The Hidden Desire of Investors

What is the most important question for a stockmarket investor?

• Whether the market is undervalued or overvalued? No!
• Whether interest rates will go up or down? No!
• Whether a particular company is undervalued or overvalued? No!
• Whether you should buy ABC or XYZ? No!
• Whether Joe Bloggs, the famous analyst, says it is a great buy? No!

All these questions are useless! There are whole office buildings full of people pumping out answers to these questions. They are not trying to mislead you. They are just trying to supply answers to these questions because people keep asking them and are willing to pay large amounts of money for the answers.

Even if they could be answered, the answers will not help you reach your financial goals. Why? Because they are the wrong questions.

Focussing on these questions will give you the illusion that you are a serious investor. Long hours reading all the articles and books, perhaps even poring over charts and financial reports, will only keep you locked in the system of struggle and mediocre success.

For others, the questions will give you an illusion of confidence and comfort because you are acting on the advice of the latest Wall Street hotshot.

But illusions hold you in bondage. As Morpheus in the film The Matrix explains, "Like everyone else, you were born into bondage. Born into a prison that you cannot taste or smell or touch. A prison ... for your mind."

Chasing answers to these questions will keep you in this prison. At best you may from time to time do better than the S&P500 or some other index. At worst you will see your money slipping away with poor returns and excessive fees.

Consider the case of trying to determine whether a company is undervalued or overvalued. It may turn out to be undervalued using some academic model. And there are hundreds of books describing such models. But if it stays undervalued for the next 10 years it is not going to be much of an investment.

Even the whole notion of what is value is flawed. Suppose you go into a jewellery store and decide to buy an emerald ring for $2,000. The jeweller assures you that it is really worth a lot more and even arranges to get an insurance certificate for $4,000. Great! You are now congratulating yourself for buying something that is valued at 100% more than you paid for it.

What if you split up with the person you were going to give the ring to. No worries, you are thinking. "I'll just sell it back to the store." But when you go back in you are told that they will only pay $1,000 to buy it back. What you thought you were getting for 50% of its true value turns out to be overvalued by 100%.

All the other questions asked above can be dealt with in a similar manner. For example, Warren Buffett said that he has no idea what the market is going to do and whether it is undervalued or overvalued, whatever that may mean. What is more, he is not interested in knowing.

The same applies to interest rates. Buffett once said, "If the Federal Reserve Chairman Alan Greenspan were to whisper to me what his monetary policy was going to be over the next two years, it wouldn't change one thing I do."

There is only one question. Underneath it all, there is only one desire. What is my profit rate or percentage return?

The core activity of an investor is to estimate with confidence the percentage return over a specified holding period when buying stock in a company. And you want to be able to do this based on numbers that you can see and adjust such as the growth rate of earnings.

When you can do this with a range of companies you have a rational basis to decide when to buy stock in a particular company, when to hold, and when to sell. You can decide between companies. You can even decide between investing in a particular company or in bonds.

You are in control. The market is now working for you instead of against you. Because you know the expected return on a range of quality companies, you can wait until Mr. Market offers to sell you stock in one of these companies that will give you the return that you want.

You can do this and more in a few minutes with the Valuesoft Investment System.

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Now it is up to you. As Morpheus said in The Matrix, "I can only show you the door--you are the one that has to walk through it."

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Berkshire Hathaway and the Buffetteers

The Return of the Buffetteers

by John Price

A friend told me that on a recent exam she was asked to explain why Warren Buffett says that diversification is a protection against ignorance and that it makes very little sense for those who know what they are doing. Based on a discussion she had with a stock analyst a few days prior to the exam, she answered roughly as follows. Buffett could buy in such large amounts and had such a following that what ever he bought would go up in price. Then he would sell and take a huge profit. What grade would you give that answer?

None of the 11,000 people crowding into the Aksarben Stadium in Omaha Nebraska on May 4, 1998, for the annual meeting of Berkshire Hathaway, the company led by Warren Buffett, would have committed such a blunder. To a person, they knew that Buffett patiently waits until Mr. Market offers to sell a great company with predictable earnings growth at a discount price. Then Buffett buys all that he can afford with the assumption that he will hold it for life.

Can such a simple-minded strategy really give worthwhile returns? Once again, ask those who attended the meeting. Many would know that when Buffett took over Berkshire Hathaway in 1965, it was trading at $18 per share. Using it as a vehicle for purchasing and investing in other companies, he has guided it to the level where it is now trading at $70,000 per share, an annual return of 28 percent. Others would know simply that since they bought stock in this former New England textile company, it has been going up like clockwork in both share price and equity per share.

No one else comes close to Buffett’s record over such an extended period covering every type of bull and bear market. He is also unique in that this has been accomplished without the use of derivatives, hostile takeovers and leveraged buyouts.

After dealing with the business in five minutes, Buffett opened the meeting to questions. For almost six hours he told stories, joked and munched on See’s Candies, while answering question after question with care, relevance and wisdom. Many questions were also dealt with by Charlie Munger, the Vice Chairman of Berkshire Hathaway. The following is a selection of the answers given by this twosome fairly much taken straight from my notes. Enjoy!

