Category: General Investing

Share buybacks is one of the more divisive topics in investing.

If you’re not familiar with the topic, share buybacks refer to a company repurchasing its own shares. Put another way, buybacks occur when the company uses its cash to purchase its own shares in the open market.

Simple economics suggests that share buybacks boost share prices by reducing the number of outstanding shares in the market. Fewer outstanding shares means remaining shareholders now own a larger piece of the pie.

However, share buybacks also reduce the company’s cash position. As such, the size of the pie is also smaller after share buybacks. 

So when are share buybacks good for shareholders and when are they detrimental?

When do share buybacks make sense?

Share buybacks can benefit shareholders if they tick certain boxes. The great Warren Buffett is a big fan of buybacks at the right price. He once said,

“The best use of cash, if there is not another good use for it in business, if the stock is underpriced is a repurchase.”

One advantage share buybacks have over dividends is that share buybacks reward shareholders in a more tax-effective manner in certain countries. In the US, local shareholders are taxed on dividends, while foreign shareholders from certain jurisdictions incur a 30% withholding tax. These taxes invariably reduce shareholder’s returns. But with share buybacks, companies can reduce their shares outstanding without incurring any tax expenses.

Share buybacks should also be most beneficial when shares are bought back below their true value. Apple, for instance, has a share buyback plan that reduced the total shares outstanding of the company. The share buybacks were made at strategic periods when shares of Apple traded at unfairly low valuations.

Competing for capital…

But share buybacks should only be undertaken when it is the best use of capital. On top of buybacks, a company has so many ways to deploy its cash, such as paying dividends, reinvesting the cash into the company, and acquiring other firms. Management, hence, needs to examine each possibility before deciding which is the best way to allocate capital. Jamie Dimon, CEO of JP Morgan Chase, reiterated:

“Buybacks should not be done at the expense of properly investing in our company.”

Again, Apple is a great example of buybacks done right. The iPhone maker generated more than US$50 billion in free cash flow each year for the past few years. Its shares were trading well below what the management believed to be its intrinsic value. As a result of its share repurchase plan, despite a fall in net income in the fourth quarter of fiscal 2019, Apple still managed to post a slight increase in earnings per share.

With more than US$100 billion in net cash, finding ways to put the capital to use can be a tough ask for Apple. That’s why I believe Apple’s decision to use the cash for buybacks when its share price was depressed is a prudent use of its excess cash.

When are share buybacks bad?

As mentioned at the start, share buybacks can be bad for shareholders too. This can happen when companies decide to pursue buybacks for the wrong reasons.

Below are some commonly cited but bad reasons I’ve come across that companies use to validate their buyback plan:

• To prop up their share price
• As a means to negate the impact of dilution due to share-based compensation
• To fend off an acquirer
• To boost earnings per share
• Because they have run out of ideas for the cash

Such companies do not take into account whether the shares are cheap or not. Simply buying back shares to boost earnings per share or prop up the share price is not good to shareholders if the stock is overpriced.

Worse still, companies that buy back shares so that they can negate the impact of dilution without thinking about the stock price will invariably hurt shareholders.

I also believe that companies that use debt to make buybacks are asking for trouble. Buybacks should only be made when the company has excess cash and as a way to reward shareholders.

In addition, in Singapore, paying dividends is just as beneficial to shareholders as buybacks. Dividends in Singapore are not taxed and by paying out dividends, shareholders can decide for themselves if they wish to reinvest the dividends back into the company by buying more shares.

The Good Investors’ conclusion

Buffett is a big fan of share buybacks and with good reason too. It is a tax-efficient way (in certain countries) of rewarding shareholders and are a great way to allocate capital if the company’s shares are trading below its true value.

However, buybacks can also harm investors if the company buys back shares that are overpriced or do not provide a good return on capital.

As investors, we should not assume that buybacks are always the most efficient use of capital. We need to look deeper into the decision-making process to assess if management is really making the best possible capital allocation decision for growing shareholder value over the long-term.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Odyssey is an epic ancient Greek poem that is attributed to Homer. It was composed nearly 3,000 years ago, but it can teach us plenty about modern-day investing. 

An ancient epic

Odyssey recounts the tale of Odysseus, a Greek hero and king. After fighting for 10 long years in the Trojan War, Odysseus finally gets to go back to his home in Ithaca. Problem is, the way home for Odysseus was fraught with danger.

One treacherous part of the journey saw Odysseus having to sail past Sirenum Scopuli, a group of rocky small islands. They were home to the Sirens, mythical creatures that had the body of birds and the face of women.

The Sirens were deadly for sailors. They played and sang such enchanting melodies that passing sailors would be mesmerised, steer toward Sirenum Scopuli, and inevitably crash their ships.

Odysseus knew about the threat of the Sirens, but he also wanted to experience their beguiling song. So, he came up with a brilliant two-part plan.

