There are many styles of Long Term Investing. I’m only going to talk about a few of them, but they are the ones I’ve had work best, or that don’t work so well but are often “pushed” at folks.
Economic / Business Cycle
Growth At A Reasonable Price
Pick A Horse
Part of what makes “investing” so confusing as a field is that there are MANY different styles that work. Prices tend to a semi-cyclical nature with a fractal stochastic edge. That means prices will generally wander up and down over the business cycle or over the monthly cycles, but that the prices on any given day may be up, down, or static based on “nothing much” or “recent news” or even news in some other area that is only slightly related.
Add in that you may have many different time cycles in overlap, and it can be that you are completely correct that “this month’s earnings will be great” but completely miss “The Fed changed interest rate policy”. Or worse, Goldman Sachs announced it didn’t like the company any more. ( GS has been known to trade against their clients, and mostly “trades their own book”, so while they are highly influential and folks DO often run this way and that as they order, they are NOT looking out for you.)
So, what to do?
Pick a Style. Then pick a Time Frame.
A “high growth momentum” investor looks for entirely different things from a “deep value” investor. Someone investing for 20 years of dividend income has a very different set of interests, and needs, from a person wanting “retirement in 40 years with growth”. Both are quite different needs from those of a company treasurer who needs “SAFE investment for an unknown number of years while the board decides what to do next”.
After you master one style, THEN, and only then, add another one. It can take a decade to get really good at one of them, and that time is slowed if you have too many fingers in too many pies too quickly. It is very hard to make the “mental switch” from “Is it CHEAP enough?” to “Damn the price, look at the GROWTH!”. Folks can end up in “analysis paralysis” as those two sides shout at each other.
With that said, I put no artificial blinders on the ability to learn. IFF you can pick up that schizoid character fast and do it well, go for it. Just remember, it’s a hard row to hoe and few folks really NEED to do it. (I’m one of those. I’m compelled to “completion”. So I am just not satisfied on a “partial answer” or a “partial skill”. I simply MUST get good at all of them, even if it takes my whole life. It’s an ASPE thing…)
So asses who you are. Are you fundamentally a cheap skate? “Value Investing” will fit you emotionally. Are you a Trend Setter with an unmatched sense of what social Fad is going to “have legs” and which is just dead dumb? High growth in new markets… Do you love numbers and detailed financial analysis? “Growth At A Reasonable Price” GARP fundamental analysis comes to mind.
If you do not know yourself now, you will after a couple of years in the market. It will find your weaknesses and exploit them. Prone to love fads? It will present the Killer Fad that just dies under you, taking your money with it. Love to think your math and analysis beats all others? You will be presented with the Best GARP Ever, and find it bankrupt as a competitor puts them out of business or a new fad makes them “buggy whips” in a FORD era.
So first, and above all else: Know Yourself.
Using that: Pick A Style. (Eventually to add others, if desired or needed).
THEN: Pick a Time Horizon, or what I sometimes call a Time Cycle.
If you are a fanatic “Gotta have action” type, go with swing trading and practice these “long term view” skills to set the context for your daily frantic jumps into and out of ‘hot tickers’. The context WILL help, but your daily actions will be on Trader Charts. 6 month daily “races” with several tickers and even 10 day hourly charts for timing swing trades and day trades.
Need “growth over 40 years”? Look for GARP, but “time” your buying with a 5 year weekly chart.
Safety First? Concentrate on bonds, but watch that 5 year bond chart for “when to shorten maturities or go to cash”.
Deep Value? Those usually are highest in a crash, so you watch the 10 year weekly chart. At the same time, though, “values” pop up all the time, so more time will be spent looking at sectors that are “beaten down” in the news; then looking at financial data to sift wheat from chaff. Annual reports, and annual charts, are helpful, but watching the financial news helps too.
Those are examples, we’ll look a bit more at the specifics below.
Timing Is Everything
It really is. You will hear it widely touted that “You can not time the market”. That’s just wrong. It is “academically proven”. But there is a very long list of Real World Investors who have “beaten the market” using market timing. I will show a couple of tools to do that, but there are others. It really isn’t hard, technically; but you must be willing to abandon the idea that it can not be done. It IS very hard emotionally, as you must ignore what everyone around you is saying and what everyone around you is doing and “be at peace” and “trust the tools”.
A very good place to start is Ben Stein:
My very first “Stock Market Indicator” was the headline, in 72 Point Type or larger “Stock Market Crashes!!” in the non-business general news papers. This will come about every decade or so. When it happens, it panics most folks into selling at the bottom. That is the moment for you to be buying at the bottom. “The Time To Buy is when blood is running in the streets”. I believe that is from Baron von Rothschild. It was, and is, true.
So first off, for the long term deep value investor, have a plaque made with that on it, and put it on the wall of your office. Look at it every day. Add the footnote: To have the money to invest then, you need to have SOLD before the crash…
I would add my dictum:
“When everyone loves stocks and all is quite – PANIC!. -E.M.Smith”
We will see a tool to quantify that moment shortly.
As we look at the different “styles”, I’ll give examples of how to find that kind of stock or fund, and I’ll give examples of how to measure the “timing” on them.
Averaging In, Scaling In, Dollar Cost Averaging
There is a special note for an “I can’t time it” technology that actually does work.
IFF you buy similar sized dollar amounts over a long period of time, sometimes prices will be low, sometimes high. On average, you get more shares when prices are low, so you automatically get more “value” bought during low price times than during high price times. It’s a mechanistic discipline that lets you “buy more at lows” based on the simple math of it.
If I buy $1000 of stock each month for a year, at the end I’ll have bought (for a $10 stock with a never changing price), 1200 shares.
But if that price dips to $8 for a month, I get 125 shares. If it rises to $12, I get 83 shares (and have a fraction of my money left over as it’s not an integer size). At the end of that time, my “average price / share” was $9.61. I got 208 shares, not 200, for my money.
