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Investing for the Best Return on Investment

Where can you get the best return on investment in the stock market? We are not talking about short term gains followed by abrupt losses but long term growth. Maybe, low priced, low grade stocks bundled up in index funds are the way to go. Thirty and more years ago stock market research revealed that, on the average, lower grade stocks outperform the blue chips over time. But, research showed that you needed to have at least 40 stocks to balance out the risk.

Now, with indexed funds based on this pool of stocks, you can tap into the long term growth of a pool of low grade stocks and get your best return on investment of all of your investments.

Why in the world would you want to invest in low priced, low grade stocks? You spend your available time looking for quality stocks to get long term growth and your best return on investment.

The answer lies in the fairness of pricing of the US stock markets and relative risk. Because of the relative transparency of the US stock markets there is a lot of attention to companies by a lot of people. With lots of research and a fluid market, prices tend toward the most accurate reflection of a company’s value for the day. Stock prices also correct themselves rapidly. Thus the price of a stock is the consensus of a lot of information and is a fair representation of the stock’s value and risk.

The risk is the other part. We know that start up companies and companies that have lost value because of management problems are low grade stocks with less chance for the best return on investment and long term growth. We also know that within the group will be the next Microsofts, Intels, and Genentecs. In order to cash in on the best return on investment with these eventual blue chips you need to be there at the beginning. But, which stock will make it and which ones will go bankrupt?

Because of the risks in investing in low grade stocks, investors demand a higher rate of return. Thus investors pay less per stock in order to balance the risk in low grade stocks. Thus, with time and a sufficient pool of stocks to balance risk low grade stocks give the best return on investment over the long term.

Before index funds one could buy forty randomly selected low grade stocks and replace the ones that went bankrupt as one waited for a couple to emerge with great long term growth and the best return on investment in the market.

Because we pay less for low grade stocks we balance the risk of low grade stocks. But, it is best to have a large pool. Forty, according the research, is the low number. It is better if you buy into a larger pool of low grade stocks. Then the odds work for you and you will end up with long term growth and, probably, the best return on investment in your portfolio.

The interesting part of this theory is that it is based upon the transparency of the market and the fairness of pricing. The theory says that you pick low grade stocks solely based upon price and condition depending upon the market to provide long term growth. Too much stock picking by fund management runs against theory and may give you lower returns!

Random Investment Thoughts About Endowment Funds, Pension Funds, And Bad Investment Choices

In the wake of the market meltdown we see that some very smart people lost money, a lot of it. The news is that several Ivy League endowments and the big California Public Employees Pension fund are down substantially. How could such smart people do so badly? Greed? And, by the way, Madoff got 150 years. At least it was not a life sentence.

I used the old joke about a long prison term in an old man being better than a life sentence to bring our attention back to the Madoff affair. One still wonders about how so many smart people got snookered by this con man. The old saying is still true that if it seems too good to be true it is probably too good to be true. Apparently this same problem infected Ivy League endowment funds, pension funds like California’s with persistently bad investment choices.

High rates of return on investments are seductive and often lead to bad investment choices. At some point along the way, I suspect that the managers of the endowment funds and pension funds that have lost so much money thought about good and bad investment choices along the way. The managers of these endowment funds and pension funds probably knew that some of their stocks and other investments were bad investment choices. But, managers of endowment funds and pension funds are subject to the desires of their constituents, their colleges, and their pension fund members. Everyone knows that something may be a bad investment choice but the money is too good.

So, what is the difference between staying with a winning stock and making a bad investment choice? Fundamentals? Market Sentiment? Market psychology?

There are times when the fundamentals of a stock are getting worse but market sentiment and psychology are such that the stock keeps going up. If you are smart enough to stay with the stock until the day before it crashes and sell just in time, good for you. Most of us do not have a crystal ball and that is why sticking with a stock long past when its fundamentals have gone bad is a bad investment choice.

