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JamesMD
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Graduated with honors in finance /accounting 1979 CPA - Deloitte and Touche-left in good standing early 90's VP-SEC reporting NYSE bank - 80's - oversaw $4 billion in mergers Vice chairman - 2000 employee pension plan - at 30 Registered SEC investment advisor - private clients - late 80s to mid... More
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  • Investment Style - Part 1 of X...
    We all have (or should have) our own unique investment style. I believe that sharp skills in your style, whatever that is, is the key to long term investment success. I hope the article below encourages the reader to pause to consider some important style elements. We all need some methods to our madness :-) 

    Which one?
    There are many investment styles and many asset classes. I won't bore with details. Trading, Holding, Hedging, Arbitrage etc. For me, I decided to work in a mix of finding and holding growth stocks, seeking good value and avoiding "momentum" valuations nearly always, all in the context of where I think the world and business cycle is and where its going. My skills and education in finance, economics and business support my style, so i feel i can compete well against unknown others. In other words, I don't trade because I don't believe I can compete against professional traders in firms who have substantial assets to support trading that I don't have. To me, they are always 3 minutes ahead of me. That's too much to compete against.

    How much risk to take?
    I've taken plenty of risks over the years. Some very conservative, some extremely aggressive. I've done well, and poorly, with both. I think a couple of Peter Lynch's comments have steered me well - "Stick with what you know" and "My best returns usually come in the 4th or 5th year of the investment". 

    Stocks are risky. Outside the realm of Telephone and Utilities, its the "Wild West".
    Yet, I would warn that the Meek do not inherit the Earth. :-) Professionals hedge their investments to reduce risks of loss, with diversification (the simplest way to hedge) or with more complex, expensive methods (not for me...). I hedge my investments with diversity to reduce risks of loss. What is diverse? I hold 90 stock investments. On average each one is a little more than 1% of the portfolio. That is definitely diversity. Are there 90 good investments on the NYSE and NASDAQ? Yes, I am sure there are. Do i have all of them? Time will tell. 

    Contrary to conventional thought, I believe the farther away from retirement a person is, the less risk you need to take, or should take, with hard earned savings. The power of compounding is tremendous over time. Bond investors take their 5-6% year after year, and protect their principal. But in May of 2011, with interest rates at all time lows, its not a good time to invest in bonds, whose prices are near all time highs and whose default risks are much higher than normal. Bond prices move inversely with interest rates and timing is everything...

    How do we define risk adequately? What's enough, too much or too little? It depends on your circumstances...its different for everyone.

    Buy and Hold?
    After some time, practice and lessons, both good and bad, I know my style and it works for me. It began in 1978, when, as a college student in finance, I was working part time doing tax returns. One day, I met with a client, a nice old gentleman named Mr. Sullivan to discuss elements of his tax return. 

    In 1978, retired Mr. Sullivan was earning $200K a year just from dividends and interest. That's a lot back then. Or even now... and I asked him how he did it. 
    "I wasn't so smart", he said with a smile..."So, in the Great Depression, I just bought a few shares of some good companies, when I had a little extra money, and I held on to them". GE, T, IBM, F are some that I remember listed on his return. His words stuck like glue in my memory. Thank you Mr. Sullivan! I own 3 of these 4, but I am sure I'll sell F when consumer confidence is peaking, down the road.

    Clearly, Mr. Sullivan benefited greatly from a buy and hold strategy. His investment style made him wealthy, and he seemed pretty happy about it. 
    I must be part Japanese, because to some degree, I am certainly trying to copy him!

    Beware the Status Quo or the Accepted Conventions
    Those 1978 days are similar to today. The more things change the more they remain the same. Stock prices were volatile then, as they are now, despite an infinite boost in available information. A few years ago, that reality, that stocks are always volatile, forced me to question everything that's ever been said or done, regarding investing. Modern Portfolio Theory? Bah Humbug. If its so good, why are the markets so volatile? PE ratios? I'm an ex-CPA who worked long in a listed NYSE company. Earnings are manageable in the short-term, and therefore, not as reliable as other metrics, when it comes to stock valuation. Earnings between two competitors can vary widely based on Accounting Policy. I seek metrics that are comparable between all firms. I know a few... 

    The world is awash in spin doctors and charlatans. Its partly why I find it so hard to trust what I read in the press.