If, instead, I bought 100 shares each month, I’d be getting 200 shares instead of 208, and at an average price of $10 / share.
I make almost 40 cents a share just from “equal dollar buys” instead of equal SHARE buys. About a 4% gain. Making an added 4% is not “chump change”… compounding will make that grow nicely.
For long term buying (years) this is called “dollar cost averaging”. For traders taking a position over a couple of months, it is called “scaling in”. Sometimes it’s called “Averaging In”.
So, maybe you use one of the timing tools to know “now is the time” generally. As in “this year”, but not “today”. How to avoid the “buy today, regret and sell tomorrow” syndrome? “Scale In” or “Dollar Cost Average” over the next year. Even experienced traders may “scale in” to a position over a week, rather than suffer the sin of arrogance and think they have timed it to the day or hour.
(That kind of precision timing requires “sliding down the time scales” and ending at an hourly or even a 5 minute chart. Very hard work, and often not worth it. One often forgets to “buy and move back up the time scale” and becomes an “accidental day trader”. )
One of THE most valuable skills to learn is that of the gambler. “Bet management”. Eventually you will have a “bad bet”. The CEO will do a “perp walk” or the news will hit that THEY invested with a Madoff…
It must be a ‘recoverable’ bad bet.
The math of this was long ago worked out. The “bottom line” is to never bet more than about 1/20 of your “stake” on any one bet. I will, occasionally, go to 1/10 th; but those are only for things like broadly diversified funds, Warren Buffet and BRKA, or short term bets on things like metals or currencies where “bankruptcy” isn’t really an option.
The best way to learn this is to think like a gambler. Read the “money management” section of “Beat The Dealer”.
Edward Thorp went on to write “Beat The Market” that is now out of print and runs a few hundred dollars a copy. THAT book is the foundation of the modern Hedge Fund industry. I’ll talk about it some in a later posting. You don’t need “Beat the Market” at this stage, and it is fairly technical.
So, divide your “pot” into 20 piles.
If you go over about 50 individual bets, it become nearly impossible to keep up with the workload of looking at them. Also, as you move above 20 positions, it becomes ever harder to “beat the S&P 500 average” as YOU are becoming closer to that average. Can you REALLY pick out 50 different sectors or stocks that are going to “beat 80% of ALL money managers”? REALLY? So you end up with “more than 20, less than 40” most of the time. Each one needs to be a decision. When in doubt, just buy SPY and enjoy being in the top 1/4 of all investors…
(Realize that as 10 bets in funds, you can rapidly reach that number. SPY, Cash, FXF, TLT, EEM. I’m 1/2 way to “a list” with all of “USA broad market, cash, Swiss Francs, Long Term bonds, Emerging Market fund’. At that point, having 1/10 of a “bet size” as a ‘low holding’ or ‘tiny’ position and having 10/10 of a bet as a ‘high holding’ and just tuning the asset allocation between those buckets will keep you pretty busy. Now pick 5 “more” that have special meaning to your “style” and you have a pretty full slate of 10 “funds and non-stock” tickers. Think about that for a while. Can you REALLY then pick another 10 that are guaranteed to outperform just swapping between SPY and TLT / cash?
So, after picking a timing, a style, and dividing your stake into “bets”. You then answer:
What do I bet it on? For how long? When do I exit?
When in doubt, leave it in cash. In a crash, “Cash is king”. If you don’t know what to do, stocks are falling, and you feel that sick “confused” feeling. “Sit in Cash”. Or as I like to say it:
“Think in cash. -E.M.Smith”.
It is much easier to think in cash than in a falling stock portfolio. I also “go to cash” when I’m sick or on vacation or just “not paying attention” for a few months. Yes, that’s a bit overly dramatic. But as I’m usually trading instead of investing, I rarely have any “deep value” or “high growth” positions for long term holding (other than Berkshire Hathaway).
OK, so your basic money management is:
No bet over 5% – 10% of my “stake”.
Each one a distinct instrument (i.e not 2 semiconductor companies…) or a broad diversified fund.
Each one monitored as its own entity.
When in doubt, go to cash.
I’m now going to go through each of the main styles above, one at a time, and give some basic ideas on how they work and what to look for. There are more “styles” than I list here, and there is more information written about each than I give here, but this ought to be enough to “get started”.
Asset Allocation and Economic Cycle
I’m going to cover these two together. They have a subtile difference, but to separate them is to confuse more than enlighten. “Asset Allocation” is often used as “code words” for “Stocks vs Bonds”. While “Economic Cycle” or “Business Cycle” usually means “sector rotation” as the economy booms and busts and different “bits” win. BUT, part of that business cycle is The Fed cutting, then raising, interest rates. And THAT drives the asset allocation… So the two are mixed.
The basic cycle runs about a decade (with some variation from era to era). THE key driver is The Fed (or the central bank of the country in question). At the top of a “boom” of economic growth, The Fed raises interest rates to “cool things off”. It becomes harder to make enough money on the loans to make a profit, so lending gets cut back. Business slows. Sometimes a “bubble pops” and we end up in a downturn. During a business downturn, The Fed cuts interest rates. Sometimes quite aggressively. But now folks are worried, so it takes even more promise of return on investment for them to borrow and risk money. After all, they just got “burned” in that peak / collapse. eventually, business starts to pick up again and then The Fed can start raising rates again. Repeat.
OK, when interest is about 1/2% on a bond, there is not much reason (other than fear) to own it. As business picks up and folks lose fear, they start to sell those bonds. But if I’m making 10% in a business, why buy a 1/2% bond? SO those bonds “sell at a discount”.
At the other end of things, when interest rates are 10% and business is starting to go belly up, folks will “bid up” bonds. As a crash happens, everyone wants to dump stock and buy bonds. (You want to already own the bonds they wish to buy, at that point.)
During a business recovery, folks start dumping bonds to buy stocks. (You want to already own the stocks they want to buy at that point).
So you can see there is a natural alternation between stocks and bonds over the “Business Cycle” (that really ought to be called The Fed cycle, IMHO).
