These Markets Are Making Everyone Look Brilliant…except Value Investors

Markets keep going up.  Everyone keeps getting more and more confident in the markets.  It's now to the point where when I hear someone say "Boy, this market is overpriced", what they typically mean is "This thing is gonna fall 5-10% and it will be a great buying opportunity."  Hardly the sign of overpriced.  That's a run-of-the-mill market pull back during normal markets. I am not a believer in that just because something has gone up for so many years does it mean it's overvalued.  What makes something overvalued is that it is selling at a level that, based on history and fundamentals, is well above the normal range of valuations.  We are at levels, right now, that historically will produce break-even results INCLUDING DIVIDENDS over the next 10 years.  This historical accuracy is around 90%, based on John Hussman's Weekly Market Commentaries.  This means that 10 years from now, we can expect the S&P 500 and Dow Jones to be 20% lower than they are today, on a nominal basis.  This is also the valuation metric that Warren Buffett has said is probably the "single most accurate measure of stock market valuations at any given time." Since 2000, we are only up 43% or so on the S&P, not including dividends.  That's a mere 2.4% annual growth rate on the S&P 500, but what you need to remember is that valuations in 2000 were at all-time highs compared to history and we are NOW at valuation levels that are merely 10-15% lower than 2000.  Everyone thought that the markets would keep going up back in 2000 and 15 years later, we have only seen 2.4% capital growth on any dollar invested in the year 2000.  So let's not forget that valuations DO matter.  There is a capitulation point for every market, good or bad.  No one remembers the bad times when things are good and no one remembers the good times when things are bad. Could the party end again? Of course...and it will. When?  No idea.  I've been calling for it since 1500 or so on the S&P...that was many moons ago, and I admit that I was trying to fight momentum. In late 2008 and early 2009, I was one of the few positive investors out there.  A lot of people have said "But you used to be so positive on the market! What happened?" Valuations happened.  My views on the market are based on historical valuation metrics that have proven to be highly accurate over time.  Clearly my timing has been off, but over the long run, these will prove to be true.  There will be a time in the next 5 years where I will be one of the few bulls out there talking about the incredible buying opportunities and low valuations.  Yes, when I make those calls, things will likely get worse and people will question me then like they question me now...but historical returns will eventually take grip then and a new secular bull market will take hold. Unfortunately, this is all part of the process.  The excesses of 1982-2000 were so large that it will take a few ups and downs in the market for people to give up on stocks and, only then, will a new secular bull market be ready to take force. I will wait patiently until valuations are at the right levels.  I have no idea when that will happen, but when it does, you will be able to read these posts and see that sound value investing can make someone look stupid for a while but brilliant later on.  I'm not hoping to look brilliant at the expense of others, but I am writing these words and showing that I will be putting my money where my mouth is....
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What is a Value Investor?

I was just on CNNfn.com and I came across an article by Scott Fearon, CFA.  He is discussing what we can learn about investing by looking at the death of pay-phones (http://cfainstitute.tumblr.com/post/111879028236/what-investors-can-learn-from-the-death-of-the-pay). His point, in a nutshell, is that back in the last 1990s, he received "Buy" recommendations from analysts about inexpensive pay phone companies but they were inexpensive because they were a dying company. Now those are penny stocks, if they even exist. He said the value investor who cares about those metrics miss the forest for the trees...hmmm. I don't disagree, much, on that point about why pay phone companies were a bad buy in the last 1990s.  However, I would make two points.  1.) Most EVERY company that wasn't a high tech high flying company was ignored in the late 1990s and had lower valuations.  Unlike today's market, small and midcap companies were actually reasonably priced even during that late 1990s boom because the overvaluation was centered on high tech highly valued companies.  2.) He has no idea what a true value investor does. Scott goes on to point out that value investors need to care about growth.  Uhhh.  We do.  That's what he is missing.  A true value investor isn't just looking for a "cheap" stock.  They are looking for an ignored stock or company, for whatever reason. Last year when I was buying Microsoft like crazy in the $25 range, everyone was telling me how stupid it was because Microsoft was dying...yet when I looked at their yearly revenue and profit numbers, every single year they were growing.  So here was a GROWING company who everyone was ignoring because they weren't sexy anymore and therefore was selling at 8-9 times earnings. THAT is value investing.  I didn't buy Radio Shack when it was dying.  I didn't buy his example of JC Penney because it was dying and a true value investor isn't looking for dying businesses.  They are looking for OVERLOOKED businesses. Ironically, we see an article like this during a major bull market and at a time when valuations are through the roof.  I get it.  It's easy to dismiss value investing when things are going gang busters.  Ironically, the best investors of all time tend to be value investors and they tend to do best when markets are dull and down.  That's when they get the best deals.  When the markets are so far down that people don't even want to buy the good companies at good prices, that's what a value investor is looking for. Not the dying companies when markets are going great....
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Patience Is A Virtue I Normally Do Not Possess

