Tag Archives: valuewalk

7 Steps To The Launching Of A National Debate On The Realities Of Stock Investing

By Rob Bennett Step One: The Buy-and-Holders Accept That a Debate Is Inevitable. This is a turf battle. Eugene Fama and Robert Shiller have both won Nobel prizes for saying opposite things about how stock investing works. It’s not possible that both are right. The natural thing would have been for the debate to have been launched in 1981, when Shiller published his “revolutionary” (his word) research findings. Things got held up because there is so much money to be made in this field, and by the time Shiller published his research, thousands of people had built careers promoting Buy-and-Hold strategies. These people were naturally not too excited about the idea of acknowledging that they had been giving bad advice for a long time. The reality is that sooner or later, they are going to have to at least acknowledge that possibility. A Nobel prize cannot be denied. And, if Shiller is right, the promotion of Buy-and-Hold strategies caused an economic crises. This affects everyone. So, the debate has to come. Once that is widely recognized, the question changes from whether or not to have the debate to how to proceed with the important business of launching it. Step Two: Industry Leaders Recognize How Much Money There Is to Be Made by Moving Forward. I often hear a cynical response when I make the case for the launching of a national debate. People say that there is too much money made promoting Buy-and-Hold for the industry to permit a debate that might discredit the strategy. I don’t think that’s right. Valuation-Informed Indexing reduces risk dramatically. Millions of middle-class people resist the lure of stocks because they are turned off by the idea of taking on too much risk with their retirement money. A transition to the Shiller model would increase profits for those in the stock-selling industry, not diminish them. The problem, for many years, has been that profits were good enough as a result of the huge bull market, and so, there was a feeling that there was no cause to rock the boat. The next price crash will change that. After prices fall hard again, the industry will be feeling the pinch and will go looking for ways to restore public confidence in the market. That’s when people will see that the model of the future has been available to us for 35 years – it’s just been a question of us developing an interest in taking advantage of the opportunity. Step Three: Jack Bogle Says “I’m Not Entirely Sure” Whether Fama or Shiller is Right. The debate has been delayed because the Buy-and-Hold Model was established first, and getting investing right is so important that the Buy-and-Holders have thus far not been able to acknowledge even the possibility of their having made a mistake. That changes on the day when Bogle says the words “I’m” and “Not” and “Sure” in a public place and his words are written up on the front page of the New York Times . Everyone who works in this field would interpret those words as giving them permission to talk openly about the case against Buy-and-Hold. Once there are people speaking openly, clearly and firmly on both sides of the story, we will all be engaged in an amazing learning experience. Step Four: Behavioral Finance Experts Seek to Distinguish Themselves By Drawing Sharp Contrasts Between Their Advice on Strategic Questions and the Advice Offered by the Buy-and-Holders. Behavioral Finance has been a growing field for many years. But it has had little impact in the practical realm, because the Behavioral Finance experts have shied away from showing how a model that considers the effect of human psychology on investing choices leads to very different advice on strategic questions (particularly, asset allocation questions). For so long as Buy-and-Hold has remained dominant, it has seemed “rude” to point out that the Buy-and-Hold advice on just about every question is dangerous if Shiller is right that valuations affect long-term returns and that risk is thus not static, but variable. Once the floodgates are opened by Bogle’s historic speech, each of the Behavioral Finance experts will tap into a healthy competitive instinct to distinguish himself or herself by showing how different his or her advice is from the conventional Buy-and-Hold advice. We will see 35 years of insights developed and explained and promoted and explored in the space of a few years. Exciting times! Step Five: Thought Leaders Recognize the Need to Help the Buy-and-Holders Save Face. We need to see a battle of ideas, not a battle of personalities. We want the Buy-and-Holders working with us, not against us. The Buy-and-Holders built the foundation on which Valuation-Informed Indexing is built. It would be as crazy for us to come to see them as enemies once the debate is launched as it has been for them to see us as enemies during the decades in which it has been delayed. Wise heads will prevail. We will see that we are all in this together. As a result, things will move ahead at a quick pace once things begin moving ahead. The Buy-and-Holders have a lot to contribute, and they will do so as long as we are careful to acknowledge their many genuine achievements. Step Six: The Political Implications of Shiller’s Breakthrough Come to Be More Widely Appreciated. It was the promotion of Buy-and-Hold strategies that caused the economic crisis (by encouraging stock prices to soar to insanely dangerous levels, and then by causing the economy to lose trillions of dollars of buying power when the bubble popped). The economic crisis affects all of us, not just the investing industry and not just those who buy stocks. The debate will go into high gear when it becomes widely understood that we all have a stake in ensuring that we all have access to sound, responsible and research-backed investing advice. The stock-selling industry has been dragging its feet for a long time. But this is bigger than the stock-selling industry. Step Seven: Outsiders Flood into the Stock-Selling Industry. The launching of the debate need not be perceived as a threat to those currently working in the field and promoting Buy-and-Hold strategies. But it will speed things up when initial discussion of the new model shows the need for the industry to welcome new types of experts. We will be seeing a transition from a focus on math-based skills to a focus on psychology-based skills. The new blood will bring the field alive (but we are, of course, always going to need lots of people with math-based skills in this field). Disclosure: None.

