Video on Hedge Fund Manager Michael Burry MD

In The Subprime of His Life – My Story

By Dr. David Edward Marcinko MBA, CMP™

[Editor-in-Chief]

I am a long time fan of financial industry journalist Michael Lewis [Liars’ Poker, Moneyball and others] who just released a new book. The Big Short is a chronicle of four players in the subprime mortgage market who had the foresight [and testosterone] to short the diciest mortgage deals: Steve Eisner of FrontPoint, Greg Lippmann at Deutsche Bank, the three partners at Cornwall Capital, and most indelibly, Wall Street outsider Michael Burry MD of Scion Capital.

They all walked away from the disaster with pockets full of money and reputations as geniuses.

About Mike

Now, I do not know the first three folks, but I do know a little something about my colleague Michael Burry MD; he is indeed a very smart guy. Mike is a nice guy too, who also has a natural writing style that I envy [just request and read his quarterly reports for a stylized sample]. He gave me encouragement and insight early in my career transformation – from doctor to “other”.

And, he confirmed my disdain for the traditional financial services [retail sales] industry, Wall Street and their registered representatives and ‘training’ system, and sad broker-dealer ethos [suitability versus fiduciary accountability] despite being a hedge fund manager himself.

I mentioned him in my book: “Insurance and Risk Management Strategies” [For Physicians and their Advisors].

http://www.amazon.com/Insurance-Management-Strategies-Physicians-Advisors/dp/0763733423/ref=sr_1_2?ie=UTF8&s=books&qid=1269254153&sr=1-2

He ultimately helped me eschew financial services organizations, “certifications”, “designations” and ”colleges”, and their related SEO rules, SEC regulations and policy wonks; and above all to go with my gut … and go it alone!

And so, I rejected my certified financial planner [marketing] designation status as useless for me, and launched the www.CertifiedMedicalPlanner.org on-line educational program for physician focused financial advisors and management consultants interested in the healthcare space … who wish to be fiduciaries.

And I thank Mike for the collegial good will. By the way, Mike is not a CPA, nor does he posses an MBA or related advanced degree or designation. He is not a middle-man FA. He is a physician. Unlike far too many other industry “financial advisors” he is not a lemming.

IOW: We are not salesman. We are out-of-the-box thinkers, innovators and contrarians by nature. www.MedicalBusinessAdvisors.com

From a Book Review

According to book reviewer Michael Osinski, writing in the March 22-29 issue of Businessweek.com, Lewis is at his best working with characters and Burry is rendered most vividly.

A loner from a young age, in part because he has a glass eye that made it difficult to look people in the face, Burry excelled at topics that required intense and isolated concentration. Originally, investing was just a hobby while he pursued a career in medicine. As a resident neurosurgeon at Stanford Hospital in the late 1990s, Burry often stayed up half the night typing his ideas onto a message board. Unbeknownst to him, professional money managers began to read and profit from his freely dispensed insight, and a hedge fund eventually offered him $1 million for a quarter of his investment firm, which consisted of a few thousand dollars from his parents and siblings. Another fund later sent him $10 million”.

“Burry’s obsession with finding undervalued companies eventually led him to realize that his own home in San Jose, Calif., was grossly overpriced, along with houses all over the country. He wrote to a friend: “A large portion of the current [housing] demand at current prices would disappear if only people became convinced that prices weren’t rising. The collateral damage is likely to be orders of magnitude worse than anyone now considers.” This was in 2003.

“Through exhaustive research, Burry understood that subprime mortgages would be the fuse and that the bonds based on these mortgages would start to blow up within as little as two years, when the original “teaser” rates expired. But Burry did something that separated him from all the other housing bears—he found an efficient way to short the market by persuading Goldman Sachs (GS) to sell him a CDS against subprime deals he saw as doomed. A unique feature of these swaps was that he did not have to own the asset to insure it, and over time, the trade in these contracts overwhelmed the actual market in the underlying bonds”.

“By June 2005, Goldman was writing Burry CDS contracts in $100 million lots, “insane” amounts, according to Burry. In November, Lippmann contacted Burry and tried to buy back billions of dollars of swaps that his bank had sold. Lippmann had noticed a growing wave of subprime defaults showing up in monthly remittance reports and wanted to protect Deutsche Bank from potentially massive losses. All it would take to cause major pain, Lippmann and his analysts deduced, was a halt in price appreciation for homes. An actual fall in prices would bring a catastrophe. By that time, Burry was sure he held winning tickets; he politely declined Lippmann’s offer”

And the rest, as they say, is history.

Link: http://www.businessweek.com/magazine/content/10_12/b4171094664065.htm

My Story … Being a Bit like Mike

I first contacted Mike, by phone and email, more than a decade ago. His hedge fund, Scion Capital, had no employees at the time and he outsourced most of the front and back office activities to concentrate on position selection and management. Early investors were relatives and a few physicians and professors from his medical residency days. Asset gathering was a slosh, indeed. And, in a phone conversation, I remember him confirming my impressions that doctors were not particularly astute investors. For him, they generally had sparse funds to invest as SEC “accredited investors” and were better suited for emerging tax advantaged mutual funds. ETFs were not significantly on the radar screen, back then, and index funds were considered unglamorous. No, his target hedge-fund audience was Silicon Valley.

And, much like his value-hero Warren Buffett [also a Ben Graham and David Dodd devotee], his start while from the doctor space, did not derive its success because of them.

Moreover, like me, he lionized the terms “value investing”, “margin of safety” and “intrinsic value”.

Co-incidentally, as a champion of the visually impaired, I was referred to him by author, attorney and blogger Jay Adkisson www.jayadkisson.com Jay is an avid private pilot having earned his private pilot’s license after losing an eye to cancer.

Join Our Mailing List

Mike again re-entered my cognitive space while doing research for the first edition of our successful print book: “Financial Planning Handbook for Physicians and Advisors” and while searching for physicians who left medicine for alternate careers!

In fact, he wrote the chapter on hedge funds in our print journal and thru the third book edition before becoming too successful for such mundane stuff. We are now in our fourth edition, with a fifth in progress once the Obama administration stuff [healthcare and financial services industry “reform” and new tax laws] has been resolved

http://www.amazon.com/Financial-Planning-Handbook-Physicians-Advisors/dp/0763745790/ref=sr_1_1?ie=UTF8&s=books&qid=1269211056&sr=1-1

Assessment

News: Dr. Burry appeared on 60 Minutes Sunday March 14th, 2010. His activities with Scion Capital are portrayed in Michael Lewis’s newest book, The Big Short.  An excerpt is available in the April 2010 issue of Vanity Fair magazine, and at VanityFair.com 

Video of Dr. Burry: http://www.cbsnews.com/video/watch/?id=6298040n&tag=contentBody;housing

Video of Dr. Burry: http://www.cbsnews.com/video/watch/?id=6298038n&tag=contentBody;housing

PS: Michael Osinski retired from Wall Street and now runs Widow’s Hole Oyster Co. in Greenport, NY http://www.widowsholeoysters.com

And, our www.MedicalBusinessAdvisors.com related books can be reviewed here: http://www.amazon.com/s/ref=nb_sb_noss?url=search-alias%3Dstripbooks&field-keywords=david+marcinko

Assessment

Visit Scion Capital LLC and tell us what you think http://www.scioncapital.com.

And to Mike himself, I say “Mazel Tov” and congratulations? I am sure you will be a good and faithful steward. The greatest legacy one can have is in how they treated the “little people.” You are a champ. Call me – let’s do lunch. And, I am still writing: www.BusinessofMedicalPractice.com for the conjoined space we both LOVE.

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Link: http://feeds.feedburner.com/HealthcareFinancialsthePostForcxos

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

Product DetailsProduct DetailsProduct Details

Product Details  Product Details

   Product Details 

[PHYSICIAN FOCUSED FINANCIAL PLANNING AND RISK MANAGEMENT COMPANION TEXTBOOK SET]

  Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™  Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

[Dr. Cappiello PhD MBA] *** [Foreword Dr. Krieger MD MBA]

***

PODCAST: Charter Communications Stock [Value Investing]

By Vitaliy Katsenelson CFA

***

Charter Communications (CHTR) is a significantly undervalued stock today. But are competition, 5G, and satellite internet significant threats to its business? How does its management compare to AT&T and Verizon? Read and/or listen to the analysis below.

***

***

COMMENTS APPRECIATED

Thank You

***

***

Value v. Growth Fund Managers

Understanding Investment Styles

By Dr. David Edward Marcinko; MBA, CMPbiz-book1

A mutual or hedge fund manager’s investment style is defined by the means or strategies used to accomplish the fund’s stated objective. Most managers have a strategy they believe to be the key to maximizing risk-adjusted investment returns. For example, two equity managers may seek growth of capital or capital appreciation over the long term. The strategies they use to achieve that goal can be vastly different, however, as evidenced by their choice of securities.

Style Characteristics

Astute physician-investors are aware that there are four, main manager style characteristics: value vs. growth, top-down vs. bottom-up—which can be refined further by additional approaches. Certain statistics and information reveal a manager’s style. An investor may prefer one style or one combination over another

Approaches Vary

Style approaches can be used in tactical asset allocation. Research has shown that one style tends to outperform the other during certain periods. If investors believe they can identify when one style will outperform the other, they could overweight the favored approach. More and more fund complexes are now offering funds in each style; especially for large healthcare entities and other institutions.

Value vs. Growth

Manager autonomy and style is an important consideration.

  1. Value managers focus on a company’s assets or net worth and attempt to place a value on such assets: if their valuation is greater than the market’s valuation, the security is a candidate for ownership. Benjamin Graham, the father of value investing, believed this approach to selecting securities would eventually be recognized by the market, rewarding patient, long-term investors. In today’s service economy, value managers also attempt to value the intangible assets of a company, such as franchise value or human capital. Value managers tend to be contrarians—they buy out-of-favor stocks or stocks not widely followed or recommended by analysts. Value managers also look at the breakup value of a company (what the individual parts could be sold for). They buy cheap stocks: stocks with low P/E ratios or low price-to-book value relative to the market, and stocks of established companies that pay dividends.
  2. Growth managers look at corporate earnings and focus on improving or accelerating earnings. They look at the trend of an industry or market sector (for example, environmental technology) to see if there is future sales-growth potential. They may lean toward companies that are dominant in the industry or have a product or service that will dramatically improve their market share. Growth managers typically own stocks with higher P/E ratios than the market average; these stocks may not be out of favor, but they may have been overlooked by market analysts. Growth stocks usually are not high-income-paying stocks.

Assessment

Prior to the recent financial meltdown, growth and momentum investing was the norm. Now it is value investing. What about the future for the physician-investor?

Conclusion

And so, your thoughts and comments on this Medical Executive-Post are appreciated.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com 

Product DetailsProduct DetailsProduct Details

COVID, Inflation and Value Investing

Millennial Investing

***

By Vitaliy Katsenelson, CFA

***

***

COVID, Inflation, and Value Investing: Millennial Investing
I was recently interviewed by Millennial Investors podcast. They sent me questions ahead of time that they wanted to ask me “on the air”. I found some of the questions very interesting and wanted to explore deeper. Thus, I ended up writing answers to them (I think through writing). You can listen to the podcast here

By the way, I often get asked how I find time to write. Do I even do investment research? Considering how much content I’ve been spewing out lately, I can understand these questions. In short – I write two hours a day, early in the morning (usually from 5–7am), every single day. I don’t have time-draining hobbies like golf. I rarely watch sports. I have a great team at IMA, and I delegate a lot. I spend the bulk of my day on research because I love doing it. 

This is not the first time I was asked these questions. If you’d like to adapt some of my daily hacks in your life, read this essay.

How has Covid-19 changed the game of value investing?

Value investing has not changed. Its fundamental principles, which I describe in “The Six Commandments of Value Investing,” (one-click sign up here to receive it in your inbox) have not changed one iota. The principles are alive and well. What has changed is the environment – the economy. 

I learned this from my father and Stoic philosophers: You want to break up complex problems into smaller parts and study each part individually. That way you can engage in more-nuanced thinking. 

