I like to compare buying stocks to playing poker. In both games you are playing against other people and your success depends directly on how poorly the other people do relative to yourself. Every dollar you make must come from someone else; they are essentially zero-sum games. If you win a hand in poker, the losing players pay you. If you sell a stock for more than its worth, the seller loses the difference to you. If you fail to do either, your loss is equivalent to their gain.
Of course, there is a fundamental difference. In poker, though the house is not against you, it does tax winnings and therefor reduces the total wealth of all involved. In the stock market, businesses are involved which are fortunately not zero-sum and instead produce wealth. The wealth that the businesses produce and the amount the house takes in poker are the game’s edge. Historically the stock market has an edge of negative 10% per year, poker has an edge of around 5% per pot. Making 10% in the stock market is as easy as losing 5% in poker, you just do what everyone else does.
However, if you want to make more than the 10% you must take that money from other investors, just as if you want to make money in poker you must take it from other players. I don’t mean to ruin the whole idea that market-beating investors are amazing people that generate wealth without hurting anyone, but it just isn’t the case. Every dollar they make above 10%/year comes from the mistake of another investor. I would argue that great investors are indirectly helping the economy far more than the they are hurting the investors they take the money from, but that’s beside the point. Beating the market means beating other investors.
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I’ve been playing with The Motley Fool’s CAPS website for awhile (and doing quite well). It attempts to combine the knowledge of tens of thousands of investors with a fancy algorithm to find the best stocks. After running its calculations, it gives each stock a rating from 1 to 5 stars proportionate to how well it is expected to do in the future. I read an article (I couldn’t find the link) by a Fool writer who had run some statistics on the CAPS database to evaluate how effective it has been in the past.
They showed that 5-star stocks had averaged a 28% return, nearly 3x the market average for the same time period. That sounds impressive, but it is a bit misleading. You couldn’t have bought those stocks then since you didn’t know what their rating was going to be a year later. Since their algorithm weighs the opinions of better performing players higher than lower performing players, there is a natural bias for stocks that have performed well in the past to be rated higher than stocks that haven’t since players that rate it highly will have performed better and their rating will be worth more. What would have been interesting is the average return of a portfolio that bought stocks when they became 5-star stocks and sold them when they lost the rating, unfortunately they keep their database private so we can’t find out.
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This recent rally is no excuse to accept satisfaction with my holdings so I am continuing my portfolio review from part 1: Recession Review.
Continued in alphabetical order:
Exponent (EXPO)
-This consulting firm has had solid growth for many years and continues to be a leader in a new and expanding market. They have a team of very talented professionals that in turn helps attract more very talented professionals which in the past has consistently provided earnings growth crushing analyst expectations. Its low $400m market cap attracts little attention from wall street and I think is a large reason why it has not been priced up to a more accurate valuation around $6-700m.
Bottom line: This type of consulting firm has a very small place in the market right now and there is a lot of ‘wait-and-see’ type thought out there, but the information we do have suggests impressive growth and I think a $1.5b footprint is very reasonable in five years.
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For those of you living under a rock, the market as a whole dropped throughout the day down about 3% at its lowest, then ended by shooting up 5% to a 2% gain for the day. CNBC (and I suspect the other news outlets) is having a field day on the good news, with Cramer even calling a bottom! What the swing meant for me, however, was a lot more valuable than any market bottom.
I checked the market indexes when they were down 3% at around 1PM EST before leaving for a couple classes. My thoughts were about the same as they had been for the past few weeks as I critically went over my holdings, constantly debating selling some to cut losses and pick up better companies. This critical attitude makes perfect sense of course, I always want to keep tabs on what I own and make sure it’s all up to snuff. The key being ‘always’.
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I wrote a bit about the recession situation and what it means to investors in Investing in Recessions, now I want to scrutinize all my holdings to see exactly where I stand in all of this! The only thing that matters is that my companies are priced significantly less than they are worth, that provides me with all the safety I need in any market condition. Because of that, I will focus my attention on what I think they are worth and what I think they will be worth in five years.
In Alphabetical Order:
Activision Blizzard, Inc (ATVI)
- Technically it is still Activision, Inc. but I see no reason for the merger not to go through and my shares will be converted 1:1 so it’s close enough to the same thing. On the Activision side we have consistent 25%+ annualized returns for the past 10 years and an almost legendary brand name that has proven it has exceptional staying power with decades of hits. On the Blizzard half we have annualized returns of over 60% for the past 14 years (best number I can find, I would guess 50% over the last 10) and a team of management and developers that can hardly produce anything except a number one seller. While every other game company is spending truckloads of cash throwing out title after title trying to land one hit in twenty and maybe even making a little profit, Blizzard produces a game once every couple of years and earns profits about equal to every other major player combined (that’s being generous, they probably make twice that). They still make up a very small portion of the entertainment industry and if recession fears really set in they could benefit greatly by providing some of the most affordable entertainment there is.
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You can get stock quotes just about anywhere nowadays and there is no shortage of finance information and business news to accompany them. The brokerages, stock exchanges, finance sites, news networks, online portals, and even search engines all want your attention and they will throw just about any information they can find at you to get it. They all have their strengths and weaknesses, I use half-a-dozen different sites just to keep up. I’ve rounded up my three favorite for a quick review.