Spinoffs: Outperformance And Investment Strategies

Originally published on March 8, 2016 By Rupert Hargreaves Spinoffs Investment Strategies… Warren Buffett, Benjamin Graham, Seth Klarman and Walter Schloss are probably some of the greatest value investors of all time, and at one point or another, these investment titans have all mentioned spinoffs as a critical area for value investors to seek out bargains. And there’s plenty of cold hard data to back up this conclusion. Indeed, only last week, Goldman Sachs issued a Portfolio Strategy Research note to clients on this very topic using data from the past six months. Spinoffs Investment Strategies – Spinoffs are highly likely to outperform parents Goldman’s research note, titled Investment Strategies For Spinoffs And Carve-Outs looked at the performance of spincos relative to their parent companies and the S&P 500 in the first two years after spinoff. The bank’s research showed that since 1999, spincos have outperformed their parents and the index by a median of 9% and 6% respectively in the first two years after the spinoff. During 2015, the value of spinoffs at completion jumped 81% to $176 billion, the highest level in 15 years. Goldman expects this trend to continue throughout 2016. The prospect of modest top line growth coupled with flat margins this year is likely to push managements to pursue spinoffs as a means of generating shareholder returns. If the above forecast does play out, and a new wave of spinoffs hits the market this year, value investors will be spoilt for choice when it comes to picking undervalued, and unloved spinoffs that have been unfairly sold by the market. Unpopular spinoffs were plentiful last year. 18 of the 28 spinoffs that have taken place since June 15 had, at least, one of three alpha-generating attributes: Spinoffs Investment Strategies – Lower P/E multiple Spincos that traded at a lower forward P/E multiple than their parents outperformed their parents by 18 pp and 26 pp respectively during the one-year and two-year period after the spinoff. Goldman found the hit rate of this outperformance was 63% and 75% respectively. Lower expected EPS growth Spincos with lower twelve-month EPS growth expectations compared to the parents generated median excess returns of 21pp and 6pp respectively during the one-year and two-year period after the spinoff. The hit rate here was 81% and 56% respectively. Operated within a distinct industry versus their parents If the spinco and parent operate in different industries, the relative median return of spinco versus the parent was +3 pp for both one and two-year periods. If the two companies operated within the same industry, the performance was -7pp and +20pp. Spincos with a lower P/E multiple, lower expected EPS growth and operating in a different industry to the parent generated a median relative return of +29 pp and +47 pp versus their parents during the one-year and two-year post-spinoff periods, with hit rates of 80% and 90%, respectively. Click to enlarge And if you’re looking for ideas, 26 announced spinoffs are currently pending completion: Click to enlarge Disclosure: Rupert may hold positions in one or more of the companies mentioned in this article. You can find a full list of Rupert’s positions on his blog. This should not be interpreted as investment advice, or a recommendation to buy or sell securities. You should make your own decisions and seek independent professional advice before doing so. Past performance is not a guide to future performance.

The Statistical Support For Long-Term Return Regimes Is Compelling

By Rob Bennett The last three columns examined a recent article by Michael Kitces (“Should Equity Return Assumptions in Retirement Projections Be Reduced for Today’s High Shiller CAPE Valuation?”) that advances the highly counter-intuitive and yet entirely accurate claim that, “The ideal way to adjust return assumptions… [may be] to do projections with a ‘regime-based approach to return assumptions. This would entail projecting a period of much lower returns, followed by a subsequent period of higher returns.” This changes everything that we once thought we knew about how the stock market works. The old (and still dominant) belief was that stock prices fall in the pattern of a random walk because price changes are caused by economic developments. If what Kitces is saying is so (I strongly believe that it is), prices do not fall in a random walk at all. They play out according to a highly predictable long-term pattern. For about 20 years, valuations rise (with short-term drops mixed in). Then, for about 15 years, valuations drop (with short-term rises mixed in). It is investor emotion that is the primary determinant of stock price changes. Investors can reduce risk dramatically, while also increasing return dramatically by adjusting their stock allocations in response to big valuation shifts, and thereby keeping their risk profile roughly constant as one “regime” is replaced with another. This is hard to accept. We are always living through either a high-return regime or a low-return regime. The regimes continue long enough to convince us that they are rooted in something solid and real and permanent, not in something as loosey-goosey and vague and seemingly ephemeral as investor psychology. When sky-high returns were being reflected on our portfolio statements in the late 1990s, we adjusted our understanding of our net worth. But improperly so! A large portion of the oversized returns were the result of the regime we were living through. Those returns were fated to disappear in the following regime. And the poor returns of today’s regime (which began in 2000) will also disappear when we enter the next return-boosting regime. The strategic implications are far-reaching. If there really are high-return regimes and low-return regimes, it makes no sense to stick with the same stock allocation at all times. If there are two types of return regimes that last for 15 or 20 years, there are two types of stock markets that last for 15 or 20 years. Decisions that make sense for one of the two types of regimes cannot possibly make sense for the other type of regime. Buy-and-hold is a mistake. We should be going with higher stock allocations in high-return regimes and with lower stock allocations in low-return regimes. There’s a rub. What if the data that Kitces is taking into consideration in forming his conclusions is the product of coincidence? Can we really be sure that the two-regime world will remain in place? If it doesn’t, and if we invest on the belief that it will, we will be underinvested in stocks while waiting for today’s low-return regime to play out (the historical reality is that no low-return regime has ever ended until the P/E10 level dropped to 8 or lower, a big drop from where it stands today). Negative consequences follow for an investor who abandons buy-and-hold for valuation-informed indexing in the event that Kitces’ regime concept turns out to be an illusion. The most convincing case that I have seen that it is not an illusion is the case put forward in a book by Michael Alexander, titled Stock Cycles: Why Stocks Won’t Beat Money Markets Over the Next Twenty Years . Please note that the claim made in the subtitle was widely perceived as crazy at the time it was made (the book was published in 2000), and yet, has proven prophetic – stock returns over the past 16 years have been far smaller than the returns that were available in 2000 through the purchase of super-safe asset classes like Treasury Inflation-Protected Securities and iBonds. Buy-and-holders would have said at the time that a prediction of 16 years of poor returns was exceedingly unlikely to prove valid. And yet, Alexander knew something (or at least thought he knew something) compelling enough to persuade him to put his name to that claim in a very public way. Alexander engaged in extensive statistical analysis to determine whether stock price changes really do play out differently in different long-term regimes. He concluded that: “The effect of holding time on stock returns in overvalued markets is the opposite of what it is for all markets. Normally, holding stocks for longer amounts of time increases the probability that they will beat other types of investments such as money markets… In the case of overvalued markets (like today), holding for longer times, up to twenty years, does not increase your odds of success.” We don’t today know everything there is to know about how stock investing works. We are in the early years of coming to a sound understanding of even the fundamentals. We need to be careful not to jump to hasty conclusions based on limited research. That’s what I believe the buy-and-holders did. Many of their insights were genuine and important, and have stood the test of time. But the claim that it is safe for investors to ignore price when buying stocks has not stood the test of time. The Kitces article is pointing us in a new direction. I hope it generates lots of debate. My guess is that we will not see that debate immediately, but that many will be giving the Kitces article a second look following the next price crash, when we will all be seeking to come to terms with what we have done to ourselves by too easily buying into the idea that the stock market is the one exception to the general rule that price discipline is what makes markets work. Disclosure: None.