Seeking Alpha
Long/short equity, contrarian, investment advisor, portfolio strategy
Profile| Send Message|
( followers)

As a leader and manager from a military background, I like to think at times we take a contrarian approach when looking at events in the stock market and in investment strategy. I think this comes from a diverse background of reading widely and training consistently, considering multiple scenarios and outcomes before deciding on a course of action and committing a plan to execution.

However, as we say in the military, “no plan succeeds H-hour”, and we must be prepared to adapt and change as our environment and battle space changes. Likewise, time spent on reconnaissance and planning is never wasted. The same can be said for professional investors and fund managers – it’s important to be widely read and understand different investment strategies, it pays to consider multiple investment courses of action and what follow on actions and decisions may be required, and it is essential to be plugged into the daily noise of the markets and current key events. But as no plan survives H-hour in the military, no investment strategy remains so fixed that it is immovable to the changing direction of the markets (the financial battle space).

Strategy – The Sun Tzu Way

The discussions on Seeking Alpha in the last two weeks (and as no doubt will appear over coming weeks) reflecting on the previous quarter and the year to date got me to thinking about one of the oldest and most widely studied texts in military circles; Sun Tzu’s ‘The Art of War’. There are many lessons to be learned from this text that dates back 2,400 years, which are equally as relevant to financial strategy as they are to military strategy, and are just as relevant today as they were thousands of years ago.

One of my favorite lessons from Sun Tzu is “Know yourself and know your enemy, and in a hundred battles you will never be defeated”; and I think that was the point Gordon Gekko was trying to make when he quoted Sun Tzu in the original movie ‘Wall Street’:

“I don't throw darts at a board. I bet on sure things. Read Sun-Tzu, The Art of War. Every battle is won before it is ever fought.”

In looking back today over a turbulent trading year and Q3 in the markets, I asked myself, “What would I do now if the financial markets were my battle space, and the advantage appeared to be resting with the markets over the investor?” In essence, I would realize it was time to take the following steps; Review, Pause, Reflect, Think, Plan, then Act’. And in doing so I would go back and review doctrinal principles – in this case Sun Tzu as an appropriate reference point and foundation to build upon. To that end, I plan on writing a series of articles that follow Sun Tzu’s thirteen key chapters and draw on lessons that can be translated across to the markets for use as reference points within their own financial battle space.

Chapter I – Laying Plans

The Chinese meaning of the chapter ‘Laying Plans’ refers to “deliberations by the General in his tent”. In financial circles we can see this as being corporate management reflecting on past performance, and weighing up its plans for the next reporting period and beyond. For the professional investor it is an individual reflection, how did they perform against the big funds and the index, how is their investment strategy holding up, and what plans do they need to put in place to correct losses or multiply gains.

Sun Tzu said that the art of war is of vital importance. Note the term the art of war… because war and military strategy is an art. Science is exact – it has definable problems, and exact solutions. War is fluid, and the problems faced at the start of battle change quickly, requiring plans that work in principle to evolve rapidly as situations change and develop, in order to maintain the tactical advantage. Much like financial markets; a sound investment strategy should perform in both a rising and declining market, as professional investors and managers should have hedged their strategy to cope with change, and to ensure they aren’t locked into immovable and unchangeable investments. Sun Tzu said that laying plans is the road to safety or ruin, and for both the military and financial strategists this holds true – poor planning and execution leads to military defeat, or for investors – financial ruin.

This is why one of Sun Tzu’s key principles is of utmost importance – Method and Discipline. He cautions us: “do not pin faith on abstract principles; while the main laws of strategy can be stated clearly enough for all and sundry, you must be guided by the actions of the enemy in attempting to secure a favorable position in warfare”. In the investors' case, those that are more successful are the ones who have the base foundations of knowledge, the ability to plan in detail and set that plan in motion, but who also have the discipline to realize when the battle space (markets) are changing, and the courage to follow through and execute contrarian trades well ahead of the pack.

An extreme example of this is those who made money by betting against the pack in the sub-prime mortgage markets, realizing that everyone else was drinking the same bathwater and starting to think that it tasted good, when it actual fact it was already turning poisonous. Gregory Zuckerman’s book ‘The Greatest Trade Ever’ reinforces this example.

Putting Theory into Practice

I have written on numerous stocks since August, the majority while identifying possible short play opportunities (primarily due to current volatility); the crux of my analysis has been on finding undervalued blue chips stocks with good fundamentals and a historical record of paying dividend income streams, with a view to holding for long term positions. So as I look to the next reporting quarter, I am going to target a small select portfolio of these stocks which offer discounted entry positions (from a long perspective) and apply the Sun Tzu principles to them in each article as to whether they remain as a BUY/HOLD/SELL rating.

