The Poor Investor

Investigatory Value Investing

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

Housekeeping

All my “ranting” about Dell has been moved over to Twitter as I believe that is a better forum for those types of conversations.  Although I still disagree with the price offer, I believe that the valuation is being properly looked into at this point.  I have since sold my stake in the company, which may be premature depending on how everything pans out, but I believe there are other opportunities which offer more certainty at this juncture.  In the future, any comments that are aimed at individual companies that do not help to illuminate a particular point or idea will be directed to Twitter as I believe that is a more appropriate venue.

The Investing Book You Haven’t Read

As a do-it-yourself investor, I love to read investing books. However, there are only a few books that have really had great educational value, the rest were merely entertainment.

Here are the books which have helped me the most:

  1. One Up on Wall Street, by Peter Lynch
  2. The Intelligent Investor, by Benjamin Graham
  3. Poor Charlie’s Almanack, by Charles Munger
  4. Common Stocks and Uncommon Profits, by Phil Fisher
  5. What Works on Wall Street, by James O’Shaughnessy
  6. See below.

Most of these books you’ve probably heard of or read yourself. If you haven’t read them, I suggest you do if you plan on investing on your own. However, there’s one more book (6) that also goes on this list that most people haven’t read. This book, in my opinion, is essential to the go-it-alone investor. The book is called “100 to 1 in the Stock Market,” by Thomas Phelps. The only problem is the book is out of print and hard to find. Your best bet is borrowing it from your local library.

Thomas Phelps offers some good advice as to what to look for when trying to find a 100- to-1 investment:

  1. Inventions that enable us to do things we have always wanted to do but could never do before. 
  2. New methods or new equipment that helps people do commonplace things easier, faster or at less cost than ever before.
  3. Processes or equipment to improve or maintain the quality of a service while reducing or eliminating the labor required.
  4. New and cheaper sources of energy.
  5. New methods of doing essential jobs with less or no ecological damage.
  6. Improved methods or equipment for recycling the materials used by civilized man instead of making mountains of waste and oceans of sewage.
  7. New methods for delivering the morning newspaper without carriers or waste.
  8. New methods or equipment for transporting people and goods on land without wheels.

He even gives 365 examples of 100-to-1 stocks (from 1932-1971) which could have turned $10,000 into $1,000,000 if bought right and held tight.  Some of  the more familiar of these include:

  • J.C. Penney Co.
  • Deere & Co.
  • Abbott Laboratories
  • Dr. Pepper
  • Lockheed
  • Greyhound Corp.
  • Philip Morris
  • Merck & Co.
  • Goodyear Tire & Rubber
  • Motorola
  • International Business Machines
  • Johnson & Johnson

These stocks all gained at least 100x their original value and some obviously much more.

Let’s say you decided to invest using Mr. Phelps’ method using $10,000 (+any additional money for fees).  Furthermore, say you decide to devote a year to trying to uncover 25 stocks which you thought fit the bill as 100-to-1 type companies.  After this, you divide your money equally into the 25, buying $400 of each company, and hold them for 20 years.  If you only identified 3 out of 25 stocks that went 100-to-1, and say the rest went to zero, even factoring in that year you were looking for the stock, you would have a compound annual growth rate of 12.56%, and $120,000.

Here is the CAGR for identifying 1 out of 25 to 10 out of 25:

  1. 6.82%
  2. 10.41%
  3. 12.56%
  4. 14.11%
  5. 15.33%
  6. 16.34%
  7. 17.20%
  8. 17.94%
  9. 18.61%
  10. 19.20%

Even identifying 2 out of 25 is nothing to scoff at, which beats the average S&P 500 return, including dividends, by ~1%.  Not to mention, this method does not include the dividends you might gain from the companies you invest in.