This chart shows a long duration bond fund, TLT, vs the stock market, S&P 500.
Notice how during the stock market crash, bonds spike up? Now look at May – June of 2008. The stock market reaches a peak, and bonds reach a bottom. THAT is the time to swap from stocks to bonds. Over the next year, bonds slowly drift up as the market wobbles down. Then the crash, and bonds SPIKE up. At the top of that spike is the time to leave bonds. Just as everyone is buying them aggressively and bidding them up “way high”.
RSI above 80, on a weekly tick mark chart, for bonds, is very rare and very outrageous. If you see that, start selling. Usually it is more of a 35 – 65 range. Also note that MACD works OK too. When slope is fairly good (over 30 degrees or so) it tells you when to be in, or out. (When flat slope, like early 2010, look at the “positive / negative” value. It is saying “trend continues” in a flat slope, and the number at the right side tells you positive or negative trend and now much… So in early 2010 it’s -1, falling, steadily) Even DMI is a decent indicator most of the time. Blue on top, be in. Blue crosses black ADX, edge out. Red crosses above blue, be out (watching for a re-entry).
This is on a chart with “weekly” tick marks. So just checking this chart one time per week would have you mostly in bonds at the right time and mostly out of stocks at the right time.
That is timing “asset allocation” on a very long term cycle.
If you “tighten the time scope” to a 4 year daily tick chart, you can see that now MACD has you trading in and out more often (on each ‘couple of month’ ripple as The Fed announces things or various financial reports are released). DMI does an OK job showing the major moments, but it’s a bit confused in the middle. RSI starts to stand out even better, though. Notice at the very start the “touch 20” is a clear “buy” while the “touch 80” is a pretty clear exit call. In June – Aug of 2010 it would have warned a bit early of an exit at the first ‘near 80’ spike, so use this fast a chart with some discretion and remember that for RSI, the first blip is the warning, the later ones usually call the trend change moment. So that first RSI spike in Dec 08 is really just the warning for the Jan very low “peak” at just above 50. Even under those extraordinary times, it would have gotten you out of bonds with most of the drop still to come, by waiting for that second “peak” that is really just a blip over the 50 midline.
Are you interested in monthly bond trades? Use the daily tick mark chart. Do you want to do “once a month or quarter” asset allocations? Then don’t look at the daily chart. Use the weekly tick mark chart. First “know who you are” then “what you want to do” THEN pick the time scope and tools. And ignore all the “talking heads” that say “buy this or sell that” as they are not telling you what time scope they are on, or what style they are working. Who THEY are is not who YOU are.
Notice, too, that bonds “called the bottom” in the stock market a full 2 months in advance. Remember that. Bonds often “call the tune” in advance of stocks…
So even if you are NOT going to buy bonds, WATCH bonds. They tell you what the big money is doing (it is a vastly larger market than the stock market).
Now look at Feb – Mar – April of 2011. Notice bonds start up? BEFORE the stock market starts to roll over? The indicators for bonds right now are DMI Blue on top, MACD above zero and flat / sideways, and RSI neutral, but in a rising trend. All that is bullish for bonds, and negative for stocks.
(I don’t expect this to last long term. IMHO, it’s a reaction to the budget mess in DC, so whenever they “do something” this can change, fast, depending on what they “do”… but for now the “worry trade” is into bonds, out of stocks.)
OK, now put it together:
You want to have some money in bonds, and some in stocks. If you use a 5 or 10 year chart of weekly tick marks for bonds vs stocks, you can “swap between them” and make more money. One rises when the other falls, so a common strategy is the “balanced fund” or “balanced portfolio” where you just by 1/2 of each. But if you vary that percentage from, say, 25:75 to 75:25 with the “allocation cycle”, you can really juice up the gains.
That, in a nutshell, is “asset allocation”.
For a novice investor, just buying and holding the S&P 500 index beats 75% to 80% of all the money managers out there. (The reason is that the S&P is a dynamic beast. Companies are dumped when they shrink out of the 500 biggest, and “size matters”, so it automatically “cuts your losers”; while growing companies “grow into it” at the bottom so it “adds new growth”. Very nice.)
Now, if just buying and holding SPY beats most folks, what do you think it would do with some added “asset allocation” juice?
Just doing this ought to put you somewhere close to the 90+ percentile of performance as a “money manager”. The “hard bit” of course is to be selling stocks just as everyone is cooing over that “Dow Record” and to be buying them (and dumping bonds) just as everyone is talking about “never buying stocks again” and “buying safe bonds”.
Yes, it really IS that simple.
Economic Cycle or Sector Rotation
This uses the same Asset Allocation as above, but adds another layer of more detailed timing. AS an economy collapses, folks buy “safety” and “defensive” stocks. Soap, food, tobacco. Stuff consumers will continue to buy even to the bitter end. At the middle of a recovery, folks buy things like tool makers and equipment makers. These were beaten down hard (as not many folks buy new factories in a depression…) and now get lifted as businesses start to buy those delayed, but now urgently needed, replacements. At the peak, it’s all “hot stocks” and stories of spectacular new ideas. The order of the sectors rotation is commonly discussed, and you can get some variation on who thinks what goes where ( so I like to use charts to see for myself, rather than just trust a list somewhere…).
Goldman Sachs teaches their folks a specific expectation, and Cramer has written that up in his book:
Probably in a bit of a simplified form. At any rate, on page 115 he has a nice chart of a sine wave for the business cycle and lists sectors along it. I’m going to list the same sectors here, but in a list format. TOP is the top of the business cycle. The Mania phase where The Fed has raised rates to high levels. BOTTOM is the bottom of the cycle where The Fed has had to cut rates like crazy trying to make things better after goring the ox… The “sine wave” is tagged “GDP Growth (annual)” and ranges from about 4-5% top to -1% bottom.
