Tag Archives: stock-picking

Security Selection is a nebulous Value proposition

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Image courtesy https://advisor.wellington-altus.ca/standupadvisors/

By John De Goey, CFP, CIM

Special to the Financial Independence Hub

By now, you will have almost certainly heard a few stories about the folly of stock picking as a viable way to beat the market.  The problem that high net worth (HNW) investors are disproportionately saddled with is they are bombarded with people who purport to be able to add value by doing things that, in aggregate, cannot possibly be true.

There are three basic equity building blocks investors might use to mix and match in their portfolio construction: individual securities, ETFs and / or mutual funds.  Very few HNW investors use funds, but I will mention them for the sake of completeness and comparison.  Mostly, funds are used as an example of what NOT to do.

To provide structure and consistency to this discussion, I should add there are a couple industry terms you might be somewhat familiar with that nonetheless need to be defined. They are:

Alpha – The pursuit of reliable, consistent and superior risk-adjusted returns; and:

Closet Indexing – The practice of masquerading as an active manager while holding a portfolio basket that nearly replicates the index it tracks.

No matter what vehicles are used, these two concepts need to be considered when assessing options.

Dreams versus Reality

There’s a simple way to think of them.  They are, respectively, the dream and the reality of how most traditional mutual funds are managed.

Everyone wants Alpha at a micro (personal) level, but Alpha does not even exist on a macro (aggregate) level.  A metaphor many use is that no matter how high anyone’s mark is, if everyone else in the class has a high mark, the class will have a high average, but it will be difficult to beat the average.  This was simply explained by a Nobel prize winner named William F. Sharpe of Stanford, who wrote a paper about 30 years ago called “The Arithmetic of Active Management.”

In it, he showed the self-evident logic that any market is made up of active managers (traders) and passive managers (benchmark replicators).  Any benchmark (such as the TSX) is merely the sum of all active and passive participants.  Seeing as the passive people merely replicate the benchmark, their returns will equal the return of the benchmark minus their fees. It follows that the average return of all active managers will also equal the total benchmark minus fees.  Since average active fees exceed average passive fees, it logically follows that the average passively managed dollar must outperform the average actively managed dollar.  Continue Reading…

Is now a good time to buy stocks? Look beyond headlines to learn answer

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Examine The Theories That Forecasters Rely On To Predict Market Swings — And Learn Their Flaws

The universe is constructed in such a way that nothing is certain. You can always come up with perfectly rational reasons why something won’t work. But people find ways to overcome obstacles, and some businesses succeed despite risks.

Is now a good time to buy stocks? Below are a couple of factors to consider. 

Is now a good time to buy stocks? Understand pendulum theory and you will understand the past

You could sum up the investment version of the pendulum theory like this: stock prices alternate between periods of overvaluation and undervaluation; the degree and duration of each period of overvaluation is related to the degree and duration of the subsequent period of undervaluation, and vice versa.

In other words, pendulum theory says that when stocks head downward after a period of overvaluation, they won’t stop at fair value. Instead, they’ll keep dropping until they hit lows that are in some sense as out-of-whack as previous highs, or close to it.

Pendulum theory is a handy way to label the past, and it gives you a sense of how stock prices behave. But it’s useless at predicting the future or timing the market. That’s why pendulum theory generally plays a small part in successful investing. If you qualify as a “successful investor,” you probably recognize that the market never gets so high that it can’t go higher, nor so low that it can’t drop some more. This is a key part of understanding the stock market.

Is now a good time to buy stocks? Consider this valuable concept to gain another perspective

Here’s one of the most valuable things you should recognize as an investor: “A rising market climbs a wall of worry.” In other words, you need to recognize that a stock market’s rise automatically generates negative comments. The higher and/or longer the market rises, the more negative comments it generates. These are the bricks in that wall of worry.

