Tag Archives: management

Investors May Be Doing The Wrong Thing (Again)

Summary In this article, I delve a little deeper into my recommended Model Stock Portfolio funds to try to get a fresh perspective that cannot be found elsewhere. The snapshot that emerges is intended to further help result-seeking investors judge what might be the best choices going forward within a group of already highly recommended funds. Investors often invest heavily in funds whose holdings are tilted toward previously strongly performing but overvalued stocks, rather than from those with a better chance of showing future strength. It should go without saying that no single or even multiple selection criteria hold the key to which funds you should hold on to and with what emphasis in your portfolio. However, in my Newsletters down through more than 15 years, I have tried to make the case that, while there are numerous good funds (or ETFs) to choose from, the best long-term results are more likely when, even within a list of highly rated funds, one focuses on those composed of stocks that are relatively more undervalued vs. those made up of stocks which have already been “discovered,” and therefore, likely have seen most of their potential run-up in prices already. Expressed a little differently, some funds may have achieved their recent success by their emphasis on holding a preponderance of already recognized “winning” stocks and stock categories and continuing to ride those winners. A simple example is funds that hold a relatively large proportion of what has proven to be an amazing stock, Apple (NASDAQ: AAPL ). The same may be said for funds that have a relatively high proportion of recently high-performing technology stocks as a group. Two such funds I have consistently recommended are the Vanguard Growth Index Fund (MUTF: VIGRX ) (or its equivalent ETF) and Fidelity Contra (MUTF: FCNTX ). The former currently holds 7.5% of the fund in Apple and 26% of the fund in Technology companies. The latter holds about 3.8% in Apple and 29% in technology stocks. Given the excellent performance over recent years of these fund components, the heavy weighting has given a boost to both these funds (and many other similarly categorized Large Growth funds), and been a contributing factor as to why these two funds have beaten the S&P 500 Index on average over many years. But another even more striking example can be cited: funds investing heavily in Health Care, such as PRIMECAP Odyssey Growth (MUTF: POGRX ), Vanguard Health Care (MUTF: VGHCX ) or Vanguard Health Care ETF (NYSEARCA: VHT ). Not surprisingly, the latter two highly narrow-focused funds have nearly all their investments in this one sector, a stock subclass that has on average returned over 20% annualized over the last five years. While, unfortunately, I have never included any of these funds in my Model Stock Portfolios, I have recommended at least one fund with greater than a 20% weighting in Health Care currently, namely T. Rowe Price Value Fund (MUTF: TRVLX ), This fund’s track record against its Large Cap Value category peers has been admirable over the last five years. Beyond this, though, is where things get very murky. As an investor, do you want to stick with funds that invest heavily in stocks and categories that have shown a lot of past momentum in the hopes that this outstanding performance will continue? Or, do you want, perhaps, to trim down your holdings of such funds, and instead for at least the next few years, favor funds more heavily invested in stocks and categories that may show even greater potential for success, namely those choosing the majority of their investments in potentially less overvalued segments of the market? Unfortunately, there is no clear-cut answer to this dilemma. Therefore, it is probably wisest to own funds weighted in both, that is, funds that invest heavily in stocks with strong current momentum, and, those that can potentially become better choices when the former momentum-driven stocks start to lose altitude. Unfortunately too, one of investors’ biggest downfalls happen when the winds of change periodically cause a big shift in the performance of previously winning stocks, categories, and the funds investing heavily in them. While we haven’t seen any such sort of massive shift going back perhaps to the 2007-09 financial crisis, or even before, we know that many investors tend to suffer when outsized bets on previous winners turn into outsized losses. While no one can say with any degree of certainty if and when the next reversal of fortune may befall