Archive for July, 2008

Rivalry (The Financial Athlete #35)

July 31, 2008

Major League Baseball’s New York Yankees vs. Boston Red Sox is probably the greatest rivalry in sports in America. This traditional rivalry is good for baseball.

Another great sports rivalry is Federer vs. Nadal, which is reviving interest for tennis in America. Rivalries always promote a sport.

A fierce rivalry of two companies is good for improving services and products, a plus for investors. But to more than offset this, in the heat of competition prices are substantially reduced. Gross profit margins erode, sometimes to the bare bone.

One of my top considerations in evaluating a stock are the three margins: gross profit margin, operating profit margin, and net profit margin. Regardless of the size of the company, I seek high margins in the financial statements. Then I evaluate whether these margins are sustainable or threatened.

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Camaraderie (The Financial Athlete #34)

July 31, 2008

One of the benefits of participating in sports is the camaraderie. On a playing field your best friends can be found, sometimes friends for life. You’ll also encounter personalities you don’t particularly care for, but team sports forces you to get along with them. Fortunately, those unpleasant types depart from your life when the season ends.

Investors have the luxury of not having to daily tolerate difficult bosses, co-workers, or clients. Oh, how lucky…but not really. Investing is mostly a lonely profession. Man, being a social animal like a wolf, needs a pack. For this reason, investors are prone to form a network of investors. Is this a detriment or an edge to returns? Obviously, it depends on who’s in your network, but isn’t there something disturbing about this question? We are obsessed with measuring everything in our culture. Instead of eating for pleasure, we count calories. Instead of running for play, we count laps. Instead of enjoying the company of a new acquaintance, we calculate whether she can lead us into a shortcut to advance in the complex maze of the rat race….

Aside the camaraderie, a team of competent and trustworthy people should share direct and indirect research and analysis. For investing in stocks direct research involves interviewing company management and participants in the industry including suppliers, competitors, and customers. Indirect research involves reading press releases, industry news and trends.

The world is flooded with information, too much for one set of eyes to observe.

‘It is better to be betrayed than to trust no one.’ — Fijotsudoela saga ch. 13

Take the open shot! (The Financial Athlete #33)

July 30, 2008

“I never looked at the consequences of missing a big shot… when you think about the consequences you always think of a negative result.” – Michael Jordan

You’ve been playing basketball almost since the day you learned how to walk. You’re comfortable making the jump shot in practice from any reasonable distance. In game time the coach calls you off the bench. The star player is double teamed and passes the ball to the open man — you! This is your opportunity for an easy bucket at one of your sweet spots, mid range. Yet, you hesitate and don’t shoot. You pass the ball to a teammate who’s covered.

Why didn’t you shoot? Are you afraid of missing? Don’t overestimate the severity of the consequences of missing. Take the open shot!

To identify a great investment opportunity and do nothing about it gets you nowhere. You might as well be playing in the sandbox. Execution of transactions makes people money. Don’t be afraid of making a mistake with a purchase of an investment vehicle after you’ve done your homework.

The beauty of investing is that you can be wrong 9 out of 10 times and still come out ahead. For example, if you invested in 10 stocks, $1,000 for each, and lose an average of 10% on 9 of the 10, but gain 200% on the 10th, your original investment of $10,000 returns a gain of $1000.

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“Yes is the key to unlock the door to our grandest dreams.”
–‘pastamanvibration’ (Ao)

Self-Defense (The Financial Athlete #32)

July 29, 2008

The Shaolin monks’ motive in developing kung fu was self-defense. A martial artist should never drop her guard. Defense is ongoing, even when attacking. For example, hands are up for protection while kicking.

Self-defense does not only involve hand-to-hand or weapon combat. It begins with awareness of surroundings and avoiding areas of trouble. Not succumbing to anger and speaking with a gentle voice can also defuse conflicts.

People study martial arts to exercise, build character and discipline, show off, pursue a spiritual quest, and for sport and self-defense. Of these, the primary reason is self-defense, probably because we live in a crazy world.

Investors would be wise to always maintain a defensive posture. Be picky about what to invest in and how much. Shun penny stocks with low average daily volume of trading (a money trap), stocks of distressed companies, and the purchase of call options. Gambling is not a form of investing.

Most properties and stocks are probably not worth investing in. Be picky about where you put your money.

As a general rule, buy strength at a reasonable price…properties in desirable neighborhoods and companies with a dominant market share or aggressive growth.

(Above picture: Capoera, developed by Brazilian slaves who disguised this martial art as a dance so that their masters would permit it)

Too lazy to stretch? (The Financial Athlete #31)

July 28, 2008

Stretching properly not only prevents injuries, it enhances game performance.

My stretching routine begins with dynamic stretches before a sports activity. This warms up my muscles. Then I do static stretches after the sports activity. The point of stretching is to relax the muscles. However, stretching alone may not relax the muscles. The mind must be calm for the body to relax. Calm mind…calm body. Calm the mind through meditation or breathing exercises. Thus, meditation and breathing exercises can be viewed as stretches for the mind.

People skip stretching because it’s boring for them or they think they have no time for it, only to pay the price with physical pain later. Likewise, many investors skip due diligence for the same excuses, only to pay an emotional toll of anger, worry, and regret later.

Investing without doing due diligence is like playing a rigorous sport with muscle tensions and spasms. As silly as this sounds, this is precisely how many go about investing. It’s the easy and fun way, until the losses start rolling in. Practice proper due diligence, which is the heart of investing.

Don’t forget the fans (The Financial Athlete #30)

July 27, 2008

There’s a certain magic in sports when the crowd goes wild during a great moment in sports. The crowd, made up of strangers from all walks of life, suddenly finds itself united in a heated emotional bond. These great moments in sports are borne in the collective memory of the fans. Years later, at the right place and time this bonding with complete strangers can be reignited only by someone recounting the story of the catch or kick or shot. Indeed, these stories take on a mythological proportion.

The fans are a mighty force to reckon with. Become a fan favorite, and you enter a world of sports bliss. Become disliked by the fans, and you’ll probably wish you were still playing in little league.

When you invest in a company, don’t forget the fans. Who are these fans? The customers. If the company’s customers are businesses, then know their reputation in the industry. If their customers are consumers, then you might already know how satisfied they are. Satisfied customers — or better yet, delighted customers — are a good starting point to find companies to invest in. And if there’s a turn for the worst in customer satisfaction, you don’t have to wait for deteriorating quarterly results to sell. Listen to the fans!

Beware the cheerleaders (The Financial Athlete #29)

July 25, 2008

If you stare at the cheerleaders, you might miss the game winning touchdown. That’s about the extent of harm they can cause for most of us.

Wall Street’s cheerleaders aren’t cute and sexy, but they sure know how to seduce — not for sex, but for money. These cheerleaders include CEOs, analysts, stock brokers, and your friend who joyfully shares a stock tip. Some are financial predators who lure naive investors with spin, perhaps in a pump and dump scheme.

The Real estate industry doesn’t lack cheerleaders, either. These cheerleaders call themselves Real Estate Agents. The typical advice from a bright and bubbly agent will always be “Now’s a good time to buy,” even when the midst of a price bubble.

Whatever a salesperson is selling, her advise is usually: “Buy! Buy! Buy!” She may persuade you through your emotions and create a sense of urgency to buy. This doesn’t make her a bad person. Remember, she has to make a living. Without sales, she can’t pay her bills.

Getting back to those football cheerleaders, I love them. I appreciate them especially during a boring game. And despite what I had opined about the other kind of cheerleaders — salespeople, I respect the profession of sales. The backbone of the economy is sales. Without sales, nothing happens economically. If your lucky, you’ve developed a positive, long-term relationships with a competent and trustworthy sales consultant who actually looks after your interest first. Just be careful about whose advise you’re taking and always do your own due diligence. And if you’re being rushed to buy, pass up on the opportunity regardless of how rewarding it may be.

Exercise effectively* (The Financial Athlete #28)

July 23, 2008

The gym is full of people doing ineffective exercise routines:

1. The middle aged man who desperately tries to lose his pot belly by doing hundreds of crunches a day does not realize crunches will only strengthen his abdominal muscles and do little or nothing to burn the fat that hides them. Meanwhile, another man beside him spends minimal time on direct ab work but has ripped abs because he concentrates on full body exercises such as pull ups, dead lifts, and lunges.

2. The young woman riding 40 minutes on the stationary bike at a leisurely pace while tuned into the TV burns less fat than her healthy friend who breaks a sweat as she maintains a mind/muscle connection in her 20 minute interval training workout on the stationary bike next to her.

3. The college kid who spends half an hour on the bench press and hardly any weight training for his back muscles only bothers to look at his chest in the mirror. In time, he will also notice a rolling in of the shoulders due to an imbalanced body structure.

4. The muscle man who consistently works out two hours a day, a good portion of that time resting in between weight lifting sets which isolate a single muscle. Another muscle man completes a comparable workout in half the time because his routine centers on multiple-joint exercises and supersets. (An example of a superset is triceps extensions followed by bicep curls.)

To save time in my workout I choose effective and efficient ways of exercise. The same holds true for the exercise of due diligence with investing. To begin with, an investment opportunity must meet my initial criteria before I dig deeper into research. This filters out unwanted assets quickly. If the investment opportunity meets my initial criteria, then I implement a system of Pros and Cons based on Michael Porter’s SWOT analysis.

SWOT is an acronym for Strengths, Weaknesses, Opportunities, and Threats. Strengths and Weaknesses are internal factors such as Working Capital and Debt/Equity Ratio. Opportunities and Threats are external factors such as product market trends and competition.

A SWOT analysis forces us to see the whole picture. See the whole picture, and eliminate the tendency to become over-bullish or over-bearish. Due diligence is incomplete without exploring all four facets (Strengths, Weaknesses, Opportunities, Threats). Incomplete due diligence is nearly as bad as no due diligence, because it leads to false conclusions.

*People with heart problems and some other physical ailments should not increase the intensity of exercise with sprints, interval training, fully body exercises, and supersets. Consultant your doctor before doing this.

Constancy of Purpose (The Financial Athlete #27)

July 23, 2008

After a rewarding private lesson of tennis, I said to my tennis instructor, “Adults like me will never turn pro. Wouldn’t you prefer to develop a child into a world class player?”
He replied with a story. “One of my favorite students was an old woman in her 80s. She had a limited range of motion, so we would work on doing more with less. One day we were practicing volleys. It was a very hot day, about 100 degrees Fahrenheit. All the other players on the other courts could not stand the heat and left. Only the old woman and I remained. After a rally, she walked with short steps to the net and said, ‘It’s hot today, isn’t it? I replied, ‘Oh, yeah!’ Without another word spoken, she walked back to her spot and we continued to volley.”
“She played with heart,” I added.
“Not just heart, PURPOSE. Some who left those courts in the heat also play with heart, but for this old woman tennis gave her purpose in life itself. I don’t seek youth in students, I enjoy most teaching people who play with heart and a sense of purpose.”

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When I invest in a small to medium size companies, I seek a strong sense of purpose and direction in management. Management guru W. Edwards Deming called this “Constancy of Purpose”. It is the first and foremost of his famous 14 Points (see below). To have constancy of purpose is to maintain focus on the long term vision, not be tossed to and fro with short-term circumstances.

A starting point to determine constancy of purpose is to read the Mission Statement. For many companies, a Mission Statement is nothing more than a creative writing exercise. Virtually all companies have them, but few are driven with a true sense of mission. The same can be said of people. How many of us really live a purposeful life?

To try to get a more accurate perception if the stated ‘raison d’etre’ (reason to be) in the Mission Statement of a small to medium size company is actually being adopted, I call management on the phone, or better yet, meet them face-to-face. I’m careful to not confuse hype for purpose. Both are spoken by CEOs with enthusiasm. Hype centers around discussion of anticipated higher stock prices. Purpose centers around discussion of long-term business development to fulfill the mission.

Seeking a sense of purpose in management sets your mind on buying businesses, not stocks. This is a very important distinction.

“Whenever Charlie and I buy common stocks for Berkshire’s insurance companies (leaving aside arbitrage purchases) we approach the transaction as if we were buying into a private business. We look at the economic prospects of the business, the people in charge of running it, and the price must pay.”
–Warren Buffet

To be lucky or not to be lucky (The Financial Athlete #26)

July 21, 2008

Luck is part of the game. Sometimes even winning a game is a matter of luck. In soccer tournaments when a tie score will not do, the game is decided by penalty kicks. In this situation the goalie makes a snap decision of where the kicker will kick the ball. The ball may go right and the goalie jump left to try to block it (or vice versa). This is what guesswork looks like in sports.

Luck has its place in investing, too. To the investor who loses, it quickly becomes obvious in his mind he has been unlucky. More likely, he didn’t know what he was doing when he invested. As for the lucky investor, he does not thank his lucky stars because he is very slow to realize luck played a large role in his new found fortune. It comforts his ego to think he is gifted with money, until his luck turns sour.

Investing is a game of probability. An investor must be objective in assessing probability of outcomes. Only when he reasonably estimates the probability of favorable outcomes far outweigh the probability of negative ones should he take a substantial position, and even then it should be measured so that if he is dead wrong he is not finished.

“Sometimes when you do your job, the ball just comes to you.” – Ray Lewis
(on a fooball teammate’s interception)