Newsletter September 11, 2004

InvestorsFriend Inc. Newsletter September 11, 2004

Special Offer

For the first time I am offering a no risk, no-questions-asked, money-back guarantee on the subscription access to my buy/sell stock ratings. If you are not satisfied with the research you purchase, notify me within 3 weeks of subscribing, that you wish to cancel, and I will refund the $10, which is the cost to subscribe for one month. (Of course there is no guarantee on the stock performance, you always invest at your risk). Click to take advantage of this offer now.

I realize that not all readers of this free newsletter are in a position to subscribe to the stock picks. However, if you do invest in stocks and have been thinking of subscribing, now may be a very good time to do so. The Fall and Winter is usually a good time to be in the market. While there are no guarantees, I do feel particularly confident about my stock picks right now.

PERFORMANCE

Most of the last 5 years since I started this Web Site have been pretty tough times in the market. The TSX and DOW went wildly up at first and then wildly down and with lots of gyrations ever since. Overall the TSX is today at almost exactly the same level it was almost five years ago. So… I’m pleased that my own all-equity portfolio is up a compounded average of 12.9% per year since January 1, 2000 or a cumulative 76%. And, had I invested strictly and equally in my Strong Buys at the start of each year and then rebalanced to my new Strong Buys at each subsequent new year, I would have achieved the average of my Strong Buys which was 28.6% per year for a cumulative gain of 222%.

Individual stocks that I have done very well on, include the following.

Cognos (software) up 159% since I first rated it a Strong Buy in June 1999

Stantec (engineering fees) up 341% since I first rated it a Strong Buy in September 1999

Canadian Medical Laboratories up 225% since I first rated it a Strong Buy in July 2001

Contrans (trucking) up 300% since I first rated it a Buy in October 2001

Pason Systems (oil field data recorders) up 254% since I first rated it a Buy in August 2001

Most of these, I no longer hold, but I did very well on them. I expect also to do very well on my current Strong Buys, available to Subscribers. Also in recent years I have been keeping a higher proportion of my portfolio in the Strong Buys and Buys. Logically, I also keep some that are only Weak Buys since that is essentially a hold rating.

Barriers to Succeeding in Life

When it comes to success many of us are our own worse enemy. I have noticed how quick most of us are to play the “devil’s advocate”. If someone tells us about a highly successful person or company we almost instinctively begin to think of reasons why that person or company is not really all that good or smart. Rather we seem to prefer to think that they were merely lucky and that their luck is probably about to run out. Instead of trying to learn from these people we are more likely to ignore them or try to deny that they are really that smart or good in the first place.

Most of us are not all that “coachable”. We are stubborn and prefer to go our own ways. We read self-improvement books and then ignore most of the advice. We fail to study the techniques of the most successful people in our field. If we do study it we fail to copy it. Basically, the offer is open to be given a hand up or even to stand on the shoulders of the greatest people in any field we are interested in and yet we (mostly) instinctively refuse the offer!

I believe that the reasons for failing to learn from the most successful people in our fields is rooted in our evolutionary history. Basically, we (especially males) are afraid to admit any possible superiority of another person because we would then be seen as a less attractive mating partner. We need to overcome our instincts and admit that the leaders in our fields are indeed smarter or are at least using better techniques and we need to go ahead and copy from the best in order to constantly improve ourselves.

Whatever your field is, do not hesitate to seek out and copy the advice of the best in your field. The surest road to success is to follow in the footsteps of the leaders in your field.

In investing, most people don’t copy from the best. In fact the whole notion of the efficient market tells us that beating the market is always a matter of taking on more risk or of getting lucky. If the efficient market hypothesis is true, then investing must be one of the few human activities that does not benefit from intelligence, skill or technique. Rich and highly successful investors like Warren Buffett think that the efficient market theory is basically nonsense.

In many human activities like sports, it is abundantly clear who the elite players are. In investing it is a lot less clear, there is a lot of “noise” in the data. There is a lot of garbage advice out there, a lot of people trying to talk investors into following very poor techniques. However, with a bit of study investors can identify some of the winners in the investment business and can follow their techniques and or advice.

In my case, I have accumulated a massive amount of education and knowledge regarding business and finance. When I think about it, most of my knowledge came from reading (actually more like studying) the words of successful business and finance practitioners. While I like to think for myself, I have also carefully studied and copied the advice of many of the most successful investors in the World including, Warren Buffett, Benjamin Graham, Philip Fisher, Peter Lynch and others.

As a core technique I have gravitated to Warren Buffett’s advice of investing in great companies (proven winners with competitive advantages and high profits) when they are available at exceptional or at least at good prices.┬áThis technique has proven to be a consistent winner. I believe I can bring value to Canadian investors by applying this method in a highly educated manner to Canadian stocks.

