Newsletter November 20, 2005

InvestorsFriend Inc. Newsletter November 20, 2005


The performance of the “generic “buy/sell ratings available on this Site has been tremendous. These ratings are “generic” in the sense that they do not consider the circumstances of any particular investor. Therefore investors need to consider their own circumstances before deciding if any of the stock picks are a good fit for their particular circumstances.

While the overall market has been weak recently, our stock picks have, on average, reached new highs for the year. My own personal overall portfolio return has been over 27% this year. (And was 20% last year and 40% the year before that)

Those of you who are not already subscribers to our stock rating / stock research service can click here to see the details of how to subscribe at a cost of just $10 per month. (And there is no obligation to continue to subscribe for any more than 1 month.)

Remember, if your investment returns have been too low, that is unlikely to change unless you take some action to start investing differently. If you think that this stock picking service sounds good, why ignore the opportunity?

Right now it is a particularly good time to subscribe as we have recently updated may of the stock picks for the Q3 earnings reports. In addition, the market seems particularly uncertain at this time due to the threat of higher long-term interest rates.

Should You Invest in Stocks?

Have you ever felt a little (or a lot) jealous of the wealth and success of the owners of successful businesses that you deal with? For example the owners of car dealerships, home builders, and the many successful franchise operations like Tim Hortons, MacDonalds, Dairy Queen and many more.

Maybe you have toyed with the idea of getting into these types of businesses. But for many people that is just not possible.

Investing in stocks should be considered to be a form of investing in business. Stocks should not be thought of as being something like collectibles that simply go up or down in price at the whim of investor demand. Rather, stocks should be thought of as being a part ownership of a business. In fact the late great Benjamin Graham has said “Investing is most intelligent, when it is most business-like”. This sentiment has been strongly seconded by the world’s most successful investor, Warren Buffett.

Investing in a business-like manner consists of investing in stocks based on the expected profits per share of the underlying company rather than simply based on an expectation that the stock will rise based on demand for the shares. Business-like investing recognizes that the ultimate price of a stock will be determined by the success of the business in achieving profitable sales and not (in the long term) by how much investor demand there is for a stock.

Can You Beat the Market?

The good news is that in any given year we should expect half of investors to beat the market before considering their costs of trading and management fees etc. And we should expect a very substantial portion of investors (perhaps over 40%) to beat the market even after considering all costs.

The bad news is that the “average” investor will trail the market by the amount of fees they pay.

In other good news, you do not have to be an “average” investor.

It may be that a certain group of investors and advisors will consistently beat the market more often than not, while other groups will consistently trail the market more often than not.

Warren Buffett is generally acknowledged as one of the most successful and skilled investors of all time. He has argued that investors using certain fundamental approaches that attempt to discern the “true” value of companies and to buy them when they are trading in the market at less (ideally substantially less) than this “true” value will and have beaten the market consistently. He talks about “buying dollar bills for 50 cents”.

On the other hand many academics teach that only by chance can you consistently beat the market.

I choose to believe the multi-billionaire.

In addition I have personally beaten the market substantially for six straight years and the stocks we have rated as Strong Buy have done so to an even greater extent for the six years since we started rating stocks.

In the past six years, the Canadian market index is up 27% while my own return has been 146% and InvestorsFriend Inc.’s  Strong Buy rated stocks have returned 337%.

In conclusion, I believe that yes, you can beat the market. And I believe that your best chance to do this by following a fundamental value type of approach such as the one offered by InvestorsFriend Inc.

Income Trusts

In late 2004, I took a look at the P/E ratios of Income Trusts as well as the ratio of their cash distributions to their GAAP earnings. At that time I concluded that they looked over-valued, on average. I have now updated this Income Trust analysis. The valuation looks better now but there are still some reasons for caution.

TSX Industry Segment Analysis

One way to view the market is by looking at individual industry segments such as Financials or Mining. I have added a new article to the Site that looks at the segment P/Es and dividend yields as of November 20, 2005.

Stock Promotion

You have no doubt seen spam type emails recommending you rush to buy some particular stock or other. Most often these are penny stocks and there is a strong prediction that the stock will soon soar in price.

My response to these is always to delete them on sight. Many of these are probably “pump-and-dump” ploys. In this scam a penny stock is heavily promoted to thousands of investors. This creates a buying interest in the stock which drives up the price. The promoters of the scam can then sell (dump) their shares at the higher price and move on to try the same scam on another stock. In this scenario it is not hard to drive the price of a penny stock up temporarily. After all any piece of garbage can rise into the sky if you blow on it hard enough. But stop blowing (pumping or promoting) and it can be expected to fall back to earth.