2014 finished in a way that was quite disappointing.  In terms of the stock market, I have missed out on the majority of the gains in the S&P 500 since it was at 1500 or so and I have even bet against Amazon and the entire market along the way.  Clearly I have missed the mark. I was just scanning Yahoo Finance and came across an article where Bill Ackman is announcing that he is in the money on his short of Herbalife.  If you are not familiar with the story, please take some time and look into it.  Ackman shorted the company by calling it a "Ponzi Scheme" as many reputable investors (Carl Icahn and George Soros) praised the company and bought shares in it.  The stock climbed from the $30 range all the way up to $82 per share, and I believe he had lost about $1Billion at that point. But he kept insisting he was right.  EVERYONE said he was wrong.  He said "Nope, i'm right. You're wrong." Now, granted, the stock isn't done yet. It could bounce right back up but right now, he is not only making money but he also feels vindication I am sure. I've been shorting Amazon (AMZN) for over 2 years now and have been "wrong" because the stock is above my original short price.  I've shorted the entire market as well and so far, I've been wrong.  But there are bright spots.  Amazon went from a high of $408 and now it's sitting under $290.  Not quite the darling it was just a year ago.  The stock market, overall, has had many jumps and falls over the past six months which are typical during the topping process. I hope, and I'm confident, that I will end up being right, but patience, my most lacking virtue, is what I need to stick with and what most investors have a problem with.  We need patience.  In my other businesses, I want things done yesterday, but with investments, you have to give the time to let things pan out if your analysis is correct.  Even then, you will be wrong sometimes. Everyone forgets the tough times during the good times and the good times during the tough times. That's why sound financial analysis is important at all times.  Be patient for the opportunistic times because that is when true wealth is built....
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Antoine Walker Went Broke – And He Blames Investing

Antoine Walker is well known for making $110MM playing basketball in the NBA and recently filing for bankruptcy.  Flat broke. Doesn't even own a car in his name.  He has come out and been open about what happened and what he went through, which I very much respect and love to hear...but a bit of me has lost some respect for that story. What I am about to say DOES involve some assumptions, but I want everyone to focus more on what my overall message is about what happened to him. If you read this article and the video in it (http://finance.yahoo.com/news/former-nba-star-antoine-walker--life-after-losing--110-million-214644672.html), he talks about his spending but during it, he also says that what really made him go broke was "bad real estate investments."  But look at the other things that were said about his spending.  Multimillion dollar homes for his family members. Not one family member..but many. Flying around in private jets with 9 or 1o of his friends.  Losing millions in gambling at casinos.  Buying four or five cars for each house he was at.  Yes, real estate was probably the final nail in the coffin, but he was on the path to going broke LONG before that.  And then he blamed the real estate bubble that so many didn't see.  I get it.  We don't always see those things, but not because we don't see them...we aren't looking for them.  I won't even get into that right now... My point is, he spent like crazy and made some bad investments.  Even if his investments did well, was it likely that his spending would have been able to keep up? I don't know but I seriously doubt it.  He made $110MM, but after taxes and agent fees, that's $55MM.  He owned four or five multimillion dollar homes, so that takes about $20MM out of that number.  And when you lose millions gambling and then how much more does it cost to fly private jets and take 9 or 10 of your buddies on every vacation you go on as well as buying expensive gifts for all of them...you can do the math. Bad investments can always cause a lot of problems. I would never minimize that fact. But to say it was what is what he really did wrong? I think that's denial and try to run away from the all too common problem that athletes have...they just spend too much money....
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Speculator vs Investor…again

