former US Marine and graduate from the US Naval Academy.  He has at least 19 military decorations, was a captain in the Vietnam War, and has lived his whole life in the United States.  The rest of his bio can be found here.  The CEO has been very forthright with shareholders and encourages shareholders to call him if they have any questions.  He even issues regular statements via the Natcore website.  And, although he is surrounded by several other individuals with pretty extended resumes, the one that stands out the most is Dennis Flood.  Dennis Flood is the CTO of the company and has worked in the solar industry for over 30 years.  He worked at NASA where he developed photovoltaic power systems for space and planetary missions.  A more extensive bio is seen below:

“He received two Special Act or Service Awards from NASA for his pioneering work on advanced solar cells for space applications and for research that established the feasibility of powering a human outpost on the surface of Mars with solar energy.

Flood also served as chair of the IEEE Electron Device Society’s (EDS) photovoltaic device technical committee for seven years and as a member of the IEEE EDS education committee. He also participated in the EDS’s Distinguished Lecturer Series, a position he held for more than a decade.
He is a member of the international advisory committees of the European, the U.S, the Japan/Asia and the World Photovoltaic Conference organizing committees.

He is an inventor or co-inventor on several patents or patent applications in photovoltaics and nanotechnology and has over 100 peer-reviewed publications and presentations in solar energy, electron devices and materials science.”

Source: PV-Tech.org

Natcore has several patents.  It has also been granted a license to use the Department of Energy’s black silicon technology.  This allows more light to be absorbed so that solar cells are more efficient.  However, the patent which holds the most promise is the company’s Liquid Phase Deposition technology.  You can read more about this technology and the benefits here, but in a nutshell, this technology allows the company to manufacture solar cells at a much lower cost than they are currently being manufactured.  Combine that with the company’s latest selective emitter technology and the cost is further reduced.

The CEO explains the company’s technology here.

The company’s technology is breakthrough, to say the least.  It could completely change the solar industry.  If you research the company some more you’ll see a myriad of great accomplishments.  So, you might be wondering, with so many “great things” going on, why is this company speculative?   Well, the company has yet to generate any revenue.  It is still working on commercializing the technology and proving the cost benefits of the technology.  The company has reached several milestones and has been making forward progress but it has nothing to sell as of yet.  Although it is working on what it calls the “AR-BOX” as its first commercialization effort, it is not ready for commercialization yet.  So questions remain.  Will the company prove that its product is commercially viable?  When will it be ready?  Will the company produce significant enough revenue with large enough margins if/when the product is ready?  Will the market adopt the product even if the company does prove it?  Several more questions like this remain.  That’s why this is speculative.  There is nothing to go off of except for future hopes and dreams of revenue.  Although the company has been marching towards that territory, there is nothing to sink your teeth into as an investor to figure out what the margin of safety is here.  This is why a small percentage of my portfolio is dedicated to this type of investing.

At the end of the day, many investors should avoid speculating.  It can be tempting to get carried away and not keep the speculative portion of the portfolio below 1-5% and sell when the speculate portion rises well above this point (assuming you adopt the 1-5% strategy).  Investors often ride a speculative investment up just to ride it back down again.  There is often times more discipline involved in speculation than there is with regular investing and many investors have enough trouble maintaining discipline with their regular strategies.  So, this is only for the bold, disciplined, and cautious investor.  It almost sounds like a paradox, being disciplined to be speculative, but it’s impossible to be successful at speculation without the discipline.  Otherwise, your “fun money” will be “dumb money,” which defeats the whole purpose of allocating a portion of your portfolio to speculation in the first place.  You might as well just cash out 1-5% of your portfolio a year and burn the money if you aren’t going to follow a disciplined approach.

Disclosure: Long NXT.V

Pawn Stars, Shark Tank, and Investing

Two of my favorite television shows are Pawn Stars, on the History Channel, and Shark Tank, on ABC.  These shows entertain, and most importantly, inform viewers.  A lot can be learned from both of these shows.  A lot can also be learned from the characters on these shows.  Rick Harrison, part owner of the pawn shop with his father and son, is one such character;  Kevin O’Leary, from Shark Tank, is another.

Rick Harrison started in the pawning business at age 13.  He co-founded the Gold & Silver Pawn Shop in 1988 with his dad, Richard Harrison, at age 23.   When Rick was 8 he had his first grand mal epileptic seizure and was bed-ridden for most of his childhood.  This proved to be fortuitous as he developed his love for reading during this time.  He read lots and lots of books.  One book series he particularly enjoyed was The Great Brain by John D. Fitzgerald, about a boy who always had new schemes to make money.  No need to explain the irony here.  His love of reading became the foundation of his life as he found his love of curiosity and knowledge.  He finds television boring, also ironic in that his show is one of the top hits, and finds reading to be the most exciting way to pass time.  Described in his own words, from his book, License to Pawn, he says “…much of the enjoyment I’ve gained from life has stemmed from a book — either researching some arcane item or reading to learn how to do something practical with my hands.”