GDP% Sector (per Cramer) The Fed ==== =================== ======= 2% BUY High Multiple tech (GOOG, Ebay) 1.5% BUY Banks and Financials (BAC, JPM, WFC) 1% BUy Retailers (WMT, TGT) Slowdown evident, Fed eases rates 0.5% BUY Housing Stocks 0.25% BUY Auto stocks 0% 2nd Fed Easing -1% 3rd Fed Easing BUY Low multiple tech (INTC, IBM) BOTTOM 4th Fed Easing -1% blank 0% blank 1% BUY Papers and Chemicals Fed Neutral 2% SELL medicine and supermarkets (PG, KMB, K, MRK, PFE, BUD) 3% BUY "smokestack" (IR, DE, CAT, MMM) Fed begins to tighten rates 3.5% 2nd Fed tightening 3.75% SELL financial, banking, retailers, autos 4% BUY metals and miners (AA, PD, NUE, NEM) 4.5% TOP SELL paper and chemicals (DOW, DD, IP) 4% 4.5% 3rd Fed tightening BUY medicine and supermarket stocks (PG, KMB, K, MKK, PFE, BUD) 3% 3.5% SELL "Smokestack" 4th Fed tightening 2.5% SELL Metals and mines Fed Neutral on interest rates. 1.25% SELL Gold 1% 0.5% Cycle starts again Fed begins to ease rates -0.5% 2nd Fed easing -1% 3rd Fed easing BOTTOM 4th Fed easing etc.
Now a lot of folks take that as gospel. I don’t. I’ve seen what was called “sector rotation”, but it seems far more “dogma” than “evidence” to me. For example, here is a roughly 5 year chart of several of those “sectors”. It looks far more to me like the old market sayings holding sway.
“A rising tide lifts all boats”
“When the cops come, they take the good girls out with the bad”
I suppose you MIGHT be able to get a tiny bit more by careful selection of individual sectors, but we’re talking some mighty fancy footwork, not “A up and B down”. More “A jumps a bit more while B saunters up”. IMHO, just leaving stocks for bonds during the down phases is more effective.
XRT - Retail ETF SP500 - S&P 500 Benchmark XLI - Industrials SWY - Safeway Groceries PFE - Pfizer drugs XME - Mining ETF XHB - Homebuilding ETF TM - Toyota Motors IYF - Financials ETF
OK, if you want to play the Economic Cycle game, you can make a list of sector funds from here:
and put them on a ‘Race Chart’ together. Then pick the one on top and watch for changes of who’s leading at inflections. Oh, and make SURE you put TLT or similar bond fund on the list to remind yourself about that particular alternative…
This is usually the strategy for folks who are “retired on a fixed income”. They don’t want to invade the principle of their funds, but want to maximize the “payout” for day to day retirement expenses and “fun”.
The “tickers” are desired to stay fairly flat, and the big thing of interest is the dividend or interest payment.
Notice that if you just say “Bonds are safe, buy bonds” and are buying them in the middle of a stock market crash when they are paying 1/2% and just before The Fed starts raising interest rates, you will find out that bonds can, and do, lose market value.
Often you will hear the statement “The bond must pay full face value at maturity”, so by implication, if it plunges you can just wait, and eventually you will get all your principle back. That is true for a single BOND, but FALSE for a BOND FUND. A bond FUND has NO MATURITY DATE.
I can not stress this enough. Folks regularly by a bond fund for “diversification” and forget they are giving away THE biggest security of a bond: At Maturity payout. So what happens is that bonds start to drop, “smart money” sells their bond fund holdings, that causes the bond fund manager to ‘dump bonds to meet redemptions’ and you get stuck with a permanently reduced FUND value and no maturity as some of the bonds were sold already; at a discount.
A bond FUND is a bet on The Fed and interest rates, with some dividends too. Nothing more.
So if you are going to play that “principle must be paid at maturity” game, you MUST own individual bonds. Great for corporate treasuries and agencies, hard for the individual “little guy”.
(Another reason why I like “asset allocation” over “buy bonds for income”…)
Other assets in this bucket are things like REITS – Real Estate Investment Trusts, that often have high dividends, and “Natural Resource Trusts”, like Oil and Gas trusts. You can also find particular companies with high dividends, and even funds that specialize in making a basket of high dividend companies and managing that basket for you.
IMHO, you still need to watch for the “asset allocation” pendulum, but the funds you use for vehicles ought to be the High Dividend bond and stock funds. Honorable mention also goes to “Prefered stocks” that often pay high dividends. They are a bit “odd” and really need an entire article of their own, but the short form is that they are a kind of stock that acts more like a bond and pays more dividends (gets a preferred claim on dividends over the common stock) but has no maturity date and is junior to the bond in bankruptcy.
Here is a chart of some of those “dividend stock funds” vs the general market and a couple of bond funds. The main ticker is an “oil and gas trust” presently paying about a 6.5% dividend.
SJT - San Juan Basin Trust SHY - Short term bond fund. Almost cash TLT - Long duration bond fund, varies more with interest rates PFF - Preferred Stock ETF IDV - International Dividend ETF DVY - Dividend ETF
First up, notice SHY. Darned near a flat line. That is the result if it having almost no “maturity risk”. It only holds short term paper, so it doesn’t wobble much, but also doesn’t pay much. If you are feeling a bit scared by market actions and thinking about cash, remember that SHY works when you are feeling shy too…
Next, notice how the various dividend rich stock funds plunge right along with all the general market? Dividends are no protection from market movements. In fact, SPY outperforms them in a recovery. WHY? Because in a business downturn, businesses will often cut the dividend. So it takes longer into the recovery for them to put it back. THEN they rise. Even that oil and gas trust is not being as aggressively bid back up even as oil rises to $100 again.
This is why I’m very “un fond” of the notion of “dividends as protection” or “high dividends” for a safety cushion.
If you want to play this game, you simply MUST watch the asset allocation pendulum and move to BONDS and out of “high dividend stocks” at the right moment.