the current crop of big winners in stocks, what follows is an analysis of which of my recently recommended funds are holding stocks perhaps overloaded with past winning, but now likely overvalued, categories of stocks. And, on the other side of the coin, can I identify which of my recommendations are more oriented toward current ownership in categories that seem to be less likely to underperform, when the next big shift in stock market winners and losers takes hold and impacts fund results for possibly years into the future? A Closer Look at My Model Stock Portfolio Funds In the first list of funds below, I analyze broadly diversified domestic stock funds recommended (or recently so) in my Model Stock Portfolio to examine the above issue. I also include some additional funds that I hold in my own personal investment portfolio. Funds more broadly classified as international stock or narrow-focused sector funds, however, are not included. For each listed fund, I have scored the fund on the extent to which it is currently (based on latest data available) invested in either what appear to be fairly priced categories of stocks, or on the other hand, seemingly overvalued categories, based on my own proprietary research. See the note at the bottom of the list for the meaning of scores. Each fund is listed in a descending order of score, starting with those least likely to be overvalued . Those with greater potential for coming out on top over the next 3 to 5 years, assuming my scoring method proves valid, are listed closer to the top; those that may be strong winners recently, but having a greater potential for underperformance when their current chosen and often overvalued stock selections lose momentum, are found further down the list. Note: If one compares the results shown in the list with the allocations shown in my Oct. ’15 Model Stock Portfolio , the results may not completely agree with the recommendations there because the listing below is based on different data. It should come as no surprise that all of the funds below, because they are diversified mixes of stocks, will have a moderate proportion of their investments in overpriced stock categories, given what we have previously labeled as an overall overvalued market. Therefore, inclusion in this list below in no way ensures that most or all of these funds will prove to be great investments over the next few years. But relatively speaking, we chose these funds, that is, those that are managed, aiming to beat market indices, or at least do well against their similarly classified peers. However, it is very possible, too, that perhaps some of the best investments for the next few years instead may turn out to be in funds that are invested internationally, as generally speaking, these fund categories seem to be relatively more undervalued than U.S. domestic funds are at the present time. Best Model Stock Portfolio Choices (from most highly rated* to less highly rated) Fund Name (Symbol) Score 3 Yr. Return (thru 10-27) (ann.) Category 1. T. Rowe Price Equity Income (MUTF: PRFDX ) 76% 10.6% Large Value 2. Vanguard US Value (MUTF: VUVLX ) 74% 16.5% Large Value 3. Fidelity Large Cap Stock (MUTF: FLCSX ) (tie) 70% 15.5% Large Blend 3. Vanguard Equity-Income (MUTF: VEIPX ) (tie) 70% 13.9% Large Value 3. Vanguard Small Cap Index (MUTF: NAESX ) (tie) 70% 14.7% Small Blend 6. Vanguard Extended Market Idx (MUTF: VEXMX ) 68% 15.0% Mid-Cap Blend 7. T. Rowe Price Value (tie) 65% 16.4% Large Value 7. Vanguard Mid Cap Index Adm (MUTF: VIMAX ) (tie) 65% 17.1% Mid-Cap Blend 9. Vanguard Small Cap Growth Index (MUTF: VISGX ) 64% 13.6% Small Growth 10. Vanguard Windsor II (MUTF: VWNFX ) 63% 13.4% Large Value 11. Vanguard 500 Index (MUTF: VFINX ) 62% 15.8% Large Blend 12. Fidelity Contrafund (tie) 58% 17.1% Large Growth 12. Vanguard Growth Index (tie) 58% 16.9% Large Growth 14. Fidelity Low-Priced Stock (MUTF: FLPSX ) 55% 15.2% Mid-Cap Value 15. AMG Yacktman Service (MUTF: YACKX ) 39% 11.7% Large Blend *Note: Top rating possible is 100%; lowest possible rating is 0%. A score of 70%, for example, means that 70% of the stocks in the fund are judged to be within a class of stocks that is fairly valued while 30% are within a category that my research indicates is overvalued. Of course, funds in the above list that are managed (that is, not index funds) will have the option of switching out of overvalued categories if it is decided to make such a switch. Index funds must stick to their mandated benchmark and typically will not change their composition unless the underlying index changes. Funds