The Greek hero knew for sure that he would fall prey to the seductive music of the Sirens – all mortal men would. So for the first part of his plan, he instructed his men to tie him to the ship’s mast and completely ignore all his orders to steer the ship toward Sirenum Scopuli when they approached the islands. For the second part, he had all his men fill their own ears with beeswax. This way, they couldn’t hear anything, and so would not be seduced by the Sirens when the ship was near Sirenum Scopuli.

The plan succeeded, and Odysseus was released by his men after his ship had sailed far beyond the dark reaches of the Sirens’ call.

A modern tragedy 

One of the great tragedies of modern-day investing is that we, as investors, are self-sabotaging.

Peter Lynch is one of the true investing greats. During his 13-year tenure with the Fidelity Magellan Fund from 1977 to 1990, he produced an annualised return of 29%, turning every $100,000 invested with him into $2.7 million. But the investors in his fund earned a much lower return. In his book Heads I Win, Tails I Win, Spencer Jakab, a financial journalist with The Wall Street Journal, explained why:

“During his tenure Lynch trounced the market overall and beat it in most years, racking up a 29 percent annualized return. But Lynch himself pointed out a fly in the ointment.

He calculated that the average investor in his fund made only around 7 percent during the same period. When he would have a setback, for example, the money would flow out of the fund through redemptions. Then when he got back on track it would flow back in, having missed the recovery.”

A 7% annual return for 13 years turns $100,000 into merely $241,000. Unfortunately, Lynch’s experience is not an isolated case.

In the decade ended 30 November 2009, CGM Focus Fund was the best-performing stock market fund in the US, with an impressive annual gain of 18.2%. But the fund’s investors lost 11% per year on average, over the same period. CGM Focus Fund’s investors committed the same mistake that Lynch’s investors did: They chased performance, and fled at the first whiff of any temporary trouble.

Two data points don’t make a trend, so let’s consider the broader picture. Investment research outfit Morningstar publishes an annual report named Mind The Gap. The report studies the differences between the returns earned by funds and their investors. In the latest 2019 edition of Mind The Gap, Morningstar found that “the average investor lost 45 basis points to timing over five 10-year periods ended December 2018.”

45 basis points equates to a difference of 0.45%, which is significantly lower than the performance-gaps that Lynch (22% gap) and CGM Focus Fund (29% gap) experienced. But the Morningstar study still highlights the chronic problem of investors under-performing their own funds because of self-sabotaging behaviour.

(If you’re wondering about the distinction between a fund’s return and its investors’ returns, my friends at Dr. Wealth have a great article explaining this.)

Tying the tales together

On his journey home, Odysseus knew he would commit self-sabotaging mistakes, so he came up with a clever plan to save himself from his own actions. The yawning chasm between the returns of Magellan Fund and CGM Focus Fund and their respective investors show that the investors would have been far better off if they had taken Odysseus’s lead. 

Having a fantastic ability to analyse the financial markets and find great companies is just one piece of the puzzle – and it’s not even the most important piece. There are two crucial ingredients for investing success.

The first is the ability to stay invested when the going gets tough, temporarily. Even the best long-term winners in the stock market experience sickening declines from time to time. This is why Peter Lynch once said that “in the stock market, the most important organ is the stomach. It’s not the brain.” The second key ingredient is the ability to delay gratification by ignoring the temptation to earn a small gain in order to earn a much higher return in the future. After all, every stock with a 1,000% return first has to jump by 100%, then 200%, then 300%, and so on.

We’re in an age where we’re drowning in information because of the internet. This makes short-term volatility in stock prices similar to the Sirens’ song. The movements – and the constant exposure we have to them – compel us to act, to steer our ship toward the Promised Land by trading actively. Problem is, the Promised Land is Sirenum Scopuli in disguise – active trading destroys our returns. I’ve shared two examples in an earlier article of mine titled 6 Things I’m Certain Will Happen In The Financial Markets In 2020. Here are the relevant excerpts:

“The first is a paper published by finance professors Brad Barber and Terry Odean in 2000. They analysed the trading records of more than 66,000 US households over a five-year period from 1991 to 1996. They found that the most frequent traders generated the lowest returns – and the difference is stark. The average household earned 16.4% per year for the timeframe under study but the active traders only made 11.4% per year.

Second, finance professor Jeremy Siegel discovered something fascinating in the mid-2000s. In an interview with Wharton, Siegel said:

“If you bought the original S&P 500 stocks, and held them until today—simple buy and hold, reinvesting dividends—you outpaced the S&P 500 index itself, which adds about 20 new stocks every year and has added almost 1,000 new stocks since its inception in 1957.”

Doing nothing beats doing something.”

We should all act like Odysseus. We should have a plan to save us from ourselves – and we should commit to the plan. And there’s something fascinating and wonderful about the human mind that can allow us to all be like Odysseus. In his book Incognito: The Secret Lives of the Brain, David Eagleman writes (emphasis is mine):

“This myth [referring to Odysseus’s adventure with the Sirens] highlights the way in which minds can develop a meta-knowledge about how the short- and long-term parties interact. The amazing consequence is that minds can negotiate with different time points of themselves.”

