DIY Investing

I’m stingy and like to save money. So, there are a few jobs around the house I try to do on my own. Changing a light bulb (still) fits my skill set, but anything much beyond that is too close to the edge of my “circle of competence” in home repair.

So, I turn to professionals when I need to. They are not free, but they are accountable, competent and their results can be quantified and measured for value.

Some people I know have essentially hired themselves as their own investment manager. They might have a portfolio they have built over the years of mutual funds, stocks and bonds. This saves on fees. But do they track their own performance? And I wonder how much time are they able to spend researching their choices given the time obligations of both family and professional duties?

The goal as I see it in investing is not to focus only on fees but to maximize investment returns after the impact of fees and taxes.

A full-time investment adviser can offer his or her clients a full-time focus on their portfolio and goals. They also provide accountability as their performance results over the long run are quantifiable. But perhaps more importantly, an adviser can provide an outside perspective and guidance in times of market turbulence when it can be needed the most.

Retreads

It’s back to the future in a lot of ways these days.  A seventh television series of 50 year old Star Trek is due out early next year.  Of course, there have already been six Star Trek movies as well.

Star Wars is going stronger than ever too.  Disney acquired the Star Wars franchise from Lucasfilm in 2012 and is busily producing new movies, and theme parks (via Disneyland).  It seems to be an even more vibrant franchise than it was nearly 40 years ago when the first movie (now known logically as Episode 4) came out.

While we might wish personally that some slightly more original entertainment would hit the big and small screens, investment managers like us actually don’t mind a few re-runs at work – of the investment idea variety, that is.

We maintain a universe of stocks that we study, in some cases for several years.  We do our homework ahead of time to be ready for what the market brings, and that is ultimately unpredictable.  On occasion, Mr. Market prices these businesses low enough for us to buy for our clients.  Many times, in fact most of the time in our view, he does not.

But when the market does provide us a chance we might invest. In some cases, the stock increases and we sell as stock price converges with our estimate of business value. Then, down the road that same stock could fall to a level where we can consider investing in it again.  The good thing is that we already know that company from our research.

A tendency in entertainment – and investing – is to glom on to the next new thing. Recall the phrase “this time it’s different” – and be wary!

What we’ve found is that stocks don’t really care if they are new or old ideas.  What matters in our view are company results and the price paid to invest in its stock. Unlike entertainment, in investing retreads are always welcome.

Thoughts on Doha

Oil market hopefuls were under the spell of magic happening at this past weekend’s Doha meeting of major global oil producers…It’s silly to think that any meeting and subsequent agreement between OPEC and non-OPEC producers will have any long-term impact on oil markets.  Here’s why.

The oil market got out of whack because supply and demand got out of whack…and the only thing that will create market equilibrium is a rebalancing of supply and demand…anything artificial (such as a production freeze) will not work…if suppliers did decide to reduce production the price would likely rise in the short-term, which would encourage some producers to cheat and increase production.

In addition, higher prices would encourage the high-cost non-OPEC producers to crank up production…And guess what, that would lead to greater supply, which ultimately leads to lower prices.  The only way to get to an equilibrium price is for the high-cost producers (some U.S. shale and conventional producers, North Sea, Mexico, Canadian Oil Sands, and Russia) to curtail production.

It hasn’t happened yet as producers are playing the equivalent of the game of “chicken” trying to hold on and squeeze whatever positive cashflow can be had from fields, while waiting for their competitors to drop out of the game.

Problem is, when everyone is thinking and doing the same thing, it takes longer for reason to prevail over hope.  They aren’t earning enough to replenish depleting wells. So, eventually the cashflow from barrels starts to dry up, and the losers drop out, shrinking supply and bringing balance back to oil markets.  Free markets work, but like many things in life, it can take longer than you’d think for the process to come full circle.

High cost producers today are pumping furiously to generate enough cash to stay alive. That’s all. It’s like the joke about the guy who jumps from a 20 story building. When he reaches the 5th floor he says “so far I’m fine”. The only things that matter are economics: long term costs and demand. Prices will be set based on these 2 things.

On a related note, how logical is it for oil producers (that means you Saudi Arabia) to drive prices down 70% to correct an oversupply of roughly 2%?  These oil producers have given up 70% on prices to regain 2% of worldwide volume.  Makes no sense.  A better approach would have been to gradually increase supply, pushing prices down by perhaps 20%, which would have caused the highest-cost producers to reduce production, and the imbalance would have been rectified gradually over time.  Instead, OPEC has overshot supply by a wide margin.  The risks now are production declines so severe that we could see a price spike at some point in the future.  And that doesn’t benefit the Saudis or other major producers, who are most interested in stable oil prices over the long-term, so that their customers have some predictability about prices, and don’t seek energy alternatives.

Grateful for Another New Year

Many people look forward to the New Year for a new start on old habits. If we look at some typical New Year’s resolutions we find a common theme – the need for more discipline:

  • Lose Weight, i.e. eat less, exercise more
  • Earn More Money, i.e. less time on the couch, more time at the office
  • Be a Better Person, i.e. be more patient with others, less anger

We can accomplish anything we want, with a disciplined approach. But for a lot of us, discipline is hard to come by. So I’m suggesting a slightly different approach: gratitude. Where we lack in discipline, let’s at least adopt the “gratitude attitude.”

