The Poor Investor

Investigatory Value Investing

Category Archives: Investing Lessons

Turn Your Portfolio Inside-Out

Often people tell you exactly what stocks they’re buying—what stocks you should buy—but, you don’t often hear others tell you what stocks not to buy.  Charlie Munger often quotes Carl Gustav Jacob Jacobi by saying, “Invert, always invert.”  This quote merely states that the solution to a problem might be in its opposite.  So how can this apply to stocks?

There are many ways in which this is applicable.  One of the most important things to consider is the fact that nowadays you have nearly unlimited opportunities in the market.  Anything you want to invest in nowadays, you probably can—from Swiss gold to soybeans.  Furthermore, you can buy and sell whenever you please, especially with today’s low transaction fees.

Well, what about the opposite?  What if you didn’t have nearly unlimited opportunities?

Warren Buffett often talks about the idea of having a “punch card” with only 20 punches on it.  He posits that if investors had only 20 investment decisions they could make in their lifetime and each time they made an investment they had to “punch” their card, would they make the same decisions?  If you were forced to invest in this way, would you buy the stocks you are buying now?

Well, let’s think about the opposite.  With only 20 punches, what types of investments would you not want to invest in?  Well, to first think about what not to invest in, you need to first think about what you would want to invest in.

To keep it simple, I would want to invest in companies that have all of the following qualities:

  • Strong, durable competitive advantage(s)
  • Large profit margin to sustain difficult times
  • Long operating history showing interest for shareholders
  • Business model not subject to changes in technology
  • Reasonably valued

So, what companies do not have the above qualities?

Car companies are a good case-in-point for the first two aspects.  For one, no car company, besides Tesla, really has any unique quality.  Car companies may have recognizable brands but no one company really offers anything truly different from any of the others.  I’m actually surprised GM is a Buffett investment.  As far as the auto industry goes, Tesla is the only company that stands out as being “different” from the crowd and has any real durable competitive advantage outside of brand recognition.  Thus, I’d stay away from all automobile investments excluding Tesla.  I certainly wouldn’t use one of my card punches here.

The second point, having a large profit margin, is another problem for car companies.  Some of the large auto companies’ net margins for 2014 are as follows: Ford- 2.21%, Honda- 4.85%, Toyota- 7.10%, GM- 1.8%, Fiat- 1.04%.  Apart from Toyota, none of these companies had a large net margin.  And over the last 4 years Toyota also struggled.  Toyota’s net margin was 1.11% in 2010, 2.15% in 2011, 1.53% in 2012, and 4.36% in 2013.  Clearly, there’s not much room there to make mistakes as a car company.  The profit margins are just too slim.  I’m not going to punch my card for slim margins, are you?

Car companies do have long operating histories though.  Here, they get a pass.  But what investments exist today that do not have long histories?  Generally, these are found in the technology sphere.  There’s Box, Inc. founded in 2006, LinkedIn launched in 2003, Facebook in 2004, Twitter in 2006, Groupon in 2008, Zynga in 2007, King Digital Entertainment (markers of Candy Crush) in 2003 and Yelp in 2004.  While these companies may seem like they’ve “been around a while,” generally we want to look for companies that have been around for decades with a stable operating history.  Companies with stable operating histories give you an idea of how they treat shareholders.  For example, you want to ask questions like: Have they raised dividends consistently?  Were they efficiently allocating capital?  Were they honest with shareholders?  Did they buy back shares?  This is not to say the above companies won’t do those things, but there’s just not a long enough timeline to answer these questions adequately.  Ask yourself again, are you willing to bet your punches on it?

To put this in perspective, let’s look at some lesser-known companies: Hawkins was founded in 1938, Cincinnati Financial in 1968, Stepan Company in 1932, United Guardian in 1942, C.R. Bard Inc. in 1907, Nucor in 1940 (with origins dating back to 1900).  These are the types of timeframes I’m referring to when I think of a long operating history.  The history shows not only what management has accomplished, but also that the company has a solid business model that will sustain it over the years.  Also, many of these companies have both been giving and raising dividends regularly for over 25 years.  It’s usually the names you never heard at first that turn out to be your truly great investments.