with the Most Investor Assets As a basis of comparison with the above funds and to see alternative funds chosen by investors that have currently attracted the most investor assets, it is also informative to look at similarly derived scores of the most popular funds using the same criteria to rate each in terms of my measure of fair vs. overvalued stock portfolio composition. (The first list also includes some of the biggest funds; it also includes a few that mirror some of the most important indices such as the S&P 500, so we won’t show funds that are identical or nearly so to those there. And, I again exclude international and sector funds.) Biggest Funds by Assets (from most highly rated* to less highly rated) Fund Name (Symbol) Score 3 Yr. Return (thru 10-27) (ann.) Category 1. Dodge & Cox Stock (MUTF: DODGX ) 71% 16.1% Large Value 2. Vanguard Value ETF (NYSEARCA: VTV ) 69% 15.0% Large Value 3. American Funds Washington Mutual A (MUTF: AWSHX ) 67% 14.4% Large Value 4. American Funds Invmt Co of Amer A (MUTF: AIVSX ) (tie) 64% 15.0% Large Blend 4. Vanguard Total Stock Mkt Idx Adm (MUTF: VTSAX ) (tie) 64% 15.8% Large Blend 6. American Funds Fundamental Inv A (MUTF: ANCFX ) (tie) 61% 15.3% Large Blend 6. American Funds AMCAP A (MUTF: AMCPX ) (tie) 61% 17.0% Large Growth 8. American Funds Growth Fund of Amer A (MUTF: AGTHX ) 54% 16.8% Large Growth 9. Fidelity Growth Company (MUTF: FDGRX ) 50% 19.6% Large Growth 10. T. Rowe Price Growth Stock (MUTF: PRGFX ) 48% 19.9% Large Growth *Note: See the Note under the first table. If you look carefully over these two lists, you will notice that the majority of funds with the highest, that is, best forward-looking scores, are categorized as Large Value funds. And, almost equally noticeable, most of the funds with a large percentage of already “discovered” stock categories, especially in the second list, are Large Growth funds. What this suggests is that the best opportunities for investors for the next several years would appear to lie in US stock funds that are classified as Large Value. Many Large Growth funds, if this analysis is valid, are likely to perform less strongly than Large Value funds because investors may have already realized most of the performance benefits of this category and are more likely to find both a greater degree of safety in Large Value funds when market conditions are no longer as bright, and a greater degree of return potential due to their less overvalued composition. While there is no way to know for sure how long the current “momentum bias” will continue, as it very well may, investors might always want to keep in mind that over long periods of time, the best way to make money in stocks is to establish and maintain your positions when prices are relatively low. It seems apparent, however, that looking at the second list featuring those funds investors have the most money invested in, they seem to be opting for many funds, including unmanaged index funds, with a relatively greater degree of already “stretched” types of stocks.

The Grandma Approach

Summary Don’t be afraid to take a long-horizon approach to investing. Invest in what you know and understand. Always do your due diligence. Introduction Recently I’ve had several conversations with my grandma that caused me to question everything I’ve ever learned about investing. My sweet grandmother is an incredibly intelligent and humble lady. She has the unique ability to light up any room with her infectious smile and unassuming attitude. On Saturdays she spends time at garage sales looking for deals, and on Sundays she attends church, likely praying for the well-being of her rebellious family. Before she retired, she was a communications professor at the University of Texas. What was she not? She is not a financial guru or valuation genius. I don’t think she knows what a price to earnings multiple is, she doesn’t know what EBITDA stands for, and I can definitively say she doesn’t build her own DCF or comps models. Regardless, my grandmother and grandfather took up investing after retiring from professional life. My grandpa primarily is a dividend investor who averages about 4-5% returns year over year on low beta stocks. My grandmother on the other hand has been very willing to take on risk, and she has averaged an absurd 35% average annual return over the last 20 years. In the last year and a half alone she has made a 100% return. When I heard this, I first apologized for spitting out my coffee all over my shirt. Then as I did my laundry, I ruminated over my disbelief and resolved myself to conduct an