Some of you may think you’re an even greater hero than Odysseus and can march forth in the investing arena without a plan to save you from yourself. Please reconsider! Nobel-prize winning psychologist Daniel Kahneman wrote in his book, Thinking, Fast and Slow:

“The premise of this book is that it is easier to recognize other people’s mistakes than our own.” 

My Odysseus-plan

So what would our Odysseus-plans look like? Everyone’s psychological makeup is different, so my plan is not going to be the same as yours. But I’m still going to share mine, simply for it to serve as your inspiration:

• I commit to never allow macro-economic concerns (some of the recent worries are the US-China trade war and the unfortunate Wuhan-virus epidemic) to dominate my investment decision making.
• I commit to focus on the performance of the business behind the ticker and never allow stock price movements to have any heavy influence on my decision to buy or sell a share.
• I commit to invest for the long-term with a holding period that’s measured in years, if not decades.
• I commit to not panic when the stock market inevitably declines from time to time (volatility in the financial markets is a feature, not a bug).
• I commit to diversify smartly and not allow a small basket of stocks to make or break my portfolio.

I can’t tie myself to a ship’s mast, but I can keep my plan within easy visual reach so that I can sail safely toward the real Promised Land each time I find myself getting seduced by the Sirens’ song. If you have your own plan, we would love to hear from you – please share it in the comments section below, or email it to us at thegoodinvestors@gmail.com!

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

The excerpt below is from a recent blog post of Tim Ferris, an investor and author. It talks about how we can make better-quality decisions in life (emphasis his):

“How can we create an environment that fosters better, often non-obvious, decisions?

There are many approaches, no doubt. But I realized a few weeks ago that one of the keys appeared twice in conversations from 2019. It wasn’t until New Year’s Eve that I noticed the pattern.

To paraphrase both Greg McKeown and Jim Collins, here it is: look for single decisions that remove hundreds or thousands of other decisions.

This was one of the most important lessons Jim learned from legendary management theorist Peter Drucker. As Jim recounted on the podcast, “Don’t make a hundred decisions when one will do. . . . Peter believed that you tend to think that you’re making a lot of different decisions. But then, actually, if you kind of strip it away, you can begin to realize that a whole lot of decisions that look like different decisions are really part of the same category of a decision.”” 

To me, Ferriss’s thought is entirely applicable to investing too. The more decisions we have to make in investing, the worse-off our results are likely to be. That’s because the odds of getting a decision right in investing is nothing close to 100%. So, the more decisions we have to string together, the lower our chances of success are.

I was also reminded of the story of Edgerton Welch by Ferriss’s blog. There’s very little that is known about Welch. But in 1981, Pensions and Investment Age magazine named him as the best-performing money manager in the US for the past decade, which led to Forbes magazine paying him a visit. In an incredible investing speech, investor Dean Williams recounted what Forbes learnt from Welch:

“You are familiar with the periodic rankings of past investment results published in Pension & Investment Age. You may have missed the news that for the last ten years the best investment record in the country belonged to the Citizens Bank and Trust Company of Chillicothe, Missouri.

Forbes magazine did not miss it, though, and sent a reporter to Chillicothe to find the genius responsible for it. He found a 72 year old man named Edgerton Welsh, who said he’d never heard of Benjamin Graham and didn’t have any idea what modern portfolio theory was. “Well, how did you do it?” the reporter wanted to know.

Mr. Welch showed the report his copy of Value-Line and said he bought all the stocks ranked “1” that Merrill Lynch or E.F. Hutton also liked. And when any one of the three changed their ratings, he sold. Mr. Welch said, “It’s like owning a computer. When you get the printout, use the figures to make a decision–not your own impulse.”

The Forbes reporter finally concluded, “His secret isn’t the system but his own consistency.” EXACTLY. That is what Garfield Drew, the market writer, meant forty years ago when he said, “In fact, simplicity or singleness of approach is a greatly underestimated factor of market success.””

Welch reduced a complicated investing question – “What should I invest in?” – into something simple: Buy the cheap stocks. By doing so, he minimised the chances of errors creeping into his investing process.

My own process for finding investment opportunities in the stock market is radically different from Welch’s. But it can also be boiled down to a simple sentence: Finding companies that can grow at high rates for a long period of time. I focus my efforts on understanding individual companies and effectively ignore interest rates and most other macroeconomic developments when making investment decisions. My process sounds simple, but that’s the whole point – and it has served me well.

To make better investing decisions, reduce the number of decisions you have to make in your investing process. Simplify!

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Robert Vinall may not be a name that rings a bell with many investors. Yet, his investing performance certainly warrants some attention. His fund, Business Owner TGV, has produced a mouth-watering 649.6% total gain since its inception in late 2008. That translates to a 19.6% annualised return, easily outpacing the MSCI World Index’s 9.47% annualised return over the same period.

I recently spent a few hours reading some of his writings on investing and his investment philosophy to gain some insight on how he managed to achieve these amazing returns.

He invests like a business owner

As the name of his fund suggests, Vinall invests as though he owns the businesses that he invests in. He says:

“My philosophy can be summed up as: Investing like an owner in businesses run by an engaged and rational owner with the capital of investors who think like an owner.”