Let’s start with what has not changed. Our desire for in-person human interaction has not changed. At the beginning of the pandemic, we (including yours truly) were concerned about that. We were questioning whether we were going to ever be able to shake hands and hug again. However, the pandemic has not changed millions of years of human evolution – we still crave human warmth and personal interaction. We need to keep this in mind as we think about the post-pandemic world. 

What we learned in 2021 is that coronavirus mutations make predicting the end of the pandemic an impossible exercise. From today’s perch it is safe to assume that Covid-19 will become endemic, and we’ll learn how to live with it. I am optimistic on science. 

Let’s take travel, for example. Our leisure travel is not going to change much – we are explorers at heart, and as we discovered during the pandemic, we crave a change in scenery. However, I can see business travel resetting to a lower base post-pandemic, as some business trips get resolved by simple Zoom calls. Business travel is about 12% of total airline tickets, but those revenues come with much higher profit margins for airlines. 

Work from home. I am still struggling with this one. The norms of the 20th-century workplace have been shaken up by the pandemic. Add the availability of new digital tools and I don’t need to be a Nostradamus to see that the office environment will be different. 

By how much? 

The work from home genie is out of the bottle. It will be difficult to squeeze it back in. My theory right now is that customer support, on-the-phone types of jobs may disproportionately get decentralized. The whole idea of a call center is idiotic – you push a lot of people into a large warehouse-like office space, where they sit six feet apart from each other and spend eight hours a day on the phone talking to customers without really interacting with each other. Current technology allows all this work to be done remotely.

On another hand, I can see that if you have a company where creative ideas are sparked by people bumping into each other in hallways, then work from home is less ideal. But again, I don’t think about it in binary terms, but more like it’s a spectrum. Even for my company. Before the pandemic, half of our folks worked outside of the IMA main office in Denver. Most of our future hires will be local, as I believe it is important for our culture. However, we provide a certain number of days a year of remote work as a benefit to our in-office employees. 

From an investment perspective, we are making nuanced bets on global travel normalizing. We don’t own airlines – never liked those businesses, never will. Most of their profitability comes from travel miles – they became mostly flying banks. 

Office buildings I also put into a too-difficult-to-call pile. There was already plenty overcapacity in office real estate before the pandemic, and office buildings were priced for perfection. The pandemic did not make them more valuable. Maybe some of that overcapacity will get resolved through conversion of office buildings into apartments. By the way, this is the beauty of having a portfolio of 20–30 stocks: I don’t need to own anything I am not absolutely head over heels in love with.

What is the importance of developing a process to challenge your own beliefs?

My favorite quote from Seneca is “Time discovers truth.” My goal is to discover the truth before time does. I try to divorce our stock ownership from our feelings. 

Let me give you this example. If you watch chess grandmasters study their past games, they look for mistakes they have made, moves they should have made, so in the future they won’t make the same mistake twice. I have also noticed they say “white” and “black,” not “I” and “the opponent.” This little trick removes them from the game so that they can look for the best move for each side. They say “This is the best move for white”; “This is the best move for black.”

You hear over and over again from people like Warren Buffett and other value investors that we should buy great companies at reasonable prices, and I’d like to dig deeper on that idea and its two key parts, great companies and reasonable prices. Could you tell us what it takes for a company to qualify as a “great” company?

This question touches on Buffett’s transformation away from Ben Graham’s “statistical” approach, i.e., buying crappy companies that look numerically cheap at a significant discount to their fair value, to buying companies that have a significant competitive advantage, a high return on capital, and a growth runway for their earnings. 

The first type of companies often will not be high-quality businesses and will most likely not be growing earnings much. Let’s say the company is earning $1. Its earnings power will not change much in the future – it is a $5 stock trading at 5 times earnings. If its fair value is $10, trading at 10 times earnings, And if this reversion to fair value happens in one year, you’ll make 100%. If it takes 5 years then your return will be 20% a year (I am ignoring compounding here). So time is not on your side. If it takes 10 years to close the fair value gap, your return halves. Therefore you need a bigger discount to compensate for that. Maybe, instead of buying that stock at a 50% discount, you need to buy a company that is not growing at a 70% discount, at $3 instead of $5. This was pre-Charlie Munger, “Ben Graham Buffett.” 

Then Charlie showed him there was value in growth. If you find a company that has a moat around its business, has a high return on capital, and can grow earnings for a long time, its statistical value may not stare you in the face. But time is on your side, and there is a lot of value in this growth. If a company earns $1 today and you are highly confident it will earn $2 in five years, then over five years, if it trades at 10 times earnings, a no-growth company may be a superior investment if the valuation gap closes in less than 5 years, while one with growing earnings is a superior investment past year 5. 

Both stocks fall into the value investing framework of buying businesses at a discount to their fair value, looking for a margin of safety. With the second one, though, you have to look into the future and discount it back. With the first one, because the lack of growth in the future is not much different from the present, you don’t have to look far.

There is a place for both types of stocks in the portfolio – there are quality companies that can still grow and there are companies whose growth days are behind them. In our process we equalize them by always looking four to five years out. 

What qualifies as a “reasonable price”? 

We are looking for a discount to fair value where fair value always lies four to five years out. In our discounted cash flow models, we look a decade out. Our required rate of return and discount to fair value will vary by a company’s quality. There are more things that can go wrong with lower-quality companies than with the better ones. High-quality companies are more future-proof and thus require lower discount rates. We are incredibly process-driven. We have a matrix by which we rate all companies on their quality and guestimate their fair value five years out, and this is how we arrive at the price we want to pay today. 

Why do you believe that buying great companies sometimes isn’t a great investing strategy?

Because that is first-level thinking, which only looks at what stares you in the face – things that are obvious even to untrained eyes and thus to everyone. First-level thinking ignores second-order effects. If everyone knows a company is great, then its stock price gets bid up and the great company stops being a great investment. With second-level thinking you need to ask an additional question, which in this case is, what is the expected return? Being a great company is not enough; it has to be undervalued to be a good stock. 

We are looking for great companies that are temporarily (key word) misunderstood and thus the market has fallen out of love with them. Over the last decade, when interest rates only declined, first-level thinking was rewarded. It almost did not matter how much you paid for a stock. If it was a great company, its valuations got more and more inflated. 

You’re a big advocate of having a balanced investment approach that is able to weather all storms. What investments have you found that you expect will be able to hold their buying power if inflation persists through 2022 and 2023?


There are many different ways to answer this question. In fact, every time I give an answer to this question I arrive at a new answer. You want to own companies that have fixed costs. You want assets that have a very long life. I am thinking about pipeline companies, for instance. They require little upkeep expense, and their contracts allow for CPI increases (no decreases); thus higher inflation will add to their revenue while their costs will mostly remain the same. 

We own tobacco companies, too. I lived in Russia in the early ’90s when inflation was raging. I smoked. I was young and had little money. I remember one day I discovered that cigarette prices had doubled. I had sticker shock for about a day. I gave up going to movies but somehow scraped up the money for cigarettes. 

Whatever answer I give you here will be incomplete. It’s a complex problem, and so each stock requires individual analysis. In all honesty, you have to approach it on a case-by-case basis. 

With higher inflation, you’d expect bond yields to rise, since bond investors will demand a higher return to keep pace with inflation. However, CPI inflation is currently over 6%, and the 10-year Treasury is sitting at 1.5%. Why haven’t we seen Treasury yields rise more, and what does it mean for investors if a spread this wide persists?

I am guessing here. My best guess is that so far investors have bought into the Fed’s rhetoric that inflation is transitory due to the economy’s rough reopening and supply chain problems. I wrote a long article on this topic. To sum up, part of the inflation is transitory but not all of it. 

I am somewhat puzzled by the labor market today. I’ve read a few dozen very logical explanations for the labor shortage, from early retirement of baby boomers to the pandemic triggering a search for the meaning of life and thus people quitting dead jobs and all becoming Uber drivers or starting their own businesses. Labor is the largest expense on the corporate income statement, and if it continues to be scarce then inflation will persist. 

I read that employees are now demanding to work from home because they don’t want to commute. The labor shortages are shifting the balance of power to employees for the first time in decades. This will backfire in the long run, as employers will be looking at how to replace employees with capital, in other words, with automation. If you run a fast-food restaurant and your labor costs are up 20–30% or you simply cannot hire anyone, you’ll be looking for a burger flipping machine. 

If we continue to run enormous fiscal deficits, then the US dollar will crack. The pandemic has accelerated a lot of trends that were in place. We were on our way to losing our reserve currency status. Let me clarify: That is going to be a very slow, very incremental process. It will be slow because currency pricing is not an absolute but a relative endeavor, and the alternatives out there are not great. But two decades ago the US dollar was a no-brainer decision and today it is not. So we’ll see countries slowly diversifying away from it. A weaker US dollar means higher, non transitory inflation. 

You wrote The Little Book of Sideways Markets, in which you point out that history shows that a sideways market typically occurs after a secular bull market. With the role that the Federal Reserve plays in the financial markets, do you still anticipate that valuations will normalize in the coming years?

I say yes, in part because declining interest rates have pushed all assets into stratospheric valuations. Rising bond yields and valuations pushed heavenward are incompatible. Yes, I expect valuations to do what they’ve done every time in history: to mean revert. In big part this will depend on interest rates, but if rates stay low because the economy stutters, then valuations will decline – this is what happened in Japan following their early-1990s bubble. Interest rates went to zero or negative, but valuations declined. 

The stock market today is very much driven by the Federal Reserve’s monetary policy. Is there a point at which they are able to take the gas off the pedal and allow markets to normalize?

I am really puzzled by this. We simply cannot afford higher interest rates. Going into the pandemic our debt-to-GDP was increasing steadily despite the growing economy. In fact, you could argue that most of our growth has come from the accumulation of debt (the wonders of being the world’s reserve currency). Our debt has roughly equaled our GDP, and all of our economic growth in some years equaled the growth in government debt.

During the pandemic we added 40% to our debt in less than two years. We have higher debt-to-GDP than we had during WWII. After the war we reduced our debt. Also, we were a different economy then – we were rebuilding both the US and Europe. As a society we had a high tolerance for pain. 

Just like debt increases stimulate growth, deleveraging reduces growth. Also, I don’t think politicians or the public care about high debt levels. So far debt has only brought prosperity. However, higher interest rates would blow a huge hole in government budgets. If the 10-year Treasury rises a few percentage points, interest rates will increase by the amount we spend on national defense. One thing I am certain about is that our defense spending will not decline, so higher interest rates will lead to money printing and thus inflation. 

I am also puzzled by the impact of higher interest rates on the housing market. Housing will simply become unaffordable if interest rates go up a few percentage points. Loan-to-income requirements will price a huge number of people out of the market, and housing prices will have to decline. This Higher rates will also reduce the number of transactions in the real estate market, because people will be locked into their 2.5% mortgages, and if they sell they’d have to get 4-5-6% mortgages. There are a lot of second-order effects that we are not seeing today that will be obvious in hindsight. Housing prices drive demand in adjacent sectors such as home improvement. And think of the impact of higher rates on any large purchase, for example a car. 

We’re seeing the continuing rise of China has a big player in the global economy, and I know you like to invest internationally. As a value investor, how do you think about China’s rise as a global powerhouse and how it might affect the financial markets?

During the Cold War there were two gravitational centers, and as a country you had to choose one – you were either with the Soviets or with the West. Something similar will likely transpire here, too. I have to be careful using the Cold War analogy, because the Cold War was driven by ideology – it was communism vs. capitalism. Now the tension is driven by economic competition and our unwillingness to pass the mantle of global leader to another country. 

We are drawing red lines in technology. Data is becoming the new oil. China is using data to control people, and we want to make sure they don’t have control over our data. Therefore, the West wants to make sure that our technology is China-free. The US, Europe, and India will likely be pursuing a path where Chinese technology and Chinese intellectual property are largely disallowed. We have already seen this happening with Huawei being banned from the US and Western Europe. Other countries, including Russia, will have to make a choice. Russia will go with China.

Also, we are concerned that most chip production is centered in Taiwan, which at some point may be grabbed by China. The technological ecosystem would then have to undergo a significant transformation. This has already started to happen as we begin to bring chip production back to the US and Europe. 