In contrast are the technology companies mentioned above (the names you know), there’s a good chance these companies won’t be around very long.  There is good reason for this and it brings us to the next point: business model not subject to changes in technology.  Almost all technology companies will have trouble withstanding the test of time due to the fact that technology is always changing.  Warren Buffett often says his favorite holding period is forever.  Do you think you could hold the technology companies mentioned above forever?  Think about the 20 punches on your card.  Do you want to use a few of these punches on technology companies?  That’s for you to decide but “no thanks” over here.

Even whole industries can be vulnerable.  A problem likely to occur with car companies is that they won’t withstand the test of time.  New competitors are moving in (like Tesla) to revolutionize the car market.  Even Apple is thinking about entering the market.  The last 50 years won’t be like the next 50 years in the automobile industry.  Always be on the lookout for underlying paradigm shifts like these.

Next brings us to the point of reasonable valuations.  It is easy to readily point out some of the technology companies mentioned above.  LinkedIn trades at 15 times sales, 10 times book value, 132 times EBITDA, and its earnings are negative.  Can it grow its earnings fast enough to sustain these levels?  Perhaps, but I’m not going to waste one of my 20 punches on it.  Nor will I waste my punches on Twitter selling at 21 times sales with no earnings, Facebook at 18 times sales and 73 times earnings, Box at 12 times sales and 16 times book, and Yelp at 100 times earnings, 9 times sales and 130 times EBITDA.  I’m not saying these companies won’t do well—they may do fabulously— I’m just not going to bet my punches on it.

Think about your current investments.  Did you waste one of your 20 punches?  Would you bet one of your punches on a whole industry?  Do you own a company in one of those industries that you wouldn’t use a punch on?  It’s always good to turn things upside-down and look at them in completely the opposite way.  For instance, do you have a case for shorting any of the stocks in your portfolio?  If so, what’s the potential downside?  And what if you could never sell any of the stocks you purchased, would you have bought any of them?  Reevaluate your decisions.  Think critically.  And invert, always invert.

Disclosure: Long UG

Bottom Digging During Market Tops

The S&P 500 has nearly tripled from a 2009 low of 735 to 2113 currently.  Just as a rising tide lifts all ships, so too does a rising stock market lift all stocks.  At greedy times like these, investors should be fearful and reexamine their portfolios.

…if [investors] insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.  -Warren Buffett

Now, I’m not saying the market has reached its peak (though some do make compelling arguments).  I am not a market timer and I’ve written about the folly of forecasting in the past; I’m merely saying a prudent investor should not let greed get the better of him.  The following strategy is one that is more likely to be applicable during market highs as investors are more likely to have a preponderance of stocks trading at prices much higher than their actual values (aka, the rising tide theory mentioned above).

So what to do?  Well, I believe the prudent investor should lock in gains on stocks pushing well beyond their valuations (close to 52-week or all-time highs) and replace them with stocks trading at reasonable valuations.  Mr. Market is offering attractive prices for your stocks, let him have them.

But then we’re left with the problem of finding alternative investments.  As markets keep pushing higher and higher, investors are often left scratching their heads wondering where to find value.  Admittedly, this can be challenging, however, opportunities do still exist.

One place to look as stocks reach all-time highs are stocks reaching new 52-week lows.  Some noteworthy examples include PriceSmart, SodaStream, Turtle Beach Corp., and Fossil.  PriceSmart is the Sam’s Club of Central America and the Caribbean.  It’s trading at a small discount to its sales, has high insider ownership, and has consistently grown sales, 15% on average, over the past ten years.  At its current price of $17.07 after-market, SodaStream trades at a large discount to sales (72% of sales) and is nearly trading at its book value of $16.59.  Turtle Beach has near-total domination in the gaming headphone market with 50% of both the UK and US markets.  It trades at 60% of sales (which it looks to nearly double sales this year) and is led by smart management with a solid near-term plan, and patents, to enter industries such as health, automotive, TV and mobile.   I’ve already written my take on Fossil, you can read it here.