I have written about this topic in the past and it is a constant sore subject for me.  Meeting many financial professionals is humorous because of their quickness to discuss how "financially minded" they are and all the "hot stocks" they are kicking ass on.  When I ask the simple question of "Why did you invest in that?" it can tell a lot about whether the person is an investor or a speculator. You, as an "average" person, can easily find out which financial advisor is right for you by asking the simple question of "why?"  If the answer sounds like b.s., it probably is.  If they can't explain, in normal terms, why an investment is worth it, it probably isn't.  I am reminded of Enron and how the CEO and President couldn't explain how they made money, and looking back, THAT is how everyone should have known it was a fraud. The same way a CEO should be able to explain how they make money, your financial advisor should be able to easily explain why you are in a specific fund or stock.  If they can't, run for the hills. After all, you can easily beat the stock market over time by just buying dividend paying stocks in the S&P.  It has been proven time and time again that just buying the dividend paying stocks in the S&P will beat the S&P handily over time (2%+ per year).  Why pay fees to someone who can't explain basic fundamentals of investing to you when you can just invest on your own and beat the market? Don't be afraid to question.  When I get asked questions, it makes me happy that someone is basically asking me to prove I know what I'm talking about...everyone who has knowledge wants to show off their knowledge.  If they don't have knowledge, they will get defensive and not be able to show you.  That will also be how you know they are a speculator vs an investor.  A speculator is someone who doesn't have a basis for making decisions and they are basically just throwing darts at a board.  Can they be right at times?  Of course! During any bull market, like the one we are in now, anyone can look brilliant.  But those who follow the trends will lose when the trends fall out of favor, which happens when markets turn and it gets ugly.  Don't follow that person.  It can be hard, though, when the herd is your buddy at work or your neighbor bragging about their 35% gains last year. Oh, and the stock market is still vastly overpriced.  Still waiting for my 40-50% bear market. In case anyone forgot.  And if you asked me why I think that, I would have many logical answers.  Because I'm not afraid to have the answers....
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Is It Really That Hard To Beat the S&P 500 over time?

Since I started investing almost 20 years ago, the goal I had always read about was beating the S&P 500 over time.  Mutual funds were, a lot of times, compared to that benchmark for performance and it was amazing how it didn't happen much at all.  When I read books about Graham/Dodd, Buffett's mentors, they always stated they had the goal of making 2.5% better than the S&P 500, annualized, over time.  It may not sound like much, but if you do the math, if market gains 10% per year for 40 years and you are able to do 12.5% per year over 40 years, you are talking about 2.5 times more money! $1MM, after 40 years, would be $45MM @ 10% per year but $111MM at 12.5% per year and that assumes not adding anymore money.  So it's quite considerable.  It makes it all the more impressive that Buffett has been able to achieve returns almost 10% more per year than the S&P 500 over a nearly 60 year career. So how hard is it really? I recently purchased a Bloomberg machine, which is a great machine that will allow me to pick different stock screeners and then backtest them as far back as 25 years in some cases.  It will then show me the per year returns vs the S&P 500 and it even allows me to select how often I rebalance.  So I decided to take a few swings to see how it would do by using some of the things I have learned in the past about equities that work over the long haul by many value investors.... What was the result?  If you stayed disciplined and followed the same rule, year after year, it actually was not hard at all to beat the S&P 500.  Yes, there were many years in which you didn't beat the S&P, but over time, you easily beat the S&P and then some. And it didn't take convoluted and complicated attributes to search for.  (More on that in another post). So why do so many money managers fail to beat the S&P 500 year after year and over long periods of time?  Well, that's when human nature comes into play. Money managers chase returns.  They're almost forced to, which is sad, but it is the business they are in.  Granted, they tend to not do a great job explaining the reason for their investment decisions and they tend to be made because other managers and the market are doing well in certain areas, but the bottom line is, it proves that chasing returns is a sure way, in the long run, to lose.  When you finally get to the party, as has been proven time and time again, you will find that everyone has either left or are on their way out. Side Note: I have found a very nice screener that over a 22 year period beat the market by over 4.5% per year.  Based on the # of stocks in that screener each year, I was VERY pleased to see the results and I will discuss, in more detail in another post, what I found with this screener.  Unfortunately, I won't be offering the exact screener because then my work on the Bloomberg machine I paid for will be released and I'm too selfish to give away the things I have spent time looking for.  :-)...
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I’m Back