independent research study on my grandmother. I was determined to know how someone with almost no financial background could so handily outperform some of the most seasoned investment professionals. The Grandmother Approach After hours of discussion, I determined my grandmother has three main criteria when investing She must personally like and use the products or services of the underlying company regularly in her own daily life She doesn’t focus on quick profits, valuation theory, or macro-economic hearsay She buys and holds a stock as long as she likes what the company sells or provides, and she subsequently liquidates her shares when she no longer cares for whatever product or service the underlying company peddles And that’s about it. She might hold a stock forever if she likes what they do. She has no timetables, and she doesn’t really care much about balance sheets. She is a firm focused trend investor with the patience you might expect from a teacher and a mother of three children. You can scoff at her approach, but the truth is she has outperformed the market for the last 20 years. So, for the sake of money, let’s give grandma the credit she deserves and maybe try to learn from her approach. I’m going to go into more detail now about her historical picks, why she decided to buy, and when she finally decided to sell. Hopefully I’ll verbalize an actionable way we too can follow in Grandma’s footsteps. Grandma’s Winners I have decided to include a select sampling of certain stocks she has owned. If this article garners interest, I may choose to included more of her stock picks. It is true that I noticeably am covering a time frame exemplified by ever increasing stock valuations (and possibly artificially inflated returns), though it should be noted that grandma outperformed the market from 2008-2010 as well. Cracker Barrel (NASDAQ: CBRL ) Enter : April 11, 2012 @ 56.20 “Grandpa and I always love to eat at Cracker Barrel when we take road trips. Their service is very good, and the parking lot is always full. Also, Cracker Barrel is always full of people like grandpa and I.” I believe the “people like grandpa and I” comment meant elderly people. After talking to grandma, I did my own due diligence to check if she was correct. The parking lot was in fact completely full, and the target demographic was indeed, shall we say “a little greyer.” I received my chicken and dumplings within 10 minutes, had some coffee, paid for my food, and left within 30 minutes. Granted I visited only one Cracker Barrel in the middle of rural Georgia. However, My grandmother and I reasoned that she had visited around 90 unique locations and assured me her experience was similar each time. 90 of 500 locations within the US is an 18% sample size which frankly was large enough to equal a statistically significant sample group in my own mind. It was official, Cracker Barrel did operate like a well-oiled machine, and my grandma had recognized this fact and capitalized on it. Exit : July 9, 2015 @ 154.65 “I really like Cracker Barrel still, but grandpa has been telling me that the stock is overpriced. Jim Cramer didn’t seem too optimistic either.” It will be hard quantifying a statement like this, but let me try. I believe what she was trying to say is that she felt like she had realized a generous return on her initial investment and was satisfied with what she had returned. When everyone is saying a stock is overvalued, it may be prudent to listen to what they have to say. Result : 171.18% ROI over 3 years and 3 months before a 3.2% dividend. This translates to a 52.67% avg. annual unrealized return without dividend reinvestment. Takeaway : Remember, the grandma approach involves patience, a long horizon, and recognizing solid business. Cracker Barrel checked all these boxes for my grandma, so she invested (and committed to regularly eating/monitoring the performance of her company). I believe there is lot to be said for patience and commitment. Starbucks (NASDAQ: SBUX ) Enter : May 31, 2010 @ 13.26 “Grandpa and I go there all the time. I noticed that it was always full of young people, and I like that I can get little gifts. It seems like there are Starbucks everywhere!” This is largely hearsay and un-technical, but as a “young person” I can attest to the fluidity and convenience of Starbucks’ daily operations. This is largely intangible, but they also offer highly convenient free wifi, they pursue environmentally and socially conscious movements, they offer seasonal beverages (ex. hibiscus tea, pumpkin spice latte’s), they employ thousands, and