Trader’s Corner (Tips regarding trading strategies)

Buying shares in small quantities:

Investors are sometimes advised that it is not feasible to buy small quantities of shares of less than a Board lot. Such small quantities are called “odd lots”.

Except for Penny shares, a Board lot is usually 100 shares. This means that a Board lot of a $10.00 share costs $1000 while a Board lot of a $100 share costs $10,000. Many investors cannot afford to commit $10,000 in a single purchase and therefore they may believe that buying shares priced at $100 or more is not feasible.

My experience has been that it is quite feasible to buy less than a Board lot. For example to buy 23 shares of a $100 stock for $2300.

Admittedly, there are some disadvantageous to buying less than a Board lot. A offer price for an odd lot has lesser priority in trading. A Board lot offer for the same price that is placed later would have priority.

An odd lot order placed “at the market” could be filled at a price somewhat higher than the market at which Board lots are trading. However, in my experience this is happens only rarely. It would be much more likely to happen in thinly traded stocks, and in that case market orders should be avoided in any case.

In my experience, an investor needs to be concerned about spending at least a minimum dollar amount on a stock purchase. Since a discount trader usually involves about a $30.00 commission to buy up to 1000 shares, it usually makes sense to buy at least $2,000 worth although that still results in a one-way commission of a hefty 1.5%. Ideally one would buy more like 1000 shares at $100 which results in a commission of 0.03%. But few people can put $100,000 into a single share purchase.

I normally try to buy a minimum of about $4000 per trade. Therefore my normal minimum number of shares is set as $4000/stock price. For stocks under about $20 I would normally round that off as so many Board lots. For example I would usually buy 200 at $22 rather than 182 at $22. However, I have often bought lots of 150. Recently I bought 20 shares of a company that was trading at $180. This was at a cost of $3600. I was not in a position to consider buying a Board lot for $18,000, but that did not stop me from investing in the company.

In summary there are a lot of considerations to think about in deciding how many shares to buy. This includes the available funds, a desire to minimize commissions, and the risk or potential for the stock price to fall which might cause you to minimize the investment or to be prepared to average down if you were confident in the stock. The trading liquidity of the stock might also affect the decision. However, it is not the case that you always need to be prepared to buy in Board lots.

Analyst’s Corner

Based on many years of analyzing stocks and having had my share of success but also having experienced some notables failures, I offer the following observations on how to pick stocks.

  1. Be patient; investing is about getting wealthy slowly but steadily. Expecting instant results leads to a gambling mentality which usually leads to large losses.
  2. Investing should rely mostly on making money from a corporation’s customers through increased earnings per share. Trying instead to make money by selling to “greater fools” is a gambling mentality.
  3. The oldest and simplest rules are the most powerful. Stocks with low price to earnings ratios and low price to book value ratios tend to be the best most reliable investments. For most of your portfolio, “fish where the fish are”, by focusing on these cheaper stocks.
  4. Be extremely skeptical of companies that ask you to ignore their poor net earnings and look instead at adjusted earnings, ex-item earnings, pro-forma earnings, or EBITDA etc. In some cases the company’s plea has some validity but in many cases the lower net earnings are more representative of reality.
  5. Be aware of earnings quality. Earnings that are not realized in cash but instead are represented by capitalized selling costs or questionable assets can turn out to be phantom earnings that are later reversed by write-offs.
  6. Remember, Winners Win and Losers Lose, that is, on average a company with a long track record of good earnings is going to continue on that track and the company with several years of losses is on average going to keep losing money, despite promises of a turnaround.
  7. Avoid companies that have any material potential of going bankrupt. A company with debt and with little or no cashflow could go bankrupt before it brings its product to market or before the situation turns around. A company with a strong balance sheet (a lower percentage debt) can usually weather a period of low or negative earnings, particularly if operating cashflow remains positive. When a company goes bankrupt you will usually lose 100% of your investment and it takes about 7 other equal sized investments making 15% just to make up for that one loser.
  8. Focus on companies that you understand something about. Most people can hope to understand companies that sell familiar products to consumers. In contrast most investors have no hope of understanding the likes of Nortel that sells mysterious equipment and services to large communication companies. (On the other hand if you are that rare person who really understands Nortel, then you may have an advantage in buying or selling short its stock).
  9. Focus on companies that appear to have some kind of competitive edge. This will be demonstrated by a high return on equity. Often they will be leaders in their industry. They have economies of scale, captive customers or proprietary technology that make it very difficult for competitors.
  10. In summary seek high quality companies with long track records of above average returns on equity in understandable businesses, with no accounting concerns and that are available at exceptional or at least reasonable multiples of book value and of earnings.

Please Pass on the Word

If you have made it this far, then you probably see the value in this Newsletter and Investment Site. If so, please pass on the word to your associates. Referrals from respected associates are one of the strongest forms of endorsement for any product or service. They will likely appreciate it and so will I.

END

Shawn Allen
President
InvestorsFriend Inc.