But what does thinking and acting like a business owner really entail? In essence, it means ignoring short-term movements of share prices, and putting greater emphasis on buying great companies that can compound value over time.

Vinall is, therefore, comfortable with buying shares that (1) have a troubled short-term outlook but have solid long-term prospects, (2) have no near-term price catalysts or (3) is shunned by Wall Street analysts.

Because of the above, he is able to buy shares that Wall Street has ignored, giving him a great entry point on what he believes are long-term compounders.

In addition, he also looks for business managers who act like business owners. Shareholder-friendly managers focus on long-term steady results, rather than near-term share price movements. 

He looks for four key things in a company

To determine if a stock is worth investing in, Vinall looks for four key characteristics in a company:

1. It is a business he understands
2. The business is building or has a long-term competitive advantage
3. The managers act with shareholders’ interests at heart
4. The share price is attractive

Using this framework, Vinnal has found investments that have compounded meaningfully over time.

Although the framework is simple it is by no means easy. Vinall points out:

“An investment process which consists of four steps, each of which has a “yes” or “no” answer may sound simple and indeed it is. This is because the best capital allocation decisions are typically made at moments of extreme market distress. To operate effectively in such an environment requires a process which is robust and simple to administer.

However, each capital allocation decision is preceded by months of research and often years of waiting for the right price to come along.”

He has a concentrated portfolio

Some of the best investors such as Warren Buffett, Chuck Akre, and Terry Smith prescribe having a concentrated portfolio and Vinall is no different.

As of January 2020, Business Owner TGV only had 10 stocks in its portfolio. That’s a heavily concentrated portfolio when compared to most other funds.

A concentrated portfolio of high-conviction stocks gives investors a better chance of market-beating returns. In his 2019 letter to shareholders, Vinall noted that he had dinner with legendary investor Charlie Munger at his home. Over the course of dinner, one of the topics that came up was how concentrated an investment portfolio should be. 

Vinall wrote:

“His (Munger’s) bigger point was that the truly exceptional opportunity only comes along a few times in a lifetime. When it does, the important thing, according to Charlie, is to: ‘use a shovel, not a teaspoon’.” 

He believes it’s always better to be invested than on the sidelines

With recession fears looming, investors today are asking whether it is a good time to invest.

Vinall believes there are two faulty assumptions underlying this question. The first faulty assumption is that the stock market gyrates around the same level. On the contrary, developed markets should increase at around 6% per year which translates to around an 8-fold increase over 48 years. 

Vinall wrote:

“If you have a 40 year plus time horizon and an investment opportunity that will go up 8-fold, how much is there to think about? The smart money is invested, not on the side-lines fretting about what to do.”

The other flawed assumption is that investing is easy. Investing is never easy, as most successful investors will tell you. As such it is not as simple as asking whether now is a good time to invest. 

Vinall explains:

“In my experience, good investment opportunities are always plentiful. The limiting factors are the ability to identify them and, having identified them, the courage to act.”

The Good investors’ conclusion

Vinall has been one of the top-performing investors of the last decade. His fund’s return speaks for itself. Vinall is also an exceptionally generous investor who is willing to share his investing insights, philosophies, and success stories. I strongly encourage you to read more of his writings which can be found here.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Sadly, the Wuhan Virus is proving more devastating than earlier expected. The latest figures yesterday afternoon showed that the death toll had already risen to 102, with more than 4,500 cases confirmed. These numbers are almost certain to mushroom.

The coronavirus has also impacted global stock markets as investors fret about the financial impact of the disease.

The S&P 500 in the US fell 1.6% on Monday, while the Straits Times Index at home in Singapore was down by as much as 3% yesterday. So what should investors do now?

Think long term

Unfortunately, the Wuhan Virus is certain to impact the world economy. Tourism to and from China is expected to fall. Shopping malls in China are closed. Schools and universities there have extended their Chinese New Year holiday and will only be reopened on a case by case basis.

China has even shut public transport in certain cities to discourage people from going out. It is likely that we will see consumers in China adjusting to the fear of the virus by going out less and spending less for a few months after the virus is controlled.

All of which will have a very real impact on not just companies in China, but around the world. The impact is exacerbated due to the Wuhan virus epidemic coinciding with the Chinese New year period- a period that usually sees higher travel and consumer expenditure.

That being said, investors should not let the near-term impact of the virus affect their investment decision making.

The SARs, H1N1, and Ebola epidemics have each been devastating. However, financial markets continued ticking on like clockwork.

As you can see from the chart above, the world has experienced 13 different epidemics since the 1970s. Yet, global stocks – measured by the MSCI World Index – has survived each of those, registering long term gains after each outbreak.

Where do you see the world in five years?

With society more prepared today to deal with a global epidemic, the spread and impact of the Wuhan virus will also hopefully not be as devastating as prior outbreaks.

Perhaps the best way to keep a clear head in these uncertain times is to do a simple mental exercise.

