Archive for November, 2006
In a classic “Sense & Nonsense in Corporate Finance”, the author, Louis Lowenstein, debunks some wrong notion on dividend policy.
“The central issue of dividend policy is how well a company uses its resources compared to the available alternatives, notably those available to shareholders. That point of view, however, necessarily tends to ignore other, short-term considerations, such as day-to-day happenings in the stock market. A great deal of ink has been spilled by scholars who believe that dividends are useful as a signal to the market of management’s expectations about future earnings. A higher dividend is said to signal its conviction that the earnings are real and will continue to grow, and this signal, in turn, is expected to produce a higher stock price. None of this makes much sense to me. Dividends can give inaccurate prophecies, as happened at Ford in 19791981, as well as accurate ones. But prophetic or not, if a company allocates capital intelligently and if it communicates those decisions with candor, dividend signals are irrelevant. Dividends are too important a business issue to be relegated to the role of (trivial) news carrier for the stock market.”
Additional Readings:
The Wal-Mart Effect :
Off-Topic Readings:
Parting Thought:
A portfolio of stocks designed on the basis of Benjamin Graham’s principles has beaten the market over the past three years.
Benjamin Graham, the author of Security Analysis, is hailed as the dean of Wall Street. In another book titled Intelligent Investor, Graham outlined an analytical method for defensive investors who want to use only simple methods of analysis as they cannot spare much time for active investment effort.
To make Graham’s method growth-oriented and more explicit, this author provided specific numerical estimates and the modified Graham-Rao method was described in A Nine-step Route to Picking Value Stocks published in the The Smart Investor dated August 25, 2003.
Additional Readings:
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It’s all in the family
Sometimes there is more than what meets the eye. This is especially true for companies with unlisted subsidiaries.
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Follow the leader?
There have been numerous private equity deals of late. But should ordinary retail investors follow in the footsteps of PE investors?
Additional Reports:
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Parting Thought:
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It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price. Now, when buying companies or common stocks, we look for first-class businesses accompanies by first-class managements. – Warren Buffett
By Maria Crawford Scott – AAII
No modern-day investment “sage” is better known than Peter Lynch. Not only has his investment approach successfully passed the real-world performance test, but he strongly believes that individual investors have a distinct advantage over Wall Street and large money managers when using his approach. Individual investors, he feels, have more flexibility in following this basic approach because they are unencumbered by bureaucratic rules and short-term performance concerns.
Mr. Lynch developed his investment philosophy at Fidelity Management and Research, and gained his considerable fame managing Fidelity’s Magellan Fund. The fund was among the highest-ranking stock funds throughout Mr. Lynch’s tenure, which began in 1977 at the fund’s launching, and ended in 1990, when Mr. Lynch retired.
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Popularly known as the “Guru of Contrarian Investing”, David Dreman follows an investment philosophy based on low P/E approach to stock selection. Dreman, who has authored the recent Contrarian Investment Strategies: The Next Generation, among several other investment books, is also the Founder and Chairman of Dreman Value Management. His Large Cap Value Fund has returned on an average 17 per cent annually, and Small Cap Value Fund 16.5 per cent annually, since inception in 1991.
There is a bit of difference between value investing and contrarian investing. Basically, I buy stocks when they are really battered. I am very strict with my discipline. I always buy stocks with low price-earnings ratios, low price-to-book-value ratios, low price-to-cash-flow ratios and higher-than-average yield.
Academic studies have shown that a strategy of buying out-of-favour stocks with low P/E, price-to-book and price-to-cash-flow ratios outperforms the market pretty consistently over very long periods of time. The operative phrase there is `very long periods of time’.
Psychology is probably the most important factor in the market — and the one that is least understood. There’s constant overreaction in the market. Low-P/E stocks are constantly priced too cheaply over long periods of time, and higher-P/E stocks are priced too dearly.
People like exciting stories; they don’t like boring companies. That is the normal cause of investor overreactionAlthough financial advisers uniformly praise good long-term records, most concentrate on performance over short terms, like three years.
