Author: expectingalpha

Resolutions: Of Chocolate and Lemonade

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Did you know that the fourth highest day of chocolate consumption is January 4th? Yes, trailing only Easter, the Christmas season and Valentine’s Day, that fourth day of every new year marks the collapse of our dreaded new year’s resolutions. You know the routine, “I’m gonna lose some weight, eat less chocolate, stop smoking and drinking and commit some time to getting my investment efforts in focus.”

Be It Resolved…

But four days? I’ll plead guilty to participating in this annual slaughter of good intentions. “No really, I’ll spend more time every day at the health club, just as soon as I can remember how to get there, Dear.”

A funny thing happened on the way to this year’s moment of fleeting resolution. I finally made one that I can feel pretty good about breaking. I pledged that this year I’d refrain from making resolutions. True to form, I began breaking this non-resolution immediately. I haven’t had a cup of coffee yet this year and I’ll confess that this “simply happened.” We’ve closed all of our fugitive investment accounts, consolidating them in a place that we can monitor and maintain using the philosophies and methods you’ll find at Manifest Investing. We’ll be continuing and redoubling our efforts to help groups of employees understand and optimize their defined contribution plans.

If you’re fairly new to investing or new to the concepts presented at Manifest Investing / Expecting Alpha, I want to take a moment and extend an extra special welcome to you. Becoming a committed, patient and strategic long-term investor is probably the most exciting thing that you can do about your future and the well-being of those you care about the most.

Natural Fear

“But I don’t understand all of this investing stuff?” I save my greatest fears for the things I understand the least. I suspect that you have some of the same feelings about uncertainty. If you’re feeling a bit overwhelmed, I want to share something one of my colleagues taught me a long time ago.

She’d been participating in a series of online discussions about stock analysis and long-term investing. She admitted that the avalanche of buzzwords and jargon was making it difficult for her to keep up. But she also shared that she simply kept a file of notes and index cards. Whenever somebody talked about something she didn’t understand, she’d file it. Then she’d periodically revisit the folder to see if there were any cards she could throw away. As time passed, she emptied the folder and discovered a peaceful confidence with her investment decisions.

The rest of the story? This lady ultimately went on to write a column on investing for a magazine!

This approach, or something similar, might work for you. But don’t make any resolutions about it!

An Antidote to the Fear

My experience with my first stock purchase is etched in stone in my memory. With CNBC blaring, I’d taken the afternoon off from work to use my Schwab account for the first time. I’d read some magazine articles and was convinced that Waste Management was destined for greatness. I set some steaks out for the celebration of our arrival as individual investors when my spouse got home from work. With sweaty palms and chronic “stage fright” I finally held on to the receiver long enough to give my purchase instructions to the broker. I hung up and lost consciousness. I recovered to watch the last fifteen minutes of ticker tape for the day. WMX 35… WMX 34 1/8… WMX 34…WMX 32 3/4… WMX 31 1/2. I lost consciousness again. My carefully considered investment had lost ten percent of its value in 15 minutes on this suddenly gloomy Friday afternoon. My wife came home, put the steaks in the freezer, and got out some hot dogs for dinner.

The fear is natural. But there are some answers. Conquering the fear and maintaining the patience and commitment to virtually anything is usually easier when you do it with friends.

Manifest Investing is approaching its 8th birthday. We support the promise and potential of investment clubs for people who want to embark on a life long journey of successful investing. Investment clubs are educational vehicles. Our community of long-term investors is unequaled and a considerable resource for people trying to remove the mystery and become successful long-term investors. If you’re not a member of this community, you should be.

Five Things Investors Need to Understand

Your objective as a serious long-term investor is actually pretty simple. You want to do well. Your version of “how well” is up to you and you’ll learn about the importance of sleeping at night as you continue your investing journey. I believe that reasonable expectations are important. I do not expect to achieve 40% returns year after year. I do expect the returns from my investments to range from one-year drops of 20-30% to single year gains of as much as 50%.

But over the long term, I expect my returns to slightly better (3-5%) than the general stock market. The accompanying figure shows the returns for any given year since 1941. We see that most years, the annual result ends up between 0-30%. In fact, the average annual return for stocks has been approximately 10%. Do you see the “bell curve?”