Consider the questions below:

• In 5 years time, will Chinese consumers still fear going out?
• Will shopping malls in China still be closed?
• Are public transports likely to be still shut down in five years time?
• Will we still even be talking about the Wuhan virus?

I think the most likely answer to all of the questions is “No”. 

The Good Investors’ conclusion

Sadly, the Wuhan virus is having a devastating impact. Lives have been lost and the number of deaths is likely to balloon. My heart goes out to everyone affected by this destructive disease.

But from a financial point of view, we as investors should not let the near-term earnings-impact cloud our judgement. Yes, the Wuhan virus will likely affect the economy and bottom-line of some companies. However, I believe the world today is better equipped to curb the spread of an outbreak than ever before. As such, I believe investors who continue to focus on fundamentals, ignore the noise, and think long will likely be rewarded eventually.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

The financial media pays plenty of attention to interest rates. We just have to look at the amount of commentary that pops up whenever central banks around the world make their interest rate decisions.

If you invest in stocks, like us at The Good Investors, there are two things about interest rates and their implications that you should know.

No.1: The reality behind the relationship between interest rates and stock prices

I’ve written about the theory behind how interest rates govern the movement of stock prices in a previous article at The Good Investors titled 6 Things I’m Certain Will Happen In The Financial Markets In 2020. Here’s the relevant excerpt:

“Stocks and other asset classes (bonds, cash, real estate etc.) are constantly competing for capital. In theory, when interest rates are high, the valuation of stocks should be low, since the alternative to stocks – bonds – are providing a good return.

On the other hand, when interest rates are low, the valuation of stocks should be high, since the alternative – again, bonds – are providing a poor return.”

But in the same article, I also pointed out that things are different in real life:

“There’s an amazing free repository of long-term US financial market data that is maintained by Robert Shiller. He is a professor of economics and the winner of a Nobel Prize in economics in 2013.

His data includes long-term interest rates in the US, as well as US stock market valuations, going back to the 1870s. The S&P 500 index is used as the representation for US stocks while the cyclically adjusted price earnings (CAPE) ratio is the valuation measure. The CAPE ratio divides a stock’s price by its inflation-adjusted average earnings over a 10-year period.

The chart below shows US long-term interest rates and the CAPE ratio of the S&P 500 since 1920:

Contrary to theory, there was a 30-plus year period that started in the early 1930s when interest rates and the S&P 500’s CAPE ratio both grew. It was only in the early 1980s when falling interest rates were met with rising valuations.”

No.2: Based on history, interest rates have declined as a country develops

Josh Brown is the CEO of Ritholtz Wealth Management. In a June 2019 blog post, Brown recounted a dinner he had with the polymath investor William Bernstein. During the dinner, Bernstein posed a question that had been in his mind for awhile: What if the cost of capital never rises again? (The cost of capital refers to the cost of money – in other words, interest rates.)

Bernstein’s question is fascinating to think about. That’s because a broad look at history shows us that interest rates have declined as countries mature. Here’s Bernstein on the subject in his book, The Birth of Plenty (I highly recommend it!):

“Interest rates, according to economic historian Richard Sylla, accurately reflect a society’s health. In effect, a plot of interest rates over time is a nation’s “fever curve.” In uncertain times rates rise because there is less sense of public security and trust.

Over the broad sweep of history, all of the major ancient civilisations demonstrated a “U-shaped” pattern of interest rates. There were high rates early in their history, following by slowly falling rates as the civilisations matured and stabilized. This led to low rates at the height of their development, and, finally, as the civilisations decayed, there was a return of rising rates.”

The implications

There are two implications I can draw from the graph on interest rates vs valuation, and Bernstein’s data on how interest rates change with the growth of countries. First, Shiller’s data show that changes in interest rates alone cannot tell us much about how stocks will move. “If A happens, then B will occur” is a line of thinking that is best avoided in finance. The second implication is that it is possible for interest rates in the US and other parts of the world to stay low for a very long period of time. That’s history’s verdict.

In 6 Things I’m Certain Will Happen In The Financial Markets In 2020, I also wrote:

“Time that’s spent watching central banks’ decisions regarding interest rates will be better spent studying business fundamentals. The quality of a company’s business and the growth opportunities it has matter far more to its stock price over the long run than interest rates.

Sears is a case in point. In the 1980s, the US-based company was the dominant retailer in the country…

… US long-term interest rates fell dramatically from around 15% in the early-to-mid 1980s to 3% or so in 2018. But Sears filed for bankruptcy in October 2018, leaving its shareholders with an empty bag. In his blog post mentioned earlier, Housel also wrote:

“Growing income inequality pushed consumers to either bargain or luxury goods, leaving Sears in the shrinking middle. Competition from Wal-Mart and Target – younger and hungrier – took off.

By the late 2000s Sears was a shell of its former self. “YES, WE ARE OPEN” a sign outside my local Sears read – a reminder to customers who had all but written it off.”

