All Of The Above Investing

This Morning’s Powerful Reminder About All-Of-The-Above Investing. We build and maintain portfolios with a sufficient number of small and medium-sized companies such that the overall growth forecast (weighted average) is approximately 11%. This assures that we’ll have a suitable balance of promising faster-growing smaller companies and large core/blue chip stalwarts.

$100 invested in the S&P 500 on 6/13/1997 would now be worth $314.85. (5.9%)

$100 invested in the Value Line 1700 Arithmetic Average ($VLE) would now be worth $820.50. (11.1%)

This Week at MANIFEST (12/30/2016)

This Week at MANIFEST (12/30/2016)

What I think a lot of great marathon runners do is envision crossing that finish line. Visualization is critical. But for me, I set a lot of little goals along the way to get my mind off that overwhelming goal of 26.2 miles. I know I’ve got to get to 5, and 12, and 16, and then I celebrate those little victories along the way.” — Bill Rancic

As most of you have guessed, our playful emphasis on Dow 20,000 is precisely that — playful.

We seem to pay way too much attention to essentially arbitrary piles of numbers and the rhinos life expectancy can be shortened by how they measure up quarter-to-quarter and year-to-year.

Brad Perry was right. A successful long-term investing experience is a marathon. And Bill Rancic is also correct, milestones matter. There’s plenty of noise, chaos and confusion that complicates life for average investors.

We’re thankful for a community of investors that is willing to focus on visions of the future and a willingness to imagine. We believe that our emphasis on return expectations and vigilance on fundamental threats and opportunity — is a path to better finish lines.

Value Line Arithmetic Average. Annual Returns. (1990-2016). The average annual total return for the equal-weight Value Line Arithmetic Average is 13.3% since 1990. The S&P 500 (VFINX) checks in at 9.3%. That Dow Jones Industrial Average that everyone is hyperventilating over has delivered 7.6% over the same time frame.

The November-December surge in the market pushed this year’s all-of-the-above index from 10-20% to 20-30%. This image will serve as the centerpiece for the January 2017 newsletter. Ask us again if we believe in a blend of small, medium and large companies as a crucial element of portfolio design and management.

MANIFEST 40 Updates

  • 1. Apple (AAPL)
  • 23. Intel (INTC)

Round Table Stocks

  • Apple (AAPL)
  • Intel (INTC)
  • IPG Photonics (IPGP)
  • Skyworks (SWKS)
  • Universal Display (OLED)

Best Small Companies

  • 6. Universal Display (OLED)
  • 18. Mellanox Technologies (MLNX)
  • 27. IPG Photonics (IPGP)

Results, Remarks & References

Companies of Interest: Value Line (12/30/2016)

The average Value Line low total return forecast for the companies in this week’s update batch is 2.1% vs. 3.4% for the Value Line 1700 ($VLE).

Materially Stronger: Logitech (LOGI), Seagate Tech (STX), Applied Materials (AMAT), Micron Technology (MU)

Materially Weaker: Fitbit (FIT), Cray (CRAY), Stratasys (SSYS), Nimble Storage (NMBL), 3D Systems (DDD), HP Enterprise (HPE)

Discontinued: Lexmark (LXK), Imgram Micro (IM), Skulcandy (SKUL), Fairchild Semiconductor (FCS)

Market Barometers

Value Line Low Total Return (VLLTR) Forecast. The long-term low total return forecast for the 1700 companies featured in the Value Line Investment Survey is 3.4%, up from 3.3% last week. For context, this indicator has ranged from low single digits (when stocks are generally overvalued) to approximately 20% when stocks are in the teeth of bear markets like 2008-2009.

Stocks to Study (12/30/2016)

There’s a wide variety of opinions in the manifest of stocks to study this weekend. But some community favorites, some widely-followed leaders and some of our recent Best Small Companies made the list.