(Reprinted with permission from Investor Journal, August, 1998)

stock investment strategies

Stock investment strategies continued...

Value Investor

In the fourth edition of the investment classic _Security Analysis_, the authors Benjamin Graham, David Dodd, and Sydney Cottle speak of the "attempts to value a stock independently of its current market price". This independent value has many names such as `intrinsic value,’ `investment value,’ `reasonable value,’ `fair value,’ and `appraised value.’ They go on to say:

A general definition of intrinsic value would be "that value which is justified by the facts, e.g., assets, earnings, dividends, [and] definite prospects, including the factor of management." The primary objective in using the adjective "intrinsic" is to emphasize the distinction between value and current market price, but not to invest this "value" with an aura of permanence.

Value investing is the name given to the method of deciding on individual investments on the basis of their intrinsic value as contrasted with their market price.

This, however, is not the standard definition. Most authors refer to value investing as the process of searching for stocks with attributes such as a low ratio of price to book value or a low price-earnings ratio. In contrast, stocks with high price to book value or a high price-earnings ratio are called growth stocks. Investors searching for stocks from within this universe of stocks are called growth investors. These two approaches are usually seen to be in opposition.

Not so, declared Warren Buffett. In the 1992 Annual Report of Berkshire Hathaway he wrote, "the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive."

Conscious Investor

This type of investor overlaps the six types just mentioned. Increasingly investors are respecting their own beliefs and values when making investment decisions. For many, quarterly earnings are no longer enough. For example, so many people are investing in socially responsible mutual funds that the total investment is now over one trillion dollars. Many others are following their own paths to clarify their investment values and act on them. The process of bringing as much honesty as possible into investment decisions we call conscious investing.

Most people invest for different reasons at different times. Also they don’t fall neatly into a single category. In 1969 Buffett described himself as 85 percent Benjamin Graham [Value] and 15 percent Fisher [Scuttlebutt].

Whatever approach, or approaches, you take, the most important thing is know why you bought a particular stock. If you bought a stock on the recommendation of your neighbor, be happy about it and recognize that this is why you bought it. Then you will be more likely to avoid the "investor imperative," namely the following behavior: If your stock rises, claim it as your ability; if it falls, pass on the blame.

Do all that you can to avoid going down this path. Write down why you bought a stock. Tell your spouse your reasons. Tape them on your bathroom mirror. Above all, if you want to be a successful investor, don’t kid yourself.

Survey of Stock Investment Strategies

This article offers a brief survey of several strategies that investors use to guide their stock purchases and sales.

Before we start the survey, here's a golden rule of investing: Know why you are buying a particular stock -- don’t wait until its price goes up or down to think about it. Many investors are not sure why they bought a stock in the first place, so when a dramatic fall in price happens, they're not sure what to do next.

Here's an example. Let's say you bought Intel. When you know why you bought Intel you will have a stronger basis for knowing what to do when its price goes up, or down, or even stays the same. So if Intel starts to go down in price and you bought it as a momentum play, then you will probably want to sell as quickly as possible. But if you bought it as an undervalued stock, and if the fundamentals have not changed, then you might want to buy more."

Of course, every investor and every stock presents a different reason for contacting your broker. But we have to start somewhere, so here is my analysis of the six main investment styles.

Brother-in-law investor

Your brother-in-law phones, or perhaps your stockbroker or the investment writer for the regional newspaper. He has the scoop on a great stock but you will have to act quickly. If you are likely to buy in this situation, then you are a "brother-in-law investor." Brother-in-law investors rely on the advice of other people to make their decisions.

Technical investor

Moving averages, candlestick patterns, Gann charts and resistance levels are the sort of things the technical investor deals with. Technical investors were once called chartists because their central activity was making and studying charts of stock prices. Nowadays this is usually done on a computer where advanced mathematics combines with grunt power to unlock past patterns and correlations. The hope is that they will carry into the future.

Economist investor

This type of investor bases his decisions on forecasts of economic parameters. A typical statement is "The dollar will strengthen over the next six months, unemployment will decrease, interest rates will climb -- a great time to get into bank stocks." Random walk investor This is the area of the academic investor and is part of what is called Modern Portfolio Theory. "I have no idea whether stock XYZ will go up or down, but it has a high beta. Since I don’t mind the risk, I’ll buy it since I will, on the average, be compensated for this risk." At the core of this strategy is the Efficient Market Hypothesis EMH. There are a number of versions of it but they all end up at the same point: the current price of a stock is what you should buy, or sell, it for. This is the fair price and no amount of analysis will enable you to do any better, says the EMH. With the Efficient Market Hypothesis, stock prices are assumed to follow paths that can be described by tosses of a coin.

Scuttlebutt investor This approach to investing was pioneered by Philip Fisher and consists of piecing together information on companies obtained informally through wide-ranging conversations, interviews, press-reports and, simply, gossip. In his book Common Stocks and Uncommon Profits, Fisher wrote:

Go to five companies in an industry, ask each of them intelligent questions about the points of strength and weakness of the other four, and nine times out of ten a surprisingly detailed and accurate picture of all five will emerge.

Fisher also suggests that useful information can be obtained from vendors, customers, research scientists and executives of trade associations.