The problem is that this period may be shorter than the life span of a Wall Street fad, like Internet stocks. First-rate funds may look weak over three years, as many did during the tech bubble, because their investing styles are temporarily out of favour.
Anyone can get lucky for three years. Daniel Kahneman of Princeton won the Nobel Prize in economics for, among other things, showing that this fixation with sizzling near-term performance hurts investors. Avoid the problem by looking at 10- or 15-year numbers.
If you follow them (popular trends), odds are you’re buying near the peak, and the lovely outperformance will end soon. Today hedge funds are hot, driven by billions of dollars that advisers are shepherding into this sector. The same is true for foreign securities, gold and natural resources. Am I being too hard on financial advisers? If the news is better than expected, the Dow Jones industrial average shoots up 150 points; if worse, the drop is just as steep.
Hedge fund managers, day traders and swarms of other quick-buck types trade instantly to get the edge from news flashes. Maybe you can make money trading on these moves, but only if your transaction costs are nil and your computer is ten seconds faster than every other trader’s. Neither condition holds.
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Parting Thought:
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It has become fashionable at public companies to describe almost every compensation plan as aligning the interests of management with those of shareholders. In our book, alignment means being a partner in both directions, not just on the upside. Many ‘alignment’ plans flunk this basic test, being artful forms of ‘heads I win, tails you lose.’ – Warren Buffett
In a classic “Classics II – Another Investor’s Anthology”, there is a piece of wisdom by Benjamin Graham and David Dodd which every investor should read and re-read.
“The old rule for the ordinary investor was that he should buy sound securities when he had funds available. If he waited for lower prices he would be losing interest on his money; he might “miss his market,” even if prices declined; in any case, he was turning himself into a stock trader or speculator. Much of this view retains its validity. However, the time when the investor should clearly not buy common stocks is during the upper ranges of a bull market. For most issues this is tantamount to saying that he should not buy them at prices higher than can be justified by conservative analysis-which is something of a truism. But, as we pointed out previously, this warning applies also to the purchase of apparent “bargain issues” when the general price level seems dangerously high.
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Additional Readings:
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Parting Thought:
I have been a great follower of yours. Each day I used to rise with what you were speaking from Tokyo and went to bed with what you were preaching from New York. I bought when you told me to and sold when you scared me to. During the NASDAQ run I made a few multibaggers but then lost all of it. You would remember how you scolded me for not having applied stop losses. That was after the stocks went below those levels. But I continued to believe in you and your community. I made money in banking, sugar and construction, lost a few here and there. On the whole I did not do better than what I could have managed myself but still I enjoyed each moment of it . In June I lost quite a fortune on your Sterlite and Hindustan Zinc call. That was because the LME prices fell and I was taken off guard. As usual you rebuked me for not having put in stop losses.
During the current carnage when the index fell to 8800 one particular member from your community stormed the TV channels from Hong Kong and preached gloom, boom and doom . The local ones told me to stay away till the dust gets settled. Again I obliged and cut all my long positions converting them for cash. I booked profits in all the counters that I had got in early . This was because you advised me to take the profits home. For the losers you advised that there is no point selling at these levels and as it always happens I listened.
Investors wishing to save themselves from the bloom gloom and doom were advised me to go on a long holiday. I could not go on that holiday since it would have cost money. Another member from your community asked me to keep 30% in cash, a few told me to wait for the US interest rate cues while the others were preparing for a US led global recession and urged gulliable investors like me to buy gold and silver. Theysaid that these would be the saviors.
At an index level of 8800 the largest fund house from the land of the rising sun talked about an index level of 7000 above which they would not invest. Does any one know what they did after making that statement?
When ever I asked you something you were uncomfortable in responding .You called it momentum and I thought that these stocks were for the greedy. But after having suffered because of my shortcomings (in not being able to understand you correctly)
I have a few questions:
1) Doctors, engineers, accountants do pass some examinations before being called experts. They undergo rigorous training and then only they are allowed to advise. Do you along with members of your community undergo the same test before advising millions of fools like me on TV?
