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stats? How did it this fund or that portfolio do this year? Did it beat its competitors? Is
be in favor for long. The best kind of stock to buy now will not be best tomorrow. And,
there has never been, nor will there ever be, a way to consistently and reliably
identify in advance the coming best approach. Over time, all broad rational
approaches to taking risk yield surprisingly similar results. Over the years, for
example, there is only a meaningless difference between the results of “value”
investing and “growth” investing. The asset class that is said to outperform depends
entirely on the time frame used for evaluation.
“Ratings” of mutual funds have been proven to have zero value for predicting out-
performers. Not one of the investment firms putting out “best stocks” list has been
able to best its “competitors” with any consistency. This year, when we look at the
press’s list of top performing stocks or funds for the past 5 or 10 years, we will likely
find none of them on the same publication’s listings of 5 or 10 years ago! The
investor who chases returns, compares performances, and/or selects
investments from lists of recommendations or “superior” past returns is
prone to longer-term investment mediocrity.
An investment portfolio should reflect each individual investor’s basic view of risk
management and opportunity, and knowledge of his or her own emotional tolerances.
How other portfolios or investors have faired matters not at all. Hopefully, these other
investors are also behaving according to the dictates of their own circumstances.
There are three components to an investment portfolio. They are 1) the underlying
philosophy, 2) the plan for building a portfolio that reflects that philosophy, and 3) the
execution of those plans. Successful portfolios are built over time by following an
investment philosophy consistent with one’s emotional tolerance for risk.
I want to state here my approach to investing. It is my hope that this is compatible with
your approach as well.
Investment philosophy
Stocks should be priced so that potential future dividends are attractive.
the intrinsic value of a stock is its potential ability to pay a dividend in the future.
Paying a dividend now (or not) does not matter. What an investor is really buying is
the right to a potential future dividend, just as the buyer of a small business is really
buying the right to its future flow of spendable profits.
Government bonds provide guaranteed interest. Stock dividends aren’t guaranteed.
Therefore, a stock should be expected to pay substantially more in income in the
future than a guaranteed bond would pay. This possible future reward is what makes
a stock worth the risk of loss to the stock investor.
Investors should concentrate positions.
Portfolios of 10–20 stocks of differing industries have been shown to move in the
same direction as the market in general. Buying many stocks does not protect an
investor well against general market losses. However, buying many stocks does have
the effect of diluting the winners in a portfolio. Over the long-term, it is usually better
to buy fewer companies of high quality than to over-diversify. This concept eliminates
mutual funds from consideration, except in unusual circumstances.
Modern Portfolio Theory does not work. Modern Portfolio Theory is the name given to
the concept that results in investors buying mutual funds of differing types of stocks.
Examples would be global, international, small cap, mid cap, large cap, value, growth,
and emerging markets funds. The gentlemen who created Modern Portfolio Theory
had noted that differing asset classes tended not to “correlate” – that is, move in the
same direction at the same time. It was therefore believed that an investor could
guard against loss in a portfolio by having a lot of differing funds. The same
gentlemen who created this theory now point out that it no longer works. All common
asset classes now correlate most or all of the time. (Sadly, this investment theory is
still being used. Worse, it is used to “project” the future value of portfolios based on
past data. Perhaps this is because investors often like to feel that they can control
their financial futures using this illusory approach. The amateur investor may be
forgiven for believing such non-sense. Financial “professionals” using it, on the other
hand, have some explaining to do.)
Methodology
I look for stocks which I believe have potential future dividends substantially above
the risk-free return an investor could get from US government bonds.
I generally buy stocks of widely traded companies. I prefer the larger-cap
names. Stocks can be volatile enough without adding the extra volatility that comes
from a stock with relatively few shares outstanding. These shares are often
whipsawed within a matter of a few days as a large shareholder liquidates a position
for reasons that may have nothing to do with the fundamentals of the company.
I generally avoid low-priced stock. Institutional investors are often proscribed
from buying lower priced shares. Institutional buying can be a great catalyst for a
stock’s advance. Stock analysts are not often assigned to review stocks not of
interest to institutions. So, usually I look for stocks at least above $10 to $15.
I generally like to buy stocks widely followed. Contrary to popular notions, the
crowd is usually right! So, I like to buy stocks that are recommended by a consensus
of a number of analysts.
I avoid over-concentration of stocks in one particular industry or industry
group.
I initially create portfolios with “space” for 10 to 20 stocks (typically). If a
position is sold, I look for a replacement.
I am not afraid of allowing a position to become an “outsized” portion of a
portfolio. I believe more wealth is created by allowing winners to continue to grow, if
possible, than by paring them down to buy an unproven alternative.