The inevitable building of this wall grows out of human nature. Many people are instinctively cautious or conservative. When they see a stock or the stock market go on a rise, they look for reasons why the rise may falter or reverse. That’s especially true of stock market commentators. When a stock or the market rises beyond their expectations, they dig deep for hidden flaws.

This spurs them to come up with comments that at times seem deliberately slanted to promote a negative view. You might call them “misleading indicators.” Here’s an example:

“The market had the biggest drop in a day (or week, or month),” or “the longest string of falling days, since … [a date chosen to maximize shock value].” When these kinds of comparisons began appearing in the news this year, after a long dry spell, some investors took it as ominous news. They assumed it meant the market was at risk of greater declines. It means nothing of the kind.

Sometimes, of course, the market puts on big one-day declines near the start of a long-term price decline. It has also done so near the end of such declines and at various points in the middle. The same goes for big one-week and one-month declines and for long strings of down days.

Every year, the market will hit a series of “new highs for the year,” or a series of “new lows for the year.” In many years, it will hit some of each.

When you adopt “A rising market climbs a wall of worry” as a mindset, it will help you maintain your perspective. You’ll start to recognize that milestones like these are trivia, passed off as meaningful statistics. The investment news is full of them. You may find they make interesting reading or listening, but they also burn up valuable time. You’ll earn a far greater return on that time if you devote it to learning and comparing facts about the companies you invest in.

Stop worrying too much about the big picture

If you constantly worry about the “big picture,” including trying to pick market tops, you may at times manage to sell at just the right moment to sidestep a serious downturn. But you may only do that after sitting through a series of downturns. The downturn you avoid may turn out to be the last in a series—the “final leg downward,” as short-term traders like to refer to it. Continue Reading…

Eight questions to ask when evaluating a stock

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By Aman Raina, SageInvestors.ca

Special to the Financial Independence Hub

The process of trying to determine what stocks to buy and sell is a very repetitive and iterative experience. I’ve analyzed thousands upon thousands of stocks and the process I’ve used for each one has been the same. For any company being evaluated, an investor must ask the same fundamental questions over and over again in order to truly assess the investment opportunity.

The level of detail required to answer these questions are a function of time you have. If you have lots of time, you can dive more deeply into the nuances and intricacies of the company’s business model. For most investors, all that is needed is an understanding of the core elements of the business.

Make no mistake; these questions have to be answered at a basic level at a minimum in order for you to have complete understanding of the company before you commit your hard earned money to buying into it. Most people I’ve had the pleasure to work with and teach often buy stocks without even knowing what the company does or sells yet they can tell you all the specs of about their vacuum cleaner they have researched for 4 months. In my Everyday Investing course I teach, I help investors answer these questions. Below I’ve listed what I’ve determined to be the 8 questions you have to ask each time when evaluating a stock.

As we go through the questions I will put them into practice by using a stock I recently purchased as an example to illustrate. I recently made a decision to buy shares in CVS Health (Ticker: CVS).

1.) What do they sell?

Stocks are pieces of paper representing ownership of businesses. Companies are not created because nature dictated they should be. Profit-generating businesses are created to sell something, be it a product and/or service that the owners perceive society will want in large quantities. When you look at companies, it is the first fundamental question to ask. What are the core products and services that the company sells? Often in larger companies this can be answered by looking at how the company is structured with products and services often having their own separate divisions. In other cases if a company is structured by geography, the product lines will be found under each regional umbrella.

There are many sources from which you can get quick sysnopsis of a company. Here’s one I pulled from Valuentum Securities that describes CVS.

“ … The 2007 merger of CVS Corp and Caremark created the largest pharmacy health care provider in the US. The company has more than 7,800 retail locations and operates in 98 of the top 100 US drugstore markets. Its PBM business serves more than 60 million plan members. The company was founded in 1892 and is headquartered in Rhode Island.