So what can we, as investors, learn from Rick Harrison?

  • His love of knowledge and reading is extremely beneficial.  For him, knowledge of an item is key to buying it for the right price.  He also discovers items at antique stores and other pawn shops because of his knowledge.  It is no different in investing.  You must love reading and knowledge.  This includes reading “arcane” material as often times lesser known information can give you a leg up on other investors.  It can also help you find rare opportunities like Rick.  Many of the most successful investors are avid readers.  Warren Buffett admits to loving to read annual reports.  His partner, Charlie Munger, put it best when he said, “In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time – none, zero. You’d be amazed at how much Warren reads – at how much I read. My children laugh at me. They think I’m a book with a couple of legs sticking out.”
  • He knows how to say no.  Rick always turns down items if the price isn’t right and he can’t make a solid return on his investment, even if he loves something.  In investing, you have to learn to pass on many opportunities.  A company many be attractive but the price may not be right.  Other times, the company isn’t right.  Sometimes, you may really like the company or its products but the management is running it into the ground.  These are just a few of the many reasons to pass on a potential company or stock.  No matter how much you like some investment, or some aspect of any investment, you have to learn to say no.  As Peter Lynch says, in Beating the Street, “Never fall in love with a stock; always have an open mind.”
  • If the price is right, he sometimes takes a perceived gamble.  If Rick sees an item that he thinks could be worth $100 to $2500 bucks, sometimes he’ll buy it for $500 dollars because the potential return is so high it’s worth the risk.  Now, why do I call it a perceived gamble?  It all comes down to expected value.  Rick might have an 80% of losing $400 here and a 20% of making $2000.  His expected value is $80.  On average, if he makes bets where the expected value is positive he comes out ahead.  So, it’s not really a gamble.  He’s also not betting the house here, he’s only risking $500, not $1,000,000.  He’s not going to risk his store on something that might be fake.  As such, sometimes you might decide to go after a stock that’s a long shot but has a positive expected value according to your calculations.  So, putting 1-5% of your portfolio in it might be worth it.  The problem with this is that the math will never be 100% accurate in investing.  This is why I say sometimes.  You do it when you’re more certain about the odds — something that won’t happen very often, if ever.  You cannot build a portfolio, or a business for that matter, going after long shots.  A good analogy is found in baseball.  It’s best to swing at the pitches right down the middle and hit base hits with near 75% certainty than swing for home runs, out of the strike zone, with 5% certainty of hitting one.  You can score a lot more points with the base hits.
  •  He always pays a lot less for something than it’s worth.  If he believes an item is worth $2000 or an expert tells him he can get $2000-5000 for an item, he never pays $2000 for it.  He’ll usually pay something like $1500 for the item to make sure he can profit off of it.  In investing, this is called margin of safety.  You don’t buy stocks to make 1% off of them.  You factor in a larger margin of safety than that, perhaps 20% or so, in case you make a mistake.  Why?  Because you, and Rick Harrison, never know what someone will actually pay for something, be it a stock or a piece of antique furniture.  The stock could actually be worth $1.10, you pay $1.05 for it, but the market might never price it at $1.10.  Just like the item Rick bought might be worth $2000, but he might only be able to get $1800 in the market.  
  • Always factors in the amount of time it will take him to sell something.  When Rick buys an item, like a book, that might take a lot longer to sell than, say, a signed Beatles album, he factors that in to what he’ll pay for it.  It also takes up room in his store for a longer period of time.  Just like if you buy a stock that might take 3-5 years to appreciate in value versus one that might take only 6 months to 1 year to appreciate the same amount, you would want to pay a lot less for the former to factor in opportunity cost, inflation, and the time value of money.

A lot more could be said about the show, and Rick, as it relates to investing, but suffice it to say the show is full of tidbits and useful information that can work to your advantage as an investor.

Likewise, Shark Tank is also a great show for an individual investor to watch.   While I won’t go much into the show and how it relates to investing, as a lot of this is self-explanatory for anyone who watches it, it may, or may not, surprise you to know that Kevin O’Leary, known as “Mr. Wonderful” on the show, also runs his own mutual fund.