Annual Returns for the Modern Stock Market. The modern stock market is the period following the reforms of 1932-33 and 1940. Take a look at the returns for the years starting with 1941, a uniquely bad year and 1945, a uniquely good year. Think about world conditions at the time. Note the ebb and flow as the decades roll by. Notice how unprecedented the late 1990s were, as consecutive years all landed to the right. The frustration of 2000-2002 gave way to better times in 2003 and 2004. Sources: Manifest Investing LLC, Ibbotson Associates.

The annualized total return for our Tin Cup demonstration portfolio since 1995 stands at 18.7% during a period when the stock market has advanced 6.4% per year. I believe that aiming for returns that are 3-5 percentage points higher than the general stock market has a decent chance of achieving that goal.  Not every year will be a bed of roses but we spend a lot more energy focusing on the results on the right than the left — all the while remaining focused on the windshield and NOT the rear view mirror when it comes to designing and managing our portfolios.

The first thing we need to understand (and have) is an objective, a target total return. Most people understand annual returns. If you’re offered a certificate of deposit with a 4% return or one with an 8% return with identical terms, most of us would choose the higher return.

Scores of investment clubs achieve long-term annualized returns that exceed market benchmarks. We’ll share details and lessons learned from successful portfolios and mutual funds in future articles. The point is, it is possible to achieve market-leading returns over the long run.

Taking aim at that long-term result requires that we understand expectations for the individual investments that comprise our portfolios. We need to build portfolios with enough return expectations to achieve the objective. Much like caring for a garden, this is a never-ending vigil. We also need to understand the differences between weeds and desired plants. This is the role understanding investment grade, or quality, plays in our efforts.

Using the methods discussed here, the expected returns and quality are built from three characteristics: projected sales growth, profitability and value. Think G-P-V.

Despite all of the buzzwords, it really boils down to common sense. Our son and daughter and our nieces and nephews used to build a lemonade stand while visiting my parent’s house. Mom and Dad lived on a golf course and the stand sat in the middle of some shady evergreen trees. Golfers do get thirsty. It was a good business model. Needless to say, the enterprise was pretty profitable. What was the business worth?

That depends. How much did the lemonade mix cost? What did these young entrepreneurs charge and how much was left after reimbursing my mother? Would it have made sense to launch another location? An income statement is no more complicated than that. How much more will the golfers drink? What profits will be left after paying all the bills?

Common stock investors own a piece of the business, a stake in the profits. A stock price is nothing more than the most recent result of a price negotiation. It doesn’t always resemble what the business is worth. That’s where the value (or valuation) comes in. We’ll take a closer look at valuation next month and attempt to demystify this challenging concept a bit. For now, think Growth-Profitability-Valuation and that this leads to an understanding of quality and expected returns. This is the core of our MANIFEST method. “Less fear.”

Jan-2013 Screen: Creme of the Crop

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Creme of the Crop

This month features the top percentile of all stocks covered at MANIFEST on the basis of return forecast and quality rating.

Overall Market Expectations

The median projected annual return (MIPAR) for all 2400+ stocks followed by MANIFEST (Solomon database) is 8.4% (12/31/2012). The multi-decade range for this indicator is 0-20% and an average reading since 1999 is 8.5%.

January Effect: Study Hall

We generated this month’s list of stocks by simply search for all companies with a MANIFEST Rank > 99 while limiting the field to financial strength ratings greater than 70 and EPS Stability of at least 60.

Screening Results (12/31/2012). Top-ranked high-quality stocks with solid return forecasts. All qualifiers also have an EPS stability of at least 60 and a financial strength rating of 70 (B++) or better.

The results are shown here in the accompanying table. With MIPAR at 8.4%, we compare it versus the long-term average forecast which happens to be 8.5%. So we’re literally looking at fairly average return conditions. And in times like this, it probably makes sense to tighten down the hatches — seeking higher-quality candidates with a little more financial strength. In the event of the next recession, we want to be well represented by industry leaders with superior profitability and relatively little debt. Likewise, in order to avoid cyclical whipsaws (and since earnings are the source of dividends) … we’d urge higher EPS stability ratings while bolstering our core holdings.

