Investing in Quality for Growth or Value - Weekly Blog # 571

                               

Mike Lipper’s Monday Morning Musings

Investing in Quality for Growth or Value

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

     
                               

Capital Preservation vs. Capital Preservation
Occasionally I assign Capital Appreciation or Capital Preservation labels to each security in my portfolio. These identities may change with each time period examined. The purpose of this exercise is to examine my decision process during the expected top and bottom phases of a cyclical market. (Perhaps a +/- 10% move before or after a recognized turning point has been reached.) For me, this is not an easy exercise and needs to be repeated periodically.

What makes this process particularly difficult for me is dealing with it in my mind, as it’s a small distinctive asset class of high quality companies. My two somewhat contrasting filters are the Charlie Munger type of good companies to own forever and most securities owned by portfolio managers with turnover rates in excess of 20%. (On average they hold their positions for less than five years.) One way to look at the capital preservation companies is that these are the positions I hope to hold for the future generation of the investment committees I serve and for the future generations of my family. On the capital appreciation side I expect market sentiment to become much more favorable to the stock, either because of general changes in attitude or changes specific to that name.

Divining Rods
Old farmers in the search of below surface water used a bent stick to find the critical element necessary for success. Most professional investors use numbers. That is why I was delighted to see Jamie Dimon’s 74-page shareholders’ letter in the JP Morgan Chase annual report, where he made the following statement “earnings is not a perfect measure of performance and economics”. Despite all the billions/trillions of dollars being spent on technology by JP Morgan and many others, as in “the world is going digital”, basic human processing remains an analog art. (I suspect the utility of earnings estimates was downgraded when analysts switched from slide rules to calculators. Slide rules produced good approximations, not precision certainties.) Jamie’s letter is full of what of they are doing for people, including clients, customers, employees, local communities and sovereign nations. This is how he is building what he calls “a financial fortress”. (I wish he would have used another term for such a high-quality organization. A study of military history shows that the strongest fortress falls due to the actions of those within the fortress, causing internal deterioration.)

One fallible measure of effective capital preservation is the company’s lowest stock price relative to tangible common equity. For example, the lowest price for JP Morgan was above its tangible common equity. This is more difficult for a service company and the number of contractual subscribers might be used as a measure in some cases.

Quality Can Be Expensive
Most of the time the US stock market goes up and the market often prices quality at a significant premium to its “bear” market price. Therefore, purchasing a new high-quality name could lead to a significant drop before a new bottom is established. However, if the purchaser is interested in long-term capital preservation, the odds are good that future cycles will give the investor substantial rewards for many years and decades into the future.

Why the Focus on Bear Market Prices?
The job of a prudent manager is to always be aware that markets can surprise on the downside. This is particularly true when sentiment is rising. The following news elements make me cautious:

1. The current low double-digit stock market gains are much larger than current earnings projections for 2019, suggesting the bull market will continue into 2020.
2. Volume is dropping as prices rise. 50 of 72 index prices rose last week and bond prices weakened.
3. Barron’s Cover “Is The Bull Unstoppable”
4. Barron’s article headline “There’s no Expiration Date on this Bull Market”
5. The risk of professional investors actually running companies may be growing, in spite of poor past results.

Question of the Week:
How Do You Identify Quality?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/03/investment-committee-and-investors-be.html

https://mikelipper.blogspot.com/2019/03/the-actively-worrying-classpassively.html

https://mikelipper.blogspot.com/2019/03/long-term-trends-may-not-be-friend.html



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