I prefer to buy stocks with constructive chart patterns. Although technical
analysis (charting) is controversial, I find charts useful when deciding when to buy
and, often, when to sell. Charts show the psychology of the market. They let me know
if the “crowd” (usually right) is generally buying or selling. Charts give me clues to let
me know that a change is happening. A stock may have stopped going down, or may
have stopped going up.
Execution
My buys and sells are usually posted on my website, so investors can see what has
triggered them. What is harder to show, yet far more important, are the shifts in the
risk a portfolio is taking. Generally, when the market is in an uptrend, I seek to take
positions in a portfolio. However, it is important to remember that few stocks can go
up if the market in general is in a downtrend. Normal pull-backs in the market are to
be expected. But abnormal behavior signals potentially increased structural risk.
Another great market adage is “don’t fight the tape” (referring to the old “ticker tape”
machines that reported stock trades). If the market is showing signs of turning
bearish, I believe that a portfolio should be increasing its defensive cash position –
even if that means that an investor is largely on the sidelines if the market reverses
and begins to climb again. It is much better to give up opportunity than capital.
Finally, I want to say that I try to act on what I see, not what I think. The “collective
brain” of millions of investors is a surprisingly reliable indicator of the direction of the
economy, and of the potential of any one asset class. Often, the market “knows” of
an impending recession or recovery, or of significant developments in a particular
industry or company, long before the news media or pundits catch on. (This is
another example of not fighting the tape.) This approach isn’t perfect (as I write, the
stock market is forecasting expansion, the bond market is forecasting recession), but
over time I have found it to be more reliable than any alternative method for properly
directing assets either to safety or to opportunity.
Of course, it’s impossible to come up with a general statement of investment
principals that covers every situation, and I welcome any inquiries clients or
prospective clients may have. Hopefully, much of what I have written here is familiar
to most existing clients. This is offered up as a reminder, as well as perhaps a fuller
explanation, of my beliefs, prejudices, and goals as in investor.
Creating and developing a successful investment portfolio is a very long-term
process. So, too, is the development and maturation of the investor. I hope that my
approach to risk management does justice to my 28 years of experience in the
financial services industry, and, more importantly, is reflected in the prudent and
careful management of my clients’ money.
December 6, 2006
be in favor for long. The best kind of stock to buy now will not be best tomorrow. And,
there has never been, nor will there ever be, a way to consistently and reliably
identify in advance the coming best approach. Over time, all broad rational
approaches to taking risk yield surprisingly similar results. Over the years, for
example, there is only a meaningless difference between the results of “value”
investing and “growth” investing. The asset class that is said to outperform depends
entirely on the time frame used for evaluation.
“Ratings” of mutual funds have been proven to have zero value for predicting out-
performers. Not one of the investment firms putting out “best stocks” list has been
able to best its “competitors” with any consistency. This year, when we look at the
press’s list of top performing stocks or funds for the past 5 or 10 years, we will likely
find none of them on the same publication’s listings of 5 or 10 years ago! The
investor who chases returns, compares performances, and/or selects
investments from lists of recommendations or “superior” past returns is
prone to longer-term investment mediocrity.
An investment portfolio should reflect each individual investor’s basic view of risk
management and opportunity, and knowledge of his or her own emotional tolerances.
How other portfolios or investors have faired matters not at all. Hopefully, these other
investors are also behaving according to the dictates of their own circumstances.
There are three components to an investment portfolio. They are 1) the underlying
philosophy, 2) the plan for building a portfolio that reflects that philosophy, and 3) the
execution of those plans. Successful portfolios are built over time by following an
investment philosophy consistent with one’s emotional tolerance for risk.
I want to state here my approach to investing. It is my hope that this is compatible with
your approach as well.
Investment philosophy
Stocks should be priced so that potential future dividends are attractive.
the intrinsic value of a stock is its potential ability to pay a dividend in the future.
Paying a dividend now (or not) does not matter. What an investor is really buying is
the right to a potential future dividend, just as the buyer of a small business is really
buying the right to its future flow of spendable profits.
Government bonds provide guaranteed interest. Stock dividends aren’t guaranteed.
Therefore, a stock should be expected to pay substantially more in income in the
future than a guaranteed bond would pay. This possible future reward is what makes
a stock worth the risk of loss to the stock investor.
Investors should concentrate positions.
Portfolios of 10–20 stocks of differing industries have been shown to move in the
same direction as the market in general. Buying many stocks does not protect an
investor well against general market losses. However, buying many stocks does have
the effect of diluting the winners in a portfolio. Over the long-term, it is usually better
to buy fewer companies of high quality than to over-diversify. This concept eliminates
mutual funds from consideration, except in unusual circumstances.
Modern Portfolio Theory does not work. Modern Portfolio Theory is the name given to
the concept that results in investors buying mutual funds of differing types of stocks.