This method, just like any other, is not fool-proof—and although I don’t know the odds, common sense tells me that they are heavily stacked against you in trying to find 100-to-1 type companies.  Keeping that in mind, I leave you with a parable Mr. Phelps shares with us in the beginning of his book:

“Ask and It Shall Be Given to You”

Five poor Arabs slept on the sand. A bright light woke them. Out of it came an angel.
“Each of you can have one wish,” the angel said.
“Praise be to Allah,” exulted the first Arab to catch his breath. “Give me a donkey.”
Instantly a donkey stood at his side.
“Fool,” thought the second Arab. “He should have asked for more.”
“Give me 10 donkeys,” the second Arab begged.
No sooner said than done. He had ten donkeys.
The third Arab had heard and seen how the first two had fared.
“To Allah all things are possible,” he said. “Give me a caravan with a hundred camels, a hundred donkeys, tents, rugs, food, wine, and servants.”
They came so fast that the third Arab was ashamed to be seen in his rags before such an entourage. But his shame did not last long. Deftly his servants dressed him in robes befitting his new status.
The fourth Arab was more than ready when his turn came.
“Make me a king,” he commanded.
So quickly did the crown appear on his head that he bruised his knuckles from scratching where an instant before there had been nothing but an itch. The palace gardens stretched out before him almost as far as the eye could see, and the palace turrets reached so high their pennants were lost in the desert haze.
Having seen his companions in misery ask too little, the fifth Arab resolved to make no such mistake.
“Make me Allah!” he ordered.
In a flash he found himself in sand, covered with leprous sores.

Recommendation Update

I am retracting my buy recommendation on Heska due to new information obtained about the company. All the posts below will now have Heska crossed out.

Bull Markets, Mega Caps, and College Campuses

Sir John Templeton famously said, “Bull-markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” As we know right now, we are still no where near the “euphoria” stage, even though the markets have had an impressive run, with the S&P 500 alone up 15% YTD.

I would like to share a video with you from Davis Advisors that I think is helpful during this time. This may not be new information, but I think it’s good to have a refresher every so often, think of it as mental flossing:

Davis Funds: Insights

Also, according to Ken Fisher’s research, this “phase” of a bull market is usually best for mega-cap stocks. To his point, I do see value in companies such as Apple, Berkshire Hathaway, Eli Lilly, Sanofi, Proctor & Gamble, and Kimberly-Clark, to name a few.

I would also like to reiterate my “buy” recommendation on Heska (pick removed due to new information: 01/03/2013), Dell, Nvidia, and Atrion. Dell has been particularly attractive as of late as it hit a new 52-week low which it has since bounced off of quite nicely. I hope you took advantage, as my readers, and picked up shares along with me.

I would also like to add one more recommendation: American Campus Communities. Ron Baron explains the moat:

“There are five million obsolete college campus housing units that need to be replaced and renovated. Colleges can’t afford to do this. That’s the growth opportunity. American Campus is the largest provider of such housing with nearly 70,000 units. It builds and owns housing on college campuses with 80 year land leases that prevent others from competing against them.”

Not to mention, the company has an 11% profit margin and a 3% dividend. Also, as housing comes back, this stock will rise with the tide. Revenue and operating cash flow have steadily increased over the past 10 years (10-year average for revenue: 25.35%) while operating margins have remained near 18-25% during this time. With a moat firmly in place, I see no reason for this not to continue.

What I would not be holding now: bonds, gold, cash.

Disclosure: Long DELL & NVDA

Higgs Boson, Markowitz, and Graham

From Roumell Asset Management’s quarterly report— I feel this exemplifies the philosophy I espouse on this website quite well.  

A “unified theory” has long been the Holy Grail in theoretical physics that could account for both subatomic and universal realities. It appears the field has made a giant leap forward with the recent discovery of the Higgs boson particle, commonly referred to as the “God particle.” Higgs boson accounts for the various strains of information, analyses, and data that physicists, working with different approaches, have gained over the years from their efforts to better understand our universe. While some physicists prefer to focus on big-picture questions like how time and space interact, others prefer to ask why some particles have mass, while others, such as light, do not. Different starting points, same goal: knowledge.

