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Stocks, Stock Markets and Portfolio Management Advice from the Big Fish
Diversification is a risk management strategy that mixes a wide variety of investments within a portfolio. A portfolio of different sorts of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio, or so the logic goes...
Q: Diversify, diversify, diversify. Or not? Is the need for diversification really a myth? What would you say to investors with this strategy?
John Bogle: “Why look for the needle in the haystack? Buy the haystack!”
Warren Buffett: “Diversification may preserve wealth, but concentration builds wealth.”
William J. O'Neil: “Diversification is a hedge for ignorance. I think you are much better off owning a few stocks and knowing a great deal about them.”
John Maynard Keynes: “As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.”
Buy and hold strategy
With a long time horizon, equities render a higher return than other asset classes such as bonds. There is a debate over whether a buy-and-hold strategy is superior to an active investing strategy. Both sides have valid arguments...
Q: You often hear the argument that the stock market is really for long-term investors. Is it worth it to pay attention to short-term price movements at all?
Charlie Munger: “You do better to make a few large bets and sit back and wait. There are huge mathematical advantages to doing nothing.”
Warren Buffett: “All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies. My favorite time frame for holding a stock is forever. I never even attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years. As far as I am concerned, the stock market doesn’t exist. It is only there as a reference to see if anybody is offering to do anything foolish.”
Philip A. Fisher: “If the job has been correctly done when a stock is purchased, the time to sell it is - almost never.”
Q: What about active traders and the dangers of 'buy and hold' tactics?
Warren Buffett: “According the name ‘investors’ to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a romantic.”
John Rothchild: “Buy and hold is far from the sure thing it’s made out to be. It works in bull markets. It works if you invest in dribs and drabs, catching the ups and downs along the way. It works in mild bear markets, when declines are quickly reversed. It may work if you’ve got 20 years to wait for stock to recover from a half-off sale. Otherwise, it’s risky. It’s risky when you’re holding stocks you bought at extravagant prices. It’s extremely risky when your retirement depends on a positive result and you’re planning to take up golf in a decade or less.”
Movement in share prices
The P/E ratio (price-to-earnings ratio) of a stock (called its "P/E", or simply "multiple") is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share.
Q: What would you say to those speculators who tout the popular argument that short term results can be calculated based on corporate earnings?
John Rothchild: “That stocks rise and fall on corporate earnings is a much ballyhooed misconception. The price investors will pay for earnings varies from hour to hour, week to week, year to year depending on the inclinations of the buyers and the sellers."
Dominic Lawson: “Share prices follow the theorem: hope divided by fear minus greed.”
Q: But corporate earnings do count in the long run, don't they?
Warren Buffett: “In the short run, the market is a voting machine. In the long run, it’s a weighing machine. If the business does well, the stock eventually follows.”
Peter Lynch: “Just because the price goes up doesn’t mean you’re right. Just because it goes down doesn’t mean you’re wrong. Stock prices often move in opposite directions from the fundamentals but long term the direction and sustainability of profits will prevail.”
Q: So ultimately, investment returns are tied to corporate returns?
Warren Buffett: “Stocks can’t outperform businesses indefinitely. Indeed, because of the heavy transaction and investment management costs they bear, stockholders as a whole and over the long term must inevitably underperform the companies they own. If American business, in aggregate, earns about 12% on equity annually, investors must end up earning significantly less. Bull markets can obscure mathematical laws, but they cannot repeal them.”
Q: How important is monetary liquidity?
Martin Zweig: “In the stock market, as with horse racing, money makes the mare go. Monetary conditions exert an enormous influence on stock prices. Indeed the monetary climate - primarily the trend in interest rates and Federal Reserve policy - is the dominant factor in determining the stock market’s major direction.”
Warren Buffett: “If Fed Chairman Alan Greenspan were to whisper to me what his monetary policy was going to be over the next two years, it wouldn’t change one thing I do.”
Bull and Bear Markets
The terms bull market and bear market describe upward and downward market trends, respectively, and can be used to describe either the market as a whole or specific sectors and securities.