Okay, maybe we could stand to lose some weight – but let’s be grateful for the food on our tables and while we’re at it – the roofs over our heads, the clothes in our closets. And maybe we’d like to earn more money, but again, let’s be grateful for the unique skills each one of us possesses that allows us to go out and obtain employment. And okay, maybe we need to work on being patient, but how about showing gratitude for the loved ones in our lives.

This year as John and I speak to the CEOs and CFOs of the companies we invest in or may invest in, we just might throw in a new question – what are you grateful for.

A new oath holds pretty well; but… when it is become old, and frayed out, and damaged by a dozen annual retryings of its remains, it ceases to be serviceable; any little strain will snap it.   ~Mark Twain, speech, New York City, 1885

Who You Gonna Call?

We prefer to learn about our companies directly – we don’t rely on what Wall Street has to say.  We believe there is value in doing things the old-fashioned way.  Reading annual reports and proxies. Listening to company management presentations.  Deriving our own estimates of company value.

Another thing we have started to do is to schedule calls with the companies we own or are researching.  Over the past several months we have spoken to the CEOs, CFOs or Investor Relations executive at nearly 50 companies.

The executives we call often tell us that our calls with them are structured differently than the calls they have with many other firms.  We ask them to describe their competitive “moat” and what sets their company apart from others in their industry.  We discuss with them the long term growth prospects of the business.  And, we ask each company to address their views on capital allocation – their plan for the free cash flow generated by their business.

Nearly every call helped us develop a deeper understanding of the company and the prospects for future profitability and growth.  We have found them to be a valuable part of our research process.

Stay Active

Traditional stock picking and active management of portfolios is more than just a little out of favor these days.  An ever-increasing amount of institutional assets are being managed in index funds and indexed Exchange Traded Funds (ETFs), otherwise known as passive strategies.

So why do we still believe in active management?

Ultimately, we believe any investor in a business, either directly or through stock ownership, will be rewarded in time based on the results of the underlying business.  We think it is worthwhile and possible to identify businesses that are attractive for investment.

For example, imagine that you moved into a new city with 50 businesses and had $1 million to invest only among those businesses, it seems unlikely that your initial thought would be to invest a little bit of your capital among all 50 companies. More likely, you would take the time to get to know those businesses and the people who managed them. They would be businesses for which you could make estimates of their total value based on their net income, the real estate they own, the capital needed to reinvest in the business and other factors such as those.

Once you did that you would select a handful of those 50 businesses to invest in. You might tend to concentrate in businesses that made sense to you, and that were run by competent people with incentives such as co-ownership to encourage them to work hard on behalf of their investors.

The following quote from a fund manager we respect sums up our view:

We believe we best serve [investors] by endeavoring to own a concentrated portfolio of stocks that has been intensively researched and carefully purchased, in the belief that such a portfolio will generate higher returns over time with less risk than a diversified basket of stocks chosen with less care.

 

Just Say No

Buying and selling stocks is pretty easy to do. Open an online brokerage account. Trade for a relatively low cost, in most cases under $10 per trade. Occasionally the broker will even throw in free trades at the start of the relationship. Trade from your iPhone, your iPad, maybe soon even your new Apple Watch!

Brokers make it easy to say yes. Don’t like falling oil prices? Sell your Exxon stock. Like the latest flavor of Lays potato chips that just came out (which have recently included Cappuccino and Wasabi Ginger)? Buy its owner, PepsiCo.

However, we think that saying no most of the time actually makes more sense. We say it when we don’t know clearly if a business will still be a relevant competitor in 3-5 years. Or if we’re considering a company run by high salaried managers with little personal investment in their company’s stock.

The biggest “no” for us is price. For all potential investments we consider, we develop our own estimate of what a company is worth. We include in our analysis the valuations paid when public companies have been taken private.

Then we set a price we are willing to pay for that stock. We say no until those occasional points in the market come around where the stock seems to be mispriced.

A cliché but still true – a great company can be a bad investment at the wrong price. Ultimately both the quality of the business and the price at which it’s available are both important to the thoughtful investor.

Independence Day

All research is not created equal. Hardly something that should have been included in the Declaration of Independence, but still it’s important to us.

Wall Street analysts produce research for their clients, of which large investment management firms are one of their biggest. Their teams of intelligent analysts cover specific companies within an industry.

Their reports shine at reporting the quarter to quarter details. When you (if you) listen to a quarterly corporate results conference call, it’s the Wall Street analysts getting called on by the company to ask questions. Their resulting reports tend to focus on whether or not a given company “beat” or “missed” quarterly expectations for earnings and sales growth.

Notice I keep using the word “quarterly”.

To be honest, we don’t place a lot of stock (so to speak) in quarterly reports aside from the industry commentary some companies provide. Issues that we think investors should pay attention to – protecting capital from permanent loss, assessing competitive threats and estimating business value over the long run – rarely get addressed on these calls.

So, we don’t read what Wall Street has to say to us. Instead, we spend our most valuable asset, time, doing our own research. Reading annual reports and proxy statements. Finding everything we can get our hands on about the industry our companies compete in. These sources help us develop our own estimate of company value as well as assess if company management is on our side as an “owner-operator”.