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Beware Of Screens

Summary When doing work on IBM recently, we came upon a significant mistake made by one of our data providers. Had we acted on this result without doing due diligence, we would have missed what we consider a profitable trade at best or lost money on puts at worst. Screens represent a general problem: a preponderance of data and a dearth of insight. Use screens as a starting point only. They should be your first tool, not only tool. Investors face a host of risks that they willingly take on. There’s the biggest risk (risk of overpaying), sentiment risk, market obsolescence, risks flowing from the capital structure etc. One of the risks that’s talked about less often is what we call “the input risk”. We know of a few horror stories where people invested based entirely on web based screens and have come to regret it. In this short piece, we want to offer a specific example of why this is such a risk and make a general point about how investors should use these valuable, but limited tools. The advice seems simple, but like a great deal of simple advice, it’s followed infrequently by some. This may be unwelcome news to some people who prefer the magic bullet solution to a systemic problem: doing well at this requires a great deal more work than running a screen. We only publish a portion (sometimes a small portion) of the work we do when analysing a company. There’s actually a great deal going on below the surface here. There are two reasons for keeping most of our work to ourselves. First, we offer it to paying clients. It’s only fair. They paid for it. Second, we believe the wider readership would rather not be subjected to even longer screeds about a given name than we normally impose upon them. For instance, we like to focus on what the sales community (sorry…the ” analyst ” community…) is saying about a particular name, since they often act as a long-run contra indicator. We also like to review the likelihood that a given company is a financial manipulator. We do this in a variety of ways and for obvious reasons. For anyone who’s interested, feel free to on one of the methods we use, developed by professor Messod Beneish . One Example Of How Things Could Have Gone Badly When we started our analysis of IBM (NYSE: IBM ) recently , we started by reviewing a financial website (Gurufocus). Gurufocus is one of our favourite go-to sites and is often very useful, but when it’s mistaken it’s really mistaken. In particular, the site claimed that there was a better than average chance that IBM was a financial manipulator, based on its M-score. When we calculated the score ourselves, we determined that IBM is no more likely to have failed Beneish’s manipulator screen than any other company. Gurufocus responded to our query by saying that it relies on financial results posted by Morningstar, so we should approach that organisation. This is strange because the Morningstar numbers and the Gurufocus numbers don’t agree across the board. In this instance, Gurufocus/Morningstar didn’t include one of the components of IBM’s accounts receivable in March 2014, making it look as though the company’s accounts receivables have ballooned massively over the past four quarters. For the record, when accounts receivables grow massively and rapidly, that’s a huge red flag. The fact is that this didn’t happen at IBM, so that company was unfairly painted with the “manipulator” brush. Source: Gurufocus, July 28, 2015 The actual results are these: Source: Company filings The actual M-Score for IBM is ~-3, which means that it does not fail the screen developed by professor Beneish. If the reader is interested in learning more about the M-Score and professor Beneish’s methodology, feel free to check out some earlier work or have a look at some online resources . If we simply placed a trade based Gurufocus’ findings, we believe we would have injured ourselves and our clients over the coming year. We would have either not bought a company that we’re actually generally bullish on, or we would have lost money on puts. If we didn’t discover the problem with the way accounts receivable was being calculated, we could have come to a faulty conclusion. There’s a lesson about double checking screens here. Conclusion This isn’t to say that such services are not valuable. Sites like Gurufocus and YCharts and others improve productivity tremendously. They help investors search the universe of stocks in seconds. The problem is that if you make investment decisions based on their results alone, you’re taking on unnecessary risk. The proliferation of sites that allow us to aggregate the vast amounts of data available is both a symptom and a cause of the preponderance of data and a (relative) dearth of insight. When starting to invest, we recommend using sites like these as a starting place, and when you find something interesting, immediately go to the actual sources. The fact that so many investors seem frightened of financial statements and their accompanying notes leads us to believe that there’s potential profit to be had if you train yourself accordingly. We’re reminded of how Jim Chanos spotted the Enron debacle first because so few other analysts read the notes to the financial statements published by that company . The SEC website is as available as any other and it should be the place you visit just after hearing about a company through one of the available tools. These screens are great as a first but not final tool. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Why Do Fundamentals Matter?