Besides being a television personality, Kevin O’Leary is a Canadian entrepreneur and investor.  He started a software company called Softkey with $10,000 from his mother and grew the company to ~$3.8 billion when it was purchased by Mattel (at that time it was known as The Learning Company).  He also had several other successes that you can read all about in his book.

O’Leary Funds was started in 2008 when Kevin O’Learly was looking for someone to manage his money but couldn’t find the right person.   The company was co-founded by Connor O’Brien.  The company’s philosophy is simple, to “provide investors with value and yield.”  It does that through three core principles, “income, capital appreciation, and capital preservation,” according to the company’s website.   The company also describes its funds as being long-term oriented and disciplined.

So what is Kevin O’Leary’s investing philosophy/approach?

  • He never buys a stock that doesn’t pay a dividend.  This is something his mother taught him long ago and he firmly believes in it.
  • He buys companies that are growing free-cash flow and calls earnings “mumbo-jumbo,” saying, “you can’t lie about cash.”
  • Believes commodities aren’t attractive but the service providers are, saying, “I’d rather own the pipeline than the oil that flows through it.”  He believes if you own commodities you are speculating, not investing as commodities don’t produce a yield.
  • Thinks diversification is the only “free lunch” in investing and that you should not dedicate more than 5% of your portfolio to one investment.  He also owns multiple currencies as a way of diversifying.
  • Uses gold as a “buffer,” or “stabilizer,” and leaves it at 5% of his portfolio.  Gold, to him, is not an investment, merely a hedge that he sells when it becomes more than 5% of his portfolio and buys when it becomes less than 5%.
  • Likes to invest in countries where GDP is growing at >3%.  Some examples he gives are Brazil, India, and China.
  • Believes China will overtake US global economic leader and invests accordingly.
  • 5% of his net worth goes to venture deals.
  • Believes people should invest 20% of your earnings the day you start working for the rest of your life.
  • Believes people should always “spend the interest, never the principal.”

Here is an example from his “Global Equity Yield Fund” of what he is buying:

While a lot can be learned from these two individuals about investing specifics, the most important lesson lies between the lines.  What makes Rick Harrison and Kevin O’Learly so successful at what they do is their passion and discipline.  They believe in what they do and they hardly ever deviate from their rules.  The times they do, you can watch with your own eyes the lessons they learn and exactly how they get burnt by not being disciplined.  You can even hear in their own words why they don’t do this or that because they have learned from their mistakes.  Above all, they’re nice and honest guys (despite the fact that Kevin is seen as cold-blooded on the show).  So turn off Mad Money with Jim Cramer, because it will only drive you mad as you watch all your money fly out the window, and turn on Pawn Stars and Shark Tank and actually learn how to be a successful investor.

Apple’s Stock and the Voting Machine

Peter Lynch put it quite simply by saying, “Buy what you know.”  Now, I’d be remiss if I didn’t mention that there was a study showing this often does not work.  Here, however, it does.

The other day I walked into an Apple store to check out the iPad mini.  It was like walking into a swarm of bees in a beehive.  People were everywhere.  Everyone I know loves Apple’s products and owns at least 1 apple device.  Those I know who don’t own an Apple device plan on buying one in the near future.  I’ve used other products, talked to others who use other products, and everyone admits these devices aren’t as good as Apple devices, this includes: phones, computers, MP3 players, portable tablets, etc.  Apple products are vastly superior in every category, there’s really no debate.  The only reason you wouldn’t buy an Apple product is because you were interested in saving money, with plans to purchase one in the future when the price goes down.

As for the current state of Apple’s stock, Peter Lynch has something else to say about that:

“When even the analysts are bored, it’s time to start buying.”

There’s no question that analysts are bored with Apple, but, really, who cares?  Apple’s stock is a no-brainer at $431.72 as I type right now, March 10, 2013.  The company has $137b in cash.  With that amount of cash Apple could buy Ford and Honda and almost have enough money left over to buy Tata Motors at the companies’ current market valuations.  This is an insane amount of cash for one company.  If Apple has any problem, it’s having too much cash, not the worst problem a company could have.  Personally, I think Apple should follow in the footsteps of IBM and buy a massive amount of its own shares.  Its current share buyback program only allots $10b for this endeavor.  With $137b in cash, that is chump change.

Apple, according to a recent press release, plans on returning a lot of that cash to its shareholders:

“Apple’s management team and Board of Directors have been in active discussions about returning additional cash to shareholders. As part of our review, we will thoroughly evaluate Greenlight Capital’s current proposal to issue some form of preferred stock. We welcome Greenlight’s views and the views of all of our shareholders.”

