Buying Stocks: Don’t Succumb to The Siren Song of the Naysayers

by Alexander Green, Chief Investment Strategist
Wednesday, August 11, 2010: Issue #1321

Comedian Dennis Miller used to joke that he was at the airport when his ship came in.

A year from now, plenty of investors are likely to feel the same way. Why?

Because they’re ignoring the good news out there right now and not buying stocks. Instead they’re succumbing to the siren song of the naysayers.

And while no one can know for certain what the stock market will do in the year ahead, there are good reasons to believe that stocks may be substantially higher.

That’s because there are two traditional indicators that investors are wise to heed:

• Don’t fight the Fed
• Don’t fight the tape

Let’s take a closer look at each of these and I’ll show you why…

Don’t Battle with Bernanke

As we all know, the Federal Reserve has taken short-term interest rates to near zero. Moreover, Fed Chairman Bernanke has repeatedly said that he expects to keep them there “for an extended period.”

This is a green light for Fed-watchers. Low interest rates…

• Make it cheaper for corporations to borrow.
• Reduce the cost of owning stocks on margin.
• Make cash and time deposits unattractive relative to stocks.

A stock investor today certainly isn’t fighting the Fed.

Let’s take a closer look at the “don’t fight the tape” part…

Don’t Fight the Tape

The stock market is in a confirmed uptrend. Seventeen months ago, the Dow bottomed near 6,500. It has had its ups and down this year, but the big trend is up, not down.

• If you’re buying stocks, you’re with the tape.
• If you’re short the market or out of stocks, you’re fighting the tape. And that’s not good.

(The tape, of course, is a reference to the ticker tape of yore.)

Some investors tell me they’re not comfortable buying stocks during a recession.

Hello?

It’s true we’re not experiencing robust economic growth. But a recession is defined as two consecutive quarters of negative economic growth. We haven’t had a single negative quarter in the past year. In fact, GDP growth has averaged 2.84% a quarter over the past 12 months.

It doesn’t feel that way, of course, because housing is in a funk, unemployment is high and consumers are reluctant to spend. But for the third consecutive quarter, profits have mostly beaten expectations.

Why? Partly because companies have laid off unnecessary personnel, refinanced debt at lower levels and cut other costs. Even a modest uptick in revenue is causing a big jump in bottom-line profits.

Plus, businesses are benefiting from technological innovation, negligible inflation and booming new markets overseas, particularly in Asia and Latin America.

Feel the Fear… And Buy Stocks Anyway

Other investors tell me they can’t buy stocks because there is just so much gloom and doom out there.

Apparently, they don’t realize that negative sentiment is a powerful contrary indicator. (Or as Warren Buffett often says, you want to be fearful when other investors are greedy and greedy when others are fearful. And without a doubt, investors are fearful right now.)

Of course, there is a lot of negativity because this is an election year, too. Republicans are talking up how bad things are to increase their chances in November. Democrats are conceding that things are bad – and still blaming things on Bush – because they don’t want to seem out of touch.

Indeed, there is plenty to dislike about how the folks in Washington are running the show. But a decision to buy stocks is not an endorsement of any political party or a statement that all is right with the world. It’s merely an acknowledgement that business conditions – and profits – are likely to improve in the future.

If you disagree, that’s fine. But at least concede that you’re fighting the Fed, fighting the tape – and fighting the sentiment indicator.

Historically, that has not been a profitable strategy.

Good investing,

Alexander Green

ben bernanke, Business, Business/Finance, Finance, Financial economics, P/E ratio, Short, Stock market, US Federal Reserve

Is Apple the Perfect Growth Stock?

by Alexander Green, Chief Investment Strategist
Monday, July 19, 2010: Issue #1304

I’ve often said that my stock-picking approach can be boiled down to this mantra:

Share prices follow earnings.

I challenge you to look back through history and find even a single company that increased its earnings quarter after quarter, year after year, and the stock didn’t tag along.

By the same token, try to find a company whose earnings were flat or declining year after year and the shares kept rising. It doesn’t happen, even in a roaring bull market.