Although investing is certainly not a hard science, it too has long pursued its own unified theory. On the one hand, financial planners and advisers use asset allocation to construct portfolios with multiple asset classes in order to spread risk and reduce volatility. Harry M. Markowitz is known for his pioneering work on Modern Portfolio Theory. Markowitz’s Portfolio Selection, which he wrote in 1952 while a graduate student at the University of Chicago, serves as the framework for planners using asset allocation as the primary portfolio construction tool. Markowitz argued that a portfolio should be designed using uncorrelated asset classes to maximize returns with the greatest efficiency (reduced volatility).

The shortcomings of the asset allocation model include today’s high level of correlation among asset classes. In addition, performance is tied to overall market returns and leaves little opportunity to exploit market inefficiencies. Of course, many investors in this camp believe security prices reflect all known information and are thus always efficiently priced.

In contrast to the investment allocators are individual securities investors. For value investors like us, Benjamin Graham wrote the gospel with its emphasis on specific security characteristics, margin of safety, and the temperament to see the process to fruition. Graham elegantly stated in 1934, “The field of analytical work may be said to rest upon a two-fold assumption: first, that the market price is frequently out of line with the true value; and, second, that there is an inherent tendency for those disparities to correct themselves.” The mantra for security-specific investors is that market price diverges from intrinsic value often enough to add investment value, particularly in smaller overlooked and/or out-of-favor securities.

As decided adherents of the security-specific, bottom-up value investment camp, Roumell Asset Management does not begin with a belief that we should own a little of everything. Rather, we begin by searching for value in the marketplace, wherever it may be. We firmly believe that obsessing about price paid has a far greater impact on securing respectable returns than gauging what John Maynard Keynes referred to as “the average opinion of the average opinion.” There are multitudes of analysts, commentators, and investors putting forth their opinions about the upcoming direction of gold bullion, U.S. Treasury bonds, and the stock market. We have nothing of substantive value to add to this conversation. It’s not what we do.

A subtle but highly important distinction in reviewing market efficiency literature is necessary, in our view. To paraphrase Warren Buffett, the difference between markets being mostly efficient and always efficient is the difference between night and day.  Interestingly, Berkshire Hathaway seeded additional capital to its two recently hired portfolio managers and gave them authority to manage the funds “exactly as they see fit.”

The reasonable question to ask then is how much should a portfolio be constructed with an emphasis on hitting all the major asset-class boxes (large cap growth, small cap value, emerging market stocks, corporate bonds, etc.) versus putting together a portfolio of security-specific-focused managers with the latitude to go anywhere in their search for value? In other words, rather than arguing about who’s “right” perhaps it’s more reasonable to simply ask: How much Markowitz and how much Graham does an investor want in his or her portfolio? An allocator only need believe that markets are inefficient enough to warrant some exposure to security-specific, bottom-up investors, be they growth or value oriented.

We do not seek to change any investor’s mind regarding investment philosophy. Rather, we want our investors to understand our investment philosophy. Our clients can trust that 100% of our own investment capital will remain invested in our portfolio options because determined research, a deep appreciation for value, a contrarian bent, and a steady temperament are what make the most sense to us.

Notes from The Poor Investor:

 It never hurts to reiterate your basic investment philosophy or tenet to see if your actions correlate with that philosophy/tenet.  If they are out of sync either: a) change your actions, or, b) change your philosophy.  However, as a word of caution, before you start investing heavily on your own you should have a philosophy that is sound (meaning it stands the common sense test), proven (is backed up by reliable data/facts), and unchanging (is time-tested and perfect enough that it does not have to be modified).  If you are constantly changing you investment philosophy and/or method of investing then you are setting yourself up for failure.

And with that I’ll leave you with a quote from James P. O’Shaughnessy:

“…we can see the simple truth that using simple, straightforward and time-tested investment strategies leads to the best overall results in virtually all market environments.”

What’s Next?

A lot has happened since I last wrote…  Mitt Romney chose Paul Ryan to be his running mate.  The European Union seems to have gotten its act together, financially speaking.  Facebook reached a new low and Amazon reached a new high.  Even the auto market has maintained most of its steam in the wake of the European Crisis.  In conjunction with this mostly good news, the stock market has also risen to new heights—following its usual trajectory during an election year.

