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InvestorsFriend Inc. Newsletter April 4, 2008

Stock Picking Performance

Our Average Buy (or higher) rated Stock from the start of 2009 is down 0.5% this year to date. My own portfolio which was more concentrated in the stock picks I liked best is up 7% this year to date. For comparison, The S&P 500 index remains down 7% year-to-date, despite the rally in March and the TSX index is up 1% in 2009 so far.

Count Your Blessings

Through all the bad economic news, most people are doing well and have many blessings to count.

Unfortunately, a smaller but still significant portion of the population is doing quite poorly. Various people are stuck in difficult circumstances be it due to poor health, lack of education, low incomes, excessive debt, responsibilities of being a single parent and many other situations. It matters little how these situations came about. What is important is that some of these people will be able to work their way into better situations. Sadly though for many there is probably no way out of the bleak situation. A future that amounts to not much more than subsistence living may be all but inevitable.

Perhaps those lamenting a financial set back in the markets can give a thought to the less fortunate.

Most North Americans are living in luxury compared to how their grandparents or certainly great grandparents lived. Most live in un-crowded homes. Suburbia is carpeted with 2000 square foot multi-bathroom homes. Many with gleaming hardwood floors and and lovely kitchens.

These houses are warm and well lit. The closets are fairly groaning with cloths. The house is typically fully furnished featuring more than one television and a decent cable package to go with the televisions. There is at least one computer with high speed internet. In the driveway is typically two reliable automobiles. The fridge and freezer are reasonably well stocked. Automatic washers and dryers are in the basement.

Nearby are mega grocery stores, Wal-Mart, Home Depot, Staples, Chapters, Shoppers Drug mart, Costco, and more all of a size that 50 years ago existed only in a few big-city down-town department stores. In the parking lots shoppers are leaving with loads of merchandise wondering if they even have room in their houses for these latest purchases. Not everyone has the money to load up at these stores, but look at how busy the stores are, a lot of people certainly are living very well.

Most although not all of us would have to admit that we are living very well indeed. Let's be thankful for that.

Stock Market - Rational Thoughts About Returns

A reasonable goal in the stock market might be to earn about 8% per year and say 5% per year in real purchasing power, after inflation. At that rate it is possible to accumulate, over a working career, quite a comfortable sum of money to fund a retirement.

But investors have increasingly not been satisfied to work with a slow and (reasonably) steady approach. They are told in fact that buy and hold is dead. Rather than look for a reasonably safe 8 or 10% return, investors are drawn to more dramatic possibilities. Everyone would love to earn 1000% on some penny stock. Or 300% in gold. Marketers hype unrealistic promises. But in large part this is because so many people respond to unrealistic promises.

Wiser investors know that lottery tickets will almost certainly not lead to wealth. And neither will investing in over-hyped lottery-ticket-type stocks. Slower and steadier approaches will work reasonably well over a long period of time.

Even for the slow approach to investing, there will be large set-backs along the way. But logically we all know that corporate North America makes money most years. It should therefore be reasonably obvious that if you own your share of corporate North America you will profit over the long term.

Stock Market - How Investors Bought High and Sold Low

At the end of 1999, the total compounded return (capital gains plus dividends) on the S&P 500 index over the 18 year period since the start of 1982 was an astounding 18.5% per year. How joyful! At that rate money doubles in just over four years, quadruples in about eight years, is nearly 8 times the original investment in 12 years and an astounding 30 times the original investment in 20 years!!!. Just $10,000 invested in the S&P 500 index at the start of 1982, and left to compound in a tax-free retirement account was $300,000 at the end of 1999. Or consider that $50,000 would have  grown to $1.5 million in that time. Sweet!!

The Problem is, very few people were investing in Stocks at the start of 1982. Stocks had provided dismal returns since the mid 60's. Inflation had decimated returns on both stocks and bonds. Stocks had crashed brutally in '73 and '74 and double digit inflation was busily destroying wealth. Stock investing had been very popular in the 60's as people flocked to invest in anything with "electronic" or even "tronic" in its name and up to the early 70's they flocked to invest in the "nifty fifty" group of stocks. These investments had given very disappointing results by 1982. Also 1982 was the time of monster interest rates. There was a brutal recession underway. In the summer of 1979, Business Weak had published an article about the "death of equities" and pointed to higher returns available in gold, real estate, futures and diamonds. Even bonds with their high interest rates were relatively unpopular due to the losses suffered by those who invested in long-term bonds in the 60's and early 70's as inflation rampaged.

So, very few people were investing in stocks in 1981. Many investors were selling stocks which helped drive their prices down. But we now know that the start of 1982 was a low-point in the markets. It was a fabulous time to invest and get rich. As Buffett says, be greedy when others are fearful. Investors were Selling Low and failing to Buy Low. The then-little-known Warren Buffett was buying stocks heavily at that time.

Now, skip ahead to 1999. Everyone was is getting rich in stocks. Returns are fabulous. Internet companies with no earnings and in some cases little or no sales are trading for billions of dollars. The general population is piling into stocks. Real estate is passé. Pension funds are piling in to stocks and projecting that they will make 10 or 12% returns from stocks, which arguably was was conservative compared to their recent 18% average annual gains.

But in 1999 there were warnings signs which some saw. Stocks had returned a compounded 18.5% annual since the start of 1982. But meanwhile the economy, as measured by U.S. GDP, had only grown at a compounded 6.2% per year. Was it logical that stocks could grow at say 16% (18.5% less say 2.5% for dividends that were part of the 18.5%) in an economy that was growing at just 6.2% per year? Mathematically that meant the stock market would one day grow bigger than the economy, an impossibility. Warren Buffett spoke of the unrealistic return expectations in August 1999 and wrote of it with Carol Loomis in Fortune Magazine November 22, 1999 indicating that stocks should be expected to return more like 7% going forward and not anything close to 18%. Buffett was dismissed by many as yesterday's man who had missed the tech stock boom (it was then not yet known as the tech bubble, much less the tech crash).