The good news is that sometimes you can get back into “high dividends from stocks” at much more attractive payouts at the bottom of the crash cycle…
This was my very first “style”. I was pretty good at it. It took me years to ‘shake off’ the imprint of it and learn to be a trader. In many cases, the instincts are exactly backwards. Part of why I stress “pick a style” first. Later you can learn to swap between “classical” and “Jazz”…
THE standard here is Warren Buffet. What many folks don’t realize, though, is that he studied from the very first to define the field. Benjamin Graham literally “wrote the book” on “securities analysis”.
I own 3 copies of it. I like the older ones better. The later ‘re-write’ by Dodd after Ben died has all the same information, but the ‘voice’ is changed. Like listening to Kevin Costner do Shakespeare… All the words are there, as is the expression, but it’s just not right…
At any rate, the better book for “starting” is his later simplification for the layman:
To blend together a bit of Ben Graham and Warren Buffet:
The whole idea is to find companies that represent a secure durable value, that have a franchise of great worth, and buy them when they are being sold at incredible discounts. This is done by looking at the financials of the company in great depth, and buying when they reach “acceptable” bargain levels.
For me, it’s pretty clear that happens when the market is mid-crash (though some individual companies are always running out of cycle. Such as HPQ right now selling at ‘deep value’ compared to the past due to a CEO change. So folks are selling it at 1/4 off…)
The downside is that you never end up buying an Apple or Cisco in their early days as the financial numbers ALWAYS look like you are just never getting a “good bargain”. How can you have “one times book value” or 10:1 PE ratio when you have no earnings and “book” is nearly nil as you are an intellectual property company startup?
A web search even found a fund that focuses on the Ben Graham style. BVT. Though it is very “thin” only trading 600 shares on the Friday last. I’ve swapped it for SJT on the prior chart and shortened the time to 3 years (as the fund is only a couple of years old). It does a very good job of showing how the Ben Graham Value Investor beats the world coming out of a crash. (It doesn’t show the lag during persistent high growth high price eras like leading into the Tech Bubble).
So during the late ’80s, Ben Graham style ‘lost luster’, then the Tech Bubble popping reminded folks that it never quit working, but it’s a slow game, running for decades.
You can find a lot of funds in the “Large Cap value” style, that use variations on the Ben Graham approach. Just remember that they “fade” in long market bull run tops, and are at their most spectacular just after a crash. Again that need to look at the “asset allocation” pendulum…
Berkshire Hathaway BRKA / BRKB has made me a bucket of money over the years. At present, it is selling at something of a discount to its highs for two reasons. First off, Warren is old, very old, and stepping back a bit from day to day operations. Nevermind that “value investing” is established as a “transferable skill” and he learned it from Ben Graham. Folks are worried that when Warren goes, so does the company. Personally, he has enough “depth on the bench” already running a lot of the day to day operations that I don’t see that as an issue. That you can buy a “value investment bundle” that is itself selling a lower than usual prices is, to me, a ‘double dip’ of a very nice kind. The second reason for discounting is that he owns a fair chunk of financials. Wells Fargo bank, for example; and has a LOT of the “reinsurance” market. Folks worry that floods, earthquakes, etc. and “Sovereign Risk” from the Obama Administration will result in lower earnings this year. They are likely correct. But as every good value investor knows, that’s when you ‘buy at a discount’… A couple of years from now when they are raising insurance rates due to the actuarial tables showing it justified, well, that will be a bit too late…
VTV is a Vanguard fund in the same “value investing” area focused on large caps. IVE picks only from the S&P 500. EMVX looks at emerging market value stocks. And so many more.
You can find many more here:
THE big feature here is that they do all that bothersome financial analysis for you. The downside is it makes it that much harder to actually FIND an “overlooked” stock at a deep discount…
Here is a chart of a semi-random set of tickers from the above link. Not endorsing, just showing how to “run a race” to compare performance. Then I look into the specifics. Is it so thinly traded as to, perhaps, be closed soon? Is it from a company I never heard of? Do they say “value” in the name, but buy junk instead? (Look into the holdings…). So you still get some homework to do. But far less than “longhand the Ben Graham way”.
Notice also that some of the tickers only “start” part way into this graph. They start at the zero line, so if the older tickers are already “down” they are getting a ‘false benefit’ from their inception date when you get to the right hand edge…
Why 7 years? That was when THAT ticker first started…
VTV - Vanguard Total Value TLT - iShares 20 Year Treasury Bond fund BVT - That Ben Graham Total Market Value fund from above EMVX - Russel Emerging Markets Value fund IVE - iShares S&P 500 Value Index Fund IWN - iShares Russel 2000 Value fund
OK, a couple of things to notice here. It helps if you open the image to a larger one to see this. The “Value Funds” tend to roll off just a bit before the market in general tops out. This is because as folks get caught up in the “bubble”, they don’t want that staid old “value” stuff, they want “Gains and JUICE!!!”. At the same time, the hard core value guys are seeing the writing on the wall from the Bond market and heading for the exits. They know it will be cheaper Real Soon Now, even for things that look like a minor bargain now.
Then, notice how bonds continue to be the place to be, even compared to value funds, during the crash? Have I made the point that you simply MUST watch bonds for proper asset allocation?
OK, some general points on this particular ticker and indicators.
RSI continues to do a good job of saying “near 80” get ready to leave. Near 20, time to prep for buying. The ideal point being just at the second ‘blip’ as the peak pulls lower from 80 (or higher from 20) than the prior one.
MACD above zero is “be in” and below zero is “be out”; with some “lag time” after the peaks. So you watch RSI to decide if “this crossover to red on top” means “buy in more to a new run”, or “nothing much”, or “I hear a top, get out”. At “blue on top” and below zero is it: “Buy in buckets” via that RSI telling you the crash is ending? Or is it: “buy a bit more ‘on the dip’; or at the end is it “just stay out”. So use RSI to give the context to use for reading MACD. High RSI, read MACD more negatively. Very low RSI, read it with a very positive “spin”.