The Long & Short. (December 30, 2016) Projected Annual Return (PAR): Long term return forecast based on fundamental analysis and five year time horizon. Quality Ranking: Percentile ranking of composite that includes financial strength, earnings stability and relative growth & profitability. VL Low Total Return (VLLTR): Low total return forecast based on 3-5 year price targets via Value Line Investment Survey. Morningstar P/FV: Ratio of current price to fundamentally-based fair value via www.morningstar.com S&P P/FV: Current price-to-fair value ratio via Standard & Poor’s. 1-Year ACE Outlook: Total return forecast based on analyst consensus estimates for 1-year target price combined with current yield. The data is ranked (descending order) based on this criterion. 1-Year S&P Outlook: 1-year total return forecast based on S&P 1-year price target. 1-Yr “GS” Outlook: 1-year total return forecast based on most recent price target issued by Goldman Sachs.

Best Small Companies (2016)

Best Small Companies (2016)

We lamented the decision by Forbes to discontinue their annual Best Small Companies list last year. 36 years in the running, the list provided a number of actionable opportunities over the last couple of decades for many of us. That said, while sticking to their core criteria, we may have actually improved the discovery and screening process. The returns posted by the lists, orphaned for two years now, have been 19.0% and 21.6%, respectively. For context, the Wilshire 5000 checked in at approximately 4% for both periods. With this experience under our belts, we head for the haystack in search of promising smaller companies to bolster our all-of-the-above investing discipline and hoping for a solid January Effect.

The Russell 2000 (RUT) gained 2.5% from 10/31/2015 through Halloween 2016.

The Wilshire 5000 (VTSMX) did a little better, checking in at 4.1% during that same period.

Every Halloween, we remind our fellow investors to be extra vigilant for opportunities among smaller, faster-growing companies, during the 4th quarter of the year. History suggests that some opportunities are created by tax-related selling. The smaller companies are impacted the most and those with solid expectations often get a stock price boost during January when investors return after wash sale periods expire.

Small Cap Does Not Mean Small Company

It’s also a time when we are reminded that small cap does not mean small company. As a case in point, the average sales growth forecast for the Russell 2000 (EQWS) is approximately 6.0% — the type of growth more closely associated with stalwarts and larger blue chip contributors. If you’re really looking for small companies, we suggest an emphasis on higher growth rates. This month’s fund feature is Conestoga Small Cap (CCASX) featuring an average sales growth rate of 13%. Go ahead. Check out the companies held by Conestoga. (See page 4.) In a word, they obviously shop for leadership small companies in much the same way that we do and can/should be considered a qualified source of ideas. Conestoga features a +2.4% (annualized) excess return versus the S&P 500 over the last ten years.

The criteria used to build the list is largely faithful to the Forbes traditions. Specifically, annual revenues were limited to less than $1 billion, but required to be greater than $50 million. We also required a minimum stock price of $5. Because we feel the sales growth forecast is the strongest characteristic to define “small” — we required a minimum growth forecast of 10%. No asset-based companies from the financial sector were included. And finally, when we think about “Best” we think the combination of quality and return forecast is a great place to start.

This Year’s Haystack

The companies that qualify for our 2016 Best Small Company Manifest are shown in the accompanying table.

Newcomer Meridian Bioscience (VIVO) checks in at #1. VIVO is covered in the Value Line Standard Edition and had a 16% low total return forecast (11/18/2016). Meridian Bioscience provides diagnostic test kits, purified reagents and related products, as well as biopharmaceutical enabling technologies. Products are marketed to hospitals, laboratories, veterinary centers, physician offices, diagnostic manufacturers and biotech companies worldwide. The company is headquartered in Cincinnati, Ohio and investors are encouraged to explore the investor relations materials at:
www.meridianbioscience.com

Diagnostics as a “theme” are fairly prevalent among the best small companies. Solomon Select feature Mesa Labs (MLAB) is one example and Mid-Michigan local favorite, Neogen (NEOG) is another. Both of these companies were “discovered” via the Forbes list and continue to qualify. Another company that qualifies as biopharma-enabling might well be Simulations Plus (SLP) but the company falls a little short of the annual revenues minimum.