The next place to look is at overlooked stocks (often smaller capitalization, less than $100m) in industries where there is a low supply of investment opportunities.  One such industry is the coffee industry.

Now, before going into individual companies, let me preface this discussion by first noting some interesting dynamics at place in this market.  For one, coffee consumption is not nearly what it used to be.  In fact, in 1946 consumers drank 46.4 gallons of coffee per person (Figure 1).  Today, even with a coffee shop on every corner, consumers drink less than half as much at only 20-25 gallons of coffee per year as coffee was replaced predominantly by soda.  As consumers become more health-conscious, pop consumption should decrease and coffee, as a viable, healthy alternative, should have an increased level of consumption.  Secondly, there is a shift taking place where high-quality shade-grown coffee (high cost to grow) is being overtaken by the rise of poorer quality shade-free coffee (cheaper to grow).  This makes coffee plants much more susceptible to climate change and topsoil erosion.  As climate change concerns begin to grow, the downfall we’ve seen in coffee prices from $300 in 2011 to a current 52-week low of $140 is not likely to last.

Figure 1

Figure 1

Now, opportunities in this market surely exist in the form of large companies.  There is, of course, Green Mountain Coffee Roasters and Starbucks, but investors in those companies will soon bail when they see these companies for what they are—overvalued.  Starbucks trades at an all-time high ($94.30) and the highest price-to-sales ratio it has ever seen in the last ten years of 4.12.  Starbucks also trades inversely to coffee prices.  Green Mountain Coffee Roasters ($124.10) shares trade even higher at a price-to-sales of 4.31 and, like Starbucks, it is also inversely correlated to coffee prices.  As coffee prices rise investors will bail on these two companies (and valuations will come back down to earth).

So when investors bail, where will they look?  On the conservative end is Coffee Holding Co., trading at 28% of its total sales.  This company is well-managed by its owners, experienced coffee industry veterans, who have a 10% stake in the company’s shares.  They also support and believe in sustainable practices.  These beliefs lead to production of higher quality coffee (shade grown) that is not as susceptible to soil erosion and climate change.  Furthermore, as experienced coffee experts, they are well-hedged against fluctuating prices.  On the risky end is Jammin Java, better known by its Marley Coffee, which is trying to force itself to turn things around before it does a complete nose-dive.  If company-estimated year-end sales are to be believed, the company trades at a 10% discount to expected year-end sales.  However, this company is only for high-risk-oriented individuals who don’t mind getting cleaned out if things turn south.

Then, there’s the oil industry.  I don’t think I need to go into this a whole lot as many have already witnessed the price collapse at the pumps, so suffice it to say that there are many opportunities to be had in this sector, both large cap and small, and everything in between.  (Check out Cale Smith’s recent notes about the oil price phenomenon).  I’m pretty sure you could throw 10 darts at oil stocks right now and make at least 8 solid investments.

Another interesting idea is James O’Shaughnessy’s strategy of looking for stocks that he calls Reasonable Runaways.  These are stocks that have a high relative strength, greater than $150m in market cap and trade at a price-to-sales ratio less than 1.  I’ve modified this strategy a little bit by including companies that have large amounts of cash in excess of debt.  Some notable examples include FreightCar America Inc., BeBe Stores, Men’s Wearhouse, LSI Industries and FujiFilm Holdings.  While I have not had time to look into each of these companies it doesn’t matter— the theory of the Reasonable Runaways strategy is one of investor agnosticism.  The theory says that you are buying $1 worth of sales for less than a dollar (low P/S) just as investors are realizing the company is undervalued (high relative strength).  You simply run the screen, buy agnostically, and diversify your portfolio by giving equal weight to the top 20 or so companies with the highest price appreciations.  Sell after a year then repeat the process.  Since 1951 this strategy had a compound annual growth rate of over 18%.

