| "Men get opinions as boys learn to spell, by reiteration chiefly." |
| -- Elizabeth Barrett Browning |
NE THING'S FOR SURE, YOU may not know where the market's going, but you know it'll be volatile getting there. At present levels, daily Dow swings of 100 points are no longer newsworthy. Of course that doesn't mean they aren't any less gut wrenching.
Volatility, especially on the downside may have you questioning a number of things. Perhaps a professional's assistance might help you see things more objectively. Perhaps not. A Losing Bet is an example.
Maybe you've gone so far as to question your overall investing philosophy. That could be appropriate, but before you make any wholesale changes, be sure you know what you're presently doing. Gralue can help you find where you presently fall on the spectrum.
What are your thoughts and observations? Let us know. We're always looking for ideas for future comments.
It's times like these when the calming words of an investment professional can help take the emotion out of your decision. Professionals have been through this before and should be able to offer some objective experience you may be lacking. But unless your professional is a quantitative computer program, he or she's human, too, and still subject to some of the same shortcomings as the rest of the investing populace. Unlike us, however, when they goof up, they still get paid for it. We can, of course, learn from it. Let's take a look at an example.
Back in August of 1992, on the advice of their value-oriented investment advisor, a business purchased 1000 shares of Food Lion. If you're not familiar with the company, it's a supermarket chain concentrated primarily in the Southeast. Their major claim to fame is their "extra low prices."
In the late eighties, Food Lion had made an ill-advised foray into the Texas market. By the time they realized their mistake, the stock had taken quite a tumble. Naturally it popped up on the radar screens of many value investors, and that's why our corporate investors were advised to buy.
Six months later, they had another opportunity to buy. The TV "newsmagazine" 20/20 ran an expose essentially claiming Food Lion had decorated for Christmas by putting green as well as red meat in the meat case. According to the report, meat was systematically being repackaged and sold when it was well beyond its sell-by date. Investors fled the stock as it fell almost 30% from the August price of $10.875 to $7.875.
What would you do at this point? Our investors weren't panicking, but they were starting to question the logic of holding on. Their advisor convinced them that it was even more of a value now, so it would be foolish to abandon it at the bottom. He was so persuasive they bought another 2000 shares.
Over the next 22 months, the stock continued its slow, torturous decline to $5.125. Throughout that time, the investors continually questioned the advisor about the value of holding on. Each time he rebuffed their suggestions to sell by challenging them with this bet, "I'll pay you $1000 for each point Food Lion falls if you agree to pay me $1000 for each point it rises."
That's pretty compelling! With the stock trading between $5 - $7, the advisor was only on the line for $7000 tops. On the other hand, the appreciation potential had no cap. The investors, reasoning it would be foolish to take such a bet, held on. Ah, the calming words of an investment professional.
Finally, in December 1994 when Food Lion had fallen to $5.125 and against the ongoing advice or their advisor, the investors sold it. In the four years since then, Food Lion has traded up to $12. Based on the February 1993 price ($7.875), the advisor would have won the bet. Was his advice vindicated? Absolutely not.
What went wrong here? Essentially, the bet is the wrong bet. It misstates the options. Sure, Food Lion had very little risk of additional loss and much more room to appreciate. But how long would it be before it turned around? How far and how fast can a company in a relatively slow-growth industry turn around, especially when it had its own serious problems to overcome?
In short, Food Lion wasn't the only game in town. If the investors sold it, they wouldn't simply hold the proceeds in cash they would invest it in an alternative. The decision to hold or sell is no different than the initial decision to buy. It isn't a question of measuring Food Lion's potential loss vs. potential gain but rather estimating its potential gain vs. alternative investments.
When you buy a stock, you forego buying all the others. You buy a stock because you think it will do better than the alternatives not because it has less to lose. If this is how you make your investment decisions, all you're doing is minimizing losses, not maximizing gains. You may as well put your money in your mattress.
If you are trying to maximize gains (as these investors were), then the correct bet should have been, "I'll pay you $1000 for each point your It sure was in this specific case. When the investors finally followed their instincts rather than their professional advice, they took the proceeds from the Food Lion sale and bought GE. The accompanying chart shows these stocks' relative performance from that trade date.
Of course, it may have just been good luck that they chose GE but the bottom line is almost any stock would have outperformed Food Lion over that period. Perhaps the advisor would have changed his tune and finally recommended the sale, but odds are he would have kept offering his misdirected bet, forfeiting potential performance. If that's all these investors wanted, they'd have been better off letting the advisor go and using his fee to purchase a good mattress. Sometimes common sense is preferable to "professional" advice.
A lot of things are like that, take value and growth investing. The two styles are constantly being compared. Proponents of each are always anxious to tell you why their method should be preferred. Each year statistics are compiled to show how one compares against the other. These findings would be a lot more compelling if things were black and white.
But they aren't. To be sure, some investors strictly adhere to one discipline or the other but they're really in the minority. While most will tell you they're either value or growth investors, they're really a combination of both. There's really nothing wrong with that, in fact, it makes a lot of sense.
Similarly, pure value investors seek stocks that are "cheap" relative to the market or their historical valuations. But if you stop there, you risk buying some real dogs. After all, if a stock is cheap there's usually a reason for it. Either its industry is out of favor or it has some specific problems. If it doesn't have the potential to turn it around -- to grow -- then it could stay "cheap" for quite some time. Read: dead money.
It's because of this that most value investors incorporate some screen for potential growth. For example, this page's value approach considers growth momentum … We're still value investors, just not "deep value".
Finally, at the center of the spectrum you find approaches incorporating both styles. Investors here Where do you fall? Probably not at one of the extremes, and that's OK. After all, growth without value is quite akin to gambling while value without growth is dog catching. The important thing is to have a specific style and stick to it. Success in investing comes from consistency. It's just not black and white.
"Nothing can be created out of nothing." -- Lucretius
ERE'S A PROBLEM WE ALL encounter sooner or later: You do your homework and purchase a promising stock, but for whatever reason it goes down. In fact, it not only goes down, it goes down big. Do you cut your losses or hold on for a recovery? If you thought it was fairly valued before the fall, it ought to be an outright steal now, right? Or were you just mistaken in the first place?
Food Dog
Betting on the Dogs
Mattress Investing
alternative investment goes up if you'll pay me $1000 for each point Food Lion goes up." That's a lot different, isn't it?
"Everything looks worse in black and white." -- Paul Simon
EMEMBER BLACK AND WHITE TV and movies? Things were really simple -- the good guys wore white hats, the bad guys black. Then along came color and things weren't so simple anymore. Hats were different shades, even different colors. Even the good guys had some negative traits. The additional complexity added to the allure.
The Ends of the Spectrum
The pure growth investor buys stocks that he or she believes have the highest growth potential regardless of price. But most growth investors aren't this aggressive. They don't want to overpay for potential growth so add an additional element of valuation -- a value element. This is usually called "growth at a reasonable price", GARP for short.
Shades
As you might have guessed, investing styles fall along a spectrum. Deep Value and Pure Growth anchor the ends. Moving towards the center, you find Value and GARP, respectively. Remember, these are dominated by their namesake style but incorporate elements of the other.
apply growth screens for some stocks (e.g. technology) while using value parameters for others (e.g. utilities). The theory here is that value measures are most appropriate for some industries while growth parameters are more suitable to others.
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