Cash considerations aside, Apple trades at a current P/E of 9.79.  This is well below the 5-yr. average P/E of 15.6.  Furthermore, Apple’s P/E has never been so far removed from the S&P 500′s P/E as it is now, trading at ~40% below the S&P 500′s (~43% below the Nasdaq’s), with Apple’s average P/E being 64% above the S&P 500′s since 2003.

If the P/E is any indication of investors’ expectation, they don’t seem to believe that Apple will grow much faster than ~10% per year.  However, over the last 5 years Apple has increased earnings by an average of 63% per year.  If Apple continues growing at even half that rate, you’d be looking at EPS of ~$174 by 2017.  This would equate to a share price of $1703.46 at the current P/E.  Now, I must reiterate, this is the half-growth scenario.  Staying at the average current growth rate would mean a share price of $4973.32.  Now, my hypothesis is that we land somewhere towards the lower end near $1703, taking into consideration that the market discounts the future and that the company is not going to realistically grow into being 20% of our economy— but this would still amount to almost a 4-fold gain in under 4 years.  Furthermore, either way growth pans out, you’re looking at what could be over a trillion dollar company sometime in the 2014-2015 range.

With growth and P/E considerations in mind, read these quotes by famous P/E investor John Neff:

“Low p/e multiples usually languished 40 percent to 60 percent below prevailing market multiples.”

“Low p/e companies growing faster than 7 percent a year tipped us off to underappreciated signs of life, particularly accompanied by an attention getting dividend yield.”

As shown earlier, the p/e multiple does languish more than 40% below prevailing market multiples.  Also, Apple is growing much faster than 7 percent with a pretty astonishing dividend, for what I still deem a “growth company,” of 2.46%.

Peter Lynch would love this stock, especially when looking at the P/E in terms of the growth.  While Yahoo gives a PEG of 0.5, Peter Lynch looks at it a slightly different way.  He takes the long-term growth rate, which I estimate on the low side to be 30% (Yahoo’s estimate is 20%), adds the dividend yield, 2.46%, and divides by the P/E ratio, 9.79.  This gives 3.3 for my estimate vs. 2.3 for Yahoo’s.  In One Up on Wall Street Lynch describes the interpretation of these values as the following:

 “Less than a 1 is poor, and 1.5 is okay, but what you’re really looking for is a 2 or better.”

He goes on to give an example of a stock that scores a “3″ and deems it “fabulous.”  If we say that the number will most likely fall somewhere between these two estimates, 2.3-3.3, we’re looking at a stock Peter Lynch would undoubtedly rate as a “strong buy.”

Now, there are concerns that Apple’s moat may be drying up as companies like Google continue to steal market share.  However, in this analysis a margin of safety was added by considering Apple’s stock in light of growth drying up 50%, which isn’t likely to happen.  You have the new Macbook Air coming out, iPad 5, iPad mini 2, iPhone 5s, iMac, Mac mini, just to name a few.  And according to CEO Tim Cook, new products in new categories are on the horizon.  Some anticipate the iWatch as one.  The bottom line: it doesn’t matter what is on the horizon.  Apple could make a car and people would buy it just because it is an Apple product.  Even if Apple didn’t come out with any new products, looking at the company from a zero growth perspective, seen here (provided by Old School Value) for those interested in more advanced valuation methods, Apple’s stock has significant downside protection.

As was said by many great value investors, “Protect the downside and the upside will take care of itself.”

Let’s forget the growth concern altogether. A huge aspect not talked about very often is the strong IP position Apple has, illuminated below, from this article:

“…Apple is falling back on its IP portfolio to protect its market position. Generating revenue by suing other companies is not the ultimate goal of Apple’s recent lawsuits. Rather, each case that Apple wins confirms the validity and enforceability of its patents to its competitors. Apple can then license its patented technologies and designs and charge Google and other competitors for using them, piggybacking on their competitors’ success.

It would appear that Apple’s business model is evolving into two modes. First, use a closed model to develop innovative technologies for sophisticated user markets; patent the utilities and designs that the company engineers. Second, license those utilities and designs to businesses that wish to use them. So long as Apple continues to be the first of its competitors to patent new technologies, combining both modes would create serious revenue for Apple and help it maintain its leadership position.”

So… to reiterate the absolute absurdness of this price and to lighten things up a bit, watch this video of Bill Maher and his guests talking about Apple:

And although this video is older, I still find it extremely relevant to this post:

As Ben Graham famously said, “In the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine.”  Long-term shareholders that buy Apple at this price can take advantage of this phenomenon.

Disclosure: Long AAPL

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