The pandemic made us realize that globalization had made us reliant on the kindness of strangers, and we found we could not even get facemasks or ventilators. 

Globalization was deflationary; deglobalization will be inflationary.

This increased tension between countries has led to your investing in the defense industry. Could you tell us how you think about this industry? 

Despite the rise of international tensions, the global defense industry has been one of sectors that still had reasonable (sometimes unreasonably good) valuations. We have invested in half a dozen US and European defense companies. The US defense budget is unlikely to decline in the near future. There is a common misperception that Republicans love defense and Democrats hate it. Those may be party taglines, but history shows that defense spending has been driven by macro factors – it did not matter who was the occupant of the White House. 

There are a lot of things to like about defense businesses. They are an extension of the US or European governments. Most of them are friendly monopolies or duopolies. They have strong balance sheets, good returns on capital, and predictable and growing (maybe even accelerating) demand. They are noncyclical. They have inflation escalators built into their contracts. I don’t have to worry about technological disruptions. They are also a good macro hedge.

We added to our European defense stocks recently for several reasons. Europe has underinvested in defense, relying on the US Yet we have shown time and again that we may not be as dependable as we once were. 

***

COMMENTS APPRECIATED

Thank You

Subscribe to the Medical Executive-Post

***

***

COVID, Inflation and Value Investing [Millennial Interview]

***

By Vitaliy Katsenelson CFA

***

COVID, Inflation, and Value Investing: Millennial Investing Interview
I was recently interviewed by Millennial Investors podcast. They sent me questions ahead of time that they wanted to ask me “on the air”. I found some of the questions very interesting and wanted to explore deeper. Thus, I ended up writing answers to them (I think through writing). You can listen to the podcast here

By the way, I often get asked how I find time to write. Do I even do investment research? Considering how much content I’ve been spewing out lately, I can understand these questions. In short – I write two hours a day, early in the morning (usually from 5–7am), every single day. I don’t have time-draining hobbies like golf. I rarely watch sports. I have a great team at IMA, and I delegate a lot. I spend the bulk of my day on research because I love doing it. 

This is not the first time I was asked these questions. If you’d like to adapt some of my daily hacks in your life, read this essay.

***

CITE: https://www.r2library.com/Resource/Title/082610254

***

COMMENTS APPRECIATED

Thank You

Subscribe to the Medical Executive-Post

***

***

My Investing “Sell” Principle

The Renaissance of Pipelines

Vitaliy N. Katsenelson, CFA - YouTube

By Vitaliy N. Katsenelson, CFA

A client recently asked me whether there is a difference in our sell discipline between high and low growth companies.

Selling is one of the hardest parts of investing. I wrote a lot on the subject in the past, but let’s zoom in on how our selling practice differs between high-growth companies with long runways for compounding and slow-growth companies.

LINK: https://contrarianedge.com/our-sell-discipline/

AUDIO: https://investor.fm/the-renaissance-of-pipelines-and-our-sell-discipline-ep-113

Your thoughts are appreciated.

EDITOR’S NOTE: It has been a few years since I spoke with my colleague Vitaliy. But, I read his newsletters and blog regularly and suggest all ME-P readers do the same.

Dr. David E. Marcinko; MBA

[Editor-in-Chief]

Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners(TM)

BOOK: https://www.amazon.com/Comprehensive-Financial-Planning-Strategies-Advisors/dp/1482240289/ref=sr_1_1?ie=UTF8&qid=1418580820&sr=8-1&keywords=david+marcinko

THANK YOU

***

CONCLUSION: The Six Commandments of Value Investing

***

Investing and Chess

By Vitaliy Katsenelson, CFA

***

Conclusion: Investing and Chess 

I read somewhere that chess is a game of small advantages. When the game starts, the players are equal – both hold the same number of pieces in the same positions. But then every move either adds to your position (competitive advantage) or subtracts from it. These little decisions (resulting in a better pawn structure, a more secure king, a centrally positioned knight, and so on) that you make with every move accumulate into victory. 

Investing is not that much different, especially in today’s world where access to information has flattened. A mutual fund that manages $100 billion may spend $100 million on research, but that $100 million doesn’t buy any more than what a patient value investor can glean by reading financial statements. 

I am not talking about Warren Buffett either, who doesn’t even have a PC in his office. Ted Weschler and Todd Combs (Warren Buffett’s right-hand men) achieved phenomenal investment success without a fancy research department by simply reading carefully and following our Six Commandments. 

The key to succeeding in this irrational world is to actively ingrain each one of these principles into your investment operating system, improving your process just a little on a daily basis, and then success will follow. 

Finally, this would not be a worthy chapter if I did not contradict myself, just a little. Investing is also unlike chess. Investing affords us a luxury that few people appreciate: You can choose your own opponent. In chess tournaments, you don’t get to choose your opponent. Tournament organizers match you to someone with an equal rating; then as you win, you are progressively matched against better opponents. 

In investing, you are the “tournament organizer.” You get to walk into the room and, instead of choosing the geekiest opponent – the dude with thick glasses who hasn’t been on a date in years and has only thought and dreamt about chess – you can go for the muscular guy who spends five hours a day in the gym, and only joined the tournament because he lost a bet. 

Money doesn’t know how you made it. A hundred dollars made by solving easy problems (buying stocks where both your IQ and EQ were at their highest) buys as much as a hundred dollars that caused you to lose your hair. In investing, you don’t have to solve the problems that everyone else is solving. There are thousands of stocks out there, and your portfolio needs only a few dozen.

***

COMMENTS APPRECIATED

Thank You

Subscribe to the Medical Executive-Post

***

***

#6: The Six Commandments of Value Investing

***

6. In the long run, stocks revert to their fair value

***

***

EDITOR’S NOTE: Although it has been some time since speaking live with busy colleague Vitaliy Katsenelson CFA, I review his internet material frequently and appreciate this ME-P series contribution. I encourage all ME-P readers to do the same and consider his value investing insights carefully.

By Vitaliy Katsenelson, CFA

***

6. In the long run, stocks revert to their fair value

Reversion to fair value is not a pie-in-the-sky concept. If a stock is significantly undervalued for a long time, then this undervaluation gets cured, eventually. That can happen through share buybacks – the company can basically buy all of its shares and take itself private.

Or it can happen by the company’s paying out its earnings in dividends, thus creating yields that the market will not be able to ignore. Or the company’s competitors will realize that it is cheaper for them to buy the company than to replicate its assets on their own. Either way, undervaluation gets cured.

This faith that undervaluation will not last forever is paramount to value investing. But this is not your regular faith, which requires belief without proof. This is evidence-supported faith with hundreds of years of data to back it. Just look at the US stock market: it has gone through cycles when it was incredibly cheap and others when it was incredibly expensive. At some points in its journey from one extreme to the other, it touched its fair value, even if it was transitory.

Historically, value investing (owning undervalued companies) has done significantly better than other strategies. Paradoxically, the reason it has done well in the long run is because it did not work consistently in the short run. If something works consistently (keyword), everybody piles into it and it stops working.

These aforementioned cycles of temporary brilliance and dumbness are not just common to us mere mortals. Even Warren Buffett’s Berkshire Hathaway goes through them. As just one example, in 1999, when the stock market went up 21%, Berkshire Hathaway stock declined 19%. In 1999, the financial press was writing obituaries for Buffett’s investment prowess.

Suddenly, in 1999, Buffett’s IQ was lagging the market by 40%. At the time, investors were infatuated with internet stocks that were not making money but that were supposed to have a bright future. Investors were selling unsexy “old economy” stocks that Buffett owned in order to buy the “new economy” ones.

If at the end of 1999, you were to sell Berkshire Hathaway and buy the S&P 500 instead, you would have done the easy thing, but it would have been a large (though very common) mistake. Over the next three years Berkshire Hathaway gained over 30% while the S&P declined over 40%. During the year 1999, Buffett’s IQ did not change much; in fact, the (book) value of businesses Berkshire Hathaway owned went up by 0.5% that year. But in 1999, the market’s attention was somewhere else and it chose to price Berkshire Hathaway 19% lower. 

As a value investor, if you do a reasonable job estimating what the business is worth, then at some point the stock market will price it accordingly. You need to have faith. I am acutely aware how wishful this statement sounds. But this faith, the belief in mean reversion, has to be deeply ingrained in our psyche. It will allow us to remain rational when people around us are not. 

***

CITE: https://www.r2library.com/Resource/Title/0826102549

COMMENTS APPRECIATED

Editor’s Final Note; Many thanks to VK for this timely series on value investing. Our ME-P readers appreciate you.

Thank You

Subscribe to the Medical Executive-Post

***

***

#5: The Six Commandments of Value Investing

***

***

EDITOR’S NOTE: Although it has been some time since speaking live with busy colleague Vitaliy Katsenelson CFA, I review his internet material frequently and appreciate this ME-P series contribution. I encourage all ME-P readers to do the same and consider his value investing insights carefully.

By Vitaliy Katsenelson, CFA

***

5. Risk is a permanent loss of capital (not volatility)

Conventional wisdom views volatility as risk. Not value investors. We befriend volatility, embrace it, and try to take advantage of it. For someone who has not researched a company, it is not readily apparent whether a decline in shares is temporary or permanent. After all, if you don’t know what the company is worth, the quoted price becomes the quotient of intrinsic value. If you do know what the company is worth, then the change in intrinsic value is all that is going to matter. The price quoted on the exchange will be your friend, allowing you to take advantage of the difference between intrinsic value and quoted stock price. If the quoted stock price is significantly cheaper than your estimated intrinsic value, you buy it (or buy more of it if you already own it). If the opposite is true, you sell it.

What is a company worth?

Determining the intrinsic value requires a combination of art and science, in that order – it is not quoted on the exchanges. We go about this the same way a businessman would figure how much he’d want to pay for a gas station or a McDonald’s franchise. Analysis of each company will be different, but at the core we estimate the cash flows the business will produce for shareholders in the long run (at least ten years) and what the business will be worth then (based on our estimate of its earnings power at the time). The combination of the two provides us an approximation of what the business is worth now. To further embed “the right” type of risk analysis into our investment operating system, we build financial models. Models help us to understand businesses better and provide insights as to which metrics matter and which don’t. They allow us to stress test the business: We don’t just look at the upside but spend a lot of times looking at the downside – we try to “kill” the business. We look at known risks and try to imagine unknown ones; we try to quantify their impact on cash flows. This “killing” helps to us understand how much of a discount (margin of safety) we should demand to what the business is worth. By applying this discount to fair value, we arrive at a buy price. For every stock we buy we probably look at a few dozen (at least).

For instance, if we are looking at a company that is selling products or services to consumers, we’ll be focusing on customer-acquisition costs. We try to drill down to the essential operating metrics of each company. If it’s a convenience store retailer, we’ll look into gallons of gas sold and profit per gallon. If it’s an oil driller, we’ll look at utilization rates, rigs in service, average revenue per rig per day. If it’s a pharmaceuticals company, we’ll have revenue lines for each major drug it sells and model the company for the eventuality that patents will run out. (Revenues usually decline 80-90% when a patent expires).

These models help us to understand the economics of the business. We usually build two type of models. We start with what we call the “tablecloth” model. This is a very detailed, in-depth model that zeros in on different aspects of the business. But the risk we run with a tablecloth model is that we get lost in the trees and forget about the forest.

This brings us to our “napkin” model. It’s a much simpler and smaller model that focuses only on the essentials of the business. It is easier to build the tablecloth model than the “napkin.” If we can build a napkin model, that means we understand the drivers of the business – we understand what matters. Models are important because they help us remain rational. It is only the matter of time before a stock we own will “blow up” (or, in layman’s terms, decline).

In this type of analysis, what happens this month, this quarter, or even this year is only important in the context of the long run – unless the company’s good or bad earnings report in any quarter changes our assumptions on the company’s long-term cash flows. If you methodically focus on what the company is worth and if your Total IQ is maximized, then price fluctuations are just noise. Volatility becomes your friend because you can rationally take advantage of it. It’s an under-appreciated gift from Mr. Market.

