Newsletter January 16, 2005
InvestorsFriend Inc. Newsletter January 16, 2005
There are many theories about how to beat the market or how to achieve high returns without high risk. There are also theories that suggest that investment success is basically random and that high returns necessarily involve high risks.
My view is that classic value oriented investing offers the best chance of higher returns without excessive risk. Value investors seek essentially to purchase something that is intrinsically worth $1.00 for substantially less than $1.00. This absolutely does not exclude “growth” companies, but it does exclude over-priced growth companies.
I believe that I can assume that most readers of this newsletter are to some extent do-it-yourself investors. While you may rely on various newsletters, stock picking services, and all the opinions you hear or read about, at the end of the day most of you are investing your money and relying on your own analysis of all the advise you see. In that case, I believe you will be most successful by continuing to learn and re-learn the basics of value oriented investing. Many of the Articles on this Site are useful in understanding basic investment math and fundamentals.
Yesterday I did some screening for Canadian stocks that are good values. I screened for a Price Earnings ratio of less than 12, a return on equity of at least 12%, a debt level that is lower than the equity level and a price not in excess of 3 times book value. The screening program returned 30 Canadian stocks. Interestingly, two out of my four current Strong Buys (available by paid subscription) were included and two of my Buys were also listed.
Now, some of these 30 stocks are truly bargain priced. However, in some cases they are showing up because of a one-time spike in earnings due to some unusual event and may not be bargain stocks. I reviewed five year summary data of these stocks to determine which of these really were bargain priced, based on consistent high earnings compared to price.
What I found encouraging was that there appear to be at about 8 companies here (in addition to the four that I already own) that are probably true compelling bargains. Examples include companies with a price earnings ratio of less than 7 combined with a return on equity of 20%. I intend to look more closely at these companies. Now some of these have tended to trade at such “low multiples” for a number of years and maybe they are not about to jump in price anytime soon. But, the low multiple reduces down-side risk and the simple retention of earnings at an ROE of 20% will inevitably lead to an attractive return if the ROE continues to be achieved, even if the multiple stays low. And, if the multiple improves that would be additional upside.
In summary, this stock screening indicates that there are still bargains in the market, even after two straight years of strong market growth.
The final performance figures for 2004 were very good at 25% for the Strong Buys and almost 27% for the model portfolio. The Strong Buys have averaged over 28% per year for the past five years. The graphs provided illustrate the tremendous consistency with which the Buys and Strong Buys have increased, on average, and the Sells have decreased, on average. Current stock picks are available by paid subscription for just $10 per month, with no obligation to continue past 1 month. Performance tracking for the Strong Buys selected January, 2005 will commence by the end of January.
Previous editions of this newsletter, from 2004, are available at http://www.investorsfriend.com/newletters.htm
Should Corporations Donate to charity?
In the wake of the Tsunami disaster and the associated corporate donations, investors need to think about whether or not the companies that they own shares in should be giving to any kind of charity and relief effort.
To cut to the chase, my own view is that they don’t have to but I am in favor of a certain amount of it, as long as it is done properly.
Many people favor a socialist agenda and would argue that corporations have a responsibility to give back to their community, their country and even the world and that they absolutely should give and if they don’t they should be pressured to do so by consumer boycotts and other means.
I don’t agree with that view for corporation or for individuals. Charitable giving is done by choice and no one, and no corporation, should be pressured to give, if they don’t want to. They can be asked, but they should not be pressured, if they refuse. If charity is to be mandatory then let’s include it in a sales tax so that all corporations pay it. Of course, if some consumers want to boycott a given corporation for not giving, that is their right. But I don’t think it is the right of anyone to say that any other person or corporation should give to charity.
Another group that generally favors corporate giving is the majority of Canadians who give to charity on a personal basis. If I give to charity then it means I support the cause and I would want other people and other corporations to also give reasonable amounts. Investors who give to charity on a personal basis, including myself, would probably want the corporations that they invest in, and certainly those that they do not invest in, to give reasonable amounts. This is different than passing judgement that corporations should give, this is simply saying you want them to.
There is also the argument that for most corporations, it is good business to give reasonably to charity because that is what the customers and the general public would want.
Overall, I think that most investors would want the corporations that they invest in to give reasonable amounts to charity and disaster relief because it might be good for business and because these investors mostly give on a personable basis and corporate giving ensures that all shareholder are (indirectly) giving and this makes the charity more efficient from the point of view of a personal donor.
