Investment Choice for 24 Yr old Son

[cute fuzzy bunny]

So is that the same device you use to measure a butt-load of pepper for the steaks?

In fact, yes it is!

Guess what I'm making for the Mrs tonight? I wish it had been triggered by our discussions here over past days, but we were watching "NCIS" last night and two of the lead characters were eating steak au poivre and licking their chops over it. The Mrs. said "Go get the stuff to make that again tomorrow..."

My butt is ready. Now...filet mignon, NY strips or top sirloin...

The blood in the streets thing is highly overrated. I saw plenty of it running from 2000-2002. Screwed up on some QQQ's figuring "how much further can they drop before they bounce?". Did okay buying more pedestrian stuff.

But thats ok, I havent had to pay a capital gain for 5 years now, and looks like it'll be a few more before I do!

 

[brewer12345]

The blood in the streets thing is highly overrated.  I saw plenty of it running from 2000-2002.  Screwed up on some QQQ's figuring "how much further can they drop before they bounce?".  Did okay buying more pedestrian stuff.

But thats ok, I havent had to pay a capital gain for 5 years now, and looks like it'll be a few more before I do!

I think it is really, really hard to tell when a whole market or fund is undervalued unless it is by a ridiculous margin. How do you know? A feeling in your water?

In contrast, I can build a model of an individual company's cash flows and come to a pretty reasonable range of fair values and compare those to a market price. This makes it pretty clear when a company is embarassingly undervalued.

 

[cute fuzzy bunny]

The only problem you run into there is investor psychology. I've seen a lot of pretty dang undervalued companies that have gone nowhere in years because the scandal taint is still on them. Or because despite their relative value, their management couldnt get out of a wet paper bag, or because their business model just doesnt work anymore or never worked.

Its not what its worth, its what people are willing to pay for it, and how many people are willing to pay for it.

Bad example, I'll go for the automobile one, because thats required by law.

Put a 2 year old Lexus LS430 on sale for 3/4 its original sticker price. Along side it put a 2 year old Infiniti Q45 for half of its original sticker price. Two fairly comparable cars in terms of quality, features and original price. See which one sells first. Then sit around tapping your fingers waiting for the other one...

Put a company with great numbers out there thats selling at a cheap price but has a crappy business model, a bad ceo, a bad board, or just got whacked by some scandal the prior year, and set a company thats fairly valued next to it, nothing dressy, but no downside. See which one sells more shares.

While its possible to more accurately place a value on an individual issue, I think you can get close on an industry segment or broader index...with way less downside if the market moves against you.

 

[brewer12345]

The only problem you run into there is investor psychology.  I've seen a lot of pretty dang undervalued companies that have gone nowhere in years because the scandal taint is still on them.  Or because despite their relative value, their management couldnt get out of a wet paper bag, or because their business model just doesnt work anymore or never worked.

Its not what its worth, its what people are willing to pay for it, and how many people are willing to pay for it.

Fair enough. I guess I would argue that youcan cut out a lot of those problems by sticking with companies that are just out of favor rather than broken. If you do that and pick rational managements that run companies that flow cash and don't piss it away (i.e. give it back to shareholders or pay down debt if you can't invest it attractively), its not that hard to see what will happen. If the market doesn't come around in relatively short order, such companies jack up dividends, buy back a ton of stock and/or sell to someone who values those cash flows more appropriately than the market. But this doesn't work if management is more interested in empire building or is composed of theives.

A couple of examples:

- JAKK: this company has always looked inexpensive, but they have two big problems. 1) they are a serial acquirer in a fad-driven industry and 2) management is all about filling their own pockets, shareholders be damned. Despite the modest PE, I don't want anything to do with them.

- PPD: stock price got trashed 5 years ago over an accounting brouhaha that meant nothing (didn't change cash flow, threaten stability or their business, and they always disclosed the alternative way of looking at the company based on cash flow). The stock priced languished, so manamgement started buying back a boatload of stock. 5 years later, they have bought back roughly 1/3 of outstanding shares, paid dividends for two years, and the stock price is triple what it was. Plus the whole shebang trades at something like 10X free cash flow. Much more attractive, IMO.

 

[cute fuzzy bunny]

I think my biggest problem with it is that if you can find a beaten down out of favor company thats trading at fair value, what keeps all the mutual fund managers who have a staff of dozens of educated people doing the same analysis from pulling it off?

And dont make me bring up Blockbuster. I really, really dont want to.

