Harry Newton's In Search of The Perfect Investment
Newton's In Search Of The Perfect Investment. Technology Investor.
8:30 AM EST Monday, December 4, 2006: It's
time to take a little more money off the table. Cash is good and pays well --
over 5.20% at many banks -- more than many hedge fund managers (especially
two of mine) earned in 2006. And there are clouds on the horizon:
+ Falling dollar.
+ Slowing growth.
+ Washington gridlock -- the administration versus Congress, etc.
+ Accelerating Iraqi problems.
weekend reading -- part 1:
Wall St. Looks Like Pamplona, Sound an Alarm
by Mark Hulbert, editor of the Hulbert Financial Digest
newsletter editors are about as bullish as they have been in nearly five years
and that doesnt bode well for the stock market.
are wildly optimistic, head for the hills; when they are truly pessimistic,
buy stocks. That, at least, is the counsel of contrarian analysis, which derives
its name from the idea that the market, in the near term, rarely does what
the majority expects it to do.
and despair reach extreme levels, for example, contrarians believe that the
market is at or near a bottom. Thats because any short-term traders who
are likely to sell their stocks when conditions are unfavorable will have already
dumped them removing potential selling pressure that could drive the
market still lower. The reverse is the case, the contrarians say, when optimism
is extremely high.
sentiment that prevailed when the stock market hit a low in June this year.
According to The Hulbert Financial Digest, investment newsletters that focused
on timing the stock markets short-term trend recommended, on average,
that their subscribers allocate 88 percent of their equity portfolios to cash
and the remainder to shorting the stock market an aggressive bet that
stocks would fall further. Far from declining, of course, the Dow Jones industrial
average is now almost 1,500 points higher.
By Nov. 24,
by contrast, the average recommendation of this same group of newsletters
had changed greatly to allocating nothing to the short side of the
market and 71 percent to the long side. Though the newsletters cut their average
recommended exposure by 12 percentage points on Thursday, to 59 percent on
the long side, the level is still very high double the average since
the bull market began in October 2002.
appear justified in their worry about the high sentiment level. The digest
recently compared the stock markets average three-month returns after
days with extreme sentiment readings (defined as the 10 percent of trading
days when sentiment was highest and the 10 percent when it was lowest). In
the three months after the most pessimistic days, the market gained 11.9 percent
more, annualized, than it did after the most optimistic days.
for contrarian analysis comes from a study published in the August issue of
The Journal of Finance. Entitled Investor Sentiment and the Cross-Section
of Stock Returns, its authors are Malcolm P. Baker, an associate professor
of finance at Harvard Business School, and Jeffrey Wurgler, an associate professor
of finance at New York Universitys Stern School of Business.
focused on those companies that economic theory suggests would be most vulnerable
to investor sentiment: small-cap growth companies, which have relatively few
assets and little or no record of consistent earnings. Traditional balance-sheet
analysis provides relatively little insight into these stocks, so their valuations
can be subjective, supported largely by investor enthusiasm. The professors
studied the period from the beginning of 1963 to the end of 2001.
They found just
what a contrarian would expect: after periods when sentiment was particularly
high, like the months and years leading to the bursting of the Internet bubble
in early 2000, small-cap growth stocks proceeded to perform very poorly. That
makes sense, because investor enthusiasm would have bid the prices of these
stocks to very high levels and made them vulnerable to even the slightest
decline in that enthusiasm.
was the case after periods of low sentiment, the professors found. Small-cap
growth stocks are punished particularly harshly when investors become discouraged,
and from such low levels they can provide handsome subsequent returns.
WHAT about companies
for which traditional balance-sheet analysis is more useful larger
companies, generally, and those in the so-called value category? The professors
found that investor sentiment has relatively little effect on these stocks.
That also makes sense, according to the professors, because such stocks
valuations are less vulnerable to the way the sentiment winds are blowing.
Given this research
and the current level of market optimism, there are a couple of strong implications
for investors. First, it would be wise to take some money off the table and
to build up some cash until sentiment drops to less-lofty levels. And, second,
you might want to shift exposure away from small-cap growth stocks.
weekend reading -- part 2:
the Pros Tell If a Stock Is a Bargain by Gregory Zuckerman of the Wall Street
Harry's note: Apparently
the story ended here, without a conclusion. Maybe the conclusion is prices are
line? To read the piece, click
Are stocks cheap or expensive?
That's the key
question on the heels of an impressive rally that has taken the Dow Jones
Industrial Average up 14% this year. Most of the gains have come in
just the past few months, although the benchmark took a breather last week,
sliding 0.7%. (The Nasdaq Composite Index is up 9.4%, after losing 1.9% last
Big gains sometimes
elicit caution from market commentators, but they don't always mean that stocks
are too expensive in relation to companies' earnings and business prospects.
Similarly, this year's double-digit growth in corporate earnings doesn't necessarily
mean stocks are attractive.
use a group of financial ratios to figure out whether the market, and individual
stocks, are cheap or pricey relative to company fundamentals. None of these
formulas is enough on its own, but together they can help locate attractive
Here's a look
at five measures, which generally suggest that the stock market is reasonably
priced, though not in bargain territory.
The ratio of a company's stock price to its per-share earnings is the
granddaddy of investment metrics. Stockholders are the owners of a public
company, so the stock value depends on the company's earnings. If a stock
sells for $20 and the company earns $1 a share, the P/E ratio is 20. The higher
the ratio, the more expensive a stock is in relation to its earnings.