Q: Can bull markets be overly deceptive? Do they flatter to deceive?
Charlie Munger: “Bull markets go to people’s heads. If you’re a duck on a pond, and it’s rising due to a downpour, you start going up in the world. But you think it’s you, not the pond.”
Nick Leslau: “You must never confuse genius with a bull market.”
Q: No one likes bear markets?
Anthony Gaubis: “If you warn 100 men of possible forthcoming bad news, 80 will immediately dislike you. And if you are so unfortunate to be right, the other 20 will as well. “
Jeffrey Laderman: “A bear in a bull market is like a prohibitionist at a cocktail party. At first, some people take his admonitions to heart and sip soda water. But as the party goes on, nearly everyone joins in the drinking. Scorned, scoffed at, and - worst of all - ignored, the prohibitionist slips out to await the morning after.”
John Rothchild: “It’s no accident that the largest investment house in the world, Merrill Lynch, has a bull for a mascot, and took ‘Bullish on America’ for its corporate motto. No investment house has dared adopt the slogan ‘Bearish on America’, even during market declines. Pessimists have a hard time making a living in America. Outperform your peers in a bull market and you’ll be applauded for your skill. Outperform them in a bear market - by turning a profit when they’re nursing losses - and check your backside for darts, your rose bushes for poison, and your driveway for nails. On Wall Street a winning bear gets more cold shoulder than an SEC gumshoe.”
Q: Why do bear markets happen and how frequently?
John Rothchild: “Bear markets happen for a simple reason: the owners of the merchandise can’t get their asking price. The shortage of buyers forces them to lower the fare, until a buyer can be coaxed into making a deal. It’s a common occurrence in retail. Stores have a bear market after every Christmas rush. Nasty bear markets happen every six and a half years. Smaller declines of 10 per cent, called ‘corrections’, happen every two years or so. Taken together, these minor and major setbacks have produced losses in thirty-three years out of the past one hundred, making investors unhappy roughly one-third of the time.”
Mark Faber: “A bear market is a financial cancer that spreads. Intermediate rallies (occasionally very strong ones) keep the hopes of investors alive. Furthermore, by continuously publishing bullish reports, brokers and economists, like good nurses, keep the flame of hope from burning out. But after 18 to 36 months of continued losses, total capitulation usually
sets in and a major low occurs.”
Byron Wein: “Markets don’t go straight down. They go down hard, get oversold, rally, then go down again.”
Q: Do bear markets offer any opportunity to the savvy investor?
Warren Buffett: “Like an oversexed guy in a whorehouse. This is the time to start investing.”
Jeremy Siegel: “The 1973-1974 collapse, brought the capitalization of the British market down to a mere $50 billion. This was less than the yearly profits of the OPEC oil-producing nations, whose increase in oil prices contributed to the decline in share values. The OPEC nations could have purchased a controlling interest in every publicly traded British corporation at the time with less than one year’s oil revenues!”
Robert Reno: “Nobody who has ever been on a falling elevator and survived ever approaches such a conveyance without a fundamentally reduced degree of confidence.”
John Maynard Keynes: “Markets can remain irrational longer than you can remain solvent.”
Timing the Markets
Market timing is the strategy of making buy or sell decisions of financial assets (often stocks) by attempting to predict future market price movements.
The prediction may be based on an outlook of market or economic conditions resulting from technical or fundamental analysis. This is an investment strategy based on the outlook for an aggregate market, rather than for a particular financial asset.
Q: Is it possible to time the markets at all? What use?
Victor Sperandeo: “The key to building wealth is to preserve capital and wait patiently for the right opportunity to make the extraordinary gains.”
Ralph Wanger: “No mutual fund manager who relies on market timing has kept his job for fifteen years. Individual investors who try to time the market will be tossed on the same horns.”
John Bogle: “In the 30 years in this business, I do not know anybody who has done it successfully and consistently, nor anybody who knows anybody who has done it successfully and consistently. Indeed my impression is that trying to do market timing is likely not only not to add value to your investment program, but to be counterproductive.”