So what does this mean for the future of the stock market?  Well, I will not pretend to know what will happen with the stock market overall, but there are still plenty of stocks out there that I think will provide favorable returns for those who buy individual stocks.  Some of these names will be familiar, some not.  Bargains come in all shapes and sizes (see Ken Fisher’s Debunkery for more on that).

In regards to the aforementioned “bargains,” let’s start with the more familiar.  At a price-to-sales ratio of 0.3 and a dividend of 3%, Dell is my favorite pick out of all the bottom-dwellers.  There is fear that Dell might be a “value trap” and this very well could be, although, I believe Black Friday and Christmas will serve as important catalysts.  As I type from my Alienware computer (Dell-owned), I remember bargain-hunting for it around the same time as the holidays were fast-approaching.  Also, there is a high margin of safety in that Dell is largely considered a value trap.  Value traps may trap buyers, but usually don’t go any lower.  In the end, the catalysts may prove false, but the stock should not depreciate much from this price.

The next in the “familiar” category, is Nvidia.  Now, this may not be familiar to all, but, computer geeks should be plenty familiar with this company.  Although Nvidia was snubbed by Amazon, its new chips are used in Google’s Nexus 7 and will be used in Microsoft’s new Surface tablet.  With around $5/share in cash, the company is effectively trading at  near 11x earnings, for a company that usually trades around 14x earnings.

In the “unfamiliar” category, the company I’d like to start with is Heska.  This company operates in the veterinary market, selling diagnostic equipment and other products to veterinary clinics.  This is a growing market and its growth is expected to continue well into the future.  The company trades with no debt, 16% of the share price is accounted for by cash, and it has a dividend of 4.60%.  As a smaller company, it is still speculative, and will require more due diligence than the more familiar companies.  However, there is more room for reward here if the company can successfully navigate the next few years.

Last, and also in the unfamiliar category, is Atrion Corporation.  This company has shown tremendous growth potential in a growing market— healthcare.  The company manufactures cardiovascular, fluid delivery, and ophthalmic devices.  It has also ranked highly over the years in Value Line’s “earnings persistence.”  The company has a small dividend (1%), positive cash per share, no debt, and boasts a profit margin of 20%.  Although the company has faced some headwinds as of late, it seems poised to perform well in the coming years.  This is another long-term growth story that will require proper due diligence.

In the face of what else is to come, be assured that there are still plenty of stocks out there whose performance will have nothing to do with what else is to come.  These are just a few of them that you might be interested in.  Feel free to mention some more that you think offer a better opportunity for potential price appreciation over the next few years.

Until next time…

The Poor Investor

Thank You Facebook and Morgan Stanley

There is much to be said about the Facebook IPO but suffice it to say it was a huge disaster.  There was even talk in the Wall Street Journal about how the whole debacle may have hurt overall investor confidence.  Not surprisingly, the average Joe is probably more than likely to avoid IPOs in the future.  But would the average Joe be right to do so?  Maybe investors should thank Facebook and Morgan Stanley for botching the offering and turning them away from IPOs.

“Three out of four have been long-term disappointments,” said famed investor Peter Lynch of IPOs.  Let’s see if he is right.

From November 1st, 2010 to May 26, 2011 there were 157 IPOs for which I found accurate data.  If you had invested $100 in each of them at their initial offering price, you would have $14,735 today— a total loss of $965.  If you include brokerage fees, assuming $7 per stock bought, you’d be in the red by $2064, not including the fees to sell.  Your chance of investing in one of those 157 IPOs and actually making money (>$1): 36.3%.  Doubling your money or greater: 5.7%.  Hitting a ten-bagger: 0.0%.  Losing 50% or more: 24.2%.  Losing it all: 1.9%.

Turns out Peter Lynch wasn’t too far off.  Out of the IPOs investigated, approximately 3 out of 5 turned out to be long-term disappointments.