Investors would want corporations to give in the proper way. This starts with management always recognizing that when they give to charity they are giving away the shareholder’s money. Management runs the company and holds its funds in stewardship for the shareholders. A proper way to give to charity would be to give a reasonable amount of corporate money and to fairly quietly press release it.
The wrong way to give shareholder’s money to charity is to do it in a very loud way seeking publicity for management rather than the corporation. If management gives money in a loud self-serving way, then this is a tip off that this management views corporate money as really belonging to management. If investors see that happening, they would probably be wise to sell their shares and run.
A very interesting point was raised by the National Post who pointed out that it was in effect, the so-called greedy capitalist system of the Western World, that allowed these counties and millions of well-off citizens to donate to the poor Asian countries. It must gall the socialist crowd to realize that it is mostly (possibly only) the free-enterprise oriented countries that were able to afford to give meaningful amounts.
In conclusion, I am glad to see many of the companies that I own shares in donate to the Tsunami relief. But I don’t think they had any particular obligation to do so. I think it was the right thing to do but it was completely discretionary. And, I’m thankful for our capitalist (mostly) non-socialist system that allowed us the luxury to help out.
Investment Advisors and the Conflict of Interest
Throughout 2004, investment advisors were frequently vilified in the financial press. They were accused of such things as: not disclosing their total profits and commissions, putting clients in higher-cost house-brand mutual funds, in the case of brokers – churning accounts to make commissions, and generally of being in a conflict of interest position and failing to always put their clients interest ahead of their own.
Well, I am about to come to their defense. And please remember, I am not an Investment Advisor and never have been, so I am defending complete strangers here.
I don’t know why Investment Advisors were singled out for putting their own interests ahead of that of their clients. Do people really think that that anyone that they deal with is truly going to make his or her own interests secondary to that of their clients. It’s really quite a conceited view to think so. Is the car salesman selling you a car for your good or for the sake of his commission cheque? Is the restaurant owner in business for your sake or for his own? Do you work for your employer’s good or your own good? The plain fact is that in a capitalist system we are all primarily interested in looking out for number “1”. Sure we care about our customers and most of us want to do a great job and provide good value. But it is really unrealistic to expect any vendor or service provider to truly put the customer’s interest ahead of his own. Such thinking is socialist drivel. As capitalists we might pretend sometimes to truly put the customer first, but it’s just not how things really work. Vendors will do things that are good for you, but they also have their own self-interest firmly in mind. And that’s actually a very good thing.
In his famous 1776 book, Adam Smith agued, in effect, that the greatest societal good and abundance is achieved (as an unplanned by product) by a capitalist free enterprise system when each person seeks to maximize his own self interest.
Consider an Investment Advisor facing the following choices of investments to recommend for clients.
|Investment||Advisor’s Annual Commission||Total Cost to Client||Client’s Return|
|External Mutual Fund||1%||2%||?|
|In-house mutual Fund||1.5%||2.5%||?|
According to many recent articles in the Financial Press, it should be a crime for the Investment Advisor to recommend the higher-cost in-house mutual fund. But when you consider that the Investment Advisor’s commission goes up 50% with the in-house fund and it only costs the client 0.5% more, it is unrealistic to suggest that the Investment Advisor should put the client’s interest first and recommend the external fund. Even if there is a rule that the Advisor must put the client’s interest first, then there will be an awful lot of incentive for the Advisor to simply convince himself that the in-house fund is superior and will likely earn a higher return and leave the client better off.
In my view, expecting an Advisor to recommend the far lower-profit product is unrealistic and an immature and conceited view that basically goes against human nature and the essence of capitalism.
I believe that the client should have a legal right to expect the advisor not to wantonly and recklessly disregard the client’s interest. But it’s really ludicrous to suggest that this should go so far as to expect the Advisor to make his own interest completely secondary to that of the client. Such an expectation would be indicative of a client and a public that expects “the system” to protect them. A more mature attitude would be to realize that in the end all clients need to be mature and look out for their own interests.
If you trust your money to an Investment Advisor, then I think it absolutely makes sense to seek out someone who is fundamentally honest and fair-minded but I don’t think you can expect an advisor to totally ignore his or her own interests in favor of yours.
The same thinking applies to life in general. The world economy does not exist to look after you or me. In fact the broader world really does not care about, or even know about, any particular individual at all, (with rare exceptions). As individuals, we are better off accepting this and making sure that we work to look after ourselves, rather than relying on wishful notions of what we think others should be doing to look after our interests.