Sector Model
|
XLB
|
0.00%
|
|
Large Portfolio
|
Date
|
Return
|
Days
|
BBRY
|
7/16/2012
|
99.31%
|
257
|
SEAC
|
9/25/2012
|
45.53%
|
186
|
CAJ
|
9/25/2012
|
6.66%
|
186
|
CFI
|
10/31/2012
|
34.72%
|
150
|
RE
|
11/26/2012
|
24.59%
|
124
|
BOKF
|
2/4/2013
|
11.13%
|
54
|
SWM
|
2/12/2013
|
7.70%
|
46
|
GMCR
|
2/19/2013
|
27.87%
|
39
|
OKE
|
2/25/2013
|
0.55%
|
33
|
TAC
|
3/25/2013
|
-0.07%
|
5
|
S&P
|
Annualized
|
8.77%
|
|
Sector Model
|
Annualized
|
27.51%
|
|
Large Portfolio
|
Annualized
|
34.18%
|
Rotation: selling CFI; buying TTM (again).
TTM has dropped over 10% since I sold it a few weeks ago,
and it’s now back in the buy zone.
CFI has reached an inflection point, outside of the
parameters of my model. I’ll take profits
for now.
Also, as I posted on the real-time note on Friday, the
sector model flipped to XLB before the close.
Now, where were we on the Buffett series?
Ah, yes, fundamentals.
Fundamentals are invisible things people appeal to when
everything else is going the other way.
In 2008 McCain was lambasted for saying “the fundamentals of our economy
are strong.”
Most of us could barely hear McCain above the chorus of
screaming terror as we stared over the edge of the abyss.
For what it’s worth, I was rolling my eyes at McCain too,
but our friend Warren Buffett was screaming “BUY!!!!!” at the same time:
We can discount McCain, but Buffett?
Anyone who looked at the news saw that we were doomed (hint,
NEVER- EVER-EVER-EVER TRADE THE NEWS).
The news was right… for a few months. The market continued to collapse until it hit
that ominous 666 in March 2009. But the
news was wrong… for a few years. It all
depends on your time frame. Buffett was
looking through a different hour glass than most of us. I remember pointing out to my family in late
2008 that the total market bullish percent index had fallen below 10 the day
before Buffett was screaming to buy. For
most traditionalists, that’s about as clear an over-sold buy opportunity as you
can get.
Those kinds of broad market opportunities don’t happen very
often, but on any given day we can look for value in individual stocks. Each stock is its own market – we don’t have
to wait thousands of days for a market
opportunity, because on any given day we can search thousands of stocks for a value opportunity.
A few weeks ago I did a fundamental screen of all the stocks
in the market – and AAPL came up in first place. First, among thousands! And then it immediately went down another
five percent. Go figure.
The truth is that fundamentals have a bad rap because they
get better looking the more the price of a stock tanks. In other words, fundamentals are like some
crazy carnival mirror image of price: the more “wrong” they appear to be, the
more “right” they really are. That’s not
always true, of course. There are indeed
value traps out there. And we can never
screen them all out. But ON AVERAGE a
stock is a better buy the cheaper it becomes.
But that begs the question, “cheaper than what?” If all you looked at is price, then a penny
stock would be “cheaper” than APPL. But
a ten dollar banana is NOT cheaper than a hundred dollar house (or at least, we
HOPE not). “Cheap” has to be measured
against… against…
Earnings? P/E should
be the trick, right?
WHICH P/E?
Current? 12 month trailing? Forward?
Cyclically adjusted?
Let’s say you have a stock that normally earns 3 dollars a
share and sells at a price of 45. That’s
a P/E of 15, which is about average for most decades. But what if they have an earnings hit this
quarter and only earn 1 dollar a share?
Suddenly that current P/E shoots up from 15 to 45! Folks panic and dump the stock. Now it’s selling at 30 dollars. The current P/E falls from 45 to 30 – still
nosebleed expensive. Even worse, the
“forward earnings” estimates are lowered (because they are really a lagging
indicator as the people making the estimates try to make the “future” look like
the most recent past). So, the forward
earnings are lowered from 3 to 2.
The current P/E is 30.
The forward P/E is 15.
But 12 month trailing earnings are for the past 4 quarters:
3, 3, 3, 1 averages to 2.5.
So, for 12 month trailing P/E we have: 30/2.5 = 12.
People looking at (expensive 30) current P/E will be selling
to people looking at (cheap 12) trailing P/E, while people looking at (average 15)
forward P/E start to get nervous.
And that’s just P/E.
There are hundreds of different fundamental features out
there, with thousands of possible ratios.
How on earth to parse them?