After looking over the data it’s unlikely that you’re going to do well with an IPO.  The odds are stacked against you.  Even worse, most companies are too new to have a history to go off of.  There’s also no guarantee that you’re going to get the IPO price.

When asked which stocks he’d avoid in the market at the Berkshire Hathaway annual meeting, Charlie Munger replied, “new issues.”  Perhaps investors should heed that advice.

Where to Look for Opportunities

In light of the recent plunge in Green Mountain Coffee Roasters’ (GMCR) share price, I thought it rather fitting to talk about where to look for opportunities in the stock market.  In my opinion, there are always opportunities out there.  Sometimes they’re hard to find, such as Vermillion, sometimes they’re right out in front of you, such as GMCR.  However, the real crux of the situation lies in deciphering whether they’re good opportunities, like buying shares of BP after the spill turned out to be, or bad ones, like buying shares of Kodak.  In choosing one versus the other, I’ll leave that up to you.

So just where do we find opportunities in the market?  Well, the question may not always be best posed as “where,” but instead, sometimes, as “when.”  The easiest when to look for opportunities is during a bear market, like the one that just occurred in the 2007-2009 period.  During this time, untold numbers of stocks were dirt cheap.  Berkshire Hathaway, perhaps one of the safest investments (perhaps even safer than US treasuries) was selling at nearly half of today’s price.  Another when is during a period of extreme panic or distress for an individual company, such as is the case of the aforementioned shares of GMCR, BP, and EK.  Even whole industries succumb to such malaise from time to time.  Coal, for example, is one such industry; shares of Peabody Energy Corp. and Arch Coal could prove to be bargains at these prices.  During a company’s turnaround also provides another when for shareholders looking for opportunities.  Successful turnarounds such as Ford Motor Co. and Nautilus Inc. (chart) come to mind here.

Sometimes market opportunities are pretty obvious.  Look for companies that are buying back their shares.  Warren Buffett bought IBM while it was reaching new highs partly due to the company’s diligent use of capital to buy back its own shares.  Look for companies trading below book value, below sales, with high dividend yields, at low price-to-earnings, low price-to-cash flow, near current company cash levels, and those growing at high returns on capital.  Current stocks that fall into some of these categories are names such as Hewlett-Packard, Chevron, and Exxon Mobil.  Companies on the verge of merging and those that are going private may also provide more obvious opportunities for investors.  US Airways, on the verge of a merger with American Airlines, could provide one such opportunity.

Sometimes the opportunities aren’t so obvious.  Companies that are on the bleeding edge of technology or the verge of new breakthroughs are of this type.  Vermillion, for instance, shot through the roof when it received FDA approval for its OVA1 cancer test.  Dendreon (DNDN) also saw its shares soar after receiving FDA approval for its cancer drug, Provenge.  In these instances, knowledge is your most important ally.  If you had followed the latest cancer research, as well as all the companies involved, with extreme dedication and focus, you may have also uncovered these opportunities.  Although these types of stocks can be found in any type of market, healthcare, biotechnology, cloud computing, and energy are some of the more common ones at this time.  Other less-than-obvious opportunities come in the form of companies exploring for vast natural resources or those that are highly leveraged, though these, especially the latter, require shrewd calculating as to what really is the risk-reward and whether or not its favorable.

The opportunities in the stock market are nearly limitless.  It all depends on the level of involvement you are willing to have to unearth them.  The list above is not nearly as exhaustive as it could be but hopefully serves as it was intended, to give you an idea of how to think about where to find market opportunities.  Don’t limit yourself to the obvious, as Ken Fisher says in his book, The Only Three Questions that Count, “Go crazy. Be creative. Flip things on their heads, backwards, and inside out. Hack them up and go over their guts. Instead of trying to be intuitive, think counter-intuitively—which may turn out to be way more intuitive.”  Sometimes finding opportunities means knowing where not to look just as much as knowing where to look.  And lastly, don’t mistake an opportunity for a good investment, only invest when the risk-reward is in your favor.

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