CVS recently acquired Target’s pharmacies and clinics and it will operate the acquired pharmacies in a store-within-a-store format. The deal expands its footprint of pharmacies by ~20% (adding more than 1,660) and clinics by ~8% (adding ~80 clinics)…”

CVS also purchased Aetna Insurance, one of the largest healthcare insurance providers in the US.  With this CVS aims to become a one-stop shop for health care services in the US using their drug stores as the prime distribution point.

2.) Who do they compete with?

Chances are the company is not the only one selling the same product or service. There are likely to be other companies offering a similar or slightly similar product at higher or lower price points. Understanding or being aware of the level of competition the company faces can give us insight into how large the demand is for their product and potentially how much revenue, profit and market share they can be expected to take in the future.

In the case of CVS, the company competes with other major pharmacy chains such as Walgreens, as well as the big retailers like Walmart and Costco. The acquisition of Target’s pharmacy footprint essentially makes them de facto direct retailers. With the purchase of Aetna, their competitive universe has now expanded to include the health care insurers, like United Health.

3.) Who buys their products and services?

You know what the company sells. Now you want to know who would actually buy their goods and services. Who are the main customers for the company? What are their characteristics and background? Why do they buy the product?

For CVS, their target market is anyone that is not well or anybody that is well and wants to stay that way. I’m being very simplistic here. Again, you could do a whole market research analysis or market segmentation of their client base if you have the time.

4.) Will they buy it over and over again?

How often will a company’s client base buy their products? Can they be counted on to be repeat customers? Repeat customers mean repeat revenues and the greater the repetition, the greater for long term sustainable cash flow which will ultimately bode well for the stock price. Continue Reading…

Should investors buy individual stocks?

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By Steve Lowrie, CFA

Special to the Financial Independence Hub

In most walks of life, rugged individualism is a virtue.  No wonder so many investors still seem so determined to beat the odds by trying to pick the very best individual stocks (and avoid the stinkers). Unfortunately, the odds are stacked so high against these sorts of financial heroics, you might as well be buying lottery tickets versus trying to consistently outperform the long-term returns everyone can expect by embracing an evidence-based investment strategy.

I’ve posted on this subject before, in “How understanding statistics can make you a better investor.”  Today, I want to take a closer look at why individuals should still avoid picking individual stocks – and, briefly, what you can do instead to come out ahead.

A Grumpy Advisor 

There are numerous real-life illustrations that have crossed my path over the years … generally on opposite ends of the spectrum.   On one extreme, there is using some mad money to buy shares (usually penny stocks) in an emerging technology or fad.  The other extreme is cashing out a well-diversified portfolio and putting everything into one illiquid investment, promising high yields, but with significant hidden risks (mostly private real estate recently).

Often, these individuals would like me to help them with the transaction. I won’t do that.  While I can’t stop them from proceeding without me, I can vehemently advise against it. If they’re a client and they still insist on getting in on the deal, they can do so directly, through a discount brokerage account.

Why am I so grumpy about it?

It’s my job

I couldn’t claim to be offering anything remotely akin to best-interest financial advice if I weren’t highly skeptical of investment “opportunities” that conflict with everything I know about how capital markets work.  I can assure you, every bit of evidence I’m aware of (based on more than six decades of peer-reviewed, academically grounded research) informs me that dumping your entire nest egg into a single, risk-laden venture flies in the face of good advice.

It’s not even investing

Alright, so maybe you’re already with me on not staking your entire life’s savings on a single bet. But what about that modest stake in a penny stock? Is there any harm done in throwing a bit of fun money at a venture that, at worst, won’t ruin you; and, at best, just may pay off?

The problem is, most investors don’t realize that stock-picking isn’t actually investing.  It’s speculating.  In practice and expected outcome, it’s no different than gambling in a casino or buying a lottery ticket. As I covered in that past post of mine, the odds are stacked anywhere from mildly to steeply against you, making it far more a matter of luck than skill whether you “win” or “lose.”

This is where I see people running aground, even with seemingly “harmless” penny stock ventures. In my experience, if they happen to lose their stake, they tend to justify it as a “nothing ventured, nothing gained” adventure, especially if they weren’t hurt too badly.