    Undervalued? Overvalued?
    For over 100 years, we've seen billions of observations, recommendations, discussions etc. about stocks, and still, we can't name even one person who knows for sure what the stock market, let alone, a single stock, will do tomorrow.
    Its remarkably like climate prediction. Weather is unpredictable, day to day, but climate is very predictable. I think the same can be said for good stocks.

    Valuation, to me, reminds me of what Will Rogers said in the early 1930's - "Buy land, they aren't making any more of it". He is still right!! But make sure you buy land in "The Path of Progress" else you may be in for a very long wait.

    Skeptical and Boring
    What is my style? At its root, its being skeptical and boring. Skepticism of anything predicted or analyzed or said about any stock at any time. Buy and Hold? Most stocks do not warrant a buy strategy, let alone a "buy and hold" position. I've looked at every stock on the NYSE and NASDAQ, as have many of us. For me, at least 80% of what I see out there is not worth my investment. That's fine, to me, because 20% of 5000 or so stocks, is plenty to choose from.

    On the contrary, I do listen to a few people (3) about stocks and the economy. They've proven to be reliable over 20+ years. Three is enough, in my estimate, and it makes it easier to avoid wasting time with the information waterfall we are all climbing. 

    Analytics -Financial and other
    Now this topic could be a book 3 thousand pages long. I start with looking at a stock's history. If I see a good 5 year history, for example, I might dig in further. But if I see a lame 5 year history, typically i move on...why? Because a lame 5 year history can only change if we speculate on a turnaround. There are enough good investments out there, with good 5 years histories, that avoiding situations where a turnaround is obviously necessary works for me.

    in other words, I use history to tell me what's worth looking at. But, as far as investing goes, history is worthless to me. We have to think hard about the future when making investments. Using history as a screening technique is not a perfect tactic, but its working well enough for me.

    When to sell?
    Probably the biggest question of all, is when are the shares we own no longer a good investment? A trader knows, its a day, or an hour, later. An investor knows its almost never a hold forever. But in between these bookends, thats a big space!

    I categorize purchases into a few categories about why I am purchasing. It may be for growth, as with AMZN, or it might have been for value, as in FCX in early 2009. Recovery is a very valuable purchase reason too. When metals prices plummeted in 08 and 09, AA stock became very cheap. The stock price decline reflected the depression in aluminum prices and this wasn't management's fault, so AA had become a good investment because when aluminum prices recovered the stock price did too. Cyclicals, dividend growth, etc. There are many "purchase reasons".

    What I really like, is when one company gives me many reasons to buy. That way, I'm not relying on just one "metric" to support my investment decision. I believe, the reason(s) to buy bears some relation on how long the hold is, but this is definitely still "Art" and not "Science".

    Of course, there's really only one reason to buy...

    My greatest mistake in investing has always been selling a smart purchase too soon. Though, at the same time, I remember what Rockefeller said long ago - "You never go broke taking a profit".  

    I really think hard when I think about selling an investment in a good company. But if it has become overweighted in the portfolio due to great performance, discipline forces some to be sold. Conversely if the investment starts to feel like a "problem child" - they are easier to toss out after they've been given enough time to straighten out and fly right :-) . Just don't toss them all at once...Good companies know their share performance sucks, and management knows their salaries depend on share performance, so sometimes they kick themselves in the butt and do what is necessary to bring smiles to all. Not always though...

    Discipline
    I don't venture into sandboxes (realms) that I don't trust, don't care for or that would dilute my focus. Options, forget it! Futures, Huh? Short sales? Why bother? Precious metals? (laughter). IPO's? I watch what's coming into the exchanges. Lately i mostly (99%) see junk coming in. But last year, I bought one tech IPO and its up some and it seems to be in a good sector with good managers. I'll hold for now. If you're going to buy an IPO, be sure the Founder is an amazing guy, young enough and is still CEO. Its allowed to age discriminate when investing :-)

    I look for large ($1 Billion Sales or more), well established companies that can grow in healthy markets and build their business over decades. I never want to sell. I want to will my stocks to my children, so the cost basis steps up, and the gains never get taxed but overall ROI leads the decision making. Moderation in everything. Sometimes cyclical stocks present compelling values and are worth holding too. Sometimes the market trashes a good company and it becomes a good investment. Sometimes not.

