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Analyzing Stocks With a Partner

Someone who reads the blog emailed me this question:

“Buffett has Munger, and you have Quan. It seems like in this industry, a collaboration of minds can be a potent formula for long-term success if approached correctly. That said, how would you recommend investors/ aspiring portfolio managers to find a suitable partner who not only is able to shine light on your blind spots, but who can also be of one mind and culture?”

It’s a huge help to have someone to talk stocks with. But, I’m not sure it’s a help in quite the way people think it is. I think people believe that Buffett is less likely to make a big mistake if he has Munger to talk to, that I’m less likely to make a big mistake if I have Quan to talk to, and so on. I’m not sure that’s true. I know from my experience working with Quan that our thinking was more similar than subscribers thought. For example, one question I got a lot was who picked which stock. And that’s a hard question for me to answer. Some of that might be the exact process we used. I can describe that process a bit here.

When I was writing the newsletter with Quan, we had a stock discussion via instant messaging on Skype. We did this every week. The session lasted anywhere from maybe 2 hours at the very shortest to maybe 8 hours at the very longest. A normal session was 4-5 hours. So, we were talking for let’s say 4 hours a week about stocks. We weren’t talking about stocks we had already decided on. Instead we were just throwing out ideas for stocks we could put on a “watch list” of sorts. We called it our candidates pipeline. It was really a top ten list. So, instead of saying “yes” or “no” to a stock – what we did is rank that stock. We always had the stock Quan was currently writing notes on, the stock I was currently writing an issue on, and then 10 other stocks. In almost every case, once I started writing an issue – that issue did end up going to print. In most (but not all) cases, whenever Quan started writing notes on a stock – that stock eventually became an issue. But, there were probably 3 to 5 times that he started writing notes on a stock and yet we didn’t publish an issue on that stock. This was rare. Most stocks we thought about but eliminated were eliminated in the “top ten” stage.

So, we’d have a list of ten stocks that we weren’t yet doing but that we planned – if nothing better came along – to work on next. Let’s make up a list here. Let’s pretend #1 is Howden Joinery, #2 is UMB Financial, #3 is Cheesecake Factory (CAKE), #4 is Kroger (KR), #5 is Transcat (TRNS), and #6 is ATN International (ATNI). It would go …

How to Find the Most Persistently Profitable Companies

“GuruFocus provides data on predictability of a business. Do you like this metric? Do you use this metric in your analysis? It seems to me that the more predictable a company’s historic earnings, the easier it should be to calculate the intrinsic value of the company. Do you agree with this assessment?

The problem with this for value investors is predictable businesses tend to not get nearly as mispriced (at least highly followed large cap stocks).”

I do use predictability in a general sense. I don’t want to talk about GuruFocus’s measure of predictability specifically – because GuruFocus publishes some of the stuff I write. So, I’m biased. If I say something good about a GuruFocus feature – you won’t believe me. And I wouldn’t want to say something bad because they’re kind enough to publish my writing. I’ll just say that “predictability” is a good measure to look at. And that is what the GuruFocus predictability rank is trying to do. So, it’s trying to do a good thing. And you’re not going to come to any harm by looking at it. And you might get something positive out of looking at GuruFocus’s predictability score for a company. So, yes, I like the metric of predictability.

Now, what do I use personally? I enter a company’s financial data into Excel myself. I’ll look at the data at places like GuruFocus. But, I want to go to the historical 10-Ks and pull the numbers out myself and adjust them as I see fit. This is to get comfortable with the numbers. There’s a difference between when you are relying on something a computer has done and when you are doing the data entry yourself. So, I set up an Excel sheet with 15 years or 20 years or 30 years of financial data. I prefer 30 years where 30 years of data exists. I also like to read the very oldest and very newest annual report from the company. Sometimes I read other specific past annual reports (like the 2008 financial crisis year) that were unusual for the company, the industry, or the country it operates in.

One thing I have Excel calculate is the variation in EBIT margin. So, if you have say 30 years of financial data for EBIT, and the EBIT margin is positive in every single year – you’ll be able to calculate both the standard deviation and the (arithmetic) mean in the series. Excel can give you other types of averages too. It does geometric and harmonic means which investors use rarely. But something like the harmonic mean is actually a useful measure for the very long-term return on capital, because as a rule – a company’s compounding in its intrinsic value will not be less than the long-term harmonic mean of its return on capital. It could – especially if it’s in a very cyclical industry – be much lower than the arithmetic mean. I bring this up because it’s sort of …

How to Invest When You Only Have an Hour a Day to Do It

Someone who reads the blog emailed me this question:

“If one was a widely-read value investor but only had 5-10hrs per week to spend on investing (due to employment / family constraints) and one had less than $1m, would you recommend a classic Graham net-net portfolio as the surest and best way to make market beating returns? If no, what other strategy (apart from indexing) would you recommend under these time constraints?”