Worse, if someone happens to come out ahead now and then by picking individual stocks, a bevy of behavioral biases (including, but not limited to: confirmation, framing, outcome, overconfidence and pattern recognition biases) tricks them into believing it was NOT random luck. For better or worse, we humans love to conclude we’re somehow smarter than the rest of the crowd. It’s so common, there’s even a name for it: “The Lake Wobegon Effect.”

It’s usually not only incorrect, it’s dangerous to mistakenly assume a successful stock pick happened because you or your stock-picking guru outwitted the entire market. Why is it dangerous? Because it increases the likelihood you’ll try your luck again, potentially with bigger bets. Eventually, you may convince yourself that stock-picking is a great way to invest in general, not realizing how much it’s probably costing you over time. This is especially so if you have no financial advisor to turn to: one who is committed to serving your best interests by showing you how your actual, long-term portfolio performance numbers stack up to a more sensible investment strategy. Which leads me to my final point today …

This rarely ends well

Based on my 25 years of experience, the vast majority of individual stock-pickers not only underperform the general market, they typically lose capital in the long-run. Recalling the casino analogy, even if you win a “hand” or two, the system (capitalism) is essentially set up so the house (the market) comes out ahead in the end, regardless of which players (investors) win or lose along the way. Continue Reading…

My search for the next great stock

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By Aman Raina, SageInvestors

Special to the Financial Independence Hub

I get asked a lot about how to find companies and stocks to invest in. Where do you start? It’s a great question and also an overwhelming question to people. They’ve set up the broker account. They put in some money. They’re now ready to buy stocks. Where to start?

A few years ago I wrote a blog on how to find stocks to invest, where I suggested a simple and easy starting point in identifying companies to evaluate. The premise was identify the core necessities of life that we need on daily basis and find those stocks that offer that value proposition. The necessities of life are essentially food, clothing, shelter, and transportation (I may add another one communication). Identify the companies in each pillar and evaluate them to find the best run, best managed, best performing.

These days, one of the prominent business thought leaders is Scott Galloway. He is a walking market research machine and can hit with you with so much data you’ll faint. If you want proof check out one if his presentations.

Galloway blogs as well and awhile back he posted a piece of how Uber could get its groove back after all the leadership missteps. He mused on the following:

“…Begin thinking of Uber as an OS. The most impressive firm of the nineties was the original gangster leveraging the operating system — Microsoft. The most influential firms of the last decade, the Four (Amazon, Apple, Facebook, and Google), have become operating systems for retail, media, connections, and information, respectively … and extract serious rents from the apps that sit on top of the OS. What firm has busted a move and blown through $100B market cap that isn’t effectively an OS? The latest, Netflix, has taken advantage of the extraordinarily lame cable industry and now occupies the second-most-important screen, the television. Netflix has increased its market cap 2400% in the last five years.

In sum, the only way Uber gets from $70B to $700B is to become the OS for travel, becoming the user interface / API / rules for all transportation. Leveraging AI, cheap capital, and relationships with 40M of the planet’s wealthiest consumers each month, Uber should expand its offering (dramatically). Same interface, but instead of entering “ACK airport,” where I’m headed Sunday morning, I type in “London,” and using AI — connecting the dots of my preferences, economic weight class, deals at the time, APIs — Uber presents the best options for not just the ride to the airport, but the flights to JFK, then London, the car that picks me up, and the hotel I stay at. Uber has the license to do this. The ride-hailing firm can’t get there on its own and will acquire other firms…”

It’s a pretty compelling argument and it made me wonder what other “OS’s” are out there in other industries? Then I thought about my pillars, food, clothing, shelter, transportation? Has anyone staked their claim as owning the OS for these pillars? Where would Google, Amazon, Facebook, Apple play in this? I thought it would an interesting exercise to carry out and may it can uncover some interesting investment opportunities. My search for the next great stock had begun.
Continue Reading…

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