With a booming market, everyone forgets fundamentals. Someone, the other day, told me that “You don’t need profits to pay bills” when talking about Amazon. If that’s not a sign of euphoria and not understanding how wealth is built, I don’t know what is. The reason fundamentals matter in the long run is that wealth is built on cash flow, profit, and overall returns. Yes, a company can profit but if you’re paying too much for that profit, it’s going to hurt you in the long run because there will be a time when your investment is out of style and everyone will revert back to fundamentals. It happens in every bear market. People flee the exciting fast growing stocks that aren’t doing as well financially to go to companies that generate cash flow and build their balance sheet. Not only in stocks. Real estate as well. The last 15 years have been a boom in real estate, even after a big bust. Real estate is driven by income. I randomly pulled 28 markets that I could think of in this country and looked at their median income growth and their real estate value growth since 1990. The direct correlation from one city to another wasn’t exactly there, but when you looked at all 28 cities as a whole, they were very much in line. Median income growth was 2.32% per year on average and the average real estate growth was 2.6% per year. Not exact, but close. During the recent 15 years of booms in major markets (that were also in my 28 city analysis), we were seeing 15-20% growth per year even though income wasn’t growing NEARLY as much. Then we saw a massive drop in prices and another rebound, so everyone assumes that the past problems were past problems. We shall see. The bottom line is that everything reverts to the mean. We are never exactly fairly valued. We are either overvalued or undervalued in every investment asset. You are either a buyer or seller of assets. It’s that simple. I choose to wait until asset prices get to the point where they are undervalued enough to make me feel that above-average returns will be experienced based on historical averages. Does it require A TON of patience? Absolutely. Is it frustrating at times? 100%. To hear the so-called “experts” tell me that I’m missing it and I don’t understand and “This time is different” has become annoying. But I stick to fundamentals. And at the end of the day, they win out. Fundamentals are the only true way to measure value. You have to find out what truly defines the price of an asset and buy when the asset is selling for below that fundamental point. Is it just one thing? No. But is it a ton of complicated points? Absolutely not. There are a few things that matter when looking at investments and it is the job of a true investor to understand what those are and where they have stood historically (not just over 25 years but over 60+ years). Share this article with a colleague

Equinox Launches Systematic Global Macro Fund

By DailyAlts Staff The investment world has become a tumultuous place. In China, stocks lost nearly 30% of their value in less than a month, and despite the heavy-handed interventions of the Communist government, the country’s stock markets appear to be on the ropes again. Oil prices also slid close to 30% in July, while the yield on the 10-year Treasury bond has bounced between 2.2% and 2.5%, often with major moves happening in a single day. Add in the ongoing Greek debt crisis, which is far from being resolved, and it’s understandable why stocks and bonds have been increasingly volatile investments in 2015 – and why investors are looking to alternative strategies to hedge against downside risk. Global macro strategies, which seek to capitalize on the inefficiencies in long-term macroeconomic cycles, can be particularly attractive in this environment. These strategies aim to generate returns by taking long and short positions, typically using futures contracts, in global markets across asset classes: equity indexes, government bonds, currencies, and commodities. “Systematic macro” is a particular kind of global macro strategy, involving rules-based factor exposures, trend-following and counter-trend trading, rather than relying on the discretion of a portfolio manager, and investors seeking exposure to systematic macro strategies have one new option as of July 6: the Equinox IPM Systematic Macro Fund (MUTF: EQIPX ). The Equinox IPM Systematic Macro Fund pursues its investment objective of long-term capital appreciation by employing two sub-strategies: The first involves investing directly in an actively managed fixed-income portfolio consisting of cash, cash equivalents, money market funds, and U.S. Treasury debt with one year or less to maturity; while the second involves investing directly or indirectly through a subsidiary in futures contracts and other related securities. The indirect investments are managed by IPM Informed Portfolio Management AB in accordance with its Systematic Macro Trading Program, also known as the IPM Program. The IPM Program attempts to build a diversified portfolio of futures contracts consisting of a large number of uncorrelated investment ideas based on four broad fundamental themes: Value themes designed to take advantage of discrepancies between market value and longer-term “intrinsic” value; Risk premia themes designed to exploit the time-varying nature of investment opportunities and returns; Macroeconomic themes based on economic, political, and/or financial trends; and Market dynamic themes focused on investment flows, interest rate volatility, and other attributes. If the fund sounds good, be prepared to make a large investment: Shares are available in I-class only with a 1.89% net-expense ratio and a minimum initial investment of $200 million. For more information, read the fund’s prospectus . Share this article with a colleague