Side Note: As an advisor, I feel it is one of my great responsibilities to be an honest and clear communicator. There is an asymmetry of information between us and our clients. We have invested weeks and months of research into the analysis of each stock; therefore, we have a good idea what each company is worth. Our clients have not done this research, and they should not have to – that is what they hired us to do.This is why we pour our heart and soul into our quarterly letters – we want to close this informational gap and so we try as hard as we can to explain what we think the companies in our portfolio are worth. Our letters are often 15-20 pages long. 

***
COMMENTS APPRECIATED

Thank You

Subscribe to the Medical Executive-Post

***

****

#4: The Six Commandments of Value Investing

***

***

EDITOR’S NOTE: Although it has been some time since speaking live with busy colleague Vitaliy Katsenelson CFA, I review his internet material frequently and appreciate this ME-P series contribution. I encourage all ME-P readers to do the same and consider his value investing insights carefully.

By Vitaliy Katsenelson, CFA

***

4. Margin of safety – leave room in your buy price for being wrong

Margin of safety is a function of two dimensions: a company’s quality and its growth.

I am generalizing here, but exogenous events have a greater impact on a lower-quality business than a higher-quality one. Thus a high-quality company needs a lower margin of safety than a lower-quality one.

A company that is growing earnings and paying dividends has time on its side and thus may not need as much margin of safety as a lower-growing one.

We quantify both a company’s quality and growth, and thus margin of safety is deeply embedded in our investment operating system.

The larger discount to the stock’s fair value (the $1) the less clairvoyance you need to have about the future of the business. For instance, in 2013, when Apple stock was trading at $400 (pre-split) we didn’t have to have a very clear crystal ball about Apple’s future; Apple just had to be able to barely fog the mirror.

In later years, at $900, we need to have a lot more precision in our analysis of Apple’s future. 

CITE: https://www.r2library.com/Resource/Title/082610254

***

COMMENTS APPRECIATED

Thank You

Subscribe to the Medical Executive-Post

***

***

#3: The Six Commandments of Value Investing (Part 2)

***

EDITOR’S NOTE: Although it has been some time since speaking live with busy colleague Vitaliy Katsenelson CFA, I review his internet material frequently and appreciate this ME-P series contribution. I encourage all ME-P readers to do the same and consider his value investing insights carefully.

By Vitaliy Katsenelson, CFA

***

***

3. The market is there to serve you, not the other way around (Part 2)

First, we increase it by subtraction, by shrinking our universe to stocks that lie within both our IQ and EQ comfort zones.

We are very careful about stocks or industries where either our IQ or EQ is questionable. For instance, we have recognized that our IQ is low when it comes to non-revenue-generating, single-future-product biotech companies. We have zero analytical insights into this business. None.

We find that our EQ is fairly low when it comes to complex financial businesses. We don’t invest in any.

The beauty of investing is that we only need 20-30 stocks, and we get to choose which problems we want to tackle. We usually like easy problems.

In other professions, that is a luxury you don’t have. If you are an orthopedic surgeon, you are not going to tell your patient that you only operate on right knees because the last time out you had a bad experience with a left knee.

Second, we look for areas where our EQ is highest.

Over the years, we’ve discovered that our EQ is much higher with higher-quality companies. Therefore, for every company in our portfolio or on our watch list, we quantify quality. And with very rare exceptions, we own only very-high-quality companies.

We quantify quality for another reason, too. As value investors, we are innately focused on a margin of safety. We found that if you don’t quantify quality, it is very easy to lower your standards when you reach for value, especially in a very expensive market.

We went a step further: Quality, for us, is a filter. If a company doesn’t pass its quality test, it is dead to us. It may have high growth prospects, pay high dividends, and it may sell at a mouthwatering valuation. But if it failed our quality test, it is still dead to us.

By quantifying quality, we can keep the overall quality of our portfolio very high. Just as importantly, we can keep our EQ high, too.

By maximizing both our IQ and EQ for individual stocks, we maximize the Total IQ of the portfolio. Thus, when we get punched in the mouth, we are able to rationally reanalyze a stock and may decide to buy more, do nothing, or sell.

We cautiously guard our EQ and long-term horizon. We don’t let the outside world come unchecked into our daily life. For instance, we spend little time watching business TV during the day, as we find it to be toxic to our time horizon and to our investor (as opposed to trader) mentality. For the same reason, we also don’t look at our portfolio more than twice a day.

Finally, and this applies to professional investors only, you need to have clients who will allow you to maintain your EQ. Following the Six Commandments is practically impossible if your clients don’t believe in them.

Here’s a real example:

On my recent purchase of Apple stock coming off a one year top and heading down.

On January 25th, 2013 at 3:55 pm I got this email from a client, David:

David and I talked on the phone, and I tried to explain our logic. I’m not going to bore you with that, but it was along the lines of “incredible brand, high recurrence of revenues, great management, a quarter of market capitalization in cash; we tried to kill it (we lowered its margins, cut sales) and we simply couldn’t.”

I told David that the price of the stock is an opinion of value, not a final verdict – he didn’t care. He’d talked to his neighbor who was a famous technician, who said, “Apple is going down.” To which my response was, “If it declines that will be a blessing – the company is buying back stock, and we are going to buy more.”

The “technician” was right: Apple declined from $455 ($65 split-adjusted), our initial purchase price, to $395 ($56 split-adjusted). We bought more Apple as it fell. This encounter also made me realize how this negative psychology around Apple was creating an opportunity in Apple, and I wrote a two-part article describing the aforementioned incident as evidence of that.

What I did not say in that article is that we had to amicably part ways with David. I tried very hard to communicate the Six Commandments to him, but he was not willing to (re)learn. Keeping him as a client would erode my overall EQ and would have impacted other clients.

Your mental state is as important as your ability to analyze a company’s balance sheet or your ability to value the business. You may spend days sharpening your investment process, your analytical skills; but in the end, if your EQ is low nothing else will matter.

CITE: https://www.r2library.com/Resource/Title/082610254

***

COMMENTS APPRECIATED

Thank Yo

Subscribe to the Medical Executive-Post

****

#3: The Six Commandments of Value Investing (Part 1)

***

The Six Commandments of Value Investing (Part 1)

***

EDITOR’S NOTE: Although it has been some time since speaking live with busy colleague Vitaliy Katsenelson CFA, I review his internet material frequently and appreciate this ME-P series contribution. I encourage all ME-P readers to do the same and consider his value investing insights carefully.

By Vitaliy Katsenelson, CFA

***

The Six Commandments of Value Investing
3. The market is there to serve you, not the other way around.

Part 1
: The market is there to price stocks on a daily basis, but it doesn’t value them on a daily basis. In the long run (the yardstick here is years, not days or months) the market will value stocks, but in the short run stock price movements are random. 

Despite this randomness, the media will always find a rational explanation for a move. However, trying to understand randomness and predict stock movements in the short run is like trying to have an intelligent conversation with a two-year-old. It may be fun, but it will consume a lot of your time and energy, and the outcome is far from certain. 

Stock fluctuations should be looked upon as a natural and benign feature of the stock market, but only if you know what the asset is worth. To make Mr. Market serve us and not become its slave, here is what we do.

If we know a stock is worth $1, then if its price falls from 50 cents to 30 cents (a 40% decline), that’s a blessing for several reasons: The company can now buy back a lot more of its stock at lower prices, and we can add to our position. After all, it’s 40% cheaper. 

Here is the key, though: You have to make sure that what you thought was worth $1 is still worth $1.

To quote Mike Tyson, “Everyone has a plan till they get punched in the mouth.” How do you remain rational when Mr. Market has just smashed you in the face by repricing your $1 stock from 50 cents to 30 cents? Maybe Mr. Market is right and that company’s fair value was never really $1 but only 40 cents?

To remain rational, we focus on maximizing our Total IQ. I know we were not supposed to have math, especially this early in the book. But indulge me with this little equation: Total IQ = IQ x EQ (where EQ <=1)Before I explain I want to stress this point: Your IQ, EQ, and thus Total IQ will vary from stock to stock and from industry to industry.

Let’s start with IQ.

IQ – our intellectual capacity to analyze problems – will vary with the problem in front of us. Just as we breezed through some subjects in college and struggled with others, our ability to understand the current and future dynamics of various companies and industries will fluctuate as well. This is why we buy stocks that fall within our sphere of competence. We tend to stick with ones where our IQ is the highest.

As I have mentioned before but will continue to repeat: If investing were an exact science – a formulaic process by which you could (in a vacuum) constantly test and retest your hypotheses and repeat your results – then EQ, our emotional quotient, would be irrelevant.

If we were characters from Star Trek – with complete control over our emotions, like Mr. Spock, or lacking emotions entirely, like Lieutenant Commander Data – then our EQ wouldn’t matter. However, investing is not a science and we are humans. We have plenty of emotions, and thus EQ is a very important part of this equation.

Though we usually think about our capacity to analyze problems as being dependable and stable over time, it isn’t.

First, emotions distort probabilities. So, even if my intellectual capacity to analyze a problem is not impacted, my brain may be solving a distorted problem.

Second, my IQ is not constant, and my ability to process information effectively declines under emotional stress. I either lose the big picture or overlook important details. This dilemma is not unique to me; I’m sure it affects all of us to varying degrees.

A friend of mine who is a terrific investor, and who will remain nameless (though his name is George), once told me that he never invests in grocery store stocks because he can’t be rational when he holds them. If we spent some Freudian time with him, we’d probably discover that he experienced a traumatic childhood event at the grocery store (he may have been caught shoplifting a candy bar when he was eight), or he may have had a bad experience with a grocery stock early in his career. The reason for his problem is irrelevant, though. What is important is that he has realized that his high IQ will be impaired by his low EQ if he owns grocery stocks.

The higher my EQ is with regard to a particular company, the more likely my Total IQ will not degrade when things go wrong (or even when they go right). This is why in the little formula above, EQ cannot be greater than 1. In your most emotionally stable state (when EQ = 1), your Total IQ will equal your IQ.

There is a good reason why doctors don’t treat their own children: Their ability to be rational (properly weighing probabilities) may be severely compromised by their emotions. 

CITE: https://www.r2library.com/Resource/Title/082610254

***

COMMENTS APPRECIATED

Thank You

Subscribe to the Medical Executive-Post

***

****

#2: The Six Commandments of Value Investing

2. Long-term time horizon (both analytical and expectation to hold) 

EDITOR’S NOTE: Although it has been some time since speaking live with busy colleague Vitaliy Katsenelson CFA, I review his internet material frequently and appreciate this ME-P series contribution. I encourage all ME-P readers to do the same and consider his value investing insights carefully.

By Vitaliy Katsenelson, CFA

***

***

The Six Commandments
of Value Investing

***
2. Long-term time horizon (both analytical and expectation to hold) 
A long-term time horizon is extremely important for value investors for several reasons: 
First, it is impossible predict how a stock will be priced in the short run. Short-term stock behavior is random, and thus its forecasting (at least using tools available to investors) cannot be turned into a repeatable process. 

Second, having a longer time horizon than Wall Street is a very important competitive advantage. The Street’s time horizon is very short – measured in months, maybe quarters, but rarely in years. 

Money flows into mutual funds and hedge funds are driven by recent performance, so Wall Street is obsessed with the short term. This creates time arbitrage. Stocks get punished because their immediate future may look unattractive, but if you look at them as businesses, that short-term performance is just a pimple on your long-term timeline. 

So, how do we embed a long-term time horizon into our process?

First, we always look at earnings and cash flows at least three (often five) years out. This forces us to look at the company’s normalized earnings power and ignores the short term. All our models focus on what the company will be worth based on its earnings power in three to five years. Then we discount (bring that future value forward to today at an 18%-40% discount rate, depending on the company’s quality) to see what we want to pay for this company today. 
Looking at the business at least three to five years out has a very important side effect: It adds “growth” to the portfolio from earnings and dividends. Stock returns come from three sources: price-to-earnings (P/E) expansion, earnings growth, and dividends. 