I note in passing that RSI is “near 80” in the early part of 2011 and the next peak is below that… And MACD is ‘red on top’… And bonds started rising a couple of months ago.
Finally, DMI / ADX is generally giving decent confirmations with “red on top” for be out and “blue on top” for be in. Just notice that the best time to BUY, is with “red on top” but with ADX inflecting to show a hard bottom is in. Then, while in mid 2007 DMI was still “blue on top”, the rest of the indicators and price action were saying “tired, time to exit”. DMI lags the market. Watch for the ADX inflection to say “ignore the red / blue color” and check out RSI and MACD then…
OK, during / just after a major market crash, Deep Value is your friend. Near a top, it can give a bit of an early warning. As “value investors” leave the field and move to bonds, don’t be the last guy at the punch bowl talking about that great killing you will make buying this tech start up with no earnings that has a great China Story…
For that, you want “mid bull market” times just before the market bubbles…
Lately, most of these have been “tech” stocks. But it wasn’t always so. In the 1800’s it was railroads. In the ’40s it was military and defense. Next? Who knows. Maybe biotech. Maybe China.
The key here is companies with very high growth prospects. The Lululemon as it first starts to market yoga. The Amazon as ‘online book selling’ is just taking off. It will look HORRID to the value investor. Price to Earings ratios of 50:1 (or even “nothing” in the earings side).
Here you simply MUST listen to the “story” (where in value investing the “story” is never of interest). And you must have an ear for sorting BS from gold. So KFC is opening stores in China right now at a rate to make your head spin. Is it a ‘reborn’ growth company? (It was one on the first expansion over the whole USA, and China is bigger.) A visit to asian neighborhoods in California shows them packed. (For some reason, Asians just LOVE KFC Chicken…) I’d say yes, it’s a reborn growth story. But a look into the financial and annual reports will show if they are actually opening stores and making a profit.
YUM is the ticker, and they also own Pizza Hut, Taco Bell, and a couple of others. Rising nicely right now. I’ll leave looking up the chart for you to do…
You must be good at spotting trends early, buying when they are ‘early hot’ and selling when they become stale. Cisco was a GREAT “growth story” in 1980. Now it’s a “so so” staid company that already has about as much market share as it can ever get and with competition all over the place. When you have most of the market, you just can’t double every year for 4 years.
So these tend to be smaller companies, in hotter new markets. Apple AAPL, has turned itself back into a “growth story” as it became a predator on the telephone and music markets with the iPod and iPad. Watch for that kind of thing. A player with a new disruptive technology picking off the old players. Amazon killing Borders books.
Yes, there are funds that do that work for you. Though then you end up trusting the fund manager to do that style well.
Yahoo has a nice chart showing the relative performance of some growth vs value funds in 2001 – 2002 years here:
But that’s old stuff, you say? Well, “old stuff matters”. Notice how “growth” just gets creamed in 2002. Down 32% for “large cap growth” vs only 18% for “large cap value”. In market downturns, “growth” gets devalued. Folks want safety… Watch out for that…
There is a lot you can learn from this chart. Clearly there is a great deal of separation that happens over a decade, even in stocks. This chart has “growth” and “value” funds plotted vs the S&P 500 benchmark. Let’s take a look at who were the winners and losers, even WITH a market crash in the middle. I’m listing the tickers from “worst to best” below. See any patterns?
IWF - Russel 1000 Growth Index IVW - S&P/Barra 500 Growth SP500 - S&P 500 Index Benchmark IWO - iShares Russel 2000 Growth IWD - iShares Russel 1000 Value IJT - iShares S&P/Barra Small Cap 600 Growth IWS - iShares Russel Midcap Value IJS - iShares S&P/Barra Small Cap 600 Value IWN - iShares Russel 2000 Value
I think you will find that “value” beats “growth” most of the time, and especially “small value companies” tend to get you some value along with growth. The “largest 500” and “largest 1000” even as “growth” companies are just too large to “grow” all that much. And even for “small growth”, if you are paying too much for it, it’s just not possible to catch the guy getting a great value in a small company with growth ahead of it.
You really want Growth but at a reasonable price…
Growth At A Reasonable Price – GARP
Yes, it is it’s very own “style”. Looking for growth, but not paying too much for it.
Many “name” investors used a GARP style. Peter Lynch, for example.
It’s a “known good” style.
This site has a pretty darned good write up of it, so I’ll just point there for the description in detail:
I need to find some tickers for funds that are GARP funds to make a comparison chart, but frankly, I don’t know any off hand and trying to find actual GARP funds takes a lot of time and work. Most every find uses the “value” and “growth” words even when not of that style, while a web search on “GARP” finds a lot of small 4 or 5 letter strange funds in exotic segments.
Perhaps after dinner… or if folks know some tickers they like, they could suggest some ;-)
The most basic metric here is “PEG ratio” Price to Earnings Growth ratio. You want PEG under 1.0 if possible, but never over 2. PEG can be found on most stock trading sites. Schwab has it as one of the standard financial metrics, for example.
Here, at Yahoo Finance, are the pages for CSCO Cisco and for LULU Lululemon.
Cicso is PEG of 0.69 while LULU is 1.67 PEG. On that metric alone, CISCO is “cheaper” than LULU for each unit of growth.
So that would lead a GARP investor to think that LULU has been hyped a lot lately, and be a bit hesitant. Yet it IS in the range, and IS growing well, so as a small holding, it would fit. If it hits a PEG of 2, the GARP investor would start heading for the exits.
What I do, after screening for a low PEG, decent book value, maybe a modest PE, is look at the charts. Any “red flags”?
And here, IMHO, you see the twin threats to watch out for in GARP investing. CSCO is the “fallen star”. It’s just Dead Money. Investment funds all over the world already own tons of it. Who is going to buy more? So not only has it underperformed the other GARP candidate, it can’t even get up with the S&P 500. Value funds are just roasting it alive. It’s “Growth at a reasonable price” getting a whole lot more “reasonable” every day. So watch the chart for an upturn, THEN, buy the GARP…
LULU was a Great Buy in 2009. Now? THAT far away from the averages? THAT far over market? With the market a bit tired? With RSI ‘near 80’ for a while? With MACD “red on top” and “mouth down”? With DMI headed for a crossover of “red on top” and ADX after an “inflection down”?
No, that’s just looking way too much like “FAD / Bubble” about to end.
Now, we want a chart that looks like LULU did about in June and July of 2009. Price just over the SMA stack, retouch from above. MACD “blue on top” and “mouth up”, headed for a crossover to “positive number”. DMI with a fresh blue on top and ADX just starting a ‘kink up’ to indicate increasing momentum to the trend. RSI freshly crossed over and with a ‘higher low’ as it get ready to rocket up. THEN I’d bet the PEG was much lower than 1.0 and with great growth still to come.
So at this point I’d add LULU to a “watch list” to buy on a big “dip”, perhaps as the PEG reached about 1 or so…
That’s how a real GARP investor works. Find the growth, but only buy it when it is really there, and really cheap… It takes a lot of patience to do that…
Then again, a REAL long term investor is making on the order of 1 buy every quarter or so? If you have 20 total positions, and you “churn” them once every 2 years, that’s 10 trades a YEAR? Hey, you can spend a month or two sifting through 200 “tickers” finding one that’s Just Right… then waiting for the moment…
But that is a LOT of work for not much action, and doesn’t meet my personal, emotional needs very well. So while I ‘sort of watch for GARP’ behaviours… I don’t do a lot of it. “Small and mid cap value” has a large overlap with GARP, and it’s much easier to find a ticker to “asset allocate” into when the time is right…
This article at Motley Fool gives a good intro to “how to do it” and points you at their ‘stock screen’ tool:
Personally, it just looks like a lot of work to me… And once I’ve done decent “asset allocation” and I’ve got a mix of SPY and “Value” funds, I’m already at about 95% of max performance ranking… Exactly how much more will a little GARP get me? But if your emotional structure leads you to love careful work, patient timing, and “looking a lot, acting rarely”, then the GARP style may suit you just fine. Many GARP screens exist. Some folks add in PE ratio, and a dividend being paid. Others add market cap (size) issues. Others like to look up the company “story”. What is the product? Is it really going to “take off”? Personally, I have no talent for picking new clothing styles nor knowing when Yoga is “the in thing”, so I just don’t look for that. But if you ARE good at it, finding a “Charming Shops” as it starts to grow or a “Hot Topic” early can be a stellar investment.
Do you need to master all of this (and then some)? No way. Just start with the basic “SPY vs TLT vs Cash” asset allocation and then work your way into the style that suits you best. It’s OK to use a fund or ETF for that style as you develop the “do it yourself” skill in that style (Or, if you like, not going the DIY route and just stay with the ETF). Frankly, after that, it’s 90% done and the rest is mostly just to give you something to do to keep entertained AND watching the charts for “the moment” to act.
Boredom can be a big deal, so having something to keep you ‘engaged’ can be very important. Don’t underestimate the impact of not checking for a couple of months and finding that the crash is 1/2 way done… and you are still “long growth stocks”…
So, as a final note, discipline is very important. Check things at least once per week. It doesn’t take long to look at one quick chart of SPY vs TLT vs FXF and have a decision of “Stocks, bonds, Dollar, or stick it in Switzerland and pour some Scotch while you get to work”.
Unlike the other charts in this article, this one is “live”. It shows FXF the Swiss Franc fund vs QQQQ the NASDAQ (heavy in Apple AAPL and tech in general) vs SPY the S&P 500, RUT the Russel 2000, and TLT that bond fund.
To me, right now, that Swiss Franc looks best of the bunch. Plenty of time for a ‘bit of think’ too:
So have a chart like that which you put on your screen once a week, and that’s all it takes to be well ahead of the pack as a “long term investment” manager. Everything after that is just gravy, IMHO. (But gravy can be good ;-)
What is it called when you by a dividend paying stock and you hold it for about a century? Buy and hold and hold and hold and hold…
(Not joking here. My grandfather bought AT&T & Marathon Oil back in the early 1900’s. His investing philosophy was to be a small part owner of a corporation and reap some of the profits. Pick a company that can be expected to be around long enough to pay back the initial investment in dividends and the rest is gravy for years to come. I’ll inherit some of that stock.)
Thank you very for this article. Much to think about here; may need to change my ways.
There is actualy a specific style of buying just that kind of company, with the addition that they ought to have a history of INCREASING dividends over time. It’s a subset of GARP and Income. The intersection of the two.
So some companies, like GE, have a long history of growth, with dividend growth. Personally, I’d likely call it “Dividend Growth Investing”.
Doing a “Bing!” search on that gives one web URL of that name:
and a Motley Fool group:
So I’d guess I’m not far off on the name to use ;-)
I looked into it once about a decade or two back and it looked decent; then I got the urge to learn how to be a trader ….
FWIW, the big thing to watch out for is buying for the “ultra long term” and getting a stock that augers in…
Read a story of a Rail Road Magnate who left his millions to his heirs. BUT, in the form of RR stocks with the requirement that they could not sell anything for something like 50 or 100 years. Problem was, he did not forsee the airplane nor the car. Most of his heirs got very little of worth by the time the RR era wound down to Amtrak…
So even for “durable franchises” as Warren Buffet likes to call them, you need to keep an eye on them. Coke? Yeah, it’s going to be around for a very long time. Studebaker? Wright Flyer? Digital Equipment Corporation? …. History is littered with such things.
The fact that the S&P 500 dumps it’s dogs when they shrink out of the top 500 instead of holding them to bankruptcy is a big part of why it is so hard to beat. Folks like to think that because that INDEX regularly makes money via “buy and hold” that the same applies to individual issues “if you diversify enough”. It doesn’t. Tossing before they drop too much is why it works… So ALWAYS watch for a fading star turning into a cold clinker…
You are most welcome. Yeah, a lot in it.