In my view good investment ideas have to be searched out (or paid for from a reputable source that has searched it out). Good investment ideas are very unlikely to arrive in the form of spam type emails.

There may be cases where a stock is being legitimately promoted by an investor relations type firm. But even there, I prefer to keep away from promotions.

Behavioral Finance

It is accepted in finance theory that investors are risk adverse. Presented with an equal chance of losing or gaining say $1000, most investors will choose not to take that gamble. Purely rational investors will make the bet only if there is a greater chance of winning than of losing.

Behavioral finance describes this by saying that the pain or discomfort of losing say $1000 is greater than the amount of joy or satisfaction that comes from gaining the same $1000

Behavioral finance also notes that investors will take on bets where they actually expect to lose such as buying a lottery ticket or purchasing insurance. They do this because in return for a small almost assured lost, there is some small chance of either winning big or of avoiding a big loss.

I believe that investors also make a big distinction between losses that they must blame on themselves and losses which they can blame on others.

Basically investors want to maximize returns, minimize losses and at the same time maximize their personal satisfaction level.

I am not sure if their have been any studies on this.

I think most people would agree that they would be happier to make $9000 based totally or at least substantially on their own skills, work or initiative than making $10,000 based totally on the skills, work and initiative of others. Similarly, there is always ultimately more satisfaction in making your own living than there is in receiving some kind of handout or free money.

When it comes to losses, I believe that investors have a much higher tolerance for those losses that they can blame on others than for losses for which there is no one else to blame.

This may explain why most investors are not well suited to selling shares at a loss to prevent further losses. If a share price suddenly dropped 50%, many active traders would tend to sell and move on. But many other investors will hang on, often holding shares all the way to zero even after they realize that the stock is almost certainly headed for zero. In my opinion investors do this partly because it is more comfortable mentally. Selling at a 50% loss means that the investor made an active decision to sell and feels some personal “blame” for the loss. By continuing to hold the money-losing position the investor can cling to the hope that the stock will recover and thus does not fully admit that there has been a loss. If the stock falls all the way to zero the investor blames the management.

Investors who do not sell at the first sign of major trouble, often have increasing mental difficulty in selling as the price declines. Investors often don’t sell when the stock is down 10% because they feel a bit dumb for not having sold when it was at the peak or only down 2%. Then when the stock is down 30% they often would feel really stupid about selling at a 30% loss when they had thought about selling at a 10% loss but did not. At this point an investor often tries to simply stop thinking about the stock and watches it fall much further because it seems more comfortable to do that than to actually lock in the loss.

In summary, I believe that part of the reason that investors refuse to lock in losses and move on is that it is too painful mentally. It can be more comfortable mentally to take a bigger loss as long as it will be easier to blame that bigger loss on others.

As a result of this behavior, I believe that most investors are better off adopting fundamental investing approaches. Most investors are just not well suited to technical strategies that require the ability to accept and lock in losses frequently. Most investors are probably better suited to buy and hold strategies. However, even buy and hold investors, invested in high quality companies, are occasionally presented with a change in circumstances whereby a once solid company starts to head for the bottom. In this case investors need to be conscious that selling at a loss may cause mental discomfort but they should try to overcome their reluctance if logic dictates that the stock is most likely headed lower permanently.

Conrad Black

I almost feel a bit sorry for Lord Black. After all, he could be facing the rest of his life in jail.

The ironic thing is that he probably could have quite legally taken the same amount of cash out of his companies by simply having it all labeled as bonus or salary money. I am not aware of any laws that prevent publicly traded corporations from paying huge and obscene bonuses or salary.

When obscene bonuses and salaries are paid I do think it is a real danger signal and I tend to avoid investing in those companies. But obscene bonuses are not generally illegal.

Conrad Black received large amounts of money in the form of non-compete payments. Prosecutors may now argue that if anyone deserved that money it was Hollinger International or Hollinger Inc. and not Conrad Black or other managers. I understand that the Non-compete payments were non-taxable. If so, then this particular tax-saving maneuver has turned out to be a very expensive one.

The National post has also revealed that Hollinger and/or Hollinger International have spent over $100 million in legal fees. If true this is another obscenity. Unfortunately there is little or nothing to stop any publicly traded company from incurring inappropriate and obscene expenses as long as the money is spent in good faith.

Shawn Allen
Investorsfriend Inc.
November 20, 2005

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