But is growth in earnings per share all you really need? Could it be that simple?

Of course not.

Any company can increase its earnings for a while merely by cutting expenses. But eventually, a firm reaches a point where it can’t cut costs further without damaging the underlying business. (Obviously, if you reach the point where you’re selling off key infrastructure or laying off top people to boost short-term profits, you’re hurting the company’s long-term prospects.)

There are other important factors as well and I can illustrate a few of them by pointing to a near-perfect growth stock…

Want to See If a Company is Growing? Look to These Three Crucial Factors

In order to see robust bottom-line growth, you need to see substantial top-line growth. In other words, sales have to rise, too.

And Apple, Inc. (Nasdaq: AAPL) is doing just that.

• Sales & Earnings: The company is selling boatloads of iPods, iMacs, iPhones and iPads. In many instances, it’s been unable to keep up with demand. In the most recent quarter, sales jumped 49%. That enabled earnings to soar 90%.
• Profit Margins: This is another important factor. If competitors can come in and easily underprice you, your business is vulnerable.

But Apple is well-protected with its iron-clad patents on the Mac operating system and many of the key features of its bestselling products. So it’s no surprise that operating margins top 29%. Or that Apple is up 63% over the last 52 weeks, even after the recent market dip.

Over time, Apple has brought down the price of most of its products, but not because competitors were forcing them down. Management did it because they wanted to broaden the potential market for Apple’s products. That’s key.

• Return on Equity: This key metric is calculated by dividing earnings per share by book value (or net assets) per share.

Why is this important? Because it tells you how efficiently management is deploying the firm’s capital. Warren Buffett – who puts a great deal of emphasis on ROE – says anything above 17% is good. Apple’s return on equity is twice that.

Happy Customers… Happy Shareholders

Apple has done plenty of other things right, too. It’s a consistent innovator and is a world-class marketer. (Its products are so cool, customers find themselves lusting over things they don’t even need.) And it’s done a good job of keeping a lid on costs.

The end result? Earnings per share have boomed over the last decade. And while the broad market has gone nowhere, shares of Apple are up several-fold.

It’s a classic story of a company that keeps its customers coming back because it makes them happy. And the resulting increase in earnings keeps shareholders delighted, too.

Good investing,

Alexander Green

Apple Inc., Business, Business/Finance, Earnings quality, Finance, Financial economics, financial ratios, Macintosh, P/E ratio, Steve Jobs, Stock, Stock market

The Japanese Stock Market: How to Play “The Land of Rising Stocks”

by Alexander Green, Chief Investment Strategist
Monday, June 28, 2010: Issue #1290

The Wall Street Journal reported last week that, for the first time in three years, foreign investors are increasing their holdings in the Japanese stock market.

Data released by the Tokyo Stock Exchange shows that foreign ownership of Japanese shares rose to 26% for the year that ended in March, up from 23.5% a year earlier.

The Journal suggests that a recovery in Japanese corporate earnings is tempting foreign investors back to the country’s equity markets.

But I think there’s more going on here. Perhaps hedge fund managers and other savvy global investors have paged back through their old, dog-eared copies of Dr. Jeremy Siegel’s Stocks for the Long Run.

If so, they may have recognized something significant…

Crunching the Numbers on Japan

Siegel notes that it’s rare for stocks to go 10 years without giving a positive return. Yet we’ve experienced just such a rarity over the last decade.

For stocks to go 20 years without giving a positive return is almost unheard of. And 30 years? That’s rarer than Big Foot, Nessie and the Abominable Snowman combined.

Which brings me back to Japan…

• In 1989, the Nikkei 225 – Japan’s equivalent of the S&P 500 – hit a new all-time high near 40,000. Today, more than 20 years later, it languishes near 10,000 – almost 75% lower.
• In other words, the Nikkei 225 would have to rise 300% just to get back where it was in 1989.

And it wouldn’t surprise me if it did just that by the end of the decade. After all, it’s happened before.

In the 1970s, the U.S. market returned just 0.34% a year – a 3.4% total return for the decade. Yet the Japanese market compounded at 16%, generating a 10-year return of 344%.