This month’s screening result delivers a smorgasbord of companies that fit this bill. In fact, virtually all of the companies that we’ve added daily to the Core Diem portfolio since October are here in this month’s results.

AeroVironment (AVAV) engages in the design, development and production of unmanned aircraft systems and energy technologies for various industries and government agencies. Whatever you think of drones, they’re here to stay. As I watched my 70-something grinning father-in-law open a remote operated helicopter on Christmas morning … these things have a lot of staying power.

Coach (COH) has been a repeat Solomon Select feature (Jun-2006 & Oct-2008). Wall-to-wall standing room only at the outlet mall this holiday season. Across the way, a much larger Michael Kors (KORS) store was COMPLETELY EMPTY. Not sure how much of a competitive threat KORS can be. Bag this one.

Masimo (MASI). November 2011 Solomon Select. Non-invasive. We still like this one a lot. And when you can’t invade, send in the drones.

For Whom The Bell: Annual Market Returns

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One of our favorite graphics to explain the vagaries of annual stock market returns to beginners (and to remind all of the rest of us) is shown here:

We start with 1941. We believe that anything before that reflects something different. The SEC was founded in 1933 in response to the Roaring Twenties and Stock Market Crash of 1929. The Investment Company Act followed in 1941 — so we think the modern stock market was established at that point in time.

The graphic displays the results of individual years ranging from the “special” (unique and virtually unprecedented) performance we experienced in 2008 with its -37% total return … up to the returns witnessed in 1954 and 1958.

It’s helpful to remind and be reminded that the results of any given year can pretty much plop anywhere from -20% to +40%, in general. But much like a bell curve, the most common results are concentrated between 0% and 30%.

Walking Main Street: 2013 Challenge

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And that walk is anything but random.

It’s the kind of walk you take after rolling out of bed, rejuvenated while practicing prudent and effective sleep-at-night investing. This morning Eddy Elfenbein rolled out for the sixth consecutive New Year’s Day after watching his 20 Buy List stocks outperform the S&P 500 over the trailing year. Six years in a row. How many funds have outperformed the S&P 500 every single year over that time frame?

Nada.

There’s a single fund that is 5-for-5 (didn’t exist six years ago). The fund (PSLDX) is a hybrid that appears to invest in stock futures and a blend of bonds. So it’s not even a direct comparison.

Eddy’s 2013 Buy List, as always — is a low turnover (no changes permitted during the calendar year) — collection of 20 stocks. They’re predominantly core stocks with a few special situations. Our tracking dashboard for Eddy’s 2013 Buy List is available here:

Crossing Wall Street: 2013 Buy List

Main Street

We sleep pretty well too. And we’ll have some fun with the (20) best-positioned stocks from your 40 most widely-held stocks as shown in the accompanying listing.

It’s not a zero sum contest. We actually hope that Eddy will roll out successfully for a seventh straight year and that our favorites will join him.

For kicks, we’ll also add a group of honorable mention entries to our Christmas Countdown collection bringing the total to (20) and compare all of these participants side-by-side as 2013 progresses.

Coca-Cola (KO)

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The 12th stock in our Christmas Countdown is Coca-Cola (KO).

It doesn’t pay to argue with Santa Claus. It’s apparent that when he’s done rocking the world and stocking homes with presents from Alaska to Zealand (New) that he settles in for the polar bear drink of choice, Coca-Cola: The Real Thing.

This high-quality company doesn’t often drift (or bubble) to the highest return forecasts but the quality rating is steady and top shelf. In this case, the Value Line low total return forecast is 10% — still a couple of percentage points above the median stock. In the accompanying visual analysis, we see a company growing at 5-6%. (The years before 2011 have been suppressed and removed from the trend because the data array wouldn’t include the combination of Coca-Cola Enterprises.)

Coca-Cola delivers steady profitability and is diversified into water, sports drinks, fruit juices — beyond the legacy soft drink beverage.