Martin Zweig: “Too many people redeem their profits too quickly. In a huge bull market they wind up with piddling profits, only to watch their former holdings soar. That usually prompts them into making mistakes later when, believing that the market owes them some money, they buy at the wrong time at much higher levels.”
Warren Buffett: “Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”
Q: What are some everyday signs of a market top or bottom?
James K. Glassman: “When you see business execs helicoptering to the golf course, waiters discussing the merits of Intel versus Applied Materials, 22-year-olds in suspenders smoking cigars and drinking. Martinis, and houses in the suburbs selling way over the asking price - then you know that the referee has brought the whistle to his lips and is about to blow. The game is nearly over.”
Peter Lynch: “When 10 people would rather talk to a dentist about plaque than to the manager of an equity mutual fund about stocks, it’s likely that the market is about to turn up. When the neighbours tell me what to buy and I wish I had taken their advice, it’s a sure sign that the market has reached a top and is due for a tumble.”
“When the ducks quack, feed them”
- traditional Wall St. saying
John K. Galbraith: “Without doubt, the most striking feature of the financial era which ended in the Autumn of 1929 was the desire of people to buy securities, and the effect of this on values. But the increase in the number of securities to buy was hardly less striking. And the ingenuity and zeal with which companies were devised in which securities might be sold was as remarkable as anything.”
When to sell your shares
The right time to sell shares is a tough call that investors have to make often. Even money managers and professional traders admit it is more than difficult. It's a lot easier to buy a stock than to sell a stock.
Q: Are there any rules whereby you can guess the right time to sell a stock?
Peter Lynch: “Some people automatically sell the ‘winners’ - stocks that go up - and hold on to their ‘losers’ - stocks that go down - which is about as sensible as pulling out the flowers and watering the weeds. Others automatically sell their losers and hold on to their winners, which doesn’t work out much better. Both strategies fail because they’re tied to the current movement of the stock price as an indicator of the company’s fundamental value.”
Q: How to cut losses?
Robert Frost: “Take care to sell your horse before he dies. The art of life is passing losses on.”
“Long term investments are short term investments which have gone wrong.”
Jim Rogers: “There is no such thing as a paper loss. A paper loss is a real loss.”
Peter Lynch: “If you know why you bought a stock in the first place, you’ll
automatically have a better idea of when to say goodbye to it.”
Nicola Horlick: “I always sell on the first profit warning. Wait til the third downgrade and you have no hope of getting out.”
Q: How to maximize profits?
Ralph Wanger: “You can’t make five or ten or twenty times your money if you don’t hold on to stocks. Most people are delighted when a stock doubles, and quickly sell to lock in their gain. If a company is still performing, let its stock, too, continue to perform.”
Q: How to sell in a bear market?
John Rothchild: “An investor in a panicky market faces the same predicament as a movie-goer in a crowded theater after somebody shouts “Fire!” Staying put is the sensible thing to do, as long as everybody else stays put and stays calm. Otherwise, people who stay put run the risk of getting trampled, and people who rush to the exit may have the best chance of escape.”
Ralph Wanger: “Selling an illiquid stock in a down market brings to mind the galley slaves in Ben-Hur, chained to their bench while the ship sinks.”
New Issues on the Stock Markets
New issue (also referred to as primary shares or new offerings) is a reference to a security that has been registered, issued and is being sold on a market to the public for the first time. The term does not always refer to newly issued stocks and securities that can be newly issued may include both equity and debt.
Q: What about new issues and the new issue market?
Timothy Vick: “The entire financial industry exists to sell a product. If you don’t understand this basic maxim, you’ll be misled time after time.”
Warren Buffett: “The new issue market is ruled by controlling stockholders and corporations who can usually select the timing of offerings. Understandably these sellers are not going to offer any bargains. It’s rare you’ll find X being sold for half-X. Indeed, selling shareholders are often
motivated to unload only when they feel the market is overpaying.”
Jay Ritter: “The IPO market is never in equilibrium. It’s either too hot or too cold. Buy in the cold periods."