P/E expansion is finite – it’s a one-time shot in the arm. Let’s say a stock’s P/E goes from an undervalued 12 to a fairly valued 15 – a 25% return. If this company doesn’t grow earnings and/or pay dividends, that 25% will be our total return. The risk of owning this type of “one-shot” stock is that without earnings growth or dividends, time is not on your side – you don’t get paid to wait.

If your time horizon is three years, that 25% return gets truncated to an annual return of only 8% a year. But if this company, in addition to trading at a depressed P/E, pays a 3% dividend and grows earnings 7% a year, that is an additional, repeatable 10% return a year. This elongation of the time horizon embeds growth in our portfolio and also forces us to demand a much higher discount for stocks that don’t pay dividends and don’t grow their earnings. 

***

COMMENTS ARE APPRECIATED

Thank You

Subscribe to the Medical Executive-Post

***

****

#1: The Six Commandments of Value Investing

1. A stock is partial ownership of a business 

***

By Vitaliy N. Katsenelson CFA

EDITOR’S NOTE: Although it has been some time since speaking live with busy colleague Vitaliy Katsenelson CFA, I review his internet material frequently and appreciate this ME-P series contribution. I encourage all ME-P readers to do the same and consider his value investing insights carefully.

***

The Six Commandments of Value Investing
Introduction

I wrote the core of this chapter in preparation for a speech I gave at an investment conference. In my speech, I wanted to show how at my firm, we took the Six Commandments of Value Investing and embedded them in our investment operating system. 

Since I was speaking to fellow value investors, this speech was written not to promote my firm but to educate. I was going to rewrite the speech for this chapter and make a bit less about us and more about you –but each attempt resulted in a dull chapter. So here is a much extended version of my original speech. 

The Six Commandments

These are the Six Commandments of Value Investing. I don’t expect any value investors reading this to be surprised by any one of them. They were brought down from the mountain by Ben Graham in his book Security Analysis.

1)    A stock is fractional ownership of a business (not trading sardines).
2)    Long-term time horizon (both analytical and expectation to hold)
3)    Mr. Market is there to serve us (know who’s the boss).
4)    Margin of safety – leave room in your buy price for being wrong.
5)    Risk is permanent loss of capital (not volatility).
6)    In the long run stocks revert to their fair value.

These commandments are very important and they sound great, but in the chaos of our daily lives it is so easy for them to turn into empty slogans. 

A slogan without execution is a lie. For these “slogans” not to be lies, we need to deeply embed them in our investment operating system – our analytical framework and our daily routines – and act on them.

The focus of this chapter goes far beyond explaining what these commandments are: My goal is to give you a practical perspective and to show you how we embed the Six Commandments in our investment operating system at my firm. 

1. A stock is partial ownership of a business 

The US and most foreign markets we invest in are very liquid. We can sell any stock in our portfolios with ease – a few clicks and a few cents per share commission and it’s gone. This instant liquidity, though it can be tremendously beneficial (we wish selling a house were that easy, fast, and cheap), can also have harmful unintended consequences: It tends to shrink the investor’s analytical time horizon and often transforms investors into pseudo-investors. 

For true traders, stocks are not businesses but trading widgets. Pork bellies, orange futures, stocks are all the same to them. Traders try to find some kind of order or a pattern in the hourly and daily chaos (randomness) of financial markets. As an investor, I cannot relate to traders –not only do we not belong to the same religion, we live in very different universes. 
Over the years I’ve met many traders, and I count a few as my dear friends. None of them confuse what they do with investing. In fact, traders are very explicit that their rules of engagement with stocks are very different from those of investors. 

I have little insight to share with traders in these pages. My message is really to market participants who on the surface look at stocks as if they were investments but who have been morphed by the allure of the market’s instant liquidity into pseudo-investors. They are not quite traders – because they don’t use traders’ tools and are not trying to find order in the daily noise – but they aren’t investors, either, because their time horizon has been shrunk and their analysis deformed by market liquidity. 

The best way to contrast the investor with the pseudo-investor is by explaining what an investor is. A true investor would do the same analysis of a public company that he would do for a private one. He’d analyze the company’s business, guestimate earnings power and cash flows. Assess its moat – the ability to protect cash flows from competition. Try to look “around the corner” to various risks. Then figure out what the business is worth and decide what price he’d want to pay for it (your required discount to what the business is worth). For an investor, the analysis would be the same if his $100,000 was buying 20% of a private business or 0.002% of a public one. This is how your rational uncle would analyze a business – your Warren Buffett or Ben Graham. 

How do we maintain this rational attitude and prevent the stock market from turning us into pseudo-investors? Very simple. We start by asking, “Would we want to own this business if the stock market was closed for 10 years?” (Thank you, Warren Buffett). This simple question changes how we look at stocks. 

Now, the immediate liquidity that is so alluring in a stock, and that turns investors into pseudo-investors, is gone from our analysis. Suddenly, quality – valuation, cash flows, competitive advantage, return on capital, balance sheet, management – has a much different, more complete meaning.

***

COMMENTS APPRECIATED

Thank You

Subscribe to the Medical Executive-Post

***

***

PODCAST: Value Investing with Vitaliy Katsenelson CFA

***

Amazon.com: Vitaliy Katsenelson: Books, Biography, Blog, Audiobooks, Kindle

By Vitaliy N. Katsenelson, CFA

***

EDITOR’S NOTE: In this interview with investment website @GuruFocus, my colleague Vitaliy shares the full gamut of how he invests, where and why. He touches on the role of being eclectic when investing, how to invest abroad, and how value investors should think about macro-economics and finance, among many other important topics. Enjoy this fun and wide-ranging interview! It is very timely with the S&P 500, DJIA and NASDAQ just posting their 4th straight day of gains while Facebook rattled investors by posting a rare profit decline, driven by the company’s heavy spending on its vision for a so-called Metaverse and simultaneously confronting advertising challenges on its existing services.

Dr. David Edward Marcinko MBA CMP®

***

PODCAST: https://www.youtube.com/watch?v=eTSTbF0GwVw&t=69s

VALUE STOCKS: https://www.msn.com/en-us/money/markets/value-stocks-just-had-their-best-month-since-the-peak-of-the-2001-dot-com-bubble-%e2%80%94-and-theres-still-more-upside-to-come-bank-of-america-says/ar-AATpt1m?li=BBnb7Kz

***

Your comments are appreciated.

THANK YOU

Subscribe to the Medical Executive-Post

***

Will Mr. Market Eat Too Much Pi?

By Vitaliy Katsenelson CFA

****

This Holiday, Will Mr. Market Eat Too Much Pi?
You can also listen to a professional narration of this article on iTunes, Google & online.

Mr. Market was less than kind to our portfolio over the last few months, and especially the last few weeks. I cannot tell you how little it worries us what Mr. Market thinks about our stocks at any particular point in time. We love* our portfolio even if the Mr. Market doesn’t fancy it today.

Also, before we take Mr. Market seriously, let us tell you about the rationality of Mr. Market lately. The World Health Organization (WHO) names each variant of the Covid virus by going to the next letter of the Greek alphabet. After Delta, which is currently the most predominant variant of the virus ravaging the world, there must have been nine others that were not important enough because we never heard of them. Why nine? Because when the latest variant of concern was found in South Africa, it emerged that the letter Nu was supposed to be applied to it. But Nu sounds a lot like new. WHO didn’t want to confuse people, so it skipped to the next letter in the Greek Alphabet, which is Xi – oops, that’s the Chinese supreme dictator. So, for the sake of global political stability, that letter was skipped, too.
This brings us to Omicron, the name of the latest variant.

This is where this story gets a bit more interesting.

The one disruption that really puzzles me is the labor shortage. There are millions of jobs going unfilled today. I hear stories of Starbucks stores being closed due to a lack of workers. Every service that has a heavy labor component has gotten worse – be it restaurants, ride-sharing, or pharmacies. There happens to be a cryptocurrency, one of thousands, that is also named Omicron. I still cannot grasp the logic behind it, but that cryptocurrency was up 900% on the day the South African variant was christened. There must have been a trading algorithm or a lot of bored investors looking for the next gamble, to drive something seemingly worthless up 900%.

That is the drunken Mr. Market that is pricing our stocks today.

I am going to repeat what you will find me saying several times in the letter: We own businesses that are priced, not valued, by Mr. Market thousands of times a day. We have done a lot of work on each company in the portfolio, and through diligent research we have reached the conclusion that each is worth more than the price it is changing hands at today. Are we going to be right about each and every stock? Of course not. This is a numbers game. But we use a time-tested methodology centered on common sense and the cash flows these businesses generate. Also, this is not our first rodeo. We’ll go on making small tweaks, taking advantage of Mr. Market’s manic-depressive moods, at least when it comes to anything that generates cash flows.

Of course, we could change our investment process and load up on the cryptocurrency called Pi Coin, which happens to take its name from the letter in the Greek alphabet that follows Omicron. But I think we all agree we should stick to our knitting, buying high-quality businesses that are significantly undervalued. (Anyway we already loaded up on pie during Thanksgiving.)

Our advice – enjoy this holiday season. Spend time with your loved ones; don’t look at your portfolio. Let us worry about it – after all, we own the same stocks you do.

We wish you joyful and safe holidays.

***
COMMENTS APPRECIATED.

Thank You

SUBSCRIBE TO THE MEDICAL EXECUTIVE-POST

***

PODCAST: Is Value Investing Dead?

Vitaliy Katsenelson CFA

***

Recent : DOW , NASDAQ , NVIDIA CORPORATION , GENERAL ELECTRIC COMPANY , PAYPAL HOLDINGS, INC. Market DOW 35,365.44 ▼ -532.20 NASDAQ 15,169.68 ▼ -10.75 S&P 500 4,620.64 ▼ -48.03 WTI Futures 70.86 ▼ -1.52

***

DEFINITION: Value investing is an investmentparadigm that involves buying securities that appear underpriced by some form of fundamental analysis. The various forms of value investing derive from the investment philosophy first taught by Benjamin Graham and David Dodd at Columbia Business School in 1928, and subsequently developed in their 1934 text Security Analysis.

Citation: https://www.r2library.com/Resource/Title/0826102549

***

See the source image

***

PODCAST: Is Value Investing Dead?

ASSESSMENT: Your comments are appreciated.

THANK YOU

***

What is Corporate “BOOK VALUE” & “PAR VALUE”?

TWO INVESTING DIFFERENCES = TWO QUICK THOUGHTS

BY DR. DAVID EDWARD MARCINKO MBA CMP®

CMP logo

SPONSOR: http://www.CertifiedMedicalPlanner.org

BOOK-VALUE: Cost of capital assets minus accumulated depreciation for a healthcare [corporation], or other organization.

The net asset value of a [healthcare] companies common stock. This is calculated by dividing the net tangible assets of the company (minus the par value of any preferred stock the company has) by the number of common shares outstanding.

****

PAR VALUE: For common stock, the value on the books of the corporation. It has little to do with market value or even the original price of shares at first issuance.

The difference between par and the price at first issuance is carried on the books of a corporation as “paid-in capital” or “capital surplus.”

***

See the source image

ASSESSMENT: Your thoughts are appreciated.

Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

ORDER TEXTBOOK: https://www.routledge.com/Comprehensive-Financial-Planning-Strategies-for-Doctors-and-Advisors-Best/Marcinko-Hetico/p/book/9781482240283

INVITE DR. MARCINKO: https://medicalexecutivepost.com/dr-david-marcinkos-

THANK YOU

***

USA v. CHINA: What a [Physician] Investor Should Do?

A PODCAST PRESENTATION ON THE C.C.P.

Vitaliy N. Katsenelson, CFA - YouTube

By Vitaliy Katsenelson, CFA

EDITOR’S NOTE: Over the last six months, my value investing management colleague Vitaliy Katsenelson has skewed his IMA’s portfolios more towards defense companies.

Dr. David Edward Marcinko MBA CMP®

WHY THE SHIFT?

The world appears less safe today than at any time since the Berlin Wall came down. Fast-forward two decades from then to now, and we find a drastically different world.

For example, China’s large Long March 5b rocket has fallen to Earth mostly as expected, much to the chagrin of critics. And some suggest the country is gearing up for “World War III” after Congress passed a multi-billion dollar defense Bill on Friday which President Donald Trump had previously vetoed.