What other asset class offers that kind of potential return over the next decade? (Gold bugs, keep your seats.)

Don’t Chase the Bullet Train… Get on Board Now

The groundwork has been laid.

Last August, after more than 50 years, Japan’s opposition party trounced the Liberal Democratic Party in a landslide election.

The new government has promised to shrink the country’s massive bureaucracy and cut wasteful public spending. It also intends to end more than 20 years of economic stagnation by cutting taxes and focusing on small and mid-sized businesses.

Of course, we’re all skeptical of politicians’ promises, but there is evidence that they mean business this time. Twenty years is a long time to leave your economy in a funk.

It’s resulted in Japanese stocks being among the cheapest and most unloved in the world. Virtually no one is enthusiastic about the Tokyo market.

However, great opportunities are born when dirt-cheap valuations marry investor apathy. Plus, Japanese investors are flush with cash. They’ve largely ignored domestic stocks after two decades of sub-par returns. And as that money begins to find its way out of mattresses and back into Japanese equities, the Tokyo market should lift off.

This is doubly true when institutional money managers return to Japan in a serious way. For years, global fund managers have outperformed the world benchmark by simply underweighting Japan. But let the Shinkansen take off without them and they will be forced to dash after it.

So how do you play this?

Two Ways to Ride the Japanese Stock Market

There are dozens of worthwhile Japanese ADRs trading on Nasdaq and the Big Board.

But you can gain exposure to the Japanese stock market through two ETFs…

• iShares MSCI Japan Index (NYSE: EWJ), which invests in large-cap Japanese stocks.
• Wisdom Tree Japan Small-Cap Dividend Fund (NYSE: DFJ), which captures the best of the Japanese small-cap sector.

Or you can spread your bets and own both.

Incidentally, if you remain skeptical about Japanese stocks digging their way out of this 21-year hole, consider again how unlikely it is that Japanese stocks will earn a negative 30-year return.

As Dr. Siegel writes in Stocks For the Long Run:

“In the 12 years from 1948 to 1960, German stocks rose by over 30% per year in real terms. Indeed, from 1939, when the Germans began the war in Poland, through 1960, the real return on German stocks matched those in the United States and exceeded those in the U.K. Despite the total devastation that the war visited on Germany, the long-run investor made out as well in defeated Germany as in victorious Britain or the United States. The data powerfully attest to the resilience of stocks in the face of seemingly destructive political, social, and economic change.”

The story in Japan was similar. By the end of 1945, stock prices stood at about approximately one-third of their level just prior to the Empire’s surrender. Over the next 40 years, the Japanese market returned more than 20 times its American counterpart.

If 200 years of world stock market history is any guide, the current decade should be another barnburner for Japan.

Good investing,

Alexander Green

asset allocation, Business/Finance, Economics, Finance, Financial economics, Financial markets, Financial services, Funds, investment, Japan, jeremy siegel, Stock, Stock market, Stocks for the Long Run

Do Trailing Stops Really Work?

by Alexander Green, Chief Investment Strategist
Monday, June 14, 2010: Issue #1280

While I was in Baltimore last week, one of our Oxford Club researchers, Matt Carr, told me over lunch that one of the most controversial aspects of our investment policy is trailing stops.

But they shouldn’t be.

If you don’t have a premeditated sell discipline – and the vast majority of investors don’t – you’re flying by the seat of your pants. And that rarely leads to superior investment performance.

But do trailing stops really work?

Survey Says: Use Trailing Stops

In a word: Yes. Trailing stops protect your profits and your trading capital. And there’s much more than just anecdotal evidence.

In a study published in The Journal of Portfolio Management, Christophe Faugere, Hany A. Shawky and David M. Smith – finance professors at the State University of New York at Albany – researched the performance of money managers who oversee pension funds, endowments and high-net-worth accounts.

Because most institutions work under strict investment guidelines, these academics were able to analyze performance based on differing approaches to selling stocks.

