Monthly Archives: June 2009

Guru Rating Changes: Latin America Rising, Chevron Falling

Each week, I take a look at which stocks my Guru Strategy computer models have newfound interest in, and which they have soured on. Here’s a look at some of the stocks that my strategies have upgraded or downgraded today. Among those on the move are Chevron and several Latin American firms:

Guru Strategy Upgrades/Downgrades -- June 30, 2009

Guru Strategy Upgrades/Downgrades -- June 30, 2009

Fisher’s Advice — The Old, and The New

This month marks the 25th anniversary of Kenneth Fisher’s Forbes magazine column, and in his latest piece Fisher offers his thoughts on what has changed — and what hasn’t — in terms of his portfolio management advice.

Among the principles Fisher says he still espouses:

  • Avoid overpaying;
  • Don’t just rely on the price/earnings ratio as a valuation metric; also look at the price/sales and price/book ratios;
  • Compare companies both to the broader market and to their peers;
  • Buy quality cheaply;
  • Learn from your mistakes;

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Buffett’s Best Advice

Fortune is running its annual “Best Advice I Ever Got” issue, with respondents ranging from golfer Tiger Woods to Google CEO Eric Schmidt to former Secretary of State and Ret. Gen. Colin Powell. It’s an interesting feature that often offers timeless, valuable wisdom. In the video below, Warren Buffett shares the best piece of advice he’s ever received, something he picked up 60 years ago from the late, great Benjamin Graham.

Best Advice -- Fortune

Faber: Gold & Equities the Places to Be

Marc Faber, the money manager and Gloom Boom & Doom Report editor who has an excellent track record of market calls, sees severe inflation coming, and says investors should be putting their money in gold and equities — not bonds and cash.

Faber says he thinks we most likely saw the market bottom on March 9, in part because any major drops in the market will be met with more government stimulus. But he also says he has “zero” confidence in the government’s ability to reduce deficits and prevent big-time inflation.

The Graham Approach: Still Making Hay after 60 Years

Every other issue of The Validea Hot List newsletter examines in detail one of John Reese’s computerized Guru Strategies. This week’s issue looks at the Benjamin Graham-inspired Value Investor strategy, which is up more than 26% this year and has averaged annual returns of more than 16% since its July 2003 inception (vs. an average annual loss of 1.4% for the S&P 500). Below is an excerpt from the newsletter along with several top-scoring stock ideas based on the Graham investment strategy.

Taken from the June 26, 2009 issue of The Validea Hot List

Guru Spotlight: Benjamin Graham

Today, many investors look to Warren Buffett for advice about the stock market and the economy. But before he became one of the world’s richest men and greatest investors, there was someone whose investment advice Buffett himself cherished: Benjamin Graham. And Buffett was far from alone. Known as “The Father of Value Investing”, Graham inspired a number of famous “sons” — Mario Gabelli, John Neff, John Templeton, and, most famously, Buffett, are all Graham disciples who went on to their own stock market greatness.

So, just who was Graham? Born in England in 1894 as Benjamin Grossbaum (his family later changed its surname to Graham during World War I, when German names were viewed with suspicion), Graham built his reputation — and fortune — by using an extremely conservative, low-risk approach to investing. To him, preserving one’s original capital was every bit as important as netting big gains, and two factors from his early years may show why. The first was Graham’s own family’s fall from financial comfort to poverty not long after his father died when he was nine. The second involved his first major business venture, an investment firm he founded with Jerome Newman. Just three years after opening, the stock market crash of 1929 and the Great Depression arrived, and Graham’s clients, like just about everyone else, were hit hard, according to Graham biographer Janet Lowe. Graham worked without compensation for five years until his clients’ fortunes were fully restored.

Having lived through both his own family’s financial troubles and the market crash, it’s no surprise that the strategy Graham laid out in his classic book The Intelligent Investor was a conservative, loss-averse approach. To Graham, an investment wasn’t something that could be turned into quick, easy profits; anything that offers such “easy” rewards also comes with substantial risk, and Graham abhorred risk. True “investment”, he wrote, deals with the future “more as a hazard to be guarded against than as a source of profit through prophecy.”