Following market sentiment and psychology as the pension funds and endowment funds seem to have done make great money for a time. However, the same argument applies. It is a matter of knowing when to get out. If you have the time and expertise for short term and day trading maybe this is your game. For the long term investor who has a full time job managing his or her work and personal life, too much market timing can be a bad investment choice.

The managers of the above mentioned endowment funds and pension fund work full time at managing their assets and they still got seduced by high returns and made bad investment choices. If that is the case how can a person with a life and a half outside of the market expect to avoid bad investment choices if stretched too thin.

The point gets back to weekly review of your long term investment plan, keeping your portfolio down to a manageable number of investments, and staying true to your long term principles. The old saying that you have not made a profit until you have taken a profit applies here too. If you are in a hot stock and the fundamentals start to look a little shaky even as the stock continues to rise, take a profit. As the stock continues to rise you may feel left out but when it crashes you will not be guilty of a bad investment choice.

Very Long Term Investment

This is a food for thought article.

Is it possible to find long term investments that will remain stable investments and secure investments over generations? If so, what will these investments look like? What kind of return will they give and will they be subject to the ups and downs of temporary market conditions? Is it possible to successfully make very, very long term investments?

This subject came to mind the other day when this author walked down a street he had not visited for some time and noticed a clothing store. The sign above the door indicated that the store is a branch of a store that was founded in Seville, Spain in 1892. El Caballo started as a shop making tack (harnesses, etc.) for horses and branched out into clothing for riders. Today the store has 32 outlets in Spain alone and is a name in women’s fashion.

In the case of this company excellent management and attention to quality have been passed on generation by generation. However, is this company a good very long term investment, a secure investment?

Another case in point might be Hormel which started in 1891. Hormel pays a 2.5% dividend each year. The company is controlled by the Hormel Foundation whose sole purpose is to provide for the welfare of Austin, Minnesota where the company has its home plant. Because of the controlling interest of stock held by the foundation this company is pretty much immune to takeovers and is a yearly cash cow that processes meat in the American Corn Belt and sells its products all over the world. This stock is never going to go very high or very low and will keep paying dividends, probably forever. Perhaps this will be the very long term investment we are looking for. Hormel is certainly a stable investment and a secure investment if not a fast grower.

Seeing into the future for successful very long term investments is not easy. However, certain types of businesses tend to be immune to fluctuations in management, current trends, and takeovers. Companies with a family or foundation in control of the majority of stock such as Hormel, Campbell Foods, or Hershey also have strong brand names that have survived for more than a century. Stability of ownership of a strong brand name would seem to be an indicator for a good very long term investment. In addition, these companies make food, or, in the case of Hershey, candy. Very long term investment in something that people eat is probably a good idea. Food is a secure investment and with century long track records these companies are stable investments.

In the last century American Telephone and Telegraph was considered the best secure investment and very long term investment, the “widow and orphan stock.” However, AT&T was based upon a strangle hold on technology and a monopoly, with of which evaporated with a court ruling and competition.

Power plants come to mind as very long term investments and, in today’s world of looming scarcity, water purification plants.

Again, this is food for thought. There is an old story of a man who passed on his wealth as stock in a stable investment, a carriage factory and bridle shop specifying in his will that the stock could never be sold. It became worthless when Henry Ford started mass producing cars.

Inflation Hedges for the Economic Expansion

The recession is showing strong signs of mending but folks are still out of work and we are not out of the woods yet. However, as the world economies recover it is time, again, to think of inflation hedges. There is going to be pent up demand and there is going to be capital chasing investments. As the economic expansion moves forward the cost of oil, an oil stocks, is already heading up.

A lot of countries have poured a lot of money into economic stimulus packages. That means a lot of public debt. The economic expansion will probably come with a loss of buying power of several major currencies. What will your inflation hedge be? Will you invest in oil stocks, a basket of high tech or biomedical growth stocks, or mining stocks?