I’m going to rephrase this question as “If one only had an hour a day to spend on investing”. You said 5 to 10 hours. I’m going to ask you to spend 5-7 hours a week on investing. But it must be an hour a day – every day – instead of five hours all at once. There’s a reason for this. I want you 100% focused when you are working on investing. You don’t have to spend a lot of time on investing. But you do need to be focused when you are doing it. Most people who invest are never fully focused for even an hour on a narrowly defined task. So, that is what I need from you. An hour a day of total focus. If you can’t do it every day – then don’t do it at all on weekends. Just spend an hour a day on Monday through Friday. But never skip a day. Okay. Let’s say you’re willing to make that commitment. Then what?

The approach for you to use is not a net-net approach. It’s a focused approach. A concentrated approach. You don’t have a lot of time. So, you need to spend that time focused on what matters most. Stock selection is what matters most. So, first I want you to give up the idea of selling stocks. Don’t worry about it. You’re only going to sell one stock to buy another stock. You’re not going to sell a stock because it is now too expensive, the situation has played out, etc. Okay. So, we’ve cut out about half the time investors spend thinking about stocks. You can now devote all the time you would have spent thinking about selling the stock you already own and instead double the time you will spend thinking of the next stock to buy. I also want to eliminate the idea of portfolio management – asset allocation, diversification, etc. – from your schedule. So, I’m going to ask you to commit to identically sized positions. By this I mean the positions will be the same size when you buy them. So, if you are comfortable being as concentrated as I am – then you’ll want to set 20% as your position size. You’ll own just 5 stocks. If you want to be more diversified – you can settle on owning 10 stocks at a time. That’s fine. But I don’t want you to have some 5% positions and some 20% positions. If you are going to own 10 stocks at a time …

Is Value Investing Broken?

Someone who reads the blog emailed me this question:

“Is value investing broken? 

To clarify: with worldwide debt at 200+ trillion and incomes stagnating or falling who exactly is going to go out and buy new products (whether from Luxottica, Movado, Swatch etc.) when they have record debt levels and are getting by at $10/hr? I realize that is a limited example but in many industries there is massive change going on that will, temporarily at least, push down income levels (driverless cars and trucks, robotic everything etc.) and people will therefore be spending less. Does value investing still work in this environment? Do you bother investing at all?

Apologies for the gloomy tone of this email but I don’t see a good place currently to invest and am frustrated by my inability to figure it out. Please help!“

No. Value investing is not dead. There’s a tendency for people – people of any time – to see the time they live in as unique, dangerous, different, unlike any other age. In some ways, they are always right. Some things really are different this time from all other times. But, mostly, they’re wrong. And what they are wrong about is reading a golden age of stability into the past. I was talking with a value investor once and this value investor said that sure Ben Graham’s ideas worked in Ben Graham’s times. But Ben Graham invested in simpler times.

Here are the times Ben Graham invested in: the 1910s through the 1950s. He invested during Two World Wars, the start of the Cold War, the atomic bombings of Nagasaki and Hiroshima by the U.S. and then the testing of nuclear weapons by other countries, The Great Depression, a big explosion (reportedly a terrorist bombing) on Wall Street, and the longest shut down of trading in Wall Street history that I can remember at least (right as World War One started). People talk about political risk today. Political risk in Ben Graham’s time meant Marxists and Fascists. Investors saw hyperinflation in Germany after the war and then they saw deflation after the 1929 crash. These were not simple times. If you go back and read the newspapers from the time – you can see how not simple they were.

Now, yes, they were different from today in some ways. Much of the period investors and economists in the U.S. study were more regulated than today. So, you either had the Gold Standard or Bretton Woods. You had much greater belief in planned and insular economies in a lot of countries. With the benefit of hindsight – and seeing the entire sweep of history – many of these decades seem simple to us. They rarely were. Try to find a decade without too much inflation, too much deflation, too much war, the mania of some bubble, or the bursting of that bubble. At any point in that past, people could have believed value investing was dead. And …

The Possibility of Negative Interest Rates in the U.S.

Someone who reads the blog emailed me this question:

“What’s your general thoughts on negative interest rates? Do you just take that out of your consideration for US banks?

I have read about some interesting analysis from smart people that outlines their reasoning for a much lower interest rates going forward than the past, say, 50 years. Most include points like less capital needed ahead because of the lower capital of new tech companies and more savings from around the world with people living longer.