Nasdaq.com - This is what I started using first and I’ve gotten pretty used to it. It has all the numbers and filings in a very quick and easy to use format. Balance sheets, income statements, financial ratios, consolidated analyst recommendations, and all the basic information is just a click away in their handy company drop down menu. When I want to check up on company financials, this is usually my first stop. They also have a real-time intra day chart of the market indexes on their front page that provides little useful information, but some days I just can’t look away.
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Recession. Recession. Recession. That seems to be the buzzword in the media right now, maybe it will work for me too! It seems everyone wants to reposition their investments to protect their portfolio in a recession, and who can blame them? Most economists agree we are either entering a recession or already in one and it makes sense that our investments should reflect the changing conditions. The only problem with everyone looking for recession proof investments, however, is that everyone is looking for recession proof investments!
A recession proof investment in the stock market means a company that is not tied to the current economic problems ravaging the rest of the stock market. For the current conditions, there are a few properties to look for: (1) A company that does not need external financing to continue business [a lot of tech], (2) companies with products that will sell well regardless of economic growth like household necessities [Proctor and Gamble, Wal-Mart, etc], (3) balance sheets with strong cash reserves and secure accounts receivable [clients unrelated to mortgages or other credit], and perhaps (4) companies that can can capitalize on the downfall of vulnerable businesses [bankruptcy firms].
Berkshire Hathaway is an excellent example with it’s large cash reserves, strong diversification, and thriving insurance business. Additionally, with Warren Buffet at the helm, investors can be confident that their money is in good hands no matter what the economy is doing. The recent performance of Berkshire’s share price provides an amusing confirmation that everyone else seems to think the same way. During the first half of the year while the market was providing consistent growth, investors stuck with hot companies and enjoyed their above average returns. As a result, Berkshire got little attention and its price stayed flat. The second half of the year went a bit differently as housing and credit concerns introduced volatility and reduced performance. During that time, investors quickly dumped their previous holdings in fear and fled for security in Berkshire and its companies, resulting in rapid price appreciation for Berkshire shares. This graph shows the almost inverse relationship between the volatility of the S&P 500 and Berkshire shares, I chuckle a bit every time I see it.
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Analysts always have three recommendations: Buy, Hold, or Sell. I understand buying, I understand selling, I cannot fathom a middle ground. A stock is either great or it’s not, that’s it. If a stock is merely good, sell it and buy one that’s great.
The only reason to hold a stock is the only reason to buy it: It’s trading for less than it’s worth. If it’s not trading for less than it’s worth, get rid of it and find one that is. I read recommendations all the time for a middle ground, where it’s not quite a buy and it’s not quite a sell. That’s absurd. I don’t want mediocre, I want amazing. Anything less is a crystal clear sell.
To be fair, I have found two reasons to hold rather than sell, but they have nothing to do with how well the stock is priced. In taxable accounts, it is sometimes reasonable to hold onto a less-than-amazing stock for tax advantages. It may be helpful to carry the capital gain or loss into the next tax year where it will have a more favorable impact on your taxes. The other reason is to increase your holding period into the ‘long-term’ tax holding period which reduces the capital gains tax based on how long you have held a position. However, at times when there is no tax advantage, or they are in a tax-free retirement account, ‘Hold’ is synonymous with ‘Sell’.
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As I mentioned earlier, I filed a brokerage transfer request with Scottrade to pull my stocks from my E*Trade account to avoid their absurd fees. Following their pattern of absurd fees, E*Trade also charges a fee if you leave to a different brokerage. The fee is $40 if you transfer the full account, and $25 if it’s only a ‘partial transfer’. I filed as a ‘partial transfer’ for the lower fee under the rationale that I was leaving the cash portion of the account (all 43 cents) with E*Trade.
E*Trade, however, has a different definition of ‘partial’. I’m not sure what it is yet, but they refused to transfer only the stock portion, they would only transfer the full account for the higher fee. Oh well, at least I’m done with them now.
The US tax code has provisions for tax advantaged retirement accounts to encourage retirement savings. Among them are the Individual Retirement Accounts (IRAs) which include the Traditional IRA and its younger brother, the Roth IRA. Both of them offer exemptions from income tax on one end; the traditional exempts contributions, the Roth exempts withdrawals, so which is better?
If tax rates were flat, the same amount of money before tax is going to to produce the same amount of money after tax in both types. This is because the tax taken out of the contribution to a Roth IRA compounds to exactly match the tax taken out of the compounded principal withdrawals from a traditional IRA. There are, however, more subtle differences.
Progressive Tax Rates
Since US income tax rates are not flat, it matters a great deal whether your tax rate will be higher or lower in retirement than it is now. This is different for different people at different times in life. Unless you have 30-40 years to go before withdrawals start (20-30 years old, hopefully closer to 20), plan to invest substantially more than 10% of your salary, plan to dramatically increase your salary, or have significant retirement income from other sources (pensions, inheritance, other savings), your retirement income will likely be lower than your current salary.
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