LINK: https://nationalinterest.org/blog/reboot/us-military-worried-china-could-start-world-war-iii-180807

And so, in this podcast, Vitaliy explains his thoughts on the US, China, and the role defense companies play in his client portfolios.

PODCAST LINK: You can watch / hear / read his article online here: https://contrarianedge.com/us-and-china-in-the-foothills-of-cold-war/

title-img

ASSESSMENT: Your thoughts are appreciated.

THANK YOU

***

Is Value Investing Dead?

 

Vitaliy Katsenelson CFA

Is Value Investing Dead?

***

MORE: http://www.msn.com/en-us/money/topstocks/value-stocks-are-trading-at-the-steepest-discount-in-history/ar-AACuYES?li=BBnbfcN

***

Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™8Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

***

Finding high-quality companies; TODAY?

At attractive valuations

By Vitaliy Katsenelson, CFA

We are having a hard time finding high-quality companies at attractive valuations.

For us, this is not an academic frustration. We are constantly looking for new stocks by running stock screens, endlessly reading (blogs, research, magazines, newspapers), looking at holdings of investors we respect, talking to our large network of professional investors, attending conferences, scouring through ideas published on value investor networks, and finally, looking with frustration at our large (and growing) watch list of companies we’d like to buy at a significant margin of safety. The median stock on our watch list has to decline by about 35-40% to be an attractive buy.

But – maybe we’re too subjective

Instead of just asking you to take our word for it, in this letter we’ll show you a few charts that not only demonstrate our point but also show the magnitude of the stock market’s overvaluation and, more importantly, put it into historical context. 

***

 

 Finding High-Quality Companies Today

*** 

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

***

Some Book Reviews on Value Investing

Articles and Papers, too:

By Michael at: https://valuestockgeek.com

If you like want to learn more about value investing, below are some great resources.

***

***

 Resources

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

8Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

***

The Warren Buffett & Charlie Munger Show

More on Value Investing

By Vitaliy Katsenelson CFA

***

The Warren Buffett & Charlie Munger Show

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

***

How Physicians and All Investors Should Deal With the Overwhelming Problem Of Understanding The World Economy

Join Our Mailing List

“What the —- do I do now?”

vitaly

By Vitaliy N. Katsenelson CFA

A SPECIAL ME-P REPORT

This was the actual subject line of an e-mail I received that really summed up most of the correspondence I got in response to an article I published last summer. To be fair, I painted a fairly negative macro picture of the world, throwing around a lot of fancy words, like “fragile” and “constrained system.” I guess I finally figured out the three keys to successful storytelling: One, never say more than is necessary; two, leave the audience wanting more; and three … Well, never mind No. 3, but here is more.

Before I go further, if you believe the global economy is doing great and stocks are cheap, stop reading now; this column is not for you. I promise to write one for you at some point when stocks are cheap and the global economy is breathing well on its own — I just don’t know when that will be. But if you believe that stocks are expensive — even after the recent sell-off — and that a global economic time bomb is ticking because of unprecedented intervention by governments and central banks, then keep reading.

Today

Today, after the stock market has gone straight up for five years, investors are faced with two extremes: Go into cash and wait for the market crash or a correction and then go all in at the bottom, or else ride this bull with both feet in the stirrups, but try to jump off before it rolls over on you, no matter how quickly that happens.

Of course, both options are really not options. Tops and bottoms are only obvious in the rearview mirror. You may feel you can time the market, but I honestly don’t know anyone who has done it more than once and turned it into a process. Psychology — those little gears spinning but not quite meshing in your so-called mind — will drive you insane. It is incredibly difficult to sit on cash while everyone around you is making money. After all, no one knows how much energy this steroid-maddened bull has left in him. This is not a naturally raised farm animal but a by-product of a Frankenstein-like experiment by the Fed. This cyclical market (note: not secular; short-term, not long-term) may end tomorrow or in five years. Riding this bull is difficult because if you believe the market is overvalued and if you own a lot of overpriced stocks, then you are just hoping that greater fools will keep hopping on the bull, driving stock prices higher.

More importantly, you have to believe that you are smarter than the other fools and will be able to hop off before them (very few manage this). Good luck with that — after all, the one looking for a greater fool will eventually find that fool by looking in the mirror.

Last Spring

As I wrote in an article last spring, “As an investor you want to pay serious attention to ‘climate change’ — significant shifts in the global economy that can impact your portfolio.” There are plenty of climate-changing risks around us — starting with the prospect of higher, maybe even much higher, interest rates — which might be triggered in any number of ways: the Fed withdrawing quantitative easing, the Fed losing control of interest rates and seeing them rise without its permission, Japanese debt blowing up. Then we have the mother of all bubbles: the Chinese overconsumption of natural and financial resources bubble. Of course, Europe is relatively calm right now, but its structural problems are far from fixed. One way or another, the confluence of these factors will likely lead to slower economic growth and lower stock prices. So “what the —-” is our strategy? Read on to find out. I’ll explain what we’re doing with our portfolio, but first let me tell you a story.

My Story

When I was a sophomore in college, I was taking five or six classes and had a full-time job and a full-time (more like overtime) girlfriend. I was approaching finals, I had to study for lots of tests and turn in assignments, and to make matters worse, I had procrastinated until the last minute. I felt overwhelmed and paralyzed. I whined to my father about my predicament. His answer was simple: Break up my big problems into smaller ones and then figure out how to tackle each of those separately. It worked. I listed every assignment and exam, prioritizing them by due date and importance. Suddenly, my problems, which together looked insurmountable, one by one started to look conquerable. I endured a few sleepless nights, but I turned in every assignment, studied for every test and got decent grades. Investors need to break up the seemingly overwhelming problem of understanding the global economy and markets into a series of small ones, and that is exactly what we do with our research. The appreciation or depreciation of any stock (or stock market) can be explained mathematically by two variables: earnings and price-earnings ratio. We take all the financial-climate-changing risks — rising interest rates, Japanese debt, the Chinese bubble, European structural problems — and analyze the impact they have on the Es and P/Es of every stock in our portfolio and any candidate we are considering.

Practical applications

Let me walk you through some practical applications of how we tackle climate-changing risks at my firm. When China eventually blows up, companies that have exposure to hard commodities, directly or indirectly (think Caterpillar), will see their sales, margins and earnings severely impaired. Their P/Es will deflate as well, as the commodity supercycle that started in the early 2000s comes to an end. Countries that export a lot of hard commodities to China will feel the aftershock of the Chinese bubble bursting. The obvious ones are the ABCs: Australia, Brazil and Canada.

However, if China takes oil prices down with it, then Russia and the Middle East petroleum-exporting mono-economies that have little to offer but oil will suffer. Local and foreign banks that have exposure to those countries and companies that derive significant profits from those markets will likely see their earnings pressured. (German automakers that sell lots of cars to China are a good example.)

Japan is the most indebted first-world nation, but it borrows at rates that would make you think it was the least indebted country. As this party ends, we’ll probably see skyrocketing interest rates in Japan, a depreciating yen, significant Japanese inflation and, most likely, higher interest rates globally. Japan may end up being a wake-up call for debt investors. The depreciating yen will further stress the Japan-China relationship as it undermines the Chinese low-cost advantage.

So paradoxically, on top of inflation, Japan brings a risk of deflation as well. If you own companies that make trinkets, their earnings will be under assault. Fixed-income investors running from Japanese bonds may find a temporary refuge in U.S. paper (driving our yields lower, at least at first) and in U.S. stocks. But it is hard to look at the future and not bet on significantly higher inflation and rising interest rates down the road.

untitled

[Moscow]

A side note:

Economic instability will likely lead to political instability. We are already seeing some manifestations of this in Russia. Waltzing into Ukraine is Vladimir Putin’s way of redirecting attention from the gradually faltering Russian economy to another shiny object — Ukraine. Just imagine how stable Russia and the Middle East will be if the recent decline in oil prices continues much further.

1447968781847

[Defense Industry]

Inflation and higher interest rates

Defense industry stocks may prove to be a good hedge against future global economic weakness. Inflation and higher interest rates are two different risks, but both cause eventual deflation of P/Es. The impact on high-P/E stocks will be the most pronounced. I am generalizing, but high-P/E growth stocks are trading on expectations of future earnings that are years and years away. Those future earnings brought to the present (discounted) are a lot more valuable in a near-zero interest rate environment than when interest rates are high. Think of high-P/E stocks as long-duration bonds: They get slaughtered when interest rates rise (yes, long-term bonds are not a place to be either). If you are paying for growth, you want to be really sure it comes, because that earnings growth will have to overcome eventual P/E compression. Higher interest rates will have a significant linear impact on stocks that became bond substitutes. High-quality stocks that were bought indiscriminately for their dividend yield will go through substantial P/E compression.

These stocks are purchased today out of desperation. Desperate people are not rational, and the herd mentality runs away with itself. When the herd heads for the exits, you don’t want to be standing in the doorway. Real estate investment trusts (REITs) and master limited partnerships (MLPs) have a double-linear relationship with interest rates: Their P/Es were inflated because of an insatiable thirst for yield, and their earnings were inflated by low borrowing costs. These companies’ balance sheets consume a lot of debt, and though many of them were able to lock in low borrowing costs for a while, they can’t do so forever. Their earnings will be at risk.

Charlie Munger speaks

As I write this, I keep thinking about Berkshire Hathaway vice chairman Charlie Munger’s remark at the company’s annual meeting in 2013, commenting on the then-current state of the global economy: “If you’re not confused, you don’t understand things very well.” A year later the state of the world is no clearer. This confusion Munger talked about means that we have very little clarity about the future and that as an investor you should position your portfolio for very different future economies. Inflation? Deflation? Maybe both? Or maybe deflation first and inflation second?

I keep coming back to Japan because it is further along in this experiment than the rest of the world. The Japanese real estate bubble burst, the government leveraged up as the corporate sector deleveraged, interest rates fell to near zero, and the economy stagnated for two decades. Now debt servicing requires a quarter of Japan’s tax receipts, while its interest rates are likely a small fraction of what they are going to be in the future; thus Japan is on the brink of massive inflation. The U.S. could be on a similar trajectory.

Let me explain why

Government deleveraging follows one of three paths. The most blatant option is outright default, but because the U.S. borrows in its own currency, that will never happen here. (However, in Europe, where individual countries gave the keys to the printing press to the collective, the answer is less clear.) The second choice, austerity, is destimulating and deflationary to the economy in the short run and is unlikely to happen to any significant degree because cost-cutting will cost politicians their jobs. Last, we have the only true weapon government can and will use to deleverage: printing money. Money printing cheapens a currency — in other words, it brings on inflation. In case of either inflation or deflation, you want to own companies that have pricing power — it will protect their earnings. Those companies will be able to pass higher costs to their customers during a time of inflation and maintain their prices during deflation.

On the one hand, inflation benefits companies with leveraged balance sheets because they’ll be paying off debt with inflated (cheaper) dollars. However, that benefit is offset by the likely higher interest rates these companies will have to pay on newly issued debt. Leverage is extremely dangerous during deflation because debt creates another fixed cost. Costs don’t shrink as fast as nominal revenues, so earnings decline.

Crystal ball

Therefore, unless your crystal ball is very clear and you have 100 percent certainty that inflation lies ahead, I’d err on the side of owning underleveraged companies rather than ones with significant debt. A lot of growth that happened since 2000 has taken place at the expense of government balance sheets. It is borrowed, unsustainable growth that will have to be repaid through higher interest rates and rising tax rates, which in turn will work as growth decelerators. This will have several consequences:

  1. First, it’s another reason for P/Es to shrink.
  2. Second, a lot of companies that are making their forecasts with normal GDP growth as the base for their revenue and earnings projections will likely be disappointed.
  3. And last, investors will need to look for companies whose revenues march to their own drummers and are not significantly linked to the health of the global or local economy.