Do you have any thoughts here?”

Yes. I do just take negative interest rates out of consideration when analyzing U.S. banks. I wrote reports on Prosperity (PB), Frost (CFR), Bank of Hawaii (BOH), Commerce (CBSH), and BOK Financial (BOKF). I can’t remember discussing negative interest rates in any of those reports. And they weren’t brief reports. I did discuss a lot of scenarios – like interest rates staying lower longer than I expected. But negative interest rates weren’t discussed.

I think talk of negative interest rates is the result of years and years of low interest rates. People talk a lot about the long-term average price of a barrel of oil, a house, etc. in the early stages of a bubble. Later, when prices have been out of whack for years and years they stop listening to the people who say you’re going to see mean reversion. Instead, they believe the now is normal. When the now is new – people know it’s abnormal. But once the now – in this case, rates near zero – goes on long enough, the recent past erodes their memory of the distant (like 70 years ago) past.

It’s natural for people to project the recent past into the future. Rates are low now. But they were low just after World War Two as well. Look at long-term corporate bond rates in 1946. They were low. Very short-term government bond yields (and the Fed Funds Rate) have been lower in the past few years than at just about any time in the past. But, I’m not sure the things that would matter more to an investor – things like the long-term corporate bond yield – are lower now than they were 70 years ago. And, of course, in between you had some very high yields. A long time ago, I wrote a series of posts about normalized P/E ratios. These are like the Shiller P/E ratio. I looked at normalization over periods longer than the 10 years he focused on. But, I don’t think the result is that different whether you are using a 10-year average, 15-year average, or 30-year average of past earnings. What I found is that the stock market – in normalized P/E terms – tended to get more expensive for about 17 years and then tended to get cheaper for about 17 years. For example, the market (I used the Dow) reached a peak normalized P/E ratio in 1965, it hit the bottom …

The Best Investing Book to Read if You’re Only Ever Going to Read One

Someone who reads my blog emailed me this question:

“Imagine you’re giving advice to a young person (early twenties) who just got their first job and has a 401k match program or has decided to set aside part of their paycheck each month for a tax advantaged investment account. They want to learn enough about investing to not get into trouble while managing their account, but they don’t want to turn this into a hobby or a part time job.

Is there one book or resource they should study to learn how to select suitable investments and manage them within a portfolio over time that you’d recommend? Imagine they’ll never read or think about the subject again, this is your one shot to set them on a good path. What do you recommend for the everyman investor?”

That’s a good question. And a tough one to answer. I can quickly come up with a list of books I’d recommend as a group. Everyone should read Peter Lynch’s “One Up on Wall Street” and “Beating the Street”. Joel Greenblatt’s “You Can Be a Stock Market Genius” and “The Little Book that Beats the Market”. Ben Graham’s “The Intelligent Investor” (the 1949 edition is best). And then Phil Fisher’s “Common Stocks and Uncommon Profits”. Just writing this I’d say that maybe the number one book I’d recommend – if I was only recommending one – is Phil Fisher’s “Conservative Investors Sleep Well.” Now, technically, “Conservative Investors Sleep Well” is included in “Common Stocks and Uncommon Profits”. It was originally published as a separate book. So, if you’re willing to count it as a separate book – even though it’s only available as a really old, used book in that form – I might say “Conservative Investors Sleep Well” is the one book I’d recommend.

Why wouldn’t I make the Lynch books, the Greenblatt books, or the Graham book the one and only book to read? A few of them are too specialized. I’m a big Ben Graham fan. But, Ben Graham is not a good choice for someone who doesn’t want to spend a lot of time picking stocks. His approach takes a lot of time to implement. And it can be dangerous if done wrong. Greenblatt’s best book is “You Can Be a Stock Market Genius”. I think that’s the single best book on investing. But, it’s not the one I’d recommend for someone who isn’t going to focus on investing all the time. His other book “The Little Book That Beats the Market” is the easier one to implement. But, it’s not that different from indexing. That is what Warren Buffett would recommend – the John Bogle approach. If an investor isn’t willing to put in the time to research stocks in depth, he should just buy the S&P 500. I don’t know if I agree with that. There is another way you could make things work I think.

Let’s say you only picked one stock a year. And let’s …

Getting Back to Blogging Regularly: Call for Questions

I’m eager to get back to blogging regularly again.

But I’m always short of topics to blog about.

So, I’m in desperate need of some questions from readers.

If you have a question you’d like me to answer in a blog post, email me at:

[email protected]

That’s:

[email protected]

Thanks.…