There has been a large gap between my most recent posts.  It's been hard to keep writing the same thing over and over again, and to watch the market continue to go higher. I have not given in and bought into this market, though.  I am still going to keep that patience because the higher this goes without any substantial increase in fundamentals, the more I know that things will revert back and revert back in a strong way. I recently purchased a Bloomberg machine which allows me to backtest stock strategies over the past 21 years.  That's annoying, however, considering I would want to backtest going back 40-50 years, to see how my strategies would have faired during secular bull and bear markets.  Now...with that in mind, going back 21 years, the stock market total return has been about 9.5% per year which is actually lower than the 100+ year historical average of 9.9%. Since September 18th, we have had a nice pull back on the S&P 500 and I love seeing the pundits on TV talking about how this is a great buying opportunity. Of course it is...if you want to ignore all fundamentals and historical valuation metrics that have proven to be accurate.  Market Cap to GDP ratio, which Warren Buffett describes as probably the single most accurate stock market valuation metric at any given time, is at levels that have only been rivaled by late 1999 and early 2000. Based on these metrics, the 10 year outlook on the S&P 500, including dividends, we are near 0% returns, annualized, per year for the next 10 years. That's awful. Historically, the market should be making 10% per year, so to get to that kind of valuation, the market has to drop in half to get the expected 10% per year annualized return.  It sounds unreasonable?  Ok.  The same thing was said after the mid 1970s cyclical bull market.  ...
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The Story Hasn’t Changed

I haven't posted in a while.  It's been a frustrating year.  I was getting excited when the S&P started the year down 5%. I thought "This is it!"  And of course, I was wrong. I keep reading more and more people say that we are in the beginning parts of a new secular bull market.  I actually get upset when I read that.  It's so unbelievably dangerous.  Secular markets start and end based on valuation.  We are at all-time historical highs in valuation.  Higher values than even 1999 and 1929, in many regards.  Secular bull markets have started, in the past, when the stock market to GDP ratio has been sub 50%, and right now we are at 130%! Patience is a virtue and I lack it in every aspect of my life...except investing.  I've been blessed with that ability to be patient.  Has it been trying?  Of course.  But these cycles do take time.  As John Hussman said in his post tonight, and as a former partner of mine always says "Market tops aren't just points...They are processes.  We are in the process, hopefully, of this.  I say "hopefully" because I have been wrong for quite some time. But I do feel good knowing that the longer I am wrong, the more likely the devastating result that will follow.  Thinking that another 50% drop (3rd in 15 years) is not likely is a fool's wish.  History has shown that during times of immense overvaluation, prices fall, fundamentals don't rise. For those reading this who think I'm kooky, keep on thinking it.  It's been hard thinking otherwise.  But again, please don't say "it was so obvious" in a few years when the market has fallen 40%.  It's just insulting....
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Survey Results – What is the Best Asset Class to Invest In?

As you have seen on the site, you get a survey popping up when you visit. This is not meant to annoy but I genuinely want to see what my readers think of things in the economy and investing. On March 28th, I put the question up: What is the Best Asset Class to Invest In?  Here are the results BestAssetClass                   I am not going to lie. I was surprised. 48% said Real Estate! So let's think back to 2009.What would investors have said about this five years ago? Real estate and stocks would have been at the bottom, right? So my point here is this:  People follow investments usually in the later stages of their big increases in price.  The key is to find these assets when others don't want them.  Gold, a few years ago, was untouchable! Now it's only the favorite of 12% of my readers. Think independently people.  You can't chase returns.  You have to think and look at true value and not care what others think.  That's the only way to get above average returns.  If someone tells you otherwise, they are lying to you to get your money and charge you fees or commissions.  Plain and simple....
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When Value Buying Can Bite You in the Ass

Ten years ago, I was given the option to buy shares in an IPO for a small company called Google. You may have heard of it.  I looked at the financials and thought, "Jeez, this thing is overpriced." So I ignored it.  The IPO price for early buyers was $60, I believe.  It currently sits at $1200 per share.  1900% increase.  Drats. So here is one of the rare examples of when value buying ends up having you lose out in the long term.  First off, I think Google is worth around $650 a share right now.  I know I know.  That's almost 50% lower than it sells for today...but it does sell for a premium. But in 2004, Google had $3Billion in sales and last year it had $60Billion in sales.  So clearly they are a growth machine.  They have done a great job meeting expectations and leading the industry in ads and it prints money.  Who would have guessed that back then?  Not many, I would presume. So do I beat myself up over this?  Yes and no.  Of course I wish I had done this, so I am upset about that, but if I had invested in Google back in 2004 based on what I saw, then I would have lost TONS more money on other IPOs now and in the future hoping for the same result and would have probably given back all of the Google gains over time. Having a plan and sticking to it...assess your work over years and years and many investments, not the short term and a few investments.  Warren Buffett and Ben Graham and all of the investing greats didn't beat the market each year...in fact, when years were good for the stock market, they tended to lag.  But they stick to their system and when times are bad, they tend to fair pretty well....
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