The result? Institutional managers who fared best were those with restrictive rules that didn’t allow much leeway for holding stocks for emotional reasons. Managers who relied on “flexible” sell strategies did far worse.

Count me as unsurprised. Institutional money managers are just as prone to rationalizing as individual investors when they make a mistake. (Hence the old Wall Street chestnut, “What does a broker call a trade gone wrong? A long-term investment.”)

Trailing Stops: Providing Protection… Securing Profits

The culprit is almost always pride, ego, or emotion. Without any kind of sell strategy, emotions come into play. And emotions are almost always wrong.

But by adhering to a disciplined trailing stop strategy, our Oxford Club investment system mows down emotion-driven trading errors like a field full of dandelions.

It cures greed. Eliminates fear. And does away with wishful thinking – as in, “I hope this stock turns around and starts going the right way.”

Of course, trailing stops aren’t the only sell discipline out there. But they’re one of the easiest to implement. They serve two purposes…

• They make sure we never let a small loss become an unacceptable loss.
• They keep us from selling stocks while they’re still trending up.

According to the independent Hulbert Financial Digest, over the past 10 years our Oxford Club portfolios have beaten the S&P 500 by a wide margin. Part of our success has come from diligent research and careful stock selection. But part has also come from cutting our losses and letting our profits run.

Maneuver Past the Market Makers With TradeStops.com

The one knock against using trailing stops is that unscrupulous market makers will sometimes take out your stop order right before a stock takes off.

But Richard Smith, President and Founder of TradeStops.com – and a PhD in mathematics – has a service that provides an ingenious solution.

If you visit www.tradestops.com, you can enter the stocks you own, the price you paid and the percentage trailing stop you want to use. There are several valuable benefits…

• If any of your stocks close beneath your selected stop, TradeStops sends a message – to your cell phone, e-mail, or account page – alerting you.
• Some brokerage firms, like Fidelity, offer trailing stop alerts with their accounts. But they generally expire after 30 or 60 days. TradeStops information never expires and even offers a 30-day risk-free trial.
• You can track up to 50 stocks at a time. (And whenever you stop out of one, you can replace it with another.)
• TradeStops is easy to use. It’s specifically designed for technophobes.
• It’s reasonably priced. Ordinarily, the cost is $7.95 a month or $79.50 a year. (If you’re an Oxford Club member, you get a special rate of $39.95 a year.) There are additional services available for dedicated short-term traders who want even more.
• It’s important to note that TradeStops notifies you of stops, not your broker. And it doesn’t enter sell orders. But the key is to make sure you have an acknowledged point where you’d be willing to sell any individual stock.

Trailing stops don’t just offer to cut your losses and protect your profits. They guarantee it.

Good investing,

Alexander Green

Editor’s Note: Much of what it takes to become a successful investor comes down to knowing the best times to buy and sell. Some investors rely on technical analysis; others pinpoint fundamentals. But regardless, trailing stops are essential to protect yourself from a volatile, unforgiving market.

Adhering to a disciplined trailing stop policy is just one of the core wealth-building strategies that has made The Oxford Club one of the most of the most successful investment publishers. In fact, over the past decade, the independent Hulbert Financial Digest has ranked The Oxford Club’s Communiqué as one of the top five investment newsletters.

So if you want to take all the guesswork out of the buying/selling process and let the Oxford Club analysts do the work for you, then consider becoming a member. For $79, you’ll receive an entire year’s worth of stock recommendations, with instructions on when to buy and when to sell for maximum profits. (You’ll also be eligible for the special TradeStops rate mentioned above, too). Take a look at the full list of Oxford Club membership benefits.

Business/Finance, Finance, Financial economics, Financial services, Funds, investment, Order, Oxford Club, Stock market

Why Value Investing and Trading Don’t Mix

by Alexander Green, Chief Investment Strategist
Tuesday, May 18, 2010: Issue #1262

Last week, I spoke at a special conference on value investing at the beautiful Driskill Hotel in Austin, TX.

Virtually every stock market investor talks about “recognizing value.” I’ve found that interest in value investing ebbs and flows depending on the market. No one wants to overpay for a stock, or keep holding one if the price gets nutty.