It’s the kind of company that won’t set a portfolio on fire but can be a bolstering buffer if things get dicey in any given year.

And with that — let’s hope for the best for our (12) countdown stocks in 2013 because we know that many of you hold them in your portfolios.

On Dasher, Dancer, Comet, Cupid …

Happy New Year and Good Luck Everybody!

The complete Countdown with links to the individual features can be found here:

Christmas Countdown 2013

MANIFEST 40 (December 2012)

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The Stocks You Follow: December 2012 Update

We’ve always believed that the collective decisions made by our community of long-term investors is worth huddling over … a place where ideas are born.  Your MANIFEST 40 is a tracking portfolio of the forty most widely-followed stocks by the community of long-term investors at Manifest Investing.

Apple (AAPL) continues in the pole position in our quarterly update.

One of the biggest surges comes from Bio-Reference Labs (BRLI) as the company moves from #7 to #3 in the new rankings. Microsoft (MSFT) slipped from #4 to #6?

Coach (COH) also has been quite popular of late — since the price pulled back — and has moved from #18 to #10.

Performance Results

It is here that our community shines. The average annualized RELATIVE return for the current tracking portfolio is +4.5%. (The absolute return for the tracking portfolio since inception is 6.3%.) The accuracy rating (% of outperforming picks) of the current selections is 62.2%. (!) Including all selections since inception (7.25 years), the annualized relative return of the MANIFEST 40 is +3.3%.

The figures in parentheses are the position of the company during the September 2012 listing of the MANIFEST 40. For example, Fastenal (FAST) moved from #15 to #12 over the last three months.

MI 40 20121231R

Chargers

What companies are making the strongest gains among this consensus collection? This may be indicative of strong fundamentals (combined with attractive prices and returns) and probably warrants further study.

The companies making the largest advances (by percent of dashboards) since 9/30/2012 are: Res-Med (RMD), Coach (COH) and Bio-Reference Labs (BRLI).

The newcomers this quarter are Intuitive Surgical (ISRG), Paychex (PAYX) and QUALCOMM (QCOM).

Strongest Performers

The top performers in the MANIFEST 40 since inception are shown here:

The tracking portfolio (dashboard) for the MANIFEST 40 can be found here.

Well Played, Mayans!

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Mayans! Well played, Mayans. Well played.

First we had the Rapture a few months ago. And now, December 21, 2012 has come and gone.

As the last few hours of 2012 wane, we’re still here. We’re either heathens (avoiding the Rapture) or the Mayan Mother Ship got lost on the way back to pick us up.

But we’re still here. At least you and me, dear reader.

Perhaps our elected representatives have been counting on one or the other — while indulging in that multi-decade game of “kick the can” (down the road). Take it from one champion can kicker from the early 1970s … they’re not very good at it. Not really.

We got lots of questions about the fiscal cliff during the December 2012 Round Table session held this past Saturday morning. So it’s on the minds of many of you. Hugh McManus compared to something to do with flinging tomatoes to see if they’ll land (???) or something like that. One of my favorite depictions comes from Eddy Elfenbein who calls it a fiscal slope, not a cliff. And there’s not really a hard deadline — at least not in the context that’s being delivered to us.

I think of it as (1) a dramatic display of incompetence and (2) an epic bipartisan abrogation of responsibility.

In the Big Picture scheme of things, it’s material and a better plan needs to pursued and we need to unleash American energy in time-honored ways or we’ll face serious challenges ahead. But, it’s not the end of the world and neither are the forty two other things you’re being told to worry about these days.

During the Round Table, we celebrated something pretty cool. The overall relative return for our stock-selecting knights and collaborators has been mired since inception. It has generally ranged from -2 to -4 percentage points and languished over time. (Drum roll) We’ll close 2012 with a COLLECTIVE relative return (since inception) of +1.8%.

During the session, we added Coca-Cola (KO), Mesa Labs (MLAB) and Staples (SPLS) to the tracking portfolio.