We expected to lose last year’s #1, Forward Air (FWRD) to “graduation” but the recessionary conditions in transporting “stuff” kept FWRD below the $1 billion maximum. Forward Air had been a resident of the Forbes listing for seven years … so this makes it nine years for this logistics leader.

The top performer from last year’s best small companies was Ubiquiti Networks (UBNT) with a total return of 79.7%. Ubiquiti develops high performance networking technology for service providers and enterprises. UBNT is closing the digital divide by building network communication platforms and has 38 million devices worldwide. Ubiquiti just missed qualifying for this year’s list — ranking #41 as the UBNT return forecast is down to 7.9% following the robust performance over the last year.

 

Diagnosis: Ubiquitous

We think a ubiquitous haystack is a path to opportunity and success. We’re reminded that we can’t achieve proper balance unless we’re continuously searching for the next promising well-managed small company. We’re reassured by the presence of several long time favorites on this study list and look forward to discovering and diagnosing at will.

Wrong Way To View Investment Risk?

After a cursory review, I’m wondering if this book doesn’t have the potential to parallel (and rhyme with) Nicholson’s 1984 Individual Investor’s Manual and for that reason, I’ve ordered my advance copy for a closer look. As you read this overview, notice how often the things he says, starting with the definition of risk through the eyes of a disciplined long-term investor, the recovery following the Great Recession of portfolios like Tin Cup … and a host of other philosophies that we hold dear, including but not limited to our practice of all-of-the-above investing. (Note his references to the equally-weighted Wilshire 5000) His objective mapping even resembles our +5% mantra. I look forward to a closer look and sharing thoughts with our community of investors during a future book review.

Looking at Investment Risk the Wrong Way

by James B. Cloonan, AAII Founder and Chairman

We have all been looking at investment risk the wrong way. And unfortunately we have been paying dearly for this mistake. Please allow me a moment to explain this statement and to teach you how you can change your day-to-day investment approach to compensate for what has more than likely been years of under performance.

You can easily produce much more investment return if you are willing to embrace what I call Level3 logic and reason when dealing with your investment program. The simple truth is that every long-term investor will hit two, perhaps three, major market downturns in their investment life.

Historically, these major downturns take only 3 to 4 years to recover from (come back to even) if you were to do nothing but simply stay in the market. Remember, markets have historically always risen and that is a great advantage for the individual investor … But the financial press, CNBC and Wall Street has everyone brainwashed to believe that we need to put 40%, 50% or even 60% of our assets into so-called safe investments (bonds and cash). Investing with that level of safety is insane when you realize that since 1871 market downturns have recovered as follows:

  • 33% of market downturns recover within a month
  • 50% of market downturns recover within 2 months
  • 80% of market downturns recover within 1 year
  • 95% of the time, those big “once or twice in a lifetime drops” return back to even in 3 to 4 years with an appropriate portfolio

Collectively, since 1871 the time it takes for the market to recover (top to trough to top again) is a mere 7.9 months. (This context and perspective is urgent to understanding what we do and how we do it.)

Unfortunately, most individual investors watch daily, weekly, monthly and quarterly market moves like their life depends on it. The logical and far more reasonable way to invest is to put only what you will need to withdraw from your portfolio for living expenses over the short term into extremely safe (cash-like) accounts and to invest the rest of your assets in stocks. I define short-term as 3 to 4 years. This is a logical and rational use of funds that serve as a safety net that can be used to ride out any downfall Mr. Market throws our way. It also serves to keep us from having to focus on the near-term performance results of our portfolios. Having a near-term safety net allows investors to be more aggressive in the overall stock portion of their portfolios while being able to simultaneously ignore short-term market swings.

The equal-weighted Wilshire 500 index represents a much broader basket of companies and has a much larger number of small-cap and mid-cap stocks in its holdings. That smaller company skew is what propelled the Wilshire 5000 equal-weighted index up to an annualized return of 17.1% over the past 45 years (the longest data set available for this segment of the market).