And that leads to a basic question: How do you find value in the stock market?

It depends whom you ask…

The Fathers of Value Investing

The fathers of value investing, of course, were Ben Graham and David Dodd, two teachers at Columbia Business School who wrote the investment classic, Security Analysis.

They argued that value investing is about buying companies that are selling below their intrinsic value.

How do you determine that? According to Graham & Dodd, that means buying companies that…

• Trade at significant discounts to book value.
• Have high dividend yields.
• Have low price-to-earnings (P/E) ratios.

Buying this way is not only supposed to lead to higher returns. It’s also designed to provide a significant “margin of safety.” The idea is that if you buy a security right, your downside is limited.

A number of academic studies have shown that if you follow the principles of Graham and Dodd, you should do very well over the long term.

But there are potential problems with this approach…

Don’t Let a Cheap Stock Suck You In

First of all, stocks are rarely as cheap as they were back in the 1930s when Security Analysis was written. Or even as cheap as they were back in 1982 when the typical stock sold for less than book value and eight times earnings and yielded more than 6%.

And if you sat out the last 28 years out because stocks were too expensive, you missed an awful lot of opportunities.

When you do find a stock that does meets Graham and Dodd’s stringent requirements, you also need to be patient. Why? Because companies that are very cheap are out of favor for a reason. Sales are often flat or down. Earnings are weak. Profit margins are low.

You can’t succeed just by buying a company that’s cheap. (It can always become cheaper.) You have to buy a company that will someday – and perhaps not too far off – be dear to others. Otherwise, when will you take profits?

So maybe Graham and Dodd’s message needs modifying. (Warren Buffett, Graham’s most famous student, has certainly found ways to modify it.)

The Problem With Defining “Value”

I’ve found that the definition of value and the tools to achieve a margin of safety are flexible. And The Oxford Club has found successful ways to bend them.

To my mind, any stock that goes from $10 to $50 was a “value” at $10. I don’t care what the P/E or price-to-book was at the time. With the luxury of hindsight, it was clearly a bargain. Why quibble?

But die-hard value investors will argue that if the stock was “overvalued” at $10, it’s only more grossly so at $50 – and therefore, you’re at great risk holding it.

I disagree. If you use our customary trailing stops, your upside is unlimited and your profits fully protected. As long as a stock keeps trending up, we’re content to hold on – no matter what the valuation. When the stock eventually turns, as all do eventually, our stops will keep the profits from slipping through our fingers.

As for value analysis, quite frankly, we don’t spend a lot of time poring over P/Es and book values. We’re just interested in identifying companies that are likely to show dramatic, better-than-expected growth in the quarters ahead. These stocks tend to be more expensive than average, just as companies that will show little or no growth tend to be cheaper than average.

This method works, too…

Do You Have the Key Traits to Profit From This Approach?

The independent Hulbert Financial Digest has ranked our Communiqué among the top five newsletters in the United States for 10-year performance.

And our approach has one significant advantage over value investing. It works quickly.

• Growth stocks tend to sprint.
• Profits often come sooner rather than later.

As someone who spent 16 years as a money manager, I know that most investors don’t have the patience to be good value investors. (John Templeton, for instance, held companies in his flagship Templeton Growth Fund an average of 7.5 years.)

Yet clients will start to grouse if a stock doesn’t move for six months. They call it “dead money” and start itching to move it elsewhere.

I understand this instinct. But deep value investing and rapid trading don’t mix.

If you’re a patient, truly long-term oriented investor, value investing can work wonders. If you’re not, you’ll be better off searching for companies that are set to smash estimates.

When a stock doubles or triples – or rises 50-fold or more like Apple (Nasdaq: AAPL) and Amazon (Nasdaq: AMZN) – don’t worry, other investors will concede it was a “value” before.

Good investing,

Alexander Green

P.S. If it’s value you’re looking for, look no further than The Oxford Club. For just $79, you’ll receive a whole year’s worth of our experts’ top stock recommendations, investment ideas and strategies that you can use to amass profits and build wealth.