Warren Buffett’s Berkshire Hathaway provides an opposite example to Sears. From the start of 1965 to the end of 1984, US long-term interest rates climbed from 4.2% to 11.5%, according to Shiller’s data. But a 23.7% increase per year in Berkshire’s book value per share over the same period resulted in a 27.6% annual jump in the company’s share price. A 23.7% input led to a 27.6% output over nearly 20 years, despite the significant growth in interest rates.

You may also be wondering: What’s going to happen to global financial markets in a world that is awash in cheap credit for a long time?

We can learn something from Japan: The country has already been in a situation like this for decades. The yield for 10-year Japanese government bonds has never exceeded 2% going back to the fourth quarter of 1997, according to data from the Federal Reserve Bank of St Louis. In fact, the yield has fallen from 1.96% to a negative 0.2% in the third quarter of 2019 (see chart below).

Interestingly, Japan’s main stock market index, the Nikkei 225, is just 40% or so higher from October 1997 to today, despite interest rates in the country having declined from an already low base in that time frame.

Yet, there’s a company in Japan such as Fast Retailing – owner of the popular Uniqlo clothing brand – which has seen its stock price increase by more than 11,000% over the same period because of massive growth in its business. From the year ended 31 August 1998 (FY1998) to FY2019, Fast Retailing’s revenue and profit grew by around 27 times and 56 times, respectively.  

What it all means for stock market investors

So to wrap up everything I’ve shared earlier in this article:

1. Rising interest rates may not hurt stock prices by depressing valuations, as seen from the S&P 500’s CAPE ratio increasing from the 1930s to the 1960s while interest rates were rising.
2. Historically, interest rates have declined and stayed low as countries develop and mature, according to William Bernstein’s book, The Birth of Plenty.  
3. Falling interest rates cannot help a stock if its business is crumbling, as seen in the case of Sears.
4. Rising interest rates also would not necessarily harm a stock if its business is flourishing, as Berkshire Hathaway has demonstrated.
5. The example of Japan’s Nikkei 225 index show that persistently low interest rates don’t always benefit stocks too. 
6. Fast Retailing’s experience highlights how Individual stocks can still be huge winners even in a flat market, if their businesses do well over time. 

And what do all these mean for us as stock market investors? It means that we shouldn’t bother with interest rates. Instead, we should focus on the health and growth of the businesses that are behind the stocks we own or are interested in. In other words, watch business fundamentals, not interest rates.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Chuck Akre is fast-becoming one of the investing greats of this generation. His Akre Focus Fund (the retail class) has achieved an annualised return of 16.72% since its inception in August 2009. The fund’s return easily outpaces the 14.14% annual gain of the S&P 500 over the same time frame.

As its name suggests, the Akre Focus Fund focuses its investments on only a small number of high-quality businesses (as of the fourth quarter of 2019, the fund only had 19 holdings). These are companies that meet Chuck Akre’s high standards related to (1) the quality of their businesses, (2) the people who manage them, and (3) their ability to reinvest capital at high returns. The Akre Focus Fund holds these companies for the long-term, allowing them to compound over time. Based on his fund’s results, this relatively straightforward strategy has worked tremendously well for Akre and his investors.

With that in mind, I want to highlight five things I learnt from Chuck Akre’s interviews and writings.

He doesn’t predict where the market is going

Unlike other investors, Akre does not scrutinise or make predictions about where the stock market is going. Instead, he focuses his efforts on finding great companies that trade at reasonable prices.

In a Wall Street Journal interview in 2018, Akre explained:

“It’s not that we don’t care what the market is going to do. It’s that there is nothing in our record that suggests we have any skill in making those predictions, so we don’t bother. We just focus on what it is that we do well. That has been successful for a long period, and we do that because we think it is logical, repeatable, simple and straightforward.”

Owning good businesses is more important than simply buying and holding

It is no secret that buy-and-hold investors have outperformed those that trade frequently. However, this is only one piece of the jigsaw.

The difficult part is actually finding stocks that are worth buying and holding. From my personal experience, buying and holding a mediocre business will, as you may have guessed, produce only mediocre returns. Akre says:

“Buy and hold is not our philosophy. What we want to do is own businesses that are exceptional until they are no longer exceptional. It’s a nuance on the notion of buy and hold.”

He also emphasises the point that investors should not hold a stock simply because they prescribe in the buy and hold strategy. If an investment thesis is flawed or the company has lost its competitive edge, it may be time to let go. He explains:

“We’re not afraid to sell, but we want to know that the company really isn’t exceptional anymore, because it has often taken me a long time to understand just how good the really good ones are. And once you own them, you shouldn’t get rid of them easily, or just because something has changed right now.”

He believes indexing is a perfectly good strategy for average investors

Despite running an actively managed fund, Akre still believes owning an index fund is a decent strategy for the retail investor.

Not only has indexing produced a decent return over the long term, but it is also difficult to find good active managers who can outperform the index over time. Akre explains:

“I think it is very difficult to understand who the good managers are and what makes them good. I think about this a lot as it relates to my partners and people in other firms. It’s hard, and people need help, and the idea of using index funds is perfectly reasonable for getting an experience that is the market experience.”