It is best to
compare a stock's P/E with that of industry peers as well as the overall market.
If a company is trading at a relatively high P/E, it means investors have
high hopes and are willing to pay up. That could work out well if the hopes
are met, but any disappointments could send shares tumbling.
demonstrates that buying low-P/E shares is a recipe for success. Several years
ago, Warren Buffett bought several Korean stocks when their P/E ratios reached
low-single-digit levels; the stocks eventually climbed. Robert Howell, a professor
at Dartmouth's Tuck School of Business, says he generally avoids stocks with
P/E ratios above 20.
is somewhat attractive based on P/E. The Standard & Poor's 500-stock
index, which tracks the largest companies, trades at a P/E ratio of 17.8
based on the past 12 months of earnings. That is lower than the average P/E
range of 19.2 since 1980. ...
Rather than reported earnings, many successful pros focus on free cash flow,
or the cash income that a company is left with after paying expenses. If a
stock has a low ratio of price to free cash flow, that suggests it is a healthy
business that has a lot of money left over for dividends, stock buybacks or
other steps to improve a stock's return. ...
Stocks now trade
at less attractive levels in relation to cash flows than they did earlier
this year, but this year's figures are among the most attractive since 1996.
Book value is a measure of a company's assets minus its outstanding debt
or other obligations. If a company's shares are worth $2 billion and its book
value is $1 billion, then it is trading at two times book value.
A low price-to-book
ratio can give comfort to an investor. That's because a company's book value
can be a good starting point in estimating the firm's value in the event it
had to be liquidated.
500 currently trades at 3.1 times book value, about the level
of the past few years though below the expensive level of about 4.5 in the
Some pros like stocks with a lot of sales compared to their price, or
a low price-to-sales ratio. So a company with shares worth $500 million and
sales of $1 billion would have an attractive price-to-sales of 0.5.
But sales don't
guarantee profits. So companies with low price-to-sales ratios should have
a good plan to turn those big sales into earnings, or the stocks won't benefit.
the S&P 500 now trade at 1.5 times their sales, close to the
level of recent years but above levels of the early 1990's.
on Invested Capital
Jack Ablin, chief investment officer at Harris Private Bank in Chicago,
urges investors to focus on a company's so-called return on invested capital,
or how much profit it generates from the amount it invests in its operations.
To get that
figure, he divides a company's earnings (before interest and taxes) by total
assets. On that basis, he says engine maker Cummins (CMI) is attractive.
explodes: Businesses are now using Skype to
talk to their people around the world. Imagine you're traveling in Europe. You
want to call your US office. Your hotel room has broadband. Bingo, plug in your
headset and make free phone, free video and free conference calls to
other Skype users anywhere in the world. Had you dialed on your hotel phone,
you'd be looking at bills for hundreds of dollars -- often bigger bills than
what your room cost.
Frankly, I'm staggered
how fast business has accepted Skype. When I used it last night, there were
five million people speaking on Skype.
This is my daughter, Claire, in her $20 Logitech
stereo headset and her $200 sunglasses. She uses the headset and her laptop
to make Skype calls. The Skype calls sound better than most landline calls and
a heck of a lot better than all cell phone calls. She and her fiancée,
Ted, are on a single Comcast cable modem in Boston. Last night, she was speaking
to me in New York. And Ted was talking to a friend in Singapore. That meant
her Comcast cable modem was handling two simultaneous Skype phone calls
and doing so flawlessly. Amazing technology. For the $20 headphones
here. That will take
you to the Cyberguys' main page. Then search for item number 1900482. To download
the free Skype software for your PC or laptop,
Apple Computer reported today that it has developed computer chips that can
store and play music inside women's breasts.
is considered to be a major breakthrough because women are always complaining
about men staring at their breasts and not listening to them.
An old cowhand came riding into town on a hot, dry, dusty day. The
local sheriff watched from his chair in front of the saloon as the cowboy wearily
dismounted and tied his horse to the rail. The cowboy then moved slowly to the
back of his horse, lifted its tail, and placed a big kiss where the sun don't
shine. He dropped the horse's tail, stepped up on the walk and aimed toward
the swinging doors of the saloon.
"Hold on there, Mister," said the sheriff. "Did I just see what
I think I saw?"
did, Sheriff. I got me some powerful chapped lips."
cures them?" the Sheriff asked.
it sure keeps me from lickin' 'em."
This column is about my personal search
for the perfect investment. I don't give investment advice. For that you have
to be registered with regulatory authorities, which I am not. I am a reporter
and an investor. I make my daily column -- Monday through Friday -- freely available
for three reasons: Writing is good for sorting things out in my brain. Second,
the column is research for a book I'm writing called "In Search of the
Perfect Investment." Third, I encourage my readers to send me their
ideas, concerns and experiences. That way we can all learn together. My email
address is .
You can't click on my email address. You have to re-type it . This protects
me from software scanning the Internet for email addresses to spam. I have no
role in choosing the Google ads. Thus I cannot endorse any, though some look
mighty interesting. If you click on a link, Google may send me money. Please
note I'm not suggesting you do. That money, if there is any, may help pay Claire's
law school tuition. Read more about Google AdSense, click
here and here.