2) Do you ever look back and see how many of your recommendations went right and how many went wrong. If so how so if not why not?
3) Do you ever feel guilty either morally or ethically when investors lose money on your recommendations?
4) You have a habit of using vague words like:
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Buy on declines
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Should give you 20% return. Whether the stock is at Rs 700 or Rs 850 you talk of the same 20% returns.
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Cautious optimism.
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Apply strict stop losses – Please name me one person who has made money by applying strict stop losses except the person who sells subscription for such advice.
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Momentum investing – If buying on a break out and selling on stop losses is not momentum investing then what is? Yet you prefer to talk of stocks that you do not understand as momentum investing.
5) Most of the time your analysis is historic. You say this stock has made a 52 week high at so and so and then retraced itself to so and so and now is trading at so and so. You know the introduction that takes 70% of you analysis does not help me. I can see it in the pink papers and that costs Rs 2.00 only.
6) I am tired of hearing words like supports, resistances, 200 day moving averages, Fibonacci, retracements, RSI’s etc .
7) Each day you looked at the NASDAQ and the Nikkei and told us where we would go . Over the last 5 years the NASDAQ has gone no where but we have gone up by more then 4 times. Do you remember the critical days when you went wrong?
When stocks fell you blamed sentiment when they went up you said liquidity . Why can’t you tell us before hand as to what will happen? Otherwise there is no difference between you and me.
Yours Truly,
“The small investor” - A bruised battered and mauled Bull
P.S.: I am not the author of the above post. – Ed
by Chetan Ahya – Morgan Stanley
Domestic private sector is rushing to announce retail plans
Even as the government continues to delay the decision to allow FDI in multi-product retail chains, the fast-emerging Indian retail sector is becoming widely recognized among domestic entrepreneurs and investors as one of the biggest opportunities in India. Apart from existing players (such as Pantaloon) ramping up their retail chain store operations, many large business groups, including Reliance Industries, Birla Group and Bharti Enterprises, have announced their intention to cumulatively invest over US$10 billion over the next five years to capture a share in the fast-growing pie of the organized retail sector. In addition, various foreign players like Walmart and Tesco have announced their intention to enter the domestic market via a joint venture with a domestic Indian player. Major consumer spending items currently form part of the addressable market for the retail chain stores format and include food and grocery, general merchandise (such as furniture and furnishings) and apparels. While growth estimates for the organized retail sector vary, forecasts by our consumer analyst, Hozefa Topiwalla, indicate that India’s organized retail market is likely to grow from the current US$4 billion (2.1% of total relevant consumer spending) to US$ 64 billion (10.8%) by F2015.
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In a great book “Classics II – Another Investor’s Anthology”, there is a piece by Peter Carman on the psychology of investment decision- making.
“One of the underlying assumptions of the Bernstein investment philosophy is that distortions in value are created by emotions that dominate investor decision-making. . . . These distortions occur regularly and provide opportunities for premium performance for those investors who can capitalize on them. . . . Use of the dividend discount model provides a rational, systematic method that can be used to uncover when these distortions occur and measure how large they are. But why should distortions or inefficiencies exist in the first place? After all, most investors are bright, sophisticated, well educated and well in formed. It seems, however, that these irrationalities are a normal part of human behavior.
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Parting Thought:
by John Authers – FT
Investors should expect an equity premium of 3-3.5 per cent from now on – less than half the popular estimates for the past 100 years.
How much of a premium do we expect for taking the risk of investing in equities rather than something safer, such as long-term government bonds? And can that premium possibly be as high in the future as the 7 per cent or so that business school texts assume, and that historical studies of the UK and the US have shown?
Some contend that it is misleading only to look at these two countries. So a new study by Elroy Dimson, Paul Marsh and Mike Staunton, finance professors at London Business School, makes a Herculean effort to overcome this, by looking at returns for 17 countries dating back to 1900.
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