He doesn’t focus on the short-term fluctuations in his portfolio

Akre’s core investing principle is to focus on long-term returns. The stock market may fluctuate wildly in the short-term. Although this can create near-term upsized returns or steep drawdowns, we should not read too much into it. Instead, we need to focus on the long-term potential of our investments.

In his semi-annual shareholder letter in March 2019, Akre and his two other portfolio managers wrote:

“You might say, ‘No one can predict stock returns even on a single day. So how can you possibly focus on long-term returns?’ The answer is we do not focus on stocks. We focus on businesses. We earn a majority of returns as portfolio businesses improve and grow, year by year. Is it so crazy to think that if we find a thriving business with strong competitive advantages and buy it at a reasonable price, it might provide us with better-than-average long-term returns?”

He believes the market’s focus on short-term goals creates investing opportunities

It is well-documented that stocks tend to be the most volatile around earnings season. An earnings miss or earnings surprise can cause a stock price to rise or fall disproportionately to its true long-term value.

This is where Akre believes long-term investors can gain the upper hand. Simply by using this price-value mismatch to pick up shares at a discount, long-term investors stand to gain above-average long-term returns. In his discussion on his investing philosophy, Akre says:

“Wall Street’s obsession with what we describe as the “beat by a penny, miss by a penny” syndrome frequently gives us opportunities to make investments at attractive valuations. We keep our focus squarely on growth in the underlying economic value per share – often defined as book value per share – over the course of time. Our timetable is five and ten years ahead, and quarterly “misses” often create opportunities for the capital we manage.”

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

I recently read the book The Behavioural Investor by Daniel Crosby. Crosby is a psychologist who specialises in behavioural finance. Through his years of research, he found that humans tend to make bad investing decisions simply because of the way our brains are wired. 

But it doesn’t have to be that way. We can learn to overcome some of our behavioural tendencies that cause poor investing decisions by learning and understanding the impact of human psychology.

Crosby explains:

“Understanding the impact of human physiology on investment decision-making is an underappreciated area of study that represents a unique source of advantage for the thoughtful investor.”

With that said, here are some things I learnt from his book.

Our brains were not designed for investing

It may seem strange, but our brains are not really designed to make investing decisions. Homo Sapiens have been around for close to 200,000 years and yet our brains have barely grown since then. A 154,000 year old homo sapien skull found in Ethiopia is believed to have held a brain similar to the size of the average person living today.

Essentially, that means our brains have remained relatively unchanged – although the world around us has changed dramatically. This resulted in emotional centres that helped guide primitive behaviour now being involved in processing complex financial decisions. This has, in turn, led to poor decision making.

Crosby explains:

“Rapid, decisive action may save a squirrel from an owl, but it certainly doesn’t help investors. In fact, a large body of research suggests that investors profit most when they do the least.”

“Behavioral economist Meir Statman cites research from Sweden showing that the heaviest traders lose 4% of their account value each year to trading costs and poor timing and that these results are consistent across the globe. Across 19 major stock exchanges, investors who made frequent changes trailed buy and hold investors by 1.5 percentage points per year.”

Our brains are hardwired to be impatient

Our brains are also hard-wired to seek out immediate rewards. This can lead to impulsive behaviour and poor investing decisions.

Crosby cited research from Ben McClure and colleagues who measure the brain activity of participants who made decisions based on immediate or delayed monetary rewards. According to the study, when the choices involved immediate rewards, the ventral stratum, medial orbitofrontal cortex, and medial prefrontal cortex were used. These are parts of the brain linked with impulsive behaviour.

On the other hand, the choices involving delayed rewards used the prefrontal and parietal cortex, parts of the brain that are associated with more careful consideration.

The experiment showed that our brains made more impulsive and greedy decisions when it comes to immediate reward. 

Crosby explains:

“Your brain is primed for action, which is great news if you are in a war and awful news if you are an investor, fighting to save for your retirement.”

Our brain makes assumptions

Our brains have been hardwired to make quick decisions. This involves making assumptions, extrapolating patterns, and relying on cognitive shortcuts. As you can imagine, this can be a beautiful thing when it comes to saving energy for other functions of the body.

Unfortunately, making quick decisions based on cognitive shortcuts is by no means ideal when it comes to investing. These cognitive shortcuts can lead to poor decisions, cognitive biases and, ultimately poor returns.

A great example of cognitive shortcuts is the irrational primacy effect. This is the tendency to give greater weight to information that comes earlier in a list or a sentence. 

The Good Investors’ Conclusion

The Behavioral Investor brings to light some of the more common human tendencies and why the human brain is not built to make sound investing decisions. But don’t let that deter you from investing.

We can overcome these behavioural tendencies simply through an awareness of what drives unhealthy behaviour and build processes to guard against poor investing decisions.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

In 2011, Jeff Bezos, the founder and CEO of the US online retail giant Amazon.com, was interviewed by Wired. During the interview, he said (emphasis is mine):

“If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people. But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that.

Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue.”

What’s an edge?

I believe Bezos’s quote above applies to stock market investing too. By simply lengthening our time horizon when investing, we can gain an edge and eliminate our competition.