 

[brewer12345]

I think my biggest problem with it is that if you can find a beaten down out of favor company thats trading at fair value, what keeps all the mutual fund managers who have a staff of dozens of educated people doing the same analysis from pulling it off?

I think if you are talking about large caps, it is pretty tough to find stuff that hasn't already been picked over by many talented analysts. That's why I mostly concentrate on small companies with little or no analyst coverage. These companies typically do not have anyone shouting about what a great deal they are and they also are generally small enough in market cap that most mutual funds either won't bother with them or can't realistically establish a meaningful position without bidding the stock into the stratosphere.

Its not for everyone, but I also like companies with large outstanding short positions in their stock. When the shorts cover or even if there is a little good news, reactions can be pretty fast and large. PPD, for example, has the highest days to cover on the NYSE (100+) and one of the highest percentages of float short (>40%).

Oh, and bring up whatever you want. Gotta learn from one's mistakes, although it would be nice to not be beaten over the head with just one thing.

 

[wildcat]

I think my biggest problem with it is that if you can find a beaten down out of favor company thats trading at fair value, what keeps all the mutual fund managers who have a staff of dozens of educated people doing the same analysis from pulling it off?

And dont make me bring up Blockbuster. I really, really dont want to.

My 2 cents - the budget for all of the analysts doesn't stretch far enough to compensate for the coverage of small/micro caps.

 

[cute fuzzy bunny]

I was just giving you a hard time Brewer...dont take it to heart. But as an example, all the numbers on that stock looked great. Only problem is, nobody wants to pay four bucks to rent a movie, especially when theres nothing new on the shelves if you go into the place after 3pm and you get whacked with late fees if you slip a day on returning it. Yes...the late fees quietly have made a return.

Really...not enough coverage on microcaps and small caps?

How many small cap and microcap mutual funds are there?

How often do actively managed small cap fund beat its style equivalent index?

I was of the impression that there are many thousands of active small and microcap fund managers, most more than one guy working alone, and that except for some occasional one or two year good times, they typically underperformed their index over 5-10+ year periods. Is that wrong? If not, how exactly would someone manage to find a real gem thats been totally whiffed by all those other guys? And why is it that guys with a lot of expertise, tools and spending their entire day doing nothing but the same sort of analysis somehow manage to lose out to the indexes year in and year out?

Really...i'm not messing with you guys...but you seem to feel like you've got something here and I'm interested in what it is.

 

[brewer12345]

I was of the impression that there are many thousands of active small and microcap fund managers, most more than one guy working alone, and that except for some occasional one or two year good times, they typically underperformed their index over 5-10+ year periods.  Is that wrong?  If not, how exactly would someone manage to find a real gem thats been totally whiffed by all those other guys?  And why is it that guys with a lot of expertise, tools and spending their entire day doing nothing but the same sort of analysis somehow manage to lose out to the indexes year in and year out?

Thousands? Not so sure about that. Maybe hundreds is more like it. There are, what?, something like 7000+ stocks out there. Chop out the top 1000 and there are a LOT of stocls left to dig through. More than enough for the likes of us to pick out a few gems.

I think you also don't quite get the impediments facing a mutual fund manager in the small cap arena. Saw you and I start up the CFP/SUDS small cap value fund. We charge 1.5% of assets annually and hire a few analysts (can't get the best because we can't afford them). We manage to raise a hundred million or so in assets. So we start buying small caps. We can buy stakes in relatively small companies (say, float of at least $100MM), but we have to make sure we have enough liquidity to meet redemptions. We also need at least 50 positions for the sake of risk diversification. So we are already living with serious constraints that individual investors don't have.

Imagine we are good (or lucky) and post some blazing returns. Pretty quickly, we get flooded with cash and the fund ballons to $1 billion plus. This is good for you and me because we have a larger asset base to charge fees on, but it makes it a lot harder to invest in small companies. So we expand the criteria and mostly invest in companies with float of greater than $500MM to $1 billion. Our liquidity issues are even worse now ecause we know that a lot of the new cash is "hot money", so we have to stay relatively liquid (no $75MM market cap stocks regardless of how attractive they are).

And through all of this, we are sucking 1.5% annually out of assets and paying trading and other costs with investors' money.

 

[Nords]

There are, what?, something like 7000+ stocks out there.

I've read 10,000 in the U.S. and another 10,000 in the rest of the world.

Below the CSRP 9/10 decile, they all have high spreads & low liquidity.  No self-respecting analyst could earn a living following them...