You’ll see exactly why The Hulbert Financial Digest has ranked The Communiqué newsletter in the top five in the United States over the past 10 years and have a portfolio of your own that can weather the market’s storms, but thrive, too.

Take the guesswork out of the investing process and let some of the best, most successful analysts do the work for you. Sign up (risk-free) to The Oxford Club today.

Business/Finance, David Dodd, Equity securities, Finance, Financial economics, fundamental analysis, investment, margin of safety, P/E ratio, Stock market, Stock valuation, Valuation, Value investing

Why the Euro Has Further to Tumble

by Alexander Green, Chief Investment Strategist
Thursday, May 6, 2010: Issue #1254

Being a contrarian is a lonely business.

If you’re a regular reader, you’ll know that ordinarily, I am market neutral on stocks, bonds, currencies and commodities.

The truth is that markets are reasonably efficient. So most years, I don’t stick my neck out and make any market calls on any asset class.

That’s because the vast majority of the time, most assets are neither grossly undervalued, nor wildly overvalued. Rational, self-interested investors keep prices close to true value.

But I am not an efficient market theorist. Investors are always self-interested, yes. But they are not always rational. And I most certainly do not believe that all publicly traded securities are efficiently priced all the time.

That would be lunacy…

Anomalies develop (and opportunities alongside them). Sometimes, these anomalies develop into outright bubbles. When that happens, you will always see eye-popping valuations paired with extreme sentiment. (In other words, sky-high prices and unbridled optimism or rock-bottom prices with extreme pessimism.)

What surprises me is how few investors recognize a bubble, even when it’s right under their nose and they have many thousands of dollars at risk…

Bubble Watch

For example…

• When I warned about the dangers of Internet stocks over a decade ago – I actually quit my Wall Street firm to take possession of my soaring pension shares – most respondents told me I was clearly ill-equipped to recognize the nature of opportunities in “the New Era.”
• Readers similarly scoffed at my warnings about the housing market five years ago. “Real estate always goes up,” they reminded me.
• At $150 a barrel, I wrote a column calling oil “The Mother of All Bubbles.” Demand was already waning and supply was rising as oil hit a new all-time high on various “peak oil” theories. It then quickly lost nearly two-thirds of its value.
• Five months ago – again, right here in Investment U – I predicted that the much-maligned dollar would soar against the euro. And yet again, my readers insisted that I was grossly mistaken and that a weaker dollar was “the ultimate no-brainer.”

Except it wasn’t…

Europe’s Monetary Policy Mish-Mash

Today, the euro hit a 14-month low against the dollar ($1.2689) on increasing recognition that Greece’s fiscal problems are bigger than expected, more expensive than expected and potentially contagious.

Trust me, this is far from over. The 16-member states in the Eurozone are about to start bickering like an old couple that has locked the keys in the car.

Understandably, weaker states don’t like having their economic policies dictated from Frankfurt. And stronger states don’t like spending billions to bail out their profligate brethren from years of fiscal mismanagement.

“Preposterous” Expectations for the Euro Against the Dollar

When the euro was born on January 1, 1999, skeptics rightly worried that the then-11-member states were too divergent to share a single currency and monetary policy.

These fears were well-founded. And the euro promptly plunged on world currency markets to well under $0.90. Today, we know that problems among member states aren’t just possible… not just probable… but right here, stinking to high heaven on our doorstep.

Yet the euro is still trading around $1.27.

Expect it to hit $1.10 by the end of this year – and trade at parity with the dollar sometime next year.

Sounds preposterous? Yes, so I’ve heard.

Good investing,

Alexander Green

Editor’s Note: Find out how The Oxford Club’s “market neutral” investment approach, combined with a keen eye for lucrative contrarian recommendations, led the Hulbert Financial Digest to rank the group’s Communiqué in the top five investment newsletters over the past 10 years.

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Behavioral finance, Business/Finance, contrarian investing, Economics, efficient market hypothesis, Euro, Finance, Financial economics, Financial markets, fundamental analysis, Stock market