The definition of “dogma” by irrefutable Wikipedia is “a principle or set of principles laid down by an authority as incontrovertibly true.” On the surface this is the most dogmatic columns I have ever written, but that was not my intention. I just laid out an analytical framework, a checklist against which we stress test stocks in our portfolio. Despite my speaking ill of MLPs, we own an MLP. But unlike its comrades, it has a sustainable yield north of 10 percent and, more important, very little debt. Even if economic growth slows down or interest rates go up, the stock will still be undervalued — in other words, it has a significant margin of safety even if the future is less pleasant than the present.

Final bits

There are five final bits of advice with which I want to leave you:

  1. First, step out of your comfort zone and expand your fishing pool to include companies outside the U.S. That will allow you to increase the quality of your portfolio without sacrificing growth characteristics or valuation. It will also provide currency diversification as an added bonus.
  2. Second, disintermediate your buy and sell decisions. The difficulty of investing in an expensive market that is making new highs is that you’ll be selling stocks that hit your price targets. (If you don’t, you should.)

Of course, selling stocks comes with a gift — cash. As this gift keeps on giving, your cash balance starts building up and creates pressure to buy. As parents tell their teenage kids, you don’t want to be pressured into decisions.

Assessment

In an overvalued market you don’t want to be pressured to buy; if you do, you’ll be making compromises and end up owning stocks that you’ll eventually regret. Margin of safety, margin of safety, margin of safety — those are my last three bits of advice. In an environment in which the future of Es and P/Es is uncertain, you want to cure some of that uncertainty by demanding an extra margin of safety from stocks in your portfolio.

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

[PHYSICIAN FOCUSED FINANCIAL PLANNING AND RISK MANAGEMENT COMPANION TEXTBOOK SET]

  Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™ Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

[Dr. Cappiello PhD MBA] *** [Foreword Dr. Krieger MD MBA]

***

Downhill Racing Meets Value Investing

Join Our Mailing List

More on Value Investing

vitaly

By Vitaliy Katsenelson CFA

I wrote this article in May. Every time it was destined to be published in the pages of Institutional Investor, it got bumped by another, more timely one I had written. Finally, when a space opened in September, the market had taken a major dive, and what was supposed to be an “evergreen” article was suddenly out of touch with reality.

Here is the irony: This piece addresses complacency, but its author was complacent too. The X-mass market has recouped its summer losses, and this article is relevant again.

The Skier

I am a skier. When someone says this, you assume he or she is good. Well, I thought I was good. I was not Lindsey Vonn, but I had the technique down. I’d be the fastest person going down the mountain, always waiting for my friends at the bottom. Then, at the beginning of last season, I went skiing with my kids at Vail. It had snowed nonstop for a few days. Vail is a very large resort, and the mountain crew could not keep up with the snow, so I found myself skiing on unusually ungroomed slopes in powder more than knee-deep. Suddenly, something changed. I could not ski. I could barely make turns. I was falling multiple times per run. My kids, including my nine-year-old daughter, Hannah, were now waiting for me as I dug myself out of pile after pile of snow. My technique — along with my confidence — was gone. The discomfort froms constant falling turned into fear. I was ready to go back to the hotel after only two hours on the slopes. I was devastated. It was as if I had never skied.

The Ski Instructor

So I talked to a ski instructor about this incident. He told me that I’m a “good skier” on groomed slopes because they allow me to go fast without trying hard. Speed covers up a lot of mistakes and lack of skill. Skiing in powder requires different skis — not the skis I had — but more importantly, it slows you down and makes you rely on skills that I thought I had but didn’t.

The FED

During the past six years, the Federal Reserve neatly groomed, manicured and then finely polished investment slopes for all asset classes by lowering interest rates to unprecedented levels — providing a substantial accelerant that indiscriminately drove valuations of all assets higher. But ubiquitously rising valuations cover up a lot of mistakes and often a lack of skill. Whether you had a rigorous investment process or were throwing darts, over the past six years it hardly mattered — you made money. Bull markets don’t last forever, and this one is not an exception. Stock valuations (price-to-earnings) are just like a pendulum, swinging from one extreme to another.

Modernity

Today the stocks in the S&P 500 index trade at about 50 percent above their average valuation (if you adjust earnings down for very high corporate margins). Historically, above-average valuations have always been followed by below-average ones — taking away the riches that the previous years provided.

In other words, at some point it is going to snow and snow hard. Just as I, the great skier, found myself overconfident and unable to deal with the new terrain, investors will find themselves doing face-plants when the stock market turns from bull to bear. But here is great news:

Now the stock slopes are still finely groomed with stocks near all-time highs, and we all are given a unique opportunity to make adjustments to our portfolios and investment process. You should start by carefully analyzing each stock position in your portfolio. No drooling over how each of them did for you in the past. Drawing straight lines from the past into the future is very dangerous.

The Future

Instead, focus on the future — a future in which average stock valuations will likely be lower. Returns for a stock are driven by three variables: earnings growth, change in P/E and dividend yield. You should impartially examine each variable to determine if a stock deserves to be in your portfolio.

Then make one of three decisions: buy (more), hold or sell. Just remember, hold is a decision. If you choose not to sell an overvalued stock, one that has low or negative expected returns in the long run, that is a decision. We must all reexamine and future-proof our investment process. Six years of rewards and no risk will loosen the process of even the most disciplined investor.

Finally, if you are feeling very confident about your investment prowess today, take a moment to relive that gut-wrenching feeling you had the last time the stock market took a 20 percent dive. This will reset your confidence to the appropriate level and help you to avoid the mistakes that come from focusing too much on reward and too little on risk.

***

penn station

***

P.S. I took the kids skiing at Beaver Creek a week ago, for the first time this season. My daughter Hannah, who will be ten in a few weeks, has magically improved over the summer. However, Jonah, who is an amazing skier, has completely lost his form. He grew five or six inches since last spring — he’s 14 and pushing 6 feet now. His center of gravity has shifted, and he is still adjusting his technique to his new, oversized body.

Assessment

As a father, I smile when I see Hannah beating Jonah down the slope. Jonah, like any teenager, needs to be humbled. My skiing? The slopes were perfectly groomed. I was awesome! I just hope it doesn’t snow.

***

ABOUT

Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of Active Value Investing (Wiley 2007) and The Little Book of Sideways Markets (Wiley, 2010).

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

***

[PHYSICIAN FOCUSED FINANCIAL PLANNING AND RISK MANAGEMENT COMPANION TEXTBOOK SET]

   Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™ Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

[Dr. Cappiello PhD MBA] *** [Foreword Dr. Krieger MD MBA]

***

On Value Investor Guy Spier

Join Our Mailing List

What I Learned from Value Investor Guy Spier 

By Vitaliy N. Katsenelson CFA

***

A few months ago I was asked by the CFA Institute to give talks to CFA societies in London (October 27), Zurich (October 29) and Frankfurt (November 3). I enjoy giving occasional talks (but only a few a year, otherwise they become a chore). I also love Europe — history, old buildings and cultures, museums, sometimes a mild adventure. But this offer was much more interesting — I was asked to give a joint presentation with Guy Spier.

About  Guy

Guy Spier is a tremendous value investor who happens to be a good friend whose company I truly enjoy. He is the most cosmopolitan person I know. He was born in South Africa, spent his childhood in Iran and Israel, received his bachelor’s degree from Oxford and MBA from Harvard, lived in New York and in 2008 got sick of the New York hedge fund rat race and moved with his family to Zurich. His wife, Lory, is Mexican, so in addition to being fluent in languages of all the above-mentioned countries, he romances in Spanish.

Last year Guy published a book, The Education of a Value Investor: My Transformative Quest for Wealth, Wisdom, and Enlightenment. It is not a traditional investing book. In fact, I’ll say that differently: This is the most untraditional book on investing you’re likely to run into. It is a self-effacing memoir of Guy’s transformation from a Gordon Gekko wannabe who believes that his Ivy League education entitles him to Wall Street riches to a committed follower of Warren Buffett and his sidekick, Charlie Munger.

It must have taken a lot of guts and self-confidence (overcoming a lot of self-doubt) to write this book. To be honest, I am not sure I could have written it. It is one thing to strive for intellectual honesty; it is another to unearth and expose one’s own greed, arrogance and envy. Many of us are trying to hide such character traits in plain sight, never mind telling the world about them in a popular book.

After all, Guy is not writing about a fictional character; he is writing about himself. The humility he displays is what makes the book so effective — you can clearly follow the deliberate transformation of a cockroach (the Wall Street version of a caterpillar) into a butterfly.

This memoir is able to achieve something that many other investments books don’t (including my own): It reveals the real, practical, behavioral side of investing, not the way you read about it in behavioral finance textbooks but the raw emotions every investor experiences.

There are a lot of lessons we can learn from Guy. The first one — and, for me, the most important one — is that environment matters.

***

value

[Eye for Value]

Enter Dan Ariely PhD

Dan Ariely PhD, the well-known behavioral economist, was interviewed on Bloomberg Television and asked, What can one do to lose weight? He said, Start with the environment around you. If you come to work and there is a box of doughnuts on your desk, losing weight is going to be difficult. Also, look in your fridge: All the stuff that is probably not good for your diet is staring you in the face, whereas the fruits and vegetables that are essential to healthy eating are buried in the hard-to-access bottom drawers.

The same applies to investing: We may not notice it, but the environment around us impacts our ability to make good decisions. Guy writes, “We like to think that we change our environment, but the truth is that it changes us. So we have to be extraordinarily careful to choose the right environment — to work with, and even socialize with, the right people.”

I have found that checking the prices of stocks I own throughout the day shrinks my time horizon, impacts my mood and wastes my brain cells as I try to interpret data that have very little information. I am getting better; I am already down checking prices only once a day. My goal is to do it just once every few days.

Guy is ahead of me: He checks them once a week. Recently, I put in price alerts for stocks my firm owns or follows. If a stock price changes more than 10 percent or crosses a certain important (buy or sell) point, I’ll get an e-mail alert.

Guy finds that he isn’t effective when he gets to the office because of external distractions. In his Zurich office he has a quiet room that he calls the library. It doesn’t have phones or computers, and this is where he reads, thinks and naps. Here in Denver, I have a lawn chair (bought at Costco for $50) that I take outside to sit on, put on headphones, and listen to music and read. My friend Chris goes to Starbucks or the local library in the morning for four hours before he goes to his office, and that’s where he does his reading. The key is to figure out what works for you and try not to fight your external environment.

Another lesson I have learned is that misery loves company. I was talking to Guy about his book, and he told me that people who love the book appreciate the fact that he is so honest about the emotions that consume him when he is struggling in the stock market. As investors, we often put on a brave face, but if we aren’t emotionally honest, our opinion of ourselves, our self-worth, may fluctuate with the performance of our portfolio.

Personally, I can really relate to this. When I read Guy’s book the first time (I’ve read it twice), I was going through a tough time with my portfolio. I found this book extremely therapeutic. In fact, I recommended it to a friend of mine who was going through a similar rough patch.

Another lesson:

Surround yourself with the right people. Friendships matter. I’ve been blatantly plagiarizing Guy on this for years. Guy created a conference called VALUEx Zurich, a gathering of like-minded people who get together and share investment ideas. I attended the very first one in 2010, and since then I have hosted a very similar event, VALUEx Vail, every year in June.

Guy has a latticework group of eight investors that meets every quarter and discusses the stock market, the investment process and personal issues. I’ve copied that, too. Four of us got together in Atlanta in October. We visited a few companies and debated stocks, industry trends, diets, women . . . okay, you get the point. That was our first latticework event, but I hope we’ll meet a few times a year.

Attending Guy’s conference in Zurich and organizing VALUEx Vail have resulted in enduring friendships. These conferences allowed me to create a large network of like-minded investors I talk to regularly. Every member of my latticework group I met at VALUEx Vail.

(A short side note: One of the most important things we can do as parents of teenage kids is to make sure they have good friends. That’s paramount. We as parents lose influence on our kids when they become teenagers. Their friends have a disproportionately larger impact on their choices than we do. We can influence the environment around our kids by helping them select friends.)