Here are two thoughts on inflation hedges. First is that the economies of India and China are still expanding. The USA, Japan, and Europe will come out of the recession. Everyone will need energy and the price of a barrel of oil will be bid up again, probably passing the previous high of $150 a barrel. Thus good inflation hedges would seem to be oil stocks, oil drilling stocks, oil refinery stocks, and the assorted industries that support big oil.

However, oil as an inflation hedge needs to be in a secure location, free from government takeover or revolution, etc. Oil shale deposits in Canada might be a good long-term inflation hedge. The cost of recovering oil is prohibitive when oil is cheap but becomes quite profitable at high oil prices.

Some portion of your inflation hedge might well be in a basket of biotech or other tech stocks. If you hit a winner it will nicely outpace inflation.

A sad fact is that safe drinking water may be hard to come by in a more densely populated world. Any number of companies are developing or acquiring the technology for large-scale water purification. Water purification will probably be an inflation hedge even better than oil stocks. Folks can drive their cars less and turn off the air conditioner but drinking water is a necessity of life, which will unfortunately make water purification stocks the best inflation hedge of all over the long term.

The other issue with inflation hedges is which currency you keep your cash in and where do you buy your stocks. Those who recall the late 70’s know what double-digit inflation coupled with a dismal stock market can do to your pocketbook. We are not advocating currency trading but owning foreign stocks comes to mind as does owning foreign real estate. These choices of inflation hedges come with some of the same risks as investing in big oil operating in unstable parts of the world. However, there are stable, democratic countries, like Costa Rica, that have no standing armies to stage coups and are reasonable prosperous and do not operate on the dollar. Australia can be a great inflation hedge as its mining operations support the developing industrial powers in Asia.

Value Orientation and Riding Winners

The successful long term investor develops a long term strategy over time. A successful long term strategy can be a combination of a value orientation and riding winners. Both of these approaches help you avoid being sucked into market “tips” that only lose money and selling as soon as a stock makes a small gain instead of riding winners to greater profits.

A successful long term strategy makes sense. For example, if you are going to practice riding winners you need to be picking winners. Where do winners come from? They come from picking stocks with a value orientation. One certainly can outguess the market at times, getting in and out with great timing. However, compared to picking stocks based upon a value orientation, the in and out method is a loser over the years.

We did say we were talking about long term investing, right? Many years ago on one of the TV investment shows an investor talked about his success in market timing. The moderator interrupted and asked how much of the man’s profit was absorbed by commissions. It turned to be none as he had a seat on the NYSE. We should all be so lucky.

An advantage in picking stocks with a strong value orientation and riding the winners is that you are not paying commissions every day. The value orientation method allows you to pick winners and following your stocks with a value orientation allows you to practice riding winners as long as the value orientation fits. When the stock no longer fits your value orientation criteria that is the time to sell, no matter what the market is doing. An example is all of those profitless dot com stocks. Market psychology had its way and a lot of folks lost their retirement plans.

You will need to develop your own value orientation strategy depending upon your age, income, and how much risk you are willing to take. However, a true value orientation takes a lot of the speculation out of investing and holding stocks. You can certainly buy and sell depending upon what your value orientation strategy dictates. However, you will tend to be riding winners when others are licking their wounds. You will also probably be watching a portfolio with less clutter to it which is the other savings, your time.

There are certainly some very successful traders who get in and out of the market but this is a different style of investing. It fact it is trading and not investing. If you have a successful full time job you need to limit the time and attention to your investments to something manageable. A value orientation will make following your stocks easier. Riding winners so long as they fit your value orientation is also less time consuming than continually fretting over what new stock to watch or purchase.

Now, you will look for new stocks and you will get in and out of investments based upon your value orientation but a strategy based on riding winners and a value orientation will make decisions easier and the results more profitable.

Investment Goals, Expectations, And Strategy

It is important for the successful long-term investor to have clear investment goals, honest investment expectations, and a consistent investment strategy. It can be too easy to be seduced by “ hot tips” which are usually old news to those with money and expertise. It can be too easy to try to invest in every promising stock and then get discouraged when it takes a downturn. A good investment strategy is to set clear and realistic investment goals consistent with realistic investment expectations.