    Cash Flows
    The global economy and its perceived trends drives Big Money, and Big Money drives share prices. Large companies attract large investors with lots of money and patience. (Or repels them)... Small companies, with less than $500 million in sales, they are pretty sketchy to me. Often they are too small to make a difference in a large portfolio and too small to make entry or exit without big price moves, so the large investors take a pass. Therefore, I avoid the illiquid stocks with little turnover. Takeovers, turnarounds, I avoid because its speculative and I don't have enough information to warrant putting my hard earned money into these situations. On the other hand, sometimes I see some core value in a stock, and I have about $500 in EK, for example. It's a big brand, and I think the market value is actually less than the value of the name. But, my $500 is now $350, so patience is key. Thankfully, I recognized up front that a turnaround situation is risky, and i used my investment style to limit my investment. For me, this applies to all stocks. No stock is worth putting too much at risk. Diversification rules my roost

    Timing the Market
    Conventional wisdom is that we can't time the market. My response is I don't own the market. I own a basket of stocks. Timing is everything, and makes the difference between a nice kickoff to getting some good investment returns, or a long wait. We can, and must time the stocks we are looking to buy or sell.

    Housing sucks right now. Its a great area to discuss the ways and means to time investments. Now's the time to look at housing related investments, to me. But, timing is everything. All sorts of forecasts are out there about housing, from "It will never recover" to "Its the greatest value of all time". I believe neither of these extremes. Investing in a housing recovery can take many forms. That's what I believe.

    Where is housing in a year? or two? Stock market participants are always discounting forecasts of the future to the present. The problem with forecasting is in how difficult it is to anticipate future unknown events that materially affect today's forecast. Simply extrapolating today's factors into the future is increasingly unreliable as we look farther and farther into the future. If you forecast, forecast often. :-)

    Greed versus Safety
    I think of my investment style in baseball terms sometimes. I want to be a singles hitter with a .980 batting average, no strikeouts and no home runs. I never want to lose a penny when investing. Thats more important to me than swinging for the fences. These are critical rules to me. Maybe to you too. I'm not quite there yet, but my direction toward this standard is good. Having direction beats wandering to me.

    Creating Incremental Returns
    Flexibility drives my style. Sometimes its top down, other times, bottom up. Sometimes both simultaneously. Inflexibility drives me too. I own $0.00 mutual funds or ETF's. I don't believe anyone, anywhere can be trusted to manage my family funds. The "Madoff Risk" is always out there. More importantly, managing my own funds positions me to teach my children how to do so too. That's an added return!

    A long time ago, a savvy business man bought a No. Calif lumber company for around $20 million. The lumber company owned complete rights to log several old growth redwood forests. The short story is that he threatened to cut it all down, and then sold the old growth forests to the Gov't. for $220 million a year or so later.

    We have to see the forest, not the trees. The hidden value was that the trees were sold as lumber to him, and not as a beautiful, practically priceless, forest. 

    That's a good example of the "Path of Progress" at work...hard to find, but very valuable.... 

    Another good example...In a world where 9 billion people will be here in 2050, the value of good farmland is clearly going to rise. I'm not a farmer, but this trend is quite easy to see. Good farmland near big cities -- even better!

    Conclusion
    What haven't I discussed? Themes, secular trends, path of progress and hedging risk are important planks of discussion, for another day...
    the list of investment topics goes on and on. Investing is not like riding a bicycle...it takes a lot of time to learn well.

    In a nutshell...stocks are risky. But remember, leaving all your savings in 1% savings accounts is even riskier. If we don't outpace inflation after taxes, our purchasing power erodes. Contrary to conventional wisdom, I think it takes a minimum of 6% annual return to stay ahead of inflation. Better to estimate high, and be safe, instead of sorry. I would like to see people take more responsibility for their investments, and that's why I write. I can make a difference with a few thoughtful words. We all can. It just takes time. Proceed with your mission and thank you for reading,

    James Danforth
    May 22, 2011

    Ps. SA rejected this article as "too broad". I would disagree. We have to see the forest before the trees. The world is awash in drill down analysts. Recently, when AAPL reported record earnings, I read an article with commentary from 10 top analysts from large well respected firms. All of these analysts did a fine job describing AAPL's results, but not one submitted an answer to the bigger, more important question....Why? Why is Apple growing so fast? 

    When it gets right down to it, good investing comes down to a lot of solid questions. Without style, an investor's route is random, like a butterfly in the wind. With style, an investor has direction, and can steer forward toward a destination. I prefer the latter. Hope you do too.



     





    Disclosure: I am long T, F, GE, AMZN, AA.
    Tags: GE, PCL, AAPL, FSLR, DD, AA
    May 21 11:38 AM | Link | Comment!
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