personally (warning the following comment is highly subjective) I think there coffee is pretty good (albeit overpriced). I think personally, Starbucks’s successful high growth, socially conscious strategy has paid off well over the long term. Strictly from Grandma’s point of view though, Starbucks is: popular, convenient, and widely available. Currently Owns : October 31, 2015 (Present) @ 62.57 Recently, I’ve had conversations with grandma in which she has expressed concern about its value. She believes it is almost time to exit, but she does in fact still own all of her shares. She cited reasons such as its 52 week high, Jim Cramer, and (of course) grandpa. To be fair, SBUX is trading at a 35X P/E multiple with a mere 1.02% dividend. SBUX’s domestic growth opportunities are decreasing, and it will be interesting now to see how SBUX pursues global growth strategies. Considering the vast uncertainty regarding Starbuck’s future growth, it isn’t entirely unfair to see why grandma might have a point here. Result : 371.87% split adjusted return, annualized 68.65% return before its 1.02% dividend. I must say, I was blown away when I crunched the numbers. Cashing out would not be such a bad thing at this point. Takeaway : Popularity, patience, and positive customer experience. These key intangible (yet important) metrics indicate a well-run business/investment. There are hundreds of other reasons why Starbucks has been so successful, but for grandma I believe the three I just mentioned sum it up fairly well. Apple (NASDAQ: AAPL ) Enter : Nov, 1 2005 @ 9.69 “Your father bought me a fancy IPOD, but I couldn’t figure out how to use it for the longest time. I saw so many people buying them though that I knew it must be something special. I thought about it for awhile, and I read up on the company before I decided to buy shares.” It’s honestly hard to say she didn’t luck out on Apple. Apple is a fantastic company that has performed incredibly well. Right now I still think Apple is in value territory and could likely continue its seemingly endless upward trajectory (my opinion). I’ll assume she did her research well and realized Apple’s R&D/marketing was a true differentiator. Honestly I’m more blown away that she never decided to sell. Currently Owns : Presently 119.50 Honestly, holding a stock for 10 years seems like an eternity to me. Grandma calls Apple her “cash cow” and has never seen any reason to sell it. I think it’s fair to say that Apple makes just about anything look good. Apple products have transcended into status symbols in many cultures, and you’d be hard pressed to find someone who does not know at least what Apple is. At a current P/E multiple of 13x, you could argue that Apple is value stock still. Result : Split adjusted return 1,300% before 1.78% dividend over a 10 year horizon. Takeaway : If the quality and desirability of a new technology is apparent in the eyes of a grandmother in her 70s, it’s possible that it’s something special. On a higher level, sometimes jumping on the bandwagon, with a long-term horizon in mind, is not necessarily a bad thing. However, it is important to remain diligent and continually research the performance of the business, the products it is offering, and the desirability of its largest cash producing offerings. The One That Got Away: Facebook (NASDAQ: FB ) What Happened? I mention Facebook because my grandma wanted to buy Facebook from the very beginning, and to this day she is angry that she did not. She was convinced (as many were) that the valuation when Facebook IPO’d was too high, so she chose not to buy in. However, Facebook (even at it’s initially high price @ 38.23 in 2012) has seen a 166.73% price appreciation as of today. Tips for Investing Like Grandma Don’t get too caught up in the noise (CNBC, Fox Business, family), instead remain patient and maintain realistic expectations Don’t be afraid to take a long-horizon approach to investing Focus on companies you understand (and like!) Do your due diligence and spend time getting personally invested in the products and services your company offers Conclusion That’s it! The grandma approach to investing takes patience and personal devotion. Just like you would put time into spouses and family members, get invested in the culture and products of the company you own. Forget the “analyst opinions” and the “most recent news” and focus on what the company you own does for the world. Don’t trust me? Luckily, numbers don’t lie and I believe even the most veteran money manager can learn a thing or two from “investing with grandma.”