Let’s look at a real life situation. You are a successful businessperson, doctor, lawyer, etc. You make a nice, steady income and you devote easily 60 hours a week to your full time job. What time is left you devote to your family and some community activity.

Now, you have been putting your savings into the bank where you are not very happy with the rate of return on your money. However, you do not have the time or expertise to take on other investments such as property development.

So, you decide to invest in the stock market. What are your investment goals? Your first investment goal is a better return on investment capital than a long-term certificate of deposit. Your second investment goal is the possibility of the substantial gains you hear about with growth stocks. Your third investment goal is something that does not require another 60 hours a week to monitor.

Now, what are realistic investment expectations? Over the seventy-five years from 1926 to 2001 the Standard and Poor’s 500 stock index gained ten and half percent a year on the average. Small cap stocks gained twelve and a half percent a year on the average. But what is a realistic expectation for the purchase of a few stocks? A realistic expectation is that you need ten big cap stocks to get the average and you need 40 small caps. That is if you throw darts at the stock page and pick where the darts hit.

A realistic expectation is that if you invest in what you know and not in what you hear about you will do better. In the 1970’s well to do physicians were buying a leasing railroad boxcars and not investing in Tagamet, the first anti-ulcer wonder drug. The drug maker’s stock did very well while many who prescribed the drug every day missed out on the stock run up.

A realistic investment expectation is that you will need to spend at least a couple of hours a week keeping up with your stocks. A realistic investment expectation is that you are not going to add twenty hours of work to your already busy life.

So, what is your investment strategy going to be so that you satisfy your investment goals and realistic investment expectations? A sound investment strategy is to pick five stocks in five different market sectors. A good investment strategy is to pick a least one stock and market sector that you know about from work, hobby, etc.

A banker may well want one bank stock and a pharmacist a pharmaceutical stock. A reasonable investment strategy for a sports enthusiast would be a sporting goods company.

Once your have picked stocks then there is more investment strategy. If you have a small cap winner an investment strategy is to take a little profit as you go. This investment strategy says that you have not made a profit until you take a profit. Another investment strategy says to let most or all of a winner ride. The best investment strategy in this regard is to keep up with the stock and have an appreciation why it has gone up and its fundamentals predict further gains.

Market Sector, Cash Reserve, and Consumer Spending Drill

Pick the five stocks that you believe will out perform the market in the one, two, and five years. Choose market sectors. Look for cash reserves. When will consumer spending pick up for your market sectors and companies? This is a drill that you should do periodically. Even though you are in the market for the long haul it does not mean than you need to stick with a dieing market sector, support a company with dwindling cash reserves, but rather look at anticipated consumer spending and be there with your stock purchase before the customers arrive at the door.

In the best of all possible worlds you already have your stocks in the best market sectors, in companies with the best cash reserves, and in companies for which consumer spending is a given. On the other hand, maybe that is not the case. The obvious, old, example is American Telephone and Telegraph, which was the “widow and orphan” stock that always paid dividends, always appreciated as the United States grew its telephone system over the early and middle 20th century. Then an antitrust ruling took the company apart and the remaining ATT arm has had continuing problems, takeovers, etc. Some of the “Baby Bells” have done well and some have not. Not to belabor the example you cannot assume that today’s great stock will last.

A good drill, whether you are going to add to your holding, divest, or stand pat, is to routinely evaluate market sectors for growth potential, companies for success and stability as evidenced by cash reserves, and consumer spending for the company’s products.

Sounds like homework again, doesn’t it? But the drill is homework. We are not suggesting that you go out and buy every hot new stock pick. For one thing once a stock hits the “news” it is, in fact, yesterday’s news and has already had its run.

A nice, conservative, approach to stocks is to look for cash reserves. Cash reserves tell you if the company is making money, as a rule, and if they have a buffer against a slide in their market sector.

A look at consumer spending and expected consumer spending tells you when to expect a jump in quarterly earnings. The typical example is retailers and the year-end holidays. Some, like Target and Walmart do well all year long and make more over the fourth quarter and some, niche, retailers depend very heavily on year end sales.

Apply the same logic to your current holdings and, if you think a new stock is a good pick, apply the same logic over a number of time frames to that stock before you buy.

The one, two, and three year forecast is obvious in that you want a stock that is not just a flash in the pan. You want to be in a market sector that is stable and growing. You want continued income, dividends, and cash reserves so that your company has the wherewithal to respond to market opportunity no matter what the economic conditions.

Consumer spending issue is an issue today. If you are invested in mining stocks and your “consumer” is manufacturing you will see a jump in sales while long before employment figures rise. If you have consumer electronic stocks you can use the rise in sales of refined copper and steel to anticipate increased sales of high definition TV sets in the next year.

Do the drill. It will give you continuing perspective on the market and on your holdings.

Time Horizon In Investments

What is your time horizon for investments? Are you investing to fund your retirement or build a family fortune? Or, are you looking to increase your current income with stock dividends. What you invest in depends to a degree upon your time horizon.

In the late 1980’s when Japan’s economy was booming one of their power companies stated that it made its basic decisions based upon a three hundred year time horizon. Certainly if you are building nuclear power plants you would like to know that three hundred years from now your spent fuel is not polluting the environment.

Now, how about investing. Three hundred years? At the speed at which society and business change some of us are happy to make decisions that turn out well after three years or even three months!

On a practical basis the long term investor needs at least to do a weekly check of his or her holdings, general market conditions, outlook for the market sector you are invested in, and political and market psychology considerations that may require you to divest yourself of a stock or buy more shares. This time horizon has to do with maintenance and planning.

If you are investing in growth stocks you hope is to buy an emerging stock in an emerging market niche and hold it while the company grows, matures, and becomes a reliable stalwart in the economy. However, the tricky part is picking the right stock and buying at the right time. Buying call options on hot pharmaceutical startups takes a little bit of the guesswork out of things as you exercise the option and buy only after the stock has made its move. But, you still need to pay attention. This is a weeks or months time horizon.

If the same stock flourishes after the development of a successful cancer cure or “killer app” piece of software you will see spectacular growth in that stock. However, what happens when the stock matures? Microsoft is a case in point. Microsoft is very stable, pays dividends, and never seems to move much. This is a different stock than what people bought years ago. So, do you count your blessings that an initial $10,000 investment is now worth a million dollars and pays a yearly dividend larger than your initial investment or do your sell when stock growth disappears. This may be an investment time horizon of many years or it may be one of months.

Of course there are stocks that have spectacular growth and, when the second possible cancer cure does not pan out, experience a sell off despite steady growth and earnings. This goes back to your weekly time horizon and having a well thought out plan for each of your holdings. By the way, write down what you will do with each holding, in a given time horizon, and why. Not only does this exercise make you think but it helps keep you honest with yourself.

Standard advice is to diversify your stock portfolio and to diversity your portfolio as regards time horizons. If you have a busy, full time job you do not have the time to follow a dozen or more active growth stocks and do it well. You will make mistakes and either lose money or lose out on an opportunity.

You need to decide how much of your time and life you will devote to property watching your investments. A good plan is to write down on a piece of paper how much time you will invest in your stocks as well as how much money and go from there.

Staying in Touch with the Economy and Your Investments

“Stay on your toes,” my old baseball coach used to tell us. To win a nine-inning game even the seemingly inactive outfielders need to stay alert on every pitch, on every throw to check the runner. So it is with long term investing. You need to stay alert, stay awake, and stay in touch with your investments.

Please pardon the baseball example but it is instructive. Long term investing is a nine-inning game or maybe it is the entire season. In a baseball game the pitcher and catcher are constantly active and those outfielders just seem to stand around. However, a good outfield is awake, alert, and ready to move at a moment’s notice. That is what the long-term investor needs to emulate.

There are those who say that, for anyone who has another job besides being an investor, five stocks is the limit. The point is that your stock homework will take time. Reading quarterly reports, thoroughly, takes time. Doing the homework to maintain a perspective on the economy as it relates to your holdings takes time.

Like an inactive outfielder the long-term investor can let his or her stock homework slide, skip the quarterly reports, and ignore the indicators in the economy that will help anticipate a market move. The long term investor who does not stay up with the homework of following the economy, reading the quarterly reports, and staying in touch with the market will be the outfield who never makes the great play that wins the game.

Today, especially, the stock market is on the move. However, in this recovery there will be big winners and there will be the losers who will never come out of the damage that the recession did to the economy.

Reading quarterly reports, doing your stock homework is drudgery. But, it is your money. As the economy improves you can prosper.

We have talked about which parts of the market, which parts of the economy will benefit from stimulus money, a preference for green energy. Following through, weekly, on your homework will help you capitalize on these opportunities.

Anticipating whose quarterly report will look worse as the economy changes will allow you to leave a stock before it dies a lingering death.

A long-term game plan is necessary for long term investing. However, the long-term game plan needs short-term action. The minimum is reading and studying quarterly and year-end reports. Then you need to read what experts say about your stock. Then you need to reread the reports and make up your own mind. Sounds like homework right? It is staying on your toes.

As anticipated companies selling consumer goods are weathering the recession. Look at their quarterly reports and things look great. Look at the economy as it starts to recover and realize that in a year or so other stocks will outperform the stalwarts. Look at your long-term game plan and do a little homework now. What other options do you have with that money in short-term treasuries or one of the old consumer goods stalwarts? And, if you are going to move you money, when will you do it?

Keep up with the economy as it changes. Do you homework every week. Read the quarterly reports.

Sorting Through the Influenza News and More

The influenza news never stops. It has temporarily nudged the recession news aside. And when the recovery is complete there will be other news to nudge that aside. The electronic press swoops down upon a story and disseminates it at the speed of light and the public focus shifts nearly as fast. For the short term trader a little sorting out is necessary to keep making a profit and to keep from letting the news disseminators drive you crazy.

The thing about computers is that they are very fast and not very smart. That sort of applies to our electronic world too. The trader needs to keep up with the news and keep a file on various trading opportunities. The recession, looming recovery, and now the possibility of the current influenza strain causing a global crisis offer a multitude of trading opportunities.

There are recession damaged industries, recovery promising companies, influenza, anti flu drugs, vaccines on the horizon, companies whose stocks have been damaged by the influenza news, and companies whose stars are shining bright because of recovery stimulus money pouring into green projects to mention a few trading opportunities. The question we pose is when is enough, enough?

The point comes down to this. If you try to follow too many influenza related events you will not be there to execute when an opportunity presents itself on the first economic stimulus green stock you have been following.

Bob Woodward, in his book, “The Commanders,” tells how Collin Powell as Chairman of the Joint Chiefs of Staff, and in charge of the Pentagon’s super computers, started his day by writing out long hand on a note pad what his five or so main responsibilities were for the day.

When the news dissemination machine inundates you with influenza, recession, recovery news and more it may be time to get out the note pad, ignore the computer screen and make a very short list of what parts of the news are important. Old timers will tell you that being an expert in one, two, or maybe three areas will serve you well and trying to know everything about everything will lead to your downfall.

There is the matter of cross coverage though. Knowing the biotech stocks will help you deal with treatments for influenza when the next plague scare comes along. Knowing about influenza treatments will help you understand medical supply companies in the current market. The point here is to learn about interconnected companies, sectors, and events so that you can anticipate how a news event in one corner of the world, or the market, will have its effect elsewhere.

Whether it is influenza related, recession related, or a set of green stocks likely to benefit from the recovery stimulus money it is a good idea to develop a game plan and work within a market sector or related sectors to optimize your research and your trading results.

Then, when the news machine inundates you with too much information you can have two files, “This is something that is useful.” and “I do not care.”

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