Investor John Huber from Saber Capital Management, who has an excellent – albeit relatively short – track record,  explained in a 2013 presentation that there are only three sources of edge: Informational; analytical; and time. I agree.

A difficult source of lasting edge

The informational edge refers to having access to information that most others do not have. In his 2013 presentation, Huber shared the story of how Buffett uncovered Western Insurance as an investment opportunity in the 1950s.

Western Insurance was a profitable, well-run insurance company and was selling at a price-to-earnings ratio of just 1. Buffett found the company by poring over Moody’s, a print magazine that listed financial statistics of stocks in the US. It would have been painstaking work in those days to look at every stock individually.

With the birth of the internet, the informational edge has mostly disappeared since information is now easily and cheaply available. The Internet – and the growth in software capabilities – have levelled the information playing field tremendously. This makes having access to information difficult to be a lasting investing edge for us.

Another difficult source of lasting edge  

The analytical edge is where you’re able to process information differently and come up with better insights compared to most. I believe, like Huber does, that this is still possible. Give two investors the exact same information about a company and it’s highly likely they will arrive at a different conclusion about its attractiveness as an investment opportunity.

As a great example, we can look at Mastercard and how investors Chuck Akre and Mohnish Pabrai think about the credit card company.

Akre runs the Akre Focus Fund, which has generated an impressive annual return of 16.8% from inception in August 2009 through to 30 September 2019. Over the same period, the S&P 500’s annual return was just 13.5%. Pabrai also has a fantastic long-term record. His fund’s annual return of 13.3% from 1999 to 30 June 2019 is nearly double that of the US market’s 7.0%.

At the end of September 2019, Mastercard made up 10% of the Akre Focus Fund. So clearly, Akre thinks highly of the company. Pabrai, on the other hand, made it very clear in a recent interview that he wouldn’t touch Mastercard with a 10-feet barge pool. In the October 2019 edition of Columbia Business School’s investing newsletter, Graham and Doddsville, Pabrai said:

“Is MasterCard a compounder? Yeah. But what’s the multiple? I can’t even look. Investing is not about buying great businesses, it’s about making great investments. A great compounder may not be a great investment.”

The fact that two highly accomplished stock market investors can have wildly differing views on the same company means that it is possible for us to develop an analytical edge. But it is not easy to achieve. In fact, I have a hunch that the ability to consistently produce differentiated insight may be an innate talent that some investors possess and others don’t.

A simple but lasting edge

Huber’s last source of edge, time, refers to our ability to simply adopt a long time horizon in the way we invest. It sounds simple, but it’s not easy to achieve. Because like Bezos said, not many people are willing or able to be patient. This makes time a lasting edge we can have in the market.

You may be surprised to know just how short-term minded many professional investors can be. A recent article from Huber showed how the hedge fund SAC Capital was predominantly focused on short-term stock price movements (emphasis is mine):

“The firm spent hundreds of millions of dollars they collectively spent on research [sic] was all designed to figure out if a stock was going to go up or down a few dollars in a short period of time, usually after an earnings announcement or some other significant event.

These traders were moving billions of dollars around with no concern for what the company’s long-term prospects were, other than how those prospects might be viewed by other traders in the upcoming days…

… The traders at SAC weren’t even discussing this type of edge [referring to the time-related edge]. It wasn’t even on their radar, because they had no interest in the long game.”

Another example can be seen in a story that Morgan Housel from the Collaborative Fund shared in a blog post (emphasis is mine):

“BlackRock CEO Larry Fink once told a story about having dinner with the manager of one of the world’s largest sovereign wealth funds.

The fund’s objectives, the manager said, were generational. “So how do you measure performance?” Fink asked. “Quarterly,” said the manager.

There is a difference between time horizon and endurance.”

Since many investors are more concerned with short-term price movements than long-term business value, this creates an opportunity for us if we’re focused on the latter. In the same article on SAC Capital, Huber explained:

“[T]he investor who is willing to look out three or four years will have a lasting edge because the more money that gets allocated for reasons other than a security’s long-term value, the more likely it is that the security’s price becomes disconnected from that long-term value.” 

The curse of patience, and a switch in mindset

Although having time on our side is a simple way for us to gain a lasting edge in the stock market, it is not easy to achieve, since we have to pay a price – of enduring short-term volatility. History bears this out: Even the biggest long-term winners in the stock market have also suffered painful short-term declines. 

Take the US-listed Monster Beverage for instance. I’ve written previously that from 1995 to 2015, Monster Beverage produced an astonishing total return of 105,000% despite its stock price having dropped by 50% or more from a peak on four separate occasions in that timeframe.

But a switch in our mindset can make the sharp swings over the short run easier to manage. “Fees are something you pay for admission to get something worthwhile in return. Fines are punishment for doing something wrong,” Morgan Housel once wrote. Most investors think of short-term volatility in the stock market as a fine, when they should really be thinking of it as a fee for something worthwhile – great long-term returns.

So, fee or fine? I love paying fees. Do you?

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.