Alaska Air Group (ALK) – The best of the airline options for reasons best outlined here. Currently trading at $62.09, it has demonstrated strong capital growth during these turbulent times. With EPS of 7.86 and P/E of 7.90, it is well positioned to take advantage of markets as they strengthen.

BHP Billiton (BHP) – The big Australian will continue to grow and provide year-in year-out returns, and with plans to triple its iron ore output over the next five years, it’s currently at an excellent discount entry position. Currently trading at $75.86, it has experienced a downward trend to its overall share price, but this seems overly discounted even noting market volatility. Its intrinsic value is far greater, with EPS of 8.54 and P/E of 8.70 it offers long term capital growth support by consistent dividend income.

Citigroup (C) – The rose among the thorns as far as the big financial banks, with less exposure to the big issues facing US banks, and a CEO who seems to understand the challenges (both real and protest driven) the stock is currently trading at $29.31 with EPS of 3.19 and P/E of 8.70. It will continue to face the current immediate issues causing pressure on banking stocks, but even so, it will be well positioned for capital growth and dividend growth as markets recover.

Caterpillar (CAT) – Like BHP, this is a long time sentimental favorite stock of mine for the way the company thrives during booms and survives (well) during difficult economic times. The stock is currently trading at $81.70 (a conservative 20% discount to what I would state as its intrinsic value), has EPS of 6.05 and P/E of 13.30. China’s economy will continue to influence the stocks longer term value, but again (like BHP) the ongoing commodities demand worldwide will continue to drive CAT’s growth in the medium to long term.

General Dynamics (GD) – This strong defense industrial stock has a long history of delivering time and time again for militaries across the globe. It is currently trading at $62.53 with EPS of 7.01 and P/E of 8.80 the company’s consistent revenue stream from US military projects continues with a number of large multi-year contracts awarded recently.

PNC Financial Services Group (PNC) – Much like ALK and WMT, PNC has a long history of consistent performance and stability in value even during turbulent periods. Currently trading at $51.97, it has EPS of 6.81 and P/E of 7.30 and is well positioned to grow without some of the constraints holding back customer satisfaction with some of the other big financial banks.

Wal-Mart Stores (WMT) – The market place where people go to bag a discount, or when times get tough – either way, this is a relatively stable stock regardless of economic conditions and has fared well during these turbulent times. Currently trading at $55.20 with EPS of 4.69 and P/E of 11.70, it is a blue chip share to add stability to any long term portfolio, with longer term potential for capital growth and dividend growth.

Patriot Coal (PCX) - My one exception to my focus on reliable blue chips is to place a small stake in a speculative stock, in this case I am looking to include a position in PCX for the reasons outlined here. I believe the stock is a high risk high gain option that has an enduring market to supply with fewer fluctuations on demand compared with other commodities. The stock is currently trading at $9.69.

The start state of the portfolio ($100K) is detailed by position size below.

Ticker

%

Price

# Shares

$ Value

ALK

10

62.09

161

$ 9,997

BHP

25

75.86

330

$ 25,033

C

10

29.21

342

$ 9,990

CAT

15

81.70

184

$ 15,033

GD

10

62.53

160

$ 10,005

PNC

10

51.97

192

$ 9,978

WMT

10

55.20

180

$ 9,936

PCX

5

9.69

516

$ 5,000

Cash

5

$ 5,028

$ 100,000

Summary

So, as we all sit back in ‘the tent’ and reflect on the trading year so far, (perhaps over a beer if things went poorly, or maybe a 25 year single malt scotch if you finished ahead of the markets), take the time to consider the concept ‘Review, Pause, Reflect, Think, Plan, then Act’. Consider Sun Tzu’s principles and reasoning behind the importance of ‘Laying Plans’ and remember the following parting thought:

The General who wins a battle makes many calculations in his temple, before the battle is fought”.

The sage investor follows suit. Or as Gordon Gekko suggested in Wall Street;

Are you gonna tell me the difference between this guy and that guy is luck?

As we follow the fortunes of these eight stocks time will tell whether luck, or a calculated strategy is responsible for their performance and the effect on the portfolio overall. Stay tuned for my next Sun Tzu article for the portfolio that will focus on Chapter II – Waging War.

Disclosure: I am long BHP.

Source: Stock Management The Sun Tzu Way: Part I