Adding one of the world’s strongest and established brands, one of the best companies from October’s Forbes Best Small Companies and accumulating Hugh’s favorite deep value play all seem like appropriate things to ponder during these “final days.” Steady. Promising. Beaten down but with potential. Hugh’s perspective is uncommonly long-term. He sees stabilizing growth, a steadying and modest growth of the Staples store portfolio … restoration of profitability and a potential that a P/E expansion (currently 8x) could accompany a resounding recovery. The low total return forecast is approximately 30% if these dominoes fall into place and Hugh openly admits that he doesn’t know when … or IF … this will happen — only that there’s a finite probability that it could.

Ken Kavula lamented the 24/7 news cycle during our discussion of how faith in investing has leaped from a bunch of people who need it most. And we’ve all been around long enough to know that opportunities are created (close your eyes and think back to March 2009) when it’s darkest before dawn. PIMCO’s Bill Gross recently clarified that he didn’t mean that “stocks were dead,” but that “the cult of equities was dying …” and with that some of the excesses and exuberances just might be obliterated, at least for a while.

Those who leap with a little faith and prudent analysis just might discover and live an interesting journey.

And unless you’re in the shadow of the Mayan mother ship, there’s another dawn ahead and no better time to plan, prepare and select some opportunities to live through in years and decades ahead.

Value Line Low Total Return Screen (1/4/2013)

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Why do we pay attention to the Value Line weekly updates? Because a number of highly successful long-term investors cite Value Line as one of their favorite trusted resources.

“I don’t know of any other system that’s as good… The snapshot it presents is an enormously efficient way for us to garner information about various businesses… I have yet to see a better way, including fooling around on the internet, that gives me the information as quickly.” — Warren Buffett, Berkshire Hathaway, 1998 Annual Meeting speaking about The Value Line Investment Survey.

“[Value Line is]…the next best thing to having your own private securities analyst.”
—Peter Lynch, One Up On Wall Street

In our case, we’ve found the low total return forecasts for all companies to be among the most compelling opinions/forecasts while we either (1) search for opportunities or (2) practice effective stewardship when it comes to staying vigilant about our current holdings.

And in this case — this week — we find an outsized number of opportunities as the average Value Line low total return forecast (11.5% as shown in the accompanying figure) for the companies in Issue 7.

Materially Stronger: SanDisk (SNDK)

Materially Weaker: Western Digital (WDC), Questcor Pharma (QCOR), Skullcandy (SKUL), Benchmark Electronics (BHE), Pitney Bowes (PBI), International Rectifier (IRF), Advanced Micro Devices (AMD), Intersil (ISIL), PMC-Sierra (PMCS)

With the median low total return forecast (for all 1700 stocks) at 8.7%, we’ve found that shopping in the range where the return forecasts are 5-10 percentage points better than the market average. In this case, we’d be drawn to Intel (INTC), Logitech (LOGI) and Cree Research (CREE) as they’re closer to the “heart” of the “sweet spot.”

This graphic provides a quick check (second and third opinions) versus the Value Line forecast for the featured companies. The second and third opinions are from Standard & Poor’s (S&P) and Morningstar. A comparison is made versus the fair value (FV) opinion expressed by both of these research services. In the case of Staples (SPLS), the elevated low total return forecast aligns pretty well with the Value Line opinion — but the Morningstar analysis doesn’t even think Staples is undervalued at these levels with a Fair Value Ratio (FVR) greater than 0%. (For Fair Value Ratios, negative figures suggest stocks that are potentially undervalued or “on sale.”)

Our experience is that the S&P opinions are more reliable when it comes to non-core stocks and/or special situations. The Morningstar analysis seems to correlate more closely with our methods when it comes to core stocks.

In the case of Staples (SPLS), we’d lean towards the S&P judgment and agree with Hugh McManus. Hugh presented Staples as his featured stock for the December 2012 Round Table — fully noting and disclosing that challenges lie ahead. We’ll take a closer look at Staples (SPLS) with a full analysis as well as Intel (INTC) as it appears relatively well-positioned here.

Note the different opinions from S&P and Morningstar on Apple (AAPL). As noted, for special situations — we’d place more credence on S&P in these situations, and see Apple (AAPL) as less undervalued than most people think it is.

Happy New Year, to stock hunters everywhere!  May the new year find good hunting and exceptional returns.