We now know that stocks had reached an unsustainable peak by the end of 1999. As of today, the S&P 500 index is down 44% since the end of 1999 and its total return over that nine years and three months has been negative 32% (before any fees) even including dividends. We now know that the masses of investors including almost all pension funds and institutional investors were (unknowingly)  trampling all over each other to Buy High in 1999. Buffett of course was not buying much and was instead amassing a huge war chest of cash.

And what of now? We have suffered brutal losses in stocks in 2008, as the S&P 500 tumbled 38% and the Canadian TSX index similarly slid 35%. 2009 then started off with with additional brutal losses of about 20% before staging a dramatic partial  recovery in the past few weeks. But the S&P 500 is still down about 44% in the past 15 months. And the TSX index is down about 34% in the past 15 months. Almost everyone is expecting the current recession to get worse. Unemployment is rising, house prices are falling. Fear is pervasive. There is talk of the virtual end of capitalism. The end of globalization. Some fear a depression.

So, with some exceptions, investors are fearful of buying stocks at this time. Will it later be proven that investors managed once again to Sell Low rather than Buying Low? Only time will tell. We do know that Warren Buffett has said that an investment in the S&P 500 index at this time (and more particularly) last Fall is likely to work out well in the long term though as always he made no predictions about the short term.

Getting Help in Selecting Stocks to Invest In

If you are a stock investor or want to invest in stocks, you probably have or would like to have some help. That help could come from reading financial newspapers, watching the financial shows on television, purchasing a stock investment newsletter or from many other sources.

As President and owner of InvestorsFriend Inc., I am in the business of selling an online service that provides Buy/Sell ratings on selected stocks.

Here are my thoughts on what you might want to look for if considering paying for information regarding which stocks to buy.

Track Record - You would want to see a strong track record of beating the market index, or of making positive annual returns. It has been proven that it is actually very difficult to beat the market index over time. Certainly, on average,  no more than half of all advisors will beat the index in any particular year. A far fewer percentage will beat the index with any consistency. Beating the index consistently does not mean each and every year, rather beating the index say 75% of the time should be considered to be a reasonably consistent performance. Some will argue that many of those who do consistently beat the index will have done so through luck rather than skill. Still, it would seem silly to follow advice from someone who has done poorly against the index.

Believability - An incredible track record is not enough. Anyone can claim to have a great track record. But is it believable? Do you get a sense of trust when reviewing a posted track record? If only winning stocks and almost no losers are shown, is that believable? Does the track record give the return based on its "subsequent high" even though there may have been no advice to sell on that day. It makes absolutely no sense to invest based on claims that just don't seem believable.

Rational Approach - Does the Stock Picker use a rational approach? Whether based on fundamental analysis or trend analysis, is the approach rational? There are those who believe that stocks will rise in years in which the Eastern team wins the super bowl. Whatever the rationale and approach is, does it seem logical to you?

Replicable Approach - If the approach requires buying and selling incredibly rapidly, could you even possibly replicate that approach? Does it make sense that you would be able to match the trades that are advised? Are the stocks too thinly traded to allow for trades at the advised buy or sell price?

Compatible Style - Are you comfortable selling out stocks that drop? Some people are fundamentally uncomfortable with that approach. Others swear by such an approach to limit losses. Are you a day trader or a buy and hold investor by temperament? Someone who likes to move a bit more slowly and only after some thought and analysis and reflection will simply find a day-trader's approach to be incompatible.

Our track record has to date consistently beaten the index and we think that our our honesty is readily apparent and that our approach is highly rational and is compatible with the styles and temperaments of most (but not all) investors.

But, we don't want just anyone as a paid customer to our Stock Picks service.

As a provider of Stock Picks, we also prefer certain characteristics in our customers.

We don't use a day-trader approach and we don't want day traders for customers. Our focus on fundaments like profits and price to book ratio is simply foreign to most day traders. There is no point to us having someone as a customer who invests strictly based on charts and does not wish to look at profits and such.

We hope to appeal to more emotionally mature investors. Some investors will not be happy unless they win on almost every trade. Some investors will not understand that individual stocks are subject to unpredictable events that can cause losses. Or that the stock markets overall are highly unpredictable and that it is probably impossible to predict market crashes. We only want customers who while valuing our analysis ultimately understand that they are responsible for their own trading decisions and that there can be no guarantees in the market. (And I am happy to report that at least 99% of our customers have that emotional maturity. They have understood that the losses suffered in 2008 are part of the "heat" of being involved in the stock market. They have understood that while we have an excellent long-term track record, loses in some years are part of the landscape of investing)

We offer our service to do-yourself-investors. We don't touch anyone's money or make trades for people. Our customers have to have self-directed stock trading accounts or be willing to open one. We can help you decide which stocks to buy but we can't buy them for you.

Our paid service is only of value to stock investors. Those who invest strictly in mutual funds will not find our service to be suitable.

If our Stock Picks service is of interest to you, learn more about it by clicking here.

Understanding the Canadian Economy

Click the link for our short article that shows you graphically which sectors contribute to the GDP of Canada and which countries are our most important trading partners.

What is the Fair Value of the Dow Jones Industrial Average?

Are stocks at bargain prices  or  are they overvalued? We just today updated our popular analysis analysis of the valuation of the Dow Jones Industrial Average. Check it out by clicking.

END

Shawn Allen, President

InvestorsFriend Inc.

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