How to Become a Successful Investor–Part Four: It’s A Matter of Discipline

After thirty years as a professional investor I have heard just about every cocktail party stock tip or market timing success.  With their hand wrapped around a highball, everyone’s a winner.

Were that it were true.  But it’s not.

Important for us to remember is that no investor or investment discipline can be right all the time.  If we were to listen to every hot tip advocated by friends or acquaintances, we would likely chase our tales right into bankruptcy. So what is an investor to do?

First, consider what kind of investor you are.  By that I mean:  what kind of investing suits your temperament?  Are you, for example, an early adapter?  Did you own the first iPhone or iPad or are you first in line for the latest new movie release?  If so, you are likely to be comfortable buying growth stocks.  Growth stock investors are less focused on the price of the stock than they are the price momentum of the stock.

Value stock investors, however, are more reticent and conservative by nature.  Though not necessarily risk averse, value investors wait for products or companies to become established before they jump in.  If you still carry a flip phone you are likely a value investor.  Or if you drive your car, as I did, to the point of deafening rattles and yards of electrical tape holding the side-view mirror in place, you are someone who is less concerned with the latest trend and more concerned with obtaining value.

Both growth and value stock investing can be successful.  The fabled Peter Lynch of Fidelity’s Magellan Fund was the epitome of a successful growth stock investor.  Warren Buffett is the quintessential value investor.  Both have made billions of dollars for their respective clients.  And both have implemented strategies that are compatible with their personalities.  As should you.

Once you understand your investing bias (growth or value), do not stray from the kinds of stocks you are comfortable holding.  It is unwise for us to act against our nature in general and particularly so as investors.   Discipline and consistency pay off in the stock market.  Consider my Intelligent Investing Rule #1:  Having any investment discipline is better than having no discipline at all; once your investment strategy is established, never deviate.

But if you do fall off the wagon, don’t give up, get right back on and stay the course.

Next post we will explore two specific valuation disciplines you can employ in your own portfolio.


How to Become a Successful Investor–Part Three

Over the weekend I came across an interview I gave to The Wall Street Transcript ten years ago almost to the day.  I read the interview with great interest since the last ten years have been a difficult time for investors.  In the article I recommended five stocks for purchase and those five stocks provide the perfect opportunity to examine my third premise:  investing for the long-term is accessible to the average individual.

On April 14, 2003 the five value stocks I suggested to the TWST were all considered to be high-quality, well-managed companies, each out of favor for some reason. (You can read the interview for the specifics.)  As a value investor my premise then was the same as it is now–buy great companies when they are cheap and hold them for the long-term.

The five stocks I discussed in April of 2003 were Genentech (DNA–purchased by  Roche Holdings in 2009), Cisco (CSCO), Disney (DIS), Citigroup (C) and General Electric (GE).  In the table below, the performance for each stock is calculated on a weekly basis from the close of trading April 11th 2003 (the last trading day prior to the Monday, April 14th publication) through the close of trading Friday, April 12th, 2013. The first column represents the absolute return for each stock over the entire holding period.  The second number represents the average annual return.  Below the five stocks you will see the performance of the S&P 500 and the combined (equally weighted) performance of the portfolio of five stocks over the same period.

DNA     432.9%   32.5%

DIS       286.8%            14.5%

CSCO     70.7%              5.5%

C           -84.8%             -17.2%

GE         20.1%               1.8%

S&P      109.4%     7.7%

PORT   249.7%             9.6%

What can we conclude from the performance of these stocks?  Three things.  Diversification is always important.  Despite making sound, thoughtful investment decisions we cannot possibly know which stock will quadruple and which one will tank.  But, we do know that if we diversify our holdings into different industries (Biotech, Entertainment, Technology, Banking and Industrials, for example) we have a better chance of collectively generating excess return.  The second thing we learn is that we can have one or two laggards and still do as well as or better than the market.  And thirdly, over time well managed companies, for the most part, manage to fix their problems and return to growth.

Make a list of the companies whose products you use on a regular basis.   Then, begin to watch the stock.  Charts are readily available on Yahoo Finance and you can begin building a knowledge base on each company.  It is knowledge, after all, that provides the courage to buy stocks when they are cheap and makes investing accessible to the average individual.

(Recently I blogged on one of my favorite stocks–Coca Cola–at Read my post for ideas on what to look for.

Buy Great Companies and Hold Them. Really.

The headlines have been filled with the march of the Dow Jones Industrial Average to the high last reached in October 2007.  Yet, what the headlines don’t tell you is that if you factor in the effects of inflation the Dow actually does not reach new highs until 15, 651.80 over 1,000 points higher than the current level.  But even if you ignore the effects of inflation the question for the average investor is whether or not now is the time to commit new money to the market.  Yes, earnings have steadily grown as has the quality of the balance sheet since 2007.  And that means that valuations are much more attractive though the price level (as measured by the Dow) is approximately even.  But who wants to buy an asset when it has recently appreciated?  Shouldn’t I wait for a correction and buy stocks at cheaper prices?  Perhaps.  But, given the low returns in cash and the bond market and the relative attractiveness of stocks, it is conceivable the market will continue to rise in the short term; beyond the 2007 level into new highs.