But what is NOT in it is even greater. The 20 feet of books read, and strategies from them tried and evaluated over the last 30 years. The endless hours spent listening to “Wise Heads” on financial TV shows only to realize that 90% of them were empty “Talking Heads”. The “stopped watches” who were right once a decade, but too brittle to change style with The Fed.
It’s the editing that matters more than the bit that was written… the thing that took all the time was learning what to leave out.
Re “Talking Heads”
I guess there has gotta be some kinda reason why they are still talking about it – instead of living the good-life at their dream destination.
Of course it would be possible that their goal was to be a “talking head”
@E.M. Thanks for the comments. AT&T spun something off at one time during the dotcom era. Dad didn’t understand the new business – how they were going to make money – so even though it was shooting up to the moon, he sold the spinoff stock and bought their retirement home with the proceeds (about $140k after taxes and my dad didn’t even hold the stocks long enough to be taxed at the capital gains rate – sheesh! what a dummy! except that spinoff tanked in the bust not long after he ditched the stock.)
I’ll follow that link to “Investing for the millenia” ;o) Thanks, again.
IIRC that “Spinoff” was Lucent. They made the “phone switches”. Basically, the computers that route the phone calls. At the time, they had the best and just about everyone used them. (Ericsson also made switches, common in Europe, as did Alcatel? and someone in Britain… Marconi? Then there was Nortel and Siemens.). Problem was, when dot-com companies stopped growing like crazy, so did phone switch growth. The massive move to cell phones also cut demand for land line equipment AND a gaggle of folks came out with much less costly alternatives. The loss of monopoly positioning put global pressure on Lucent as the European makers could expand here. They didn’t (couldn’t) cut costs enough to keep up.
After dropping to a stock price of pennies, they mergered with Alcatel, I think.. Yup:
I bought one of the last AT&T phone switches and then added some expansion to it that was Lucent brand at that time. Bought some of the stock, made a good gain, dumped when it rolled over. Then bought something like 5000 shares at 10 cents a share as a ‘mad money’ gamble. That, of course, turned to zero. (Part of learning things like “the product may be great, but not the stock” and “the company may survive, but not the stock” and “It does not matter what the STORY is, look at the damn chart”. Net, I made money on it, but gave back more than I ought to have given back.
Sounds like your Dad was a smart cookie ;-)
Lots to think about here.
Some of us don’t have the nerve to trade.
Maybe it could be called ‘fear of the Weimar Republic” syndrome. There is an awful lot to think about in your piece, and wisdom. I have enormous respect for someone known to put their money up to test their ideas, and communicate in real time…as opposed to after the fact cherry picking successes.
The tatics i’ve evolved to are companies with lots of cash that have good franchises and pay nice dividends — if one can live on the dividends, with a cash cushion for, say, a 24 month blip, that ought to solve all but the most extreme social collapse. My bet limit has been 4%, my 2 real clunkers recently were companies that basically lied about their numbers.
If this happens much more life will really be tough for us paranoid folks.
Folks often say “This time is different”. So far this always seems wrong which is what makes the patterns you’re tracking so interesting.
I do find it hard to figure out the degree to which you are a chartist, relying on the march of the numbers, and the degree to which you look at fundamentals, a la Graham. How do your straddle these two views in your mind, and which do you trust most?
You start with “paper trading”. Just pretending to do it with a workbook. THEN move up to “tiny trades”. Maybe a $500 “buy”. After that, it’s just “adding size”… And yeah, it takes a while to get to where you jump out of the airplane without that “pulse race” thing… (And yes, I’ve jumped out of airplanes… still have the pulse race… but after that, a stock trade is nothing … 8-}
For the “Dividends, earnings, and numbers” style, you want “Ben Graham Value Investing”. Order “The Intelligent Investor” and just remember that it is a transferable skill and at least a half dozen of The Greatest Ever investors credit him… including his student, Warren Buffet…
BTW, it’s often the case that experienced folks will say “This Time It’s DIFFERENT!” with a strongly over stressed irony… because it NEVER is different… I’ve got a nice posting up about a collapse of the housing market after some stupid government law changes and fiddling with taxes. Caused a “run” on a couple of the biggest name fiancial houses ever and a near complete banking collapse was on the cards. It was “fixed” by a massive government bailout with money from the central government.
Yes, you read that URL right. 33 A.D. as in Jesus era… Rome, and all that…
The window dressing gets more fancy, but it’s always “short money lent long” then a “need for surprise extra liquidity” and a “run on the banks” then collapse. Often after a government rule change (as we had from Franks, Clinton, et. al.)
Fix is the same too. Government provides lots of liquidity and backs out the stupid law / rule changes… goes back to sound lending practices and lets business get back to work. Sweep details under rug. Try to forget… Blame the other side. Blame the bankers.
But it’s never “different”…
Per charts and fundamentals:
I’m both. I started “fundamentals”. Now I know that the chart reflects a lot of other folks looking at the fundamentals for larger companies. So do I look at the annual report of GE? Nope. But if it’s a small “story stock”? You Bet. I’ll look at profit, PE, PEG, cash burn rate. That gives me a “acceptable” filter. THEN I use charts to “time the trade / buy”.
I’ll also use “races” to let me find interesting tickers to look at.
For most of my “trades” (as opposed to investments or toys) I like to use index tickers. That way there are no “fundamentals” to worry about. So SPY is THE best 500 companies in America. I need to read 500 annual reports why? … but my holding of Walmart, Macy’s or Penny’s vs “Bobs Cloths Mart” is based on relative growth rates and profits. Macy’s is NOT going away any time soon… but the other guy? He gets a good looking at before anything other than a day trade.
Why? Because way too many times I had the “fundamentals” right, and got “smoked” by bad timing. Charts fixed that “problem”…
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