Wednesday, February 18, 2015

We're all Warren Buffett now

Every day brings more disasters and threats, actual and potential. I have no cure to suggest. (I know you were counting on me; sorry about that.) So let me take up a subject many of us are familiar with: money.

That's the neat thing about this topic: it's easy to relate to. And, it seems, easy to advise about. Amid winter's gloom (if you're anywhere north of Florida or Scottsdale), it's natural to dream of turning a dolor into into a dollar. And there is no shortage of blogs and web sites, not to mention financial publications -- all right, so I just did mention them -- to plant a word to the wise in your brain. We're all Warren Buffett now, just waiting our turn to say the magic word that will make the duck with the cigar drop in. (For those of you under 50 or outside the U.S., that was a running gag on Groucho Marx's TV quiz show many a year ago.)

The heck of it is, while some of the advice is mainly self-promotion, a lot of it is valid, at least if you accept its premises.

If these pundits are so smart, why aren't we rich? (No offense meant if you are rich.)

Part of the trouble is that so much of what they say is reasonable, but impracticable. Let's take as an example a post from Clear Eyes Investing, headed "5 Ways to Avoid Permanent Losses." The writer, Todd Wenning, CFA, is an equity analyst currently with Morningstar.

He first makes clear what is meant by a permanent loss.
... A permanent loss of capital differs from a temporary loss of capital that's due to market volatility and it occurs when an investment's value has declined so much that getting back to break-even within a few years is unlikely. Effectively, an unrecoverable loss.
As most people who've been in the investment game for a while know, a loss of x percent means you will have to make more than x percent just to return to where the dip began. For instance, as Wenning shows in a table, if you own a stock that sinks 30 percent, you can tell yourself it's only a "paper loss," but for you to be made whole the stock must climb 43 percent. Possible, but the odds are against it. Even if it does recover 43 percent or more, chances are it won't happen quickly.

I won't paraphrase his five ways of avoiding permanent losses; please just click the link and read them for yourself. In principle, they all sound sensible. So what's the problem?

Mostly they are procedures that only a professional financial analyst could love. They are enough to make us amateurs run screaming from the room. Let's take one as an example:
4. Focus on trends in competitive advantages. The market has become incredibly focused on the short-term. For example, the average stock mutual fund turnover rate have [he means has] jumped from an average of 17% between 1945 and 1965 (implying an average holding period of about five years) closer to 100% today (implying an average holding period of about one year). Naturally, then, market participants seek short-term information advantages -- e.g. "Will this company beat next quarter's consensus estimates?" -- at the expense of gathering helpful long-term information. ...

Spend more time in your research process thinking about where this company might be three- to five-years from now. A simple way to get started is with a "SWOT" analysis -- listing the company's strengths, weaknesses, opportunities, and threats. Then ask how the company might enhance its current strengths, reduce its weaknesses, capitalize on opportunities, and respond to competitive threats. 
Who can say aught against long-term thinking? With all respect to Wenning, who is undoubtedly far more sophisticated than I am about security analysis, I don't believe anyone (especially outside the company being analyzed) can acquire more than a general idea of its "strengths, weaknesses, opportunities, and threats."

Still less relevant is how the company "might" enhance its current strengths, reduce its weaknesses, capitalize on opportunities, and respond to competitive threats. Even if anyone could divine how the company might do all those things, it's anyone's guess whether it will. 

And say the company looks from here to be on the right track. Think of all the things that could cause it to pack up in the next three to five years: technological changes, a smart new competitor arriving like a lightning bolt from a blue sky, a change of management, a law suit, a huge increase in the cost of raw materials, international crisis ... and on and on. All possible, none predictable.

Short-term trading gets a bad name in the financial media commentariat. We're all supposed to assure ourselves with deep research before we splash out on a stock, and then stay the course. Warren Buffett groupies like to quote him: "My favorite holding period is forever." Well, Mr. Buffett can lose a few million dollars and not bother to look for it under the sofa cushions. Others aren't so blasé about parting with money on a mistaken buy, especially if it's a permanent loss.

Maybe at least some of those short-term thinkers aren't so dumb after all.

Me, I do trades now and again, but mainly I've come to (a) avoid individual stocks and (b) hedge by allocating my modest stash among exchange-traded funds. That doesn't guarantee I won't lose on any of them, but asset classes as a whole are more likely to recover than single companies that go haywire. And it takes a lot less time than trying to figure out the strengths, weaknesses, opportunities, and threats of particular names. Time is an asset class, too.

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