Excellent work, Steven. Thanks for creating the portfolio.
FWIW, I thought an article today from Pat Dorsey of Morningstar was interesting, and I'm curious if posters behind their nominees for James's challenge think their pick fits into any of these categories.
Snip:
While the obvious investing lesson is simple--you’re generally better off going against the grain than following the crowd--there's more to be gleaned from the A's story. After all, Beane bought undervalued traits of baseball players and sold or avoided overvalued traits, and we can do the same thing in the stock market.
So, in the spirit of building your own winning set of investing skills, I've compiled a list of company traits and investing practices that I think are "undervalued" and "overvalued." Since the heart of investing successfully is finding inefficiencies in the market, you'd be better off seeking out the undervalued traits and practices--the ones that most people ignore--and avoiding the overvalued or popular ones.
Overvalued: Acquisition-fed growth. Undervalued: Internally generated growth. Wall Street loves acquisitions because they generate headlines and investment-banking fees. Unfortunately, acquisitions fail to add economic value more often than not, so look for companies with a quiet, solid track record of growing through their own efforts.
Overvalued: Initial public offerings (IPOs). Undervalued: Spin-offs. IPOs are sold to the highest bidder amidst a slew of hype and propaganda, while spin-offs quietly come to market when a parent firm casts off its unwanted progeny. Which do you think has the better long-term track record for investors? Hint: It's the one that no one initially wants, not the one that everyone clamors for.
Overvalued: Well-known firms in big industries. Undervalued: Leaders in niche industries. This inefficiency stems from the industry-oriented way research is done on Wall Street. In order to do a good job researching a company like Cintas CTAS or Moody's MCO, an analyst has to go out and learn the dynamics of a brand-new industry. Since there are few other public players in niche industries, all that research results in just one more stock on his or her coverage list--whereas an analyst who becomes an exp! ert on semiconductors or retailing can leverage that industry knowledge into a lot more companies. So, small and offbeat industries aren’t as well followed, which means more opportunity for those willing to do some digging. (For example, Moody's and Cintas are each followed by about a dozen Wall Street analysts, while a lower-quality firm like Advanced Micro Devices AMD has 29 analysts tracking its every move.)
Overvalued: What the stock has done. Undervalued: What the company is likely to do. The market tends to chase hot stocks up, and run away from dogs when they're sinking. However, the recent short-term performance of a stock has absolutely no bearing on the future long-term performance of a company. Ignore what the stock chart looks like over the past few months and spend your time thinking about whether the company is still healthy, and you'll be a better investor.
Overvalued: What everyone else is doing. Undervalued: Common sense. Humans are social creatures, and so we often look for "validation"--we like knowing that others agree with our courses of action, because then we don't feel quite so stupid if what we do turns out to be wrong. Unfortunately, being able to blame everyone else doesn’t make a financial loss go away. So, when common sense tells you that a stock or industry is priced for perfection or is too cheap to pass up, don't worry about what the crowd is saying. Listen to yourself, because you’re the one making the investment.
Overvalued: Retained earnings. Undervalued: Dividends and share repurchases. There's nothing wrong with a company hanging on to its earnings and plowing them back into the business; in fact, that's exactly what you want a company with lots of great internal investment opportunities to do. But companies often plow money into dubious projects rather than returning it to shareholders. In fact, a recent academic study showed that companies with high dividend payout ratios actually had higher subsequent earnings growth than companies that retained lots of their earnings, which is exactly the opposite result than conventional wisdom would have expected. Moreover, the tax cut on dividends has made dividend-paying stocks even more attractive over the past year. (You wouldn't know this to look at the market, of course, since it has been speculative stocks that have really led the charge over the past 12 months.)
Overvalued: Flashy businesses that sound exciting. Undervalued: Steady businesses with wide economic moats. It's easy to get worked up over a company that unravels the human genome or invents a great electronic gadget, but firms like these turn out to be flashes in the pan more often than not. Over time, companies with strong competitive advantages--or wide economic moats--tend to outperform stocks with weak competitive advantages, no matter how boring their businesses might be. Long-term stock performance is tied to high returns on capital, not headline-grabbing products or services. So avoid the flash and go for the cash. |
