Mike Lipper’s Monday Morning Musings
People Make the Difference – Weekly Blog # 538
Editors: Frank Harrison 1997-2018, Hylton
Phillips-Page 2018 -
Factor
Investing
I have often been told that given an
earnings growth rate a bright investor can tell the appropriate price/earnings
ratio, leading to a prediction of the right future price of a stock. In only a
slightly more complex approach there are a number of investment products or
funds being offered that are driven by an identified factor or a collection of
factors. As these are new vehicles they are being pitched as something brand
new and superior to the traditional methods of security analysis. Investors
have for a number of generations used various statistical measures as a filter
to determine better than average choices for additional investment analysis.
Modern Portfolio Theory (MPT)
There is very little that is
brand-new in investment analysis. Nevertheless, we periodically receive
marketing messages that extoll these new methods as a better way to make money.
This reminds me that a number of years ago, based on now recognized faulty
academic research, we learned about Modern Portfolio Theory (MPT), which
actually was not modern in identifying different rates of change in stock price
momentum. MPT was identified hundreds of years ago and had very little to do
with portfolio construction and management, other than stock selection. The
theory before and after its publication did not regularly produce investment
success, but did generate marketing success.
Better Tools for Investment Success
What then are better tools for
investment success? A continuing study
of successful investors suggests that the biggest help is the analysis of
people at three or more very different levels. Behavior of market participants,
buyers and sellers of specific products and services, and finally important
portfolio managers, which can improve investment success. In each case the study of these areas
has been helpful in the past and I suspect will be so in the future.
Market Transactions
There are a group of market analysts
and their followers that focus intently on stock transactions to identify recognized
patterns of past movements being repeated currently. For these so-called
technical analysts the key to success is the improved chance of being right.
They are not interested in the known or unknown motivations of the buyers and
sellers, just that their actions follow past trends. This type of analysis is
more popular when there are fewer new factors or information introduced.
Looking back to Friday August 10th,
the three major stock price indices - the Dow Jones Industrial Average (DJIA), the Standard & Poor’s 500 and the NASDAQ Composite, all opened below the last
price of the previous day and over at least the next four trading days did not bridge
the price gap. Most of the time a price gap needs to be closed before the
dominant trend can continue. Some of the price gap of the DJIA was probably
filled last Friday, but the gaps in the S&P 500 and the NASDAQ Composite remain
open. The continued existence of gaps suggests that the forward price movement
for the bulk of the US stock market will be limited and will only rise through
their past peak at some point in the future.
From my vantage point, the
predictability of gap filling is measured by the quality of the analysis of the
market technicians.
Customer Analysis
Successful investors often place
their bets on their perception of future changes. My wife and I had the
pleasure of spending time this week with Ralph Wanger and his wife Monique.
Ralph for many years was the portfolio manager of the very successful Acorn
Fund. The fund initially invested in smaller companies that in numerous cases
became mid-cap leaders. In discussing a number of his very successful
investments it became clear that in addition to studying a great amount of
relevant financial data, Ralph had a deep understanding of the people at
various companies.
In one example, he noticed that a
company’s logo had become a body tattoo, establishing a body of trust with its
customers that might give the company enough time to execute a well-founded
turnaround plan coming out of bankruptcy. Many sound turnaround plans take too
long to reach fruition as existing and potential customers’ patience is worn
out waiting for the new and improved products. In this particular case with the
tattooed bodies, the present customers and the potential customers waited for a
couple of years for Harley Davidson’s new and significantly improved
motorcycles. Ralph recognized the potential power of the relationship that the tattoo
created, buying the needed time for
recovery. He also had a similar population of patient investors in his Acorn
Fund, I was one of them. A number or factor driven investors would not have
participated in the stock rise, which multiplied its worth many times over.
Earlier in the week I met with the
CEO of a statistically driven company experiencing some disappointing results.
While not close to bankruptcy, it is in a multiple year plan to evolve with its
big company clients into an enhanced relationship. They perceive, along with a
number of their leading manufacturing clients, that many of them are becoming
service companies. An auto manufacturer is in the after-sale service business
as well as in the financial services businesses. It is their successes in these businesses
that is becoming equal to or more important than the success of their new
exciting models coming off the production line. These are some of the required
elements being implement in order to increase customer loyalty and market
share. They are mission critical for both the manufacturer and its
statistically driven suppler, for both the auto company and other companies too.
I am withholding my investment judgement as to whether they will succeed in a
major way, but I am looking for changes rather than extrapolations.
Need for Tolerance
At any given time the investment
process produces winners and losers. I am comfortable with this result from
learning basic securities analysis at the racetrack. There I learned that if you
bet prudently you can walk away at the end of the day by properly selecting only a few
races, varying betting procedures so that you can afford to lose more races
than you win. You walk away a winner overall because the money won was larger
than the money lost. I apply the same philosophy to investing, particularly
with the use of mutual funds. But perhaps more important than the money earned
was the knowledge acquired. When something turned out differently than expected,
the key knowledge gained was the analysis of what happened. There was a growing
recognition that all the actors, either on two legs or four are not perfect and
can make mistakes, some surprising on the upside. The key to future racing and
investment success is to learn what happens unexpectedly. This allows us to
tolerate the unexpected and most importantly to tolerate our own and others’
mistakes while learning to manage our expectations.
I would be happy to discuss your
expectations and suggest some things that you may wish to consider. Please
contact me, as we both might gain from this learning experience. We would be glad to help with the selection and management
of funds to fulfill your needs.
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A. Michael Lipper, CFA
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