While the S&P 500 may have reached its top, your portfolio doesn’t have to top-out.  You can simply shift your current best performers to companies that offer greater opportunity and more attractive valuations.  Employing several different search techniques, such as those mentioned above, can get you on the right track to optimizing your portfolio towards value and thus reducing your overall risk by increasing your margin of safety.  But don’t forget to hold on to a fair amount of just in case cash for when the market does plummet.  You’ll want to have that cash in your back pocket to snatch up undervalued companies when the falling tide lowers all the ships again and more opportunities abound.

Disclosure: Long Coffee Holding Company (JVA) and Fossil (FOSL)

Forecasting for Dummies

I recently attended the New Orleans Investment Conference and although I do not invest in mining companies and I’m not a “gold bug,” or a gold investor at all for that matter, I did take away a lot of useful information.

Though, perhaps the most useful piece of information was this:

Never forecast.

Now, admittedly, this was something I always knew, but the conference did help to solidify this thought some more in my mind. Watching people make big assertions about the price of gold going up, predicting stock valuations and movements in commodities only to see them be dead wrong two years later just made people look foolish. The people who made these forecasts and the people who followed them. All foolish. Imagine the hard-earned capital that was probably lost as well.

I worked at an investing research company for a short while and watched a seasoned analyst, who had been working there since the company’s inception, miss one of the most important calls in his industry.  One of the dozen or so companies he was following was bought out and he missed it completely.  It totally side-swiped him.  He even went as far as to say the company would never be bought out when another analyst brought up the prospect of the company being sold.  Talk about egg on the face.

Still not convinced? Well, think about this, do you even know what’s going to happen to you tomorrow? You know your life, your schedule, how many hours are in a day, etc. and I’ll bet you can’t accurately predict most of what happens to you tomorrow. You don’t know what your boss is going to say to you. You don’t know if you’ll get in a car wreck on the way to work. You don’t know if you’ll even wake up tomorrow. Test yourself. Try to predict a dozen or so things and see how many work out as planned.

So, if you can’t predict what’s going to happen to you, the person, or thing, you probably know the most about, how can you accurately predict what millions of investors are going to do? The bottom line is that you can’t. The best we can do as investors is look at the trees and forget about the forest. Will the market crash this week? I don’t know. Will it be down next year? No clue. However, I do have confidence that solid, well-managed companies trading for less than they are worth will most likely be trading at values higher than they are now. That’s the best we can do as investors. We take bets on stocks where the odds are in our favor and don’t when they’re not. And then we spread these bets out so we don’t bet the farm on one company because if there’s anything about this “not being able to forecast” thing it’s the whole “not being able to forecast” part.  You don’t know if “company X” will go to zero tomorrow. If “X” does go to zero, you want to have companies A, B, C, D, etc. to fall back on. Maybe it’s 20 companies, maybe it’s 100. That’s for you to decide. The point is to build your portfolio structure so that it won’t fall over if one brick crumbles. Keep the odds in your favor.

Examples of the “odds being in our favor” are things like companies trading at a discount to book value, or even cash value. Maybe it’s a company like BDCA Venture, Inc. trading below its NAV of $6.89 per share at $5.00 per share. Or maybe it’s a company like Electronic Systems Technology, Inc. trading at or near cash. Maybe it’s a management team that lowers the risk; management that’s honest about the direction of their company and can back up what they say with an excellent track record. People like Apple’s Tim Cook or Tibco Software’s Vivek Ranadivé. Perhaps it’s a catalyst on the horizon like a patent approval or a drug approval. Whatever it is, you put the odds in your favor in some way. If there’s nothing putting the odds in your favor, you’re no longer investing. You’re speculating; you’re gambling; you’re forecasting.

Never forecast.

Who You Know or What You Know?

I’ve recently finished my MBA and am now searching for employment opportunities. In this search I’m reminded, quite starkly, of the oft-quoted phrase, “It’s not what you know, it’s who you know.” The great thing about the stock market is that it works in exactly the opposite way. In the stock market, it’s not who you know that matters but what you know. The market, as Ken Fisher puts it, is “The Great Humiliator” and does not care who you are or who you know, “it wants to humiliate everyone.” In fact, who you know often works against you and may even entice investors towards illegal activities, as exemplified recently by a few well-known individuals.

The “what you know” I’m referring to here is your own analysis of individual companies and the markets in general. In fact, if you would have listened to common wisdom (the “who”) you might have sold in May, went away and missed out on a 2.1% gain in the S&P 500. You might have missed the boat on Apple at around $427 a share when everyone was claiming the sky was falling only to watch it rise to $633 a share, a lost opportunity of $206 per share. Once, when I was new to investing, I told a friend not to invest in Sirius XM when it was trading around $0.30 per share and he missed out on a potential 10-bagger. Or, you might have listened to friends who told you to buy Facebook when it first went public at $38 per share only to watch it drop to $18 in the first three months.

Nothing works better in investing than coming up with your own conclusions. For one, you won’t have the conviction in the company you are buying if you go based off of someone else’s recommendation. Even if someone is spot on about a company’s valuation and tells you that company X will go from $5 a share to $15 a share—even if this person is absolutely right and has a compelling enough reason— are you going to be able to hold the company’s stock when it goes from $5 a share to $1 a share before it goes up to $15 a share? Will you really have that level of discipline and, more importantly, trust in someone else’s judgment? Only by doing your own analysis, coming up with your own valuation and buying a company that you have strong conviction in because you put in the hard work will you be able to hold through the downs (or buy more) and not sell too early during the ups. This person’s recommendation may be 100% accurate but you might be enticed to sell at $7 for a $2 gain because you just won’t have the commitment you would have had if you came up with the idea in the first place.

Secondly, if your investment is in a company someone else recommends, you probably won’t have any idea of what to look for when things are going south. Are insiders selling? Did a member of management leave? Is this good or bad? How do you know if you didn’t investigate the company thoroughly? Now, say, the company has to raise funds by issuing stock— is this good? Was this part of the company’s plan all along? If you weren’t following the company, if you didn’t do your homework, you wouldn’t have any idea on these questions or any others. There won’t be any tip-offs to tell you when things are going well or if the management is running the company into the ground when you don’t put in the long hours of work it takes to investigate a company thoroughly enough to have conviction in it.

These are just a few of the reasons why you need to think for yourself when it comes to investing. This is why I don’t like recommending companies, it takes away from a core part of what will make someone a successful investor. I like to use companies as examples to illustrate ideas and how to think about companies, not as advice for what to buy. And with that, I will leave you with a quote from the Oracle of Omaha himself:

“You have to think for yourself. It always amazes me how high-IQ people mindlessly imitate. I never get good ideas talking to other people.”  -Warren Buffett

Investing: Life Lessons

From the last issue of The Marathon Perspective, written by Jim Kennedy of Marathon Capital Management.

LESSONS FOR LIFE:

1. At the heart of every investment is a value proposition. Sometimes it’s disguised as a good balance sheet, other times as a prospective stream of future earnings or cash flow, and other times as the seed of an idea by a competent management team. Regardless of the proposition, with some conviction you need to identify both the future investment return and the anticipated time frame for that return. The key words here are “conviction, return and time frame.” Strive to have all three before you enter into an investment. None of us will be right 100% of the time, but having these three partners at your side will increase your odds of success.

2. Stay away from “story” stocks and water cooler tips. As investors, we are bombarded by ideas 24/7: the Internet, friends, talking heads on network shows, publications, etc. Use the simple rules noted above (conviction, return, time frame) and you will be able to cut through the clutter and avoid the less than honorable promotions. Just remember that every “story” or idea can be made to sound terrific by the right promoter. Take the time to look behind the curtain and do a little homework. Walk away from things that don’t smell right. A simple perusal of SEC filings and other research materials can save you lots of heartache and money.

3. Learn from your mistakes. To paraphrase Einstein: the definition of insanity is to do the same thing over and over and expect a different outcome. We all make investment mistakes. The sad truth is that we don’t always learn from them. As painful as it sometimes is, revisit your bad investment decisions and try to figure out why they went south. Not only will this exercise reveal weakness in your investment process, but it will make you a better investor in the long run. No one gets it right every time, but by understanding your mistakes, you increase the odds of success going forward.

4. Sell your losers. Remember our premise from above: conviction, return, time frame? If one or more of these change and the equation becomes unacceptable based on your risk tolerance and investment goals, sell. Too many investors hang on to losing positions even as the red flags mount. Strike the phrase “I’ll sell when I get back to break-even” from your vocabulary. Your only thought should be “opportunity cost.” Think about it this way. Suppose you put $10,000 into XYZ stock and it went south on you. At the end of the year it was worth $5,000, but your conviction in the name has been cut in half because management did not deliver on its promise. At the same time, you research ABC stock and are enamored with its prospects. You wish you had funds to put into ABC, but you’re “stuck” in XYZ for now. The wise investor sells XYZ (remember that loss of conviction?) and redeploys that capital into ABC. The foolish investor will not admit a mistake and will “hope” that things turn out okay with XYZ. Fast forward 18 months: the foolish investor feels pretty good because XYZ is up 20% from its nadir, while the wise investor has made twice as much on ABC and is ready to redeploy capital again. Compound this type of behavior over a multi-decade investment time frame and the “opportunity cost” to the foolish investor is enormous.

As a side note: try to differentiate between a “mistake” and “steak on sale.” We are big proponents of averaging down on an investment, but only if your conviction is high and it satisfies your other investment criteria.

5. Check your emotions at the door. Woven throughout these discussions is an undercurrent of emotional investing. As difficult as it can be, you should approach every investment opportunity and decision rationally. Think about the past two years: when were you the most nervous about your investments? We’ll bet it was right near the bottom of the markets.

As Warren Buffett says: be greedy when others are fearful, and be fearful when others are greedy. Our phone rings off the hook when the markets are going through a rough patch. But history has shown time and time again, the best time to invest is when everyone else is scared. Were you taking money off the table in late 1999 and early 2000? Probably not, as most investors believed that trees do grow to the sky. Hindsight is always 20/20, but so is rational, fundamental investing.

6. Do your homework. One of the ways to remain rational while those around you are running for the hills is to understand what you own. If a stock is nothing more than a symbol and quote in the newspaper, then you will be subject to the foibles of investing. On the other hand, if you believe that by owning stock you actually own part of a business, you will become somewhat immune to the short-term fluctuations in share price. The foolish investor flits from idea to idea without doing any serious homework, while the wise investor digs into a story and either develops a reasonable level of conviction or moves on to the next idea. Most investors do more homework and research buying a new refrigerator than putting $10,000 to work in the stock market. There’s something wrong with that equation.

7. Read and think. If we had a nickel for every time someone asked “where do you get your ideas?,” we’d be long retired. Ideas come from every direction, but if you aren’t ready to assess them and make rational decisions, you may as well throw your money out the window. This is where reading and thinking enter the equation. The more you read, the more knowledge you will acquire on a wide variety of topics. This base foundation of knowledge is the bedrock of the investment process. It doesn’t mean you become an expert in any particular area, it just means that you are that less likely to make a mistake. Thinking is just as important. Many of us read, but how many of us think about what we’re reading? One of our favorite sayings is “research is to see what everyone else has seen, and to think what no one else has thought.” Turn off the Internet, T.V. and iPod and think for one hour a day. You’ll be amazed at what you find.

8. Management, management, management. We have an advantage over the average investor, in that management teams are more willing to meet with institutional money managers than with individual investors. It doesn’t mean they won’t talk to you on the phone or meet with you on occasion, but it’s a rare individual investor that has the time and perseverance to undertake such activities. With that said, there are ways for individuals to get to “know” management. Read the SEC filings that detail management’s background and pedigree; look at the top executives that a CEO has chosen to run the organization; listen to quarterly conference calls, particularly the unscripted Q & A session at the end of prepared remarks; ask friends, relatives and acquaintances if they know anyone in the industry; look at the board of directors – is it independent with the background and experience necessary to guide the organization? At the end of the day, a bad management team can run a good company into the ground. If you can not develop a reasonable level of confidence in management, move on to your next idea.

9. To concentrate or diversify. This one is a function of your willingness to embrace the investment process, being mindful of your risk tolerance and time frame. Think about your life – how many jobs, spouses, pets, houses, kids, cars, etc. do you have? Most of us are willing to concentrate our “investment” in just about everything else in life, except when it comes to the stock market. This is not an endorsement
of concentration in the stock market – that would be too risky for the vast majority of investors. But for those willing to do a lot of homework, concentration can be very rewarding. The average investor might own 5 – 10 mutual funds investing in a variety of equity classes (e.g., large companies, small companies, international, etc.). This is a prudent way to spread equity risk, but at the end of the day, you end up
owning hundreds and sometimes thousands of individual stocks within these funds. Most people become closet indexers without ever realizing it. Contrast that with owning 10 – 20 individual equities that you know well. Sure it takes a lot of work, and you will lose money on a number of your choices (remember, we all make mistakes), but if you’ve done your homework and develop conviction through your reading and research, we think this can be a very rewarding investment approach.

10. Don’t lose money. This one comes back to the Warren Buffett school of investing: Rule #1 is don’t lose money; Rule #2 is don’t forget Rule #1. This one is much easier said than done, and yet, even Warren Buffett has lost money on some of his investments. But the key message here is that permanent loss of capital is very difficult to come back from.

Here’s a very simple concept that is foreign to most investors. When you first look at an idea, focus on how you can lose money, not on how much you can make. We are all enamored with how much we can make in any given investment, but how many times has your judgment been clouded by the “upside.” It is human nature to dismiss the red flags when you are excited by the tremendous potential of something. Our recommendation is to catch your breath, step back from the “story”, and look at the situation rationally. It’s okay to take a flyer on something that has lots of upside, but you can’t build a portfolio around too many ideas that result in goose eggs. So weigh the risk vs. reward carefully before investing a dime, and make sure that you stay within your investment discipline and risk tolerance.

11. Last but not least, wait for your pitch. You can not be an expert at all facets of investing, but you can become very good at certain approaches and styles. Don’t be afraid to say this one’s “too hard” to figure out and assess; there’s another pitch coming your way soon. Wait for the one that’s in your sweet spot and swing away.

We’ll leave you with a final cautionary note on the proliferation of Exchange Traded Funds (ETF’s). For the uninitiated, ETF’s are similar to mutual funds in that they allow an investor to put money to work in a particular sector or focused approach. As opposed to open-ended mutual funds that set their Net Asset Value (NAV) and allow buys/sells at the closing price each day, ETF’s trade continuously throughout the day.
These “trading vehicles” have taken Wall Street by storm and have attracted billions in assets. Call it a hunch, a cool breeze at the end of summer, or maybe just the ramblings of an old buy-and-hold investor unwilling to pass the torch, but there’s something going on here that just doesn’t feel right. That doesn’t mean that all ETF’s are questionable, but we highly recommend that you understand the structure of what you are investing in, asking such common sense questions as: does the ETF hold the underlying assets (e.g., stocks, bonds, gold, commodities, etc.); does it use leverage; is it a financial derivative of some other financial investment; what guarantees sit behind the “fund”; do you as an investor “own” the underlying asset in the event of liquidation; who “manages” the fund and where does it reside?

The bottom line after the last couple of years in volatile markets: fool me once, shame on you; fool me twice, shame on me. If someone can not explain something to you in plain English, and you have trouble understanding what you are investing in, walk away.

Notes from The Poor Investor:

The Marathon Perspective is another casualty among what is quickly becoming a dying breed: quality newsletters and writings pertaining to investing (among other topics).  In Jim Kennedy’s own words, “Eventually, the strong will survive and the choices will narrow, but for now the online universe is a thousand miles wide but only an inch deep.”  In other words, it’s becoming increasingly hard to “separate the wheat from the chaff” when the internet offers so much more “chaff.”  For most of us the lessons of investing will be hard-learned, especially when many of us foolishly emulate advice from books and websites which offer little value and insight.  My hope is that this website will provide investors with an abundance of “wheat.” 

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