Yet, short-term market levels are difficult, if not impossible, to forecast.  Look, instead, to the long-term. Incrementally buy the stocks of great companies and hold them.  Here’s why.

If you are a regular viewer of any of the financial news networks you may be hard put to find support for a buy and hold strategy.  This is not surprising since urgency and breaking news stories attract audience.  Buy and hold?  Not so much.

But for those of us who do not have the luxury of consulting an army of research analysts, accessing unlimited real time data or parking ourselves in front of the TV for the entire trading day, buying great companies and holding them for the long term is not only prudent, but a highly successful strategy.

Consider the results of Wharton School finance professor Jeremy Siegel’s research featured by Gene Epstein in this week’s Barron’s.  Siegel has compiled data on stock-market performance dating all the way back to the year 1871.  He examines the performance of stock returns in rolling five, ten, twenty and thirty-year periods.  His conclusion?  Over thirty years the median return for stocks is 9.22%.  For twenty years the median performance is 8.09%.  Despite the fact that the five and ten year periods can be negative (though the median return is 9.4% and 8.6% respectively) “all the 20- and 30-year periods have been positive.”

Since Siegel’s work includes stock-market performance, we can assume if we are buying excellent companies who are leaders in their business our returns should match, if not exceed the performance of the overall market.  The Dow stocks are a good place to start.  Look for the leaders.  Companies whose products you use.  Companies who demonstrate a history of growing dividends because managements and boards of directors tend to set their dividend as a portion of long-term, sustainable earnings power and that, after all, is one of the reasons we buy stocks–to own a share of future (growing) earnings.   Which, in turn, proportionally increases the value of our portfolio.  And that is the main reason we buy stocks.

Use Market Weakness to Buy Great Companies at a Discount

On Monday the market pundits were heading full speed for the exits.  Italy’s election and bearish Fed meeting notes were blamed for the sell-off.  Adding further uncertainty was the looming sequester.  For two days the sky was falling and as they are wont to do the experts extrapolated short-term data to conclude the market had moved too far too fast.  That was Monday.  
Tuesday the DJIA rose 115.96 points (.84%) and Wednesday the index rocketed 175.24 points or 1.26%.  The reasons subsequently proffered were clarification from the Fed that it would continue easing (read:  the Fed will continue to buy treasuries and mortgage-backed securities to ensure interest rates stay at current historically low levels) thereby forcing investors seeking yield and total return into riskier assets, like stocks.  Traders believe this is good for the market.  And, bam, the rally that wasn’t suddenly is once more.  
For individual investors this head-spinning day-to-day volatility is no way to make stock buy and sell decisions. We can’t compete with Wall Street traders.  Nor do we have to.  
When the frenzy begins, step back and take a good look at your portfolio.  Are you properly diversified?  Do you have an inordinate concentration in tech stocks, for example?  Or in one holding?  Are you missing exposure to a particular industry, say cyclicals?  If so, take a look at  the industry leaders to determine if there are any bargains to be had.  After the election in November when investors were worried about the impact of rising taxes and the then Washington crisis du-jour, the looming “fiscal cliff,” the market sold off and I saw an opportunity to increase my holdings in cyclical stocks (among other industries).  
Caterpillar (CAT) was coming off a lackluster year and the trailing p/e on the stock was hovering around 9x 2011 earnings, a significant discount to its historical average of 15x trailing earnings.  Analysts, while admitting it was one of the deepest discounts ever applied to the stock, were also quick to cite the global economic slowdown as a reason not to own the stock.  But the price was already reflecting those concerns.  I began picking away at the stock and continued to buy as it went up.  My average cost is $86.99.  The stock recently spiked at close to $100 and has come back to the low $90’s closing yesterday at $92.49.  If it spends more than a few days below $90 per share I’ll be adding to my position.  
As a long-term investor I don’t need CAT to return 50% in six months.  I am look for 10-12% per year which means that some years I may get 3% and some years I may get 20% or a decline of 10% but, every year I will be collecting my (currently) 2.25% dividend yield which beats money market or intermediate bond returns and I have the potential for dividend growth and price appreciation. 
Of course there is the risk the stock will decline.  In fact, because it is a cyclical stock and its earnings are subject to the ups and downs of the economy, I expect to experience periods when the stock declines.  That is why I own a portfolio of stocks and why I only purchase shares of well-managed companies.  However, good management will find a way to get the company back on track.  And they almost always do.  I am owning this stock for the total return it will produce over the next ten to twenty years not the next few weeks.  Look at the chart below courtesy of  Wells Trade.  I have selected the longest period availble and compared the performance of CAT with the S&P 500.  You will note that some short-term periods have not been good for the stock (or the market for that matter) but over the long-term, in good economic times and bad, CAT has produced an enviable return.  
Price chart, Wells Trade
I am willing to take the short-term risk when I buy high-quality companies at discounted price levels.  Frequently the lower price already reflect the risk.  As I repeatedly told my teenagers:  learn to manage expectations and you will increase your chances of success.  Stocks that Wall Street hates,  if their managements adequately manage expectations, often provide great long-term opportunities.