And then there are thank-you cards. Over the years Guy has written tens of thousands of them. He is indiscriminate about them — at one point he wrote to every employee at a boutique hotel he stayed in. All right, maybe he took it too far that time. But, writing a thank-you card to value investor Mohnish Pabrai changed his life. He attended Pabrai Investment Funds’ annual meeting in Chicago. After the meeting he sent Pabrai a thank-you note. A few months later Pabrai came to New York and invited Guy to dinner. This was the start of the Spier-Pabrai bromance. Thank-you cards work because so few people write them. They leave a lasting impression on the receiver because they say, “I like you. You are important to me.”

***

stock-exchange

[Stock-Exchanges]

Mentors

The last point is, Be yourself. Having mentors is important. For many value investors, Buffett and Munger are our north stars. There are lots of things we can learn from them. But we also have to realize that we must be ourselves, because we are not them. I remember reading a long time ago that Buffett did not do spreadsheets. That impacted me for a few months — I stopped building models and creating spreadsheets. I thought, If Buffett doesn’t do it, I shouldn’t do it either. Wrong.

Buffett is a lot smarter than I am; he is able to analyze companies in his head. He is Buffett. I have found that spreadsheets work for me because they help me think. When Buffett and I look at a company philosophically, we are looking for the same things, but I need a computer to assist me, and he doesn’t.

Mohnish Pabrai owns just a handful of stocks. Guy, on the other hand, knows that he would not be able to be a rational decision maker if he had only a handful of stocks. There will be a significant overlap between Guy’s and Pabrai’s portfolios, but Guy’s will have two or three times as many stocks.

Assessment

Dear ME-P Readers, I spoke with your Editor-in-Chief Dr. Dave Marcinko a few weeks ago, and as you can tell from this ME-P essay, I am a very biased book reviewer. I am not even sure this qualifies as a book review. Despite my biases, I can safely say that The Education of a Value Investor is one of the best books I’ve read in 2015. (I promise you that it is not the only book I’ve read this year.) Before you commit your time and money to this book, watch Guy’s presentation on Talks at Google.

ABOUT

Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of Active Value Investing (Wiley 2007) and The Little Book of Sideways Markets (Wiley, 2010).  His books have been translated into eight languages.  Forbes called him – the new Benjamin Graham.

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

***

Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners(TM)

***

 
 

Knowing the Difference Between Stock Value and Price

Join Our Mailing List

A Motley Fool Interview

vitaly

ABOUT

Vitaliy N. Katsenelson CFA is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of Active Value Investing (Wiley 2007) and The Little Book of Sideways Markets (Wiley, 2010).  His books were translated into eight languages.  Forbes Magazine called him “The new Benjamin Graham”.  

The Motley Fool,

Our own Editor Dr. Dave Marcinko recently spoke with Vitaliy, as well as The Motley Fool’s James Early and Rana Pritanjali. Vitaliy explained how he helps investors see the difference between a stock’s value and its price, as well how he assesses macroeconomic trends when investing.

Assessment

Plus, Vitaliy predicted the next category Apple will disrupt: the automotive industry.

You can listen and read the full interview here.

PS: You can read Manifesto – The Values of Value Investing, here.

I hope you enjoy it  – Ann Miller RN MHA [Managing Editor]

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™                    Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

How Emotional Intelligence Can Make You a Better Investor

Join Our Mailing List

IQ versus EQ

vitaly

By Vitaliy Katsenelson CFA

Your knee hurts, so you pay a visit to your favorite orthopedist. He smiles, maybe even gives you a hug, and then tells you: “I feel your pain. Really, I do. But I don’t treat left knees, only right ones. I find I am so much better with the right ones. Last time I worked on a left knee, I didn’t do so well.”

Though many professionals — doctors as well as lawyers, architects and engineers — get to choose their specializations, they rarely get to choose the problems they solve. Problems choose them. Investors enjoy the unique luxury of choosing problems that let them maximize the use of not just their IQ but also their EQ — emotional intelligence.

Let’s start with IQ

Our intellectual capacity to analyze problems will vary with the problem in front of us. Just as we breezed through some subjects in college and struggled with others, our ability to understand the current and future dynamics of various companies and industries will fluctuate as well. This is why we buy stocks that fall within our sphere of competence. We tend to stick with ones where our IQ is the highest.

Though we usually think about our capacity to analyze problems as being dependable and stable over time, it isn’t. It might be if we were characters from Star Trek, with complete control over our emotions, like Mr. Spock, or who lacked emotions, like Lieutenant Commander Data. This is where our EQ comes in.

I am not a licensed psychologist, but I have huge experience treating a very difficult patient: me. And what I have found is that emotions have two troublesome effects on me.

First, they distort probabilities; so even if my intellectual capacity to analyze a problem is not impacted, my brain may be solving a distorted problem.

Second, my IQ is not constant, and my ability to process information effectively declines under stress. I either lose the big picture or overlook important details. This dilemma is not unique to me; I’m sure it affects all of us to various degrees.

The higher my EQ with regard to a particular company, the more likely that my IQ will not degrade when things go wrong (or even when they go right). There is a good reason why doctors don’t treat their own children: Their ability to be rational (properly weighing probabilities) may be severely compromised by their emotions.

Example:

A friend of mine who is a terrific investor, and who will remain nameless though his name is George, once told me that he never invests in grocery store stocks because he can’t be rational when he holds them. If we spent some Freudian time with him, we’d probably discover that he had a traumatic childhood event at the grocery store (he may have been caught shoplifting a candy bar when he was eight), or he may have had a bad experience with a grocery stock early in his career. The reason for his problem is irrelevant; what is important is that he has realized that his high IQ will be impaired by his low EQ if he owns grocery stocks.

There is no cure for emotions, but we can dramatically minimize the impact they have on us as investors by adjusting our investment process. First and foremost, investors have the incredible advantage of picking domains where they can remain rational.

For instance, I would not be able to keep a cool head if I owned gold. I can recite the arguments for and against gold (lately, with negative interest rates in certain European countries, the “for” arguments have started to make even more sense). But, intellectually, I cannot reconcile the fact that gold is an asset that generates no cash flows, and thus to me it has no financial center of gravity. I have no idea what it is worth. The very idea of owning gold bothers me, and therefore I know that if I did own it, my EQ would be low. I’d be buying high and selling low.

Now, as a value investor, when I buy a stock and it declines 30 percent, I want to buy more of it (assuming its business has not changed). I wouldn’t trust that I could do this in the gold market.

To be a successful investor, you don’t need Albert Einstein’s IQ (though sometimes I wish I had Spock’s EQ). Warren Buffett undoubtedly has a very high IQ, but even the Oracle of Omaha chooses carefully his battles; for instance, he doesn’t invest in technology stocks.

***

masks

Our Luxury

Investors have the luxury of investing only in stocks for which both their IQ and EQ are maximized, because there are tens of thousands of stocks out there to choose from, and they need just a few dozen.

Assessment

Meanwhile, I hope when I go see the doctor, he will tell me, “I don’t do left knees,” because the best result will come from a doctor who while treating me will utilize both IQ and EQ.

ABOUT

Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo.

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

Written by doctors and healthcare professionals, this textbook should be mandatory reading for all medical school students—highly recommended for both young and veteran physicians—and an eliminating factor for any financial advisor who has not read it.

The book uses jargon like ‘innovative,’ ‘transformational,’ and ‘disruptive’—all rightly so!

It is the type of definitive financial lifestyle planning book we often seek, but seldom find.

LeRoy Howard MA CMPTM [Candidate and Financial Advisor, Fayetteville, North Carolina]

http://www.CertifiedMedicalPlanner.org

Fiduciary Burden of Participant-Directed Investment Plans

Join Our Mailing List

An Emerging Issue for Physician-Executives

[By Jeffery S. Coons; PhD, CFP]

Managing Principal-Manning & Napier Advisors, Inc

fp-book1

The goal of designing a participant-directed investment menu should be to provide enough diversification of roles to allow participants to make an appropriate trade-off between risk and return, without having so many roles as to create participant confusion. 

Medical Administrative Burden

Ultimately, the burden on plan administrators and physician executives is to adequately educate employees and is largely driven by the investment decisions we require them to make in the plan, with more choices necessitating a greater understanding of the fundamental differences between and appropriate role for each choice.  The logical questions that arise when selecting options on a menu are:

  • Are there clear differences among the options?
  • Are these differentiating characteristics inherent to the option or potentially fleeting?
  • Are the differences among options easily communicated to and understood by the typical plan participant?
  • Most importantly, if participants are given choice among these different options, can the decisions they make reasonably be expected to result in an appropriate long-term investment program?

Fiduciary Concerns and Liabilities

All this adds up to additional fiduciary concerns for the health care entity and plan sponsor. 

For example, can the typical participant understand growth and value as concepts when even the experts can not agree on their definitions? The use of style based menus for self-directed plans bring this issue to the forefront. What about investment strategy?  What choices are we expecting the participant to make when offering growth and value styles for one basic asset class role? 

Finally, beyond the responsibility to provide effective education, what other fiduciary issues are associated with style categorization for a participant-directed investment menu?

Effective Style Communications

Consider whether the differences among manager styles can be effectively communicated to the average participant.  Because the general style categories of “growth” and “value” are not well defined, we are expecting the participant to understand how the manager is making investments in a fundamental manner and the differences in risk/return characteristics of these alternative approaches.  This exercise is difficult for investment professionals and trustees, so it will be even more unlikely to be properly understood by an average participant.

Given Assumptions

Let’s assume for the moment that there is an effective means for understanding the different risk and return characteristics of two managers investing in what is ultimately the same basic asset class.  When allowing the choice of these two differing approaches, what decision can the participant make?  There are four possibilities:

  1. Select the single manager whose investment philosophy makes the most sense overall to the participant;
  2. Time the decision of when to move from one management philosophy to another;
  3. Split the allocation between the two managers; or,
  4. Give up from confusion and do not participate in the plan.

We have already discussed the difficulty of the first choice, so let’s consider the second possibility.  This decision is an extremely risky choice that typically leads to poor or even catastrophic performance. 

Why?  Timing decisions such as this are typically based upon recent past performance, which is cyclical in nature.  In essence, investors generally chase after yesterday’s returns and invest in funds after their period of strong relative performance.  The strong flows into S&P 500 Index funds and growth/momentum firms of today were preceded by flows into value/fundamentally-oriented investment firms a few years ago. 

In fact, a Journal of Investing academic article in the Summer of 1998 (“Mutual Fund Performance: A Question of Style”) found that mutual funds changing their investment style had the worst performance of any style individually.

Allocation Choices

The next choice is to split the allocation between growth and value.  While this approach may mean that the participant will not under-perform significantly when any one style is out-of-favor, it also means that the participant will generally never out-perform either.

Nevertheless, by combining two halves of the same basic universe within an asset class, it is likely that the basic performance of the asset class will result (i.e., index-like returns).  Since the participant is paying the higher expenses of active, value-added mutual funds, the end result is likely to be index-like returns less the significantly greater fees and consistent under-performance over the long-term.

Assessment

While there may be participants who can handle the investment process, the previous discussion illustrates why it remains an open question whether educational efforts and typical menu choices provided by plan fiduciaries will be adequate from a regulatory and legal standpoint.

However, while it is unreasonable for participants to select the single best manager, it is reasonable for trustees to choose managers by defining investment policy and objectives that focus on characteristics like broad asset classes. 

And; do you think that by creating an investment menu that removes soft, overlapping, and largely qualitative distinctions such as style; plan sponsors can take a significant step toward mitigating the potential for participant confusion that inevitably could lead to litigation?

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Link: http://feeds.feedburner.com/HealthcareFinancialsthePostForcxos

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

DICTIONARIES: http://www.springerpub.com/Search/marcinko
PHYSICIANS: www.MedicalBusinessAdvisors.com
PRACTICES: www.BusinessofMedicalPractice.com
HOSPITALS: http://www.crcpress.com/product/isbn/9781466558731
CLINICS: http://www.crcpress.com/product/isbn/9781439879900
BLOG: www.MedicalExecutivePost.com
FINANCE: Financial Planning for Physicians and Advisors
INSURANCE: Risk Management and Insurance Strategies for Physicians and Advisors

 

Product Details  Product Details

%d bloggers like this: