The Poor Investor

Investigatory Value Investing

Tag Archives: stocks

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)

Investing in the Stock Market: What Beginners Should Know

There seems to be a contradiction in what the “experts” tell us about investing in the stock market.  I’ve heard investment professionals who have said the process is simple and that individuals just make it too complicated.  On the other end of the spectrum, I’ve heard that investing is extremely difficult and only those that put in extraordinary amounts of time and effort will be able to be successful.  I’ve also heard the in-between argument, that it’s not too difficult but you still have to “do your homework.”  My belief is that they’re all right.  However, investing really is only as complicated as you want to make it.

The concept of investing itself is very simple.  Investing is foregoing money now to obtain more money in the future; more, meaning, after taxes and inflation are considered.  When it comes to stocks, an investor is buying a slice, or fractional ownership, of something, usually a business.  One can either buy a slice of a company, a sector, or a slice of a market index.  For instance, you can invest in General Electric (a company), an exchange-traded fund that tracks clean energy (a sector), or an S&P 500 index fund that gives you the exact return of the S&P 500 (a market index).  Each of these provide various levels of challenges and time commitments; hence, why investing is only as complicated as you want to make it.  Moving from an individual company to a market index is, generally, going from the most to the least complicated.  (There are other variations of these forms of investing, such as investing in mutual funds, that will be covered in a separate post).

Let’s start with the least complicated: the market index.  There are many market indices to choose from, the NASDAQ, S&P 500, Dow Jones Industrial Average, Willshire 5000, to name just a few.  If you’re going to go this route you should at least study the basics of market index investing, such as fee structure and how to buy into an index fund, be familiar with the makeup of each of these indices, and know the benefits of dollar-cost averaging and tax-deferred accounts (such as a Roth IRA).  Then just decide which market you’d like to buy into.  This is all the leg work you have to do on your own.  Then, after learning about index funds and what they’re all about, you can basically take a “set it and forget it mentality.  This is why investing in index funds is called passive investing.  Set up a tax-deferred account for automatic disbursement into an index fund with a small percentage of each paycheck and every year or so you can check on it just to make sure your money’s still there.  By the time you’re ready to retire you should have a pretty nice nest egg. For example, the S&P 500 has returned around 9.4% annually, from 1965-2010, with dividends reinvested.  $100 invested in a Roth IRA in the S&P 500 at the start of 1965 without any annual contributions would have grown to nearly $5700 at this rate.  If you started with the same $100 and contributed $100 each year, it would have grown to nearly $71,000 (fees are usually nearly negligible for index funds).  In my opinion, index investing is the best way for the majority of people to invest because all the complexity is taken out of the process.

Next, let’s look at ETFs, or exchange-traded funds.  These are baskets of securities that track the ups and downs of various markets or sectors.  The ETF market has grown over the years and gives an individual investor nearly every opportunity to invest in whatever market he or she wants.  There are index fund ETFs for nearly every market index.  For instance, the ETF with ticker symbol SPY tracks the S&P 500.  If you want to invest in gold, there’s a gold ETF, symbol GLD.  Sick of rising gas prices?  Invest in an oil ETF, symbol OIL.  Or, how about a double oil ETF that goes up or down at twice the rate of oil?  There’s that too, symbol UCO.  However, be careful to look at the fee structures of these as many can be costly.  ETFs are considered more complicated than index funds because, for one, they trade the way stocks do.  Also, there are many more options.  If you want to invest in an agriculture ETF, for instance, you really need to know the ins-and-outs of the agriculture market.  Mix that agriculture ETF with a gold ETF and now you have to track and learn about both markets.  Plus, you can’t just have a set-it and forget-it mentality with all ETFs, it really depends on which ones you buy.  Some you need to track daily, others, hardly ever.  Some are extremely volatile.  Personally, I am wary of ETFs and do not invest in them myself for various reasons.

(See this interesting article about ETFs: http://www.springreef.com/springreef-insights/exchange-traded-funds-etfs-proceed-with-caution/)

Depending on how one looks at stocks, investing in an individual company can be the most complicated, yet the most rewarding.  Buying a stock is just buying a slice, or part ownership, of a company.  Sounds simple, right?  Someone can even make the process extremely simple by saying, “I shop at Walmart and really like the store so I’m going to buy the stock.”  This can, and does, work out for people… sometimes.  But is this really a prudent way to invest?  Do you really want to risk your hard-earned money taking this approach?  My belief is that in order to invest prudently in a company you should know the basics of accounting, business fundamentals, and have studied the stock market well.  You should also know yourself really well to be a disciplined person who does not let emotions get to them and can view the world objectively.  If you do not meet that criteria, at the very minimum, I do not believe you should invest in individual companies.  There are way too many pitfalls to investing in individual companies where permanent loss of capital can be the end result.  Also, if you’re going to invest in individual companies, your goal is to beat out index investing at the very least, a pretty tall order (remember the S&P 500’s 9.4% annual return?).  So, if you can passively invest at around a 9.4% return annually, you really need to be extremely dedicated to learning about individual companies if you’re going to go at it alone.  However, for those who wish to put in the time and effort, investing in individual companies can be the most rewarding, as the greatest investor, Warren Buffett, can surely attest to.  If you had invested $1,000 in 1965 in the stock of Berkshire Hathaway, Warren Buffet’s company, you would have nearly $4 million today.

The main goal of this blog is to explore the last part of the investing process presented, investing in stocks, with the ultimate goal of empowering the individual investor.  Over many posts, I’ll explore the strategies and philosophies of the greatest investors, analyze individual companies, present market history and data, show tools which can be used to guide the investment process, discuss my own strategies, explore business fundamentals, psychology, and other topics related to investing.  

——Written by: The Poor Investor

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