Trust me when I say that long term most investors would be jumping up with joy to achieve just the S&P 500’s return. But the fact is, most investors fail to come even close to the overall market return, let alone our favored cousin – the equal-weighted Wilshire 5000. In-the-know researchers and studies from actual brokerage account transactions show that most investors get into and out of the market at the absolute wrong time. That coupled with their fixation on large-cap growth stocks has produced returns that are closer to 7% or 8% on an annualized basis.

Following the Level3 Investing approach that I have developed allows investors the ability to implement 3 investor advantages that can propel portfolio returns and generate huge sums of wealth:

Advantage #1—My Level3 Investment Strategy teaches you how to understand and use risk to your advantage by building a cash cushion that will weather any market downturn. Simultaneously the strategy frees you to put more of your assets into higher returning portions of the investment marketplace – individual stocks and a handful of passive ETFs (I call them forever funds.)

Advantage #2—Level3 Investment Research has tapped into academic and time-tested studies to show beyond a reasonable doubt that investment portfolio growth comes from small and mid-cap stocks not large-cap companies. So if you are a long-term investor, you should be looking closely at building up not only the overall size of your equity portfolio but the percent you equate to small and mid-cap stocks and funds. Remember, these are the types of investments that history shows have outpaced the overall market by more than 4% per year. Average investors produce 8% return, while a Level3 approach should produce 12%. Regardless of the size of your portfolio, that 4% difference will provide you with twice the assets of a regular investor in 18 short years.

Advantage #3—Level3 Investing drives home the use of Time Diversification. My new Level3 approach uses investment research that has proven that no matter how much the equity market collapses it historically has always exceed its previous high.We know that investing can be difficult when markets drop, but as an individual investor you must remember that history shows that all dips all crashes and all drops ultimately lead to higher returns. Market data since 1871 bears this out. And best of all, the kinds of stocks that Level3 investing favors are the kinds of stocks that rebound the fastest! Going forward, if you can keep the concept that time favors the individual investor in the forefront of your mind, you will find that investing becomes much easier.

If you are interested in becoming a Level3 type of investor, I encourage you to do the following …

Accept that true investment risk is not some arbitrary percentage downfall in the market this day, week, month or year, but that investment risk is actually failing to meet your retirement lifestyle goals because the funds we reasonably expect to have are NOT THERE when needed. That’s the Level3 definition of long-term risk, not having the assets needed to live the life you deserve!

Think about what it means to be a true long-term investor and recognize that any funds you need in the next 4 to 5 years should simply not be invested in stocks or bonds. Your near-term spending needs should be placed in money market accounts, CDs or savings. Thus when and if the market drops, near-term you know that you will have the funds needed to live your current lifestyle and not have to worry about selling at a bottom to get cash or fleeing the overall market because you are afraid of losses. This one simple strategy allows you to earmark the bulk of your overall assets into long-term Level3-type stock and fund investments that can generate wealth quicker than any other asset class.

Recognize that greater long-term [appreciation] comes from investing in smaller and mid-cap companies. If these types of holdings are not in your portfolio, consider adding them. You can start by looking into Guggenheim’s RSP or you can use the link below to purchase my new “Investing at Level3” book where I share a handful of ETFs that you could simply hold forever.

“Investing at Level3” is a refreshingly simple and historically proven way to invest that has the power to greatly impact your wealth as well as your retirement lifestyle.

The “Investing at Level3” approach, if followed diligently, could double or triple the value of a portfolio at retirement for the long-term investor when compared to today’s current investment practices. The book provides a research-driven yet easy-to-use approach to help individual investors with overcoming their unease with investment risk, investing while in retirement, investment selection, asset allocation, retirement funding and more.

Fondly,

James B. Cloonan
AAII Founder and Chairman

  • The Wilshire 5000 Equal Weighted index is not generally quoted and has no symbol. There is no fund replicating it because many of the stocks have limited float, but it does serve as a good proxy for the type of investing I outline in my new book “Investing at Level3.” If I have piqued your interest, current and past values can be found at Wilshire.com under the Wilshire Index Calculator. (This is why we use the Value Line Arithmetic Average, $VLE via www.stockcharts.com)