Best And Worst Q4’15: Materials ETFs, Mutual Funds And Key Holdings

Summary The Materials sector ranks seventh in Q4’15. Based on an aggregation of ratings of 12 ETFs and 14 mutual funds. IYM is our top-rated Materials sector ETF and FSCHX is our top-rated Materials sector mutual fund. The Materials sector ranks seventh out of the 10 sectors as detailed in our Q4’15 Sector Ratings for ETFs and Mutual Funds report . Last quarter , the Materials sector ranked sixth. It gets our Neutral rating, which is based on an aggregation of ratings of 12 ETFs and 14 mutual funds in the Materials sector. See a recap of our Q3’15 Sector Ratings here . Figure 1 ranks from best to worst the nine Materials ETFs that meet our liquidity standards and Figure 2 shows the five best and worst-rated Materials mutual funds. Not all Materials sector ETFs and mutual funds are created the same. The number of holdings varies widely (from 25 to 139). This variation creates drastically different investment implications and, therefore, ratings. Investors seeking exposure to the Materials sector should buy the Attractive rated mutual fund from Figure 2. Figure 1: ETFs with the Best & Worst Ratings – Top 5 (click to enlarge) * Best ETFs exclude ETFs with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings The ProShares Ultra Basic Materials ETF (NYSEARCA: UYM ), the Van Eck Market Vectors Steel Index ETF (NYSEARCA: SLX ), and the Fidelity MSCI Materials Index ETF (NYSEARCA: FMAT ) are excluded from Figure 1 because their total net assets are below $100 million and do not meet our liquidity minimums. Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5 (click to enlarge) * Best mutual funds exclude funds with TNAs less than $100 million for inadequate liquidity. Sources: New Constructs, LLC and company filings The Rydex Series Basic Materials Fund (MUTF: RYBOX ) (MUTF: RYBAX ) is excluded from Figure 2 because its total net assets (TNA) are below $100 million and do not meet our liquidity minimums. The iShares Dow Jones U.S. Basic Materials Index ETF (NYSEARCA: IYM ) is the top-rated Materials ETF and the Fidelity Select Chemicals Portfolio (MUTF: FSCHX ) is the top-rated Materials mutual fund. IYM earns a Neutral rating and FSCHX earns an Attractive rating. The PowerShares S&P SmallCap Materials Portfolio ETF (NASDAQ: PSCM ) is the worst-rated Materials ETF and the ICON Materials Fund (MUTF: ICBAX ) is the worst-rated Materials mutual fund. PSCM earns a Dangerous rating and ICBAX earns a Very Dangerous rating. 168 stocks of the 3000+ we cover are classified as Materials stocks. LyondellBasell Industries (NYSE: LYB ) is one of our favorite stocks held by Materials ETFs and mutual funds and earns our Attractive rating. Since 2011, Lyondell has grown after-tax profit ( NOPAT ) by 11% compounded annually. Over the same timeframe, the company has improved its return on invested capital ( ROIC ) from 17% to a top-quintile 23%. While LYB is up nearly 20% year-to-date, shares could still have large upside for long-term investors. At its current price of $93/share, LYB has a price to economic book value ( PEBV ) ratio of 1.0. This ratio implies that the market expects Lyondell’s profits to never grow from current levels. If Lyondell can grow NOPAT by just 5% compounded annually for the next five years , the stock is worth $115/share today – a 24% upside. Friedman Industries, Inc. (NYSEMKT: FRD ) is one of our least favorite stocks held by Materials ETFs and mutual funds and earns our Very Dangerous rating. Friedman’s NOPAT has rapidly declined since 2011, from $11 million to -$5 million in 2015. Friedman has also been inefficient at managing its invested capital , and its ROIC has fallen from 19% to a bottom quintile -7% over the same timeframe. Despite the struggling business, FRD has outperformed the overall market over the past six months and is now significantly overvalued. To justify the current price of $6/share, Friedman must immediately achieve positive pre-tax margins of 1%, (compared to -4% in 2015) and grow revenues by 20% compounded annually for the next 12 years . This scenario seems unlikely considering the company’s revenues and profits have only fallen over the past decade. Figures 3 and 4 show the rating landscape of all Materials ETFs and mutual funds. Figure 3: Separating the Best ETFs From the Worst ETFs (click to enlarge) Sources: New Constructs, LLC and company filings Figure 4: Separating the Best Mutual Funds From the Worst Mutual Funds (click to enlarge) Sources: New Constructs, LLC and company filings Disclosure: David Trainer and Blaine Skaggs receive no compensation to write about any specific stock, sector or theme. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.