Examples would be global, international, small cap, mid cap, large cap, value, growth,
and emerging markets funds. The gentlemen who created Modern Portfolio Theory
had noted that differing asset classes tended not to “correlate” – that is, move in the
same direction at the same time. It was therefore believed that an investor could
guard against loss in a portfolio by having a lot of differing funds. The same
gentlemen who created this theory now point out that it no longer works. All common
asset classes now correlate most or all of the time. (Sadly, this investment theory is
still being used. Worse, it is used to “project” the future value of portfolios based on
past data. Perhaps this is because investors often like to feel that they can control
their financial futures using this illusory approach. The amateur investor may be
forgiven for believing such non-sense. Financial “professionals” using it, on the other
hand, have some explaining to do.)
Methodology
I look for stocks which I believe have potential future dividends substantially above
the risk-free return an investor could get from US government bonds.
I generally buy stocks of widely traded companies. I prefer the larger-cap
names. Stocks can be volatile enough without adding the extra volatility that comes
from a stock with relatively few shares outstanding. These shares are often
whipsawed within a matter of a few days as a large shareholder liquidates a position
for reasons that may have nothing to do with the fundamentals of the company.
I generally avoid low-priced stock. Institutional investors are often proscribed
from buying lower priced shares. Institutional buying can be a great catalyst for a
stock’s advance. Stock analysts are not often assigned to review stocks not of
interest to institutions. So, usually I look for stocks at least above $10 to $15.
I generally like to buy stocks widely followed. Contrary to popular notions, the
crowd is usually right! So, I like to buy stocks that are recommended by a consensus
of a number of analysts.
I avoid over-concentration of stocks in one particular industry or industry
group.
I initially create portfolios with “space” for 10 to 20 stocks (typically). If a
position is sold, I look for a replacement.
I am not afraid of allowing a position to become an “outsized” portion of a
portfolio. I believe more wealth is created by allowing winners to continue to grow, if
possible, than by paring them down to buy an unproven alternative.
I prefer to buy stocks with constructive chart patterns. Although technical
analysis (charting) is controversial, I find charts useful when deciding when to buy
and, often, when to sell. Charts show the psychology of the market. They let me know
if the “crowd” (usually right) is generally buying or selling. Charts give me clues to let
me know that a change is happening. A stock may have stopped going down, or may
have stopped going up.
Execution
My buys and sells are usually posted on my website, so investors can see what has
triggered them. What is harder to show, yet far more important, are the shifts in the
risk a portfolio is taking. Generally, when the market is in an uptrend, I seek to take
positions in a portfolio. However, it is important to remember that few stocks can go
up if the market in general is in a downtrend. Normal pull-backs in the market are to
be expected. But abnormal behavior signals potentially increased structural risk.
Another great market adage is “don’t fight the tape” (referring to the old “ticker tape”
machines that reported stock trades). If the market is showing signs of turning
bearish, I believe that a portfolio should be increasing its defensive cash position –
even if that means that an investor is largely on the sidelines if the market reverses
and begins to climb again. It is much better to give up opportunity than capital.
Finally, I want to say that I try to act on what I see, not what I think. The “collective
brain” of millions of investors is a surprisingly reliable indicator of the direction of the
economy, and of the potential of any one asset class. Often, the market “knows” of
an impending recession or recovery, or of significant developments in a particular
industry or company, long before the news media or pundits catch on. (This is
another example of not fighting the tape.) This approach isn’t perfect (as I write, the
stock market is forecasting expansion, the bond market is forecasting recession), but
over time I have found it to be more reliable than any alternative method for properly
directing assets either to safety or to opportunity.
Of course, it’s impossible to come up with a general statement of investment
principals that covers every situation, and I welcome any inquiries clients or
prospective clients may have. Hopefully, much of what I have written here is familiar
to most existing clients. This is offered up as a reminder, as well as perhaps a fuller
explanation, of my beliefs, prejudices, and goals as in investor.
Creating and developing a successful investment portfolio is a very long-term
process. So, too, is the development and maturation of the investor. I hope that my
approach to risk management does justice to my 28 years of experience in the
financial services industry, and, more importantly, is reflected in the prudent and
careful management of my clients’ money.
December 6, 2006
This is intended for educational purposes only. This should not be construed as a recommendation
to buy or sell any security. The information contained herein is not meant to constitute specific
investment advice. An investor should consult with Don A. Slabaugh (DAS), or his or her own
professional financial adviser (if not DAS), prior to acting on any of the information stated above.
to buy or sell any security. The information contained herein is not meant to constitute specific
investment advice. An investor should consult with Don A. Slabaugh (DAS), or his or her own
professional financial adviser (if not DAS), prior to acting on any of the information stated above.
| A Process, Not An Event! |