In terms of specifics, Graham’s approach limited risk in a number of ways, and my Graham-based model lays out several of those methods. For example, one key criterion is that a firm’s current ratio — that is, the ratio of its current assets to its current liabilities — is at least two, showing that the firm is in good financial shape. The approach also targets financially sound firms by requiring that long-term debt not exceed long-term assets.

Two other criteria the Graham method uses to find low-risk plays: the price/earnings ratio and the price/book ratio. Graham wanted P/E ratios to be no greater than 15 (and, as another signal of his conservative style, he used three-year average earnings rather than trailing 12-month earnings, to ensure that one-year anomalies didn’t skew the ratio). For the price/book ratio, he used a more unusual standard: He believed that the P/E ratio multiplied by the P/B ratio should be no greater than 22.

Here are the current holdings of the 10-stock Graham portfolio:

Validea 10-Stock Graham-Based Portfolio

Validea 10-Stock Graham-Based Portfolio

Two types of stocks that you won’t find in the Graham portfolio are technology and financial firms. Graham excluded tech stocks from his holdings because they were too risky, and, while they’re not as risky today, I do the same. Financial stocks, meanwhile, aren’t explicitly excluded from my Graham model. But because of the low-debt requirements in this strategy, it’s nearly impossible for a financial firm to garner approval.

Since I started tracking my Guru Strategies almost six years ago, the performance of my Graham-based model has been rather remarkable. Even though the strategy Graham outlined is now 60 years old, it just keeps on working. My 10-stock Graham-based portfolio is up over 144% since its July 2003 inception, making it my best performer. That’s a 16.2% annualized return in a period in which the S&P 500 has lost an average of 1.4% per year. The model’s strict balance sheet criteria helped it avoid big losers in 2008, as the portfolio lost less than half of what the broader market lost, and it has rebounded big-time this year, gaining 26.4% compared to 1.9% for the S&P.

Those figures are a great demonstration of how successful stock investing doesn’t need to be incredibly complex or cutting-edge. You don’t need fancy theories or gimmicks; you just need to focus on good companies whose stocks are selling at good values. Do that, and you should produce some strong results of your own.

New Normal? For Stocks, More Like Old Normal, O’Neil Says

A lot of investors and strategists are spending a lot of time these days trying to envision what the investment landscape will look like when the economy and market settle down. But growth stock guru William O’Neil, the founder of Investor’s Business Daily, says talk of a new era of investing is off the mark.

“Actually, I think the market has reinforced almost every single thing we had in the book [his How to Make Money in Stocks, first published in 1988] years ago from the very first edition,” O’Neil tells MarketWatch’s Chuck Jaffe. “The market is driven by the law of supply and demand. That’s what makes the charts. People should learn to read stock charts. There are patterns that are exactly the same now as 20 years ago, 40 years ago, 60 years ago, 80 years ago that show when a stock is under accumulation. These patterns work, and we don’t have just a couple of cycles, we have 120 years of cycles … so to try to reinvent the wheel to say there will be some new system or some new rule, no.”

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O’Shaughnessy on Why Stocks Are Still Attractive, and the Value Resurgence

In his latest market commentary, Jim O’Shaughnessy writes that the market is seeing a major flip-flop in leadership similar to what often occurs at the end of recessions, and says that, despite the recent run-up, it’s still a good time to buy stocks.

“While many of the once-in-a-lifetime bargains are gone, stocks still look attractively valued,” O’Shaughnessy writes on his asset management Web site. He cites the normalized price/earnings ratio of the S&P 500 (a measure that uses five years worth of earnings — 18 quarters of historical data plus two forecasted quarters) as evidence. When normalized P/Es are low, returns over the next decade tend to be high, and vice versa.

Normalized P/E Ratios vs. Forward Market Returns -- OSAM

“After the rebound,” O’Shaughnessy writes, “normalized P/E remains significantly below its long-term median. The market will likely remain cheap as earnings recover from the massive losses of 2008. In addition, 15% of the index is still trading below liquidation value. … Despite the strong bounce back since March, we continue to believe that over the next three, five, and ten years, equities will be the best performing asset class and that investors need to take the opportunity the market has given them.”

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