Well, there are two ways.
The first is trial and error (preferably someone else’s). The second is to study correlation.
Ah, yes, “correlation does not imply causation.”
In a pig’s eye. Of course
correlation implies causation. How else
did Warren Buffett get so rich?
Buffett is bright, but he isn’t some super genius with
inhuman insight – and that’s a good thing for the rest of us, because it means
that (other
than buying whole companies outright)… Buffett isn’t doing anything that
the rest of us can’t do.
He’s value investing and compounding his returns through the
tax avoidance that long term holding provides.
He isn’t looking at charts. He’s
looking at debt, profits, cash flow – or in McCain’s terms “fundamentals.”
And for all his baloney of “please tax me more” for the
front page, he tells the investors in Berkshire Hathaway that he accomplishes
just the opposite. He holds for as long
as possible to pay as little taxes as possible.
As we have seen, Buffett is using his “please tax me more”
as an inside joke… with short term traders as the punch line.
Okay – we get the joke.
Buy and hold has merit. But you
have to know WHAT to buy and HOW LONG to hold.
You could just buy anything at random and hold forever – and odds are
you’ll beat the DOW index by about a percent a year because small caps
outperform large caps over the long term.
But that won’t get you to a billion, or even help you retire at 80. No, you have to look at those fundamentals
like a businessman.
As I said last week – you aren’t buying a piece of paper;
you’re buying a piece of a company.
But most of us aren’t businessmen. How do we know WHICH of the hundreds of
fundamentals to look at?
Any of them.
No, seriously – ANY of them, as long as you look at their time ratio.
A company has a track record, a reputation, a brand, a
business model. Value is created when the short term prospects are worse than the long
term ones.
It’s really that simple.
Did you miss it? Here
it is again. Read it ten times through,
then read it again:
Value is created when
the short term prospects are worse than the long term ones.
No, I’m serious, DRILL THIS INTO YOUR HEAD:
Value is created when
the short term prospects are worse than the long term ones.
THAT is the only ratio that matters, and ALL of the
fundamental parameters you look at should serve that one theme. Book value growth – better long term or short
term? Cash flow growth – better long
term or short term? Earnings – better
long term or short term?
Value is created when
the short term prospects are worse than the long term ones.
Notice I didn’t even mention P/E there.
The ratio is not “P/E” or “Book / Price” or “Current ratio”. It’s long term / short term. That’s long term earnings over short term earnings,
or long term Book Value over short term Book Value.
We live in a flash-mob investment world, where everyone is
trying to outpace the next; and all the while those high frequency trading
algorithms are running circles around us all like wolves driving a herd of
sheep.
If you really want to compete with HFTs, figure out how to
get them to work FOR you instead of AGAINST you. Figure out what kinds of havoc they are
creating and then figure out how to pick up the pieces afterward.
Sometimes you’ll be early and you’ll see the price continue
to collapse. Don’t look at the bloody
chart. Look at long term fundamentals /
short term fundamentals.
Heck, even TECHNICAL traders do that. They’ll determine a long term trend and then
wait for a pullback to enter.
You do the same thing
with fundamentals.
That’s what Buffett does.
That’s ALL Buffett does.
And the longer term the better, because it means that you’ll
be able to trade less often and get taxed less dramatically.
We profit when we do what other people won’t do, and what high frequency trading algorithms can’t do.
A reader guessed the theme a few posts ago: it’s simple, but
not easy.
The problem is that it goes against human nature.
It’s not “easy” at all to watch your favorite stock tank in
price, with horrible news and competition eating its lunch. It’s not “easy” to invest in such a company
in the first place. My best stock to
date is the one I was most convinced would go completely bankrupt: BBRY
(formerly RIMM).
When I first decided to invest in it, I was convinced it was
a horrible mistake:
Just a few days later I was hoping the model would dump it
before I lost my investment:
I only calmed down a bit after it was up 50%:
Now, BBRY could STILL tank.
But it was a lesson to me – my gut instincts really were as bad as I
thought they were when I made the model.
We are geared to follow the herd and make Buffett richer in the process:
Investors like to look at charts, but the only thing that
charts tell you is what other investors have been doing. If humans really are programmed to just
follow other humans, as that wired article on swarms indicates, then we need to
follow something OTHER than other humans.
And that means we need to be looking at timeframes OTHER
than the ones human instincts operate in.
I’ll talk more on timeframes… next week.
Tim
Like the previous text, this one is again high-quality stuff.
ReplyDeletePlease, continue what you are doing. It is eye opening to many, I believe.
Regards,
Wil
Thank you so much, Wil. You are very kind.
ReplyDelete