Cherokee (CHKE)

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The 11th stock in our Christmas Countdown is Cherokee (CHKE).

As the Motley Fool suggested a while back, you have to “look beyond the earnings” (translation: weak track record in recent years) when performing analysis on Cherokee. The company has clearly struggled while at the same time making considerable progress in recent quarters. The new acquisitions and relationships seem to be taking hold and if the company can regain some of its luster of a few years ago, significant price appreciation (along with above-average dividends) are possible here.

We know about turnarounds and our expectations are conditioned accordingly. That said, every one in a while it’s OK to reach for a Christmas miracle.

With a sales growth forecast of 6% (that could easily ramp to 6-12%), a net margin of 29.3% and a projected P/E ratio of 15x, the long-term return forecast is 19-20% (per annum).

A Little Grace & Abbott Labs (ABT)

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From the time-honored vault: Originally published on 12/14/2010, this entry into that year’s Christmas Countdown carried a powerful reminder about the sometimes silent power of long-term investing.
The second company in our 12-day Christmas Countdown is Abbott Labs (ABT).  Abbott Labs has been featured prominently at Manifest Investing in our Sweet 16 screening results for the December newsletter and ABT has been selected twice for the MANIFEST Round Table (more on this to follow) and we regard the company as a core, or bolstering, holding with consistent steady results over the years … Speaking of “over the years,” I don’t know about you, but I get a little reflective and nostalgic as December marches on and the new year approaches.  In this case, our selection of Abbott Labs gives us an opportunity to revisit a story shared by Sharon Serres back in March with the MANIFEST community.  It’s the story of Grace Groner — one of those legendary literary little old ladies.  Grace worked for Abbott Labs and had done so for decades, holding a few shares that she’d purchased decades ago.  I don’t know what other stocks may have resided in her portfolio, but when Grace passed away earlier this year, she left behind an awesome gift for her alma mater, Lake Forest College.

It’s seems fitting to me to celebrate a little grace (in this case, a LOT of grace) during the holiday season.

Abbott Labs (ABT)

No stranger to investors in our community, Abbott Labs (ABT) is a global, broad-based health care company devoted to discovering new medicines, new technologies and new ways to manage health. Products span the continuum of care, from nutritional products and laboratory diagnostics through medical devices and pharmaceutical therapies. The comprehensive line of products encircles life itself – addressing important health needs from infancy to the golden years.  ABT is recognized as a global enterprise with the ability to serve customers around the world.

Throughout its 120+ year history, Abbott people have been driven by a constant goal: to advance medical science to help people live healthier lives. It’s part of their heritage.  Today, approximately 90,000 employees around the world share the passion for “Turning Science Into Caring.” It’s a commitment to focusing on what matters most: life and the potential it holds when we are feeling our best.

Stock Study and Equity Analysis Guide

Q: Why do we do stock studies?

A: To build a vision of what a company (stock) might be worth in the future.

That vision includes two core components: a five-year earnings forecast … and an estimate of the average value (projected P/E ratio) that we believe investors will be willing to pay — based on our assumptions, judgments and careful considerations.

Any stock study is basically a fill-in-the-blanks quiz.  If (company name) can grow sales at ____%, achieve a profitability of ___% for net margin, and if a reasonable price-to-earnings ratio (P/E, essentially the foundation of the value of any company) would be _____x … then the projected annual return (PAR) could reasonably be:  _______%.

In the case of ABT, our answers are (1) 9% … (2) 18% … and (3) 15x … for a result of 17-18% projected returns.

As I mentioned before, we’ve featured Abbott Labs frequently over the last several months.  Recently, I covered it as I discussed some screening results and shared the study results behind the answers selected for the quiz above.  You can view a video (including powerpoint discussion with audio) here:

http://www.youtube.com/watch?v=BU3ECwHXMww

Our next Round Table session is scheduled for [12/29/2012 at 11 AM ET] … with more details and information here:

http://www.manifestinvesting.com/events/103-round-table-december-29-2012

We look forward to discovering a little more grace and formidable long-term investments like Abbott Labs during our Round Table session.