Why This Market Truism Just Isn’t True

by Alexander Green, Investment U Chief Investment Strategist
Monday, December 5, 2011: Issue #1657

In my first book, The Gone Fishin’ Portfolio, I made a confession that startled some readers…

I retired from the investment services industry while I was still in my early 40s, but many of my clients had not become financially independent. This was not because I advised them poorly. I dealt with my clients honestly and gave them the best advice and service I could.

Yet, in many ways, they operated at a disadvantage. Some had a poor understanding of investment fundamentals. Others found it impossible to commit to a long-term investment plan. Many were simply too emotional about the markets, running to cash at the first hint of danger.

Contrarian instincts are rare, too, I learned. Few people are emotionally stirred by low stock prices. But every time there was a correction, a crash, or financial panic, my Scottish blood would surge, my pulse would rise, I’d rub my hands together, and start buying.

My clients, on the other hand, often did just the opposite, sometimes because they were too nervous but often because they bought into the old chestnut that a good investor doesn’t buy into a market downturn.

“The trend is your friend,” they’d say. Or “Don’t try to catch a falling knife.” This is surely the conventional wisdom in some quarters, but it’s not particularly wise. Here’s why …

For the last several months, traders have obsessed over problems in the Eurozone and the strength (or perceived weakness) of the U.S. economy. Taking a decidedly downbeat view, the market had a pretty horrendous November. But sentiment can turn on a dime and stocks can put on a furious – and completely unexpected – rally.

If you don’t already own stocks, it’s tough to catch the train after it has left the station.

Yet many gurus, including growth-stock advocate William O’Neill and his widely read publication Investor’s Business Daily, often insist that you shouldn’t but a stock unless the market itself is in a confirmed uptrend.

That may make sense in theory, but it often fails in practice. For instance, on page one each day, that paper reports whether the market is in a confirmed uptrend or downtrend. (And sometimes hedges, using language such as “Uptrend Under Pressure.”)

As we all know, this has been a volatile year for the market with the major indices bouncing up and down repeatedly. But you could hardly have chosen a worse strategy than to wait until the market was in a confirmed uptrend before buying. All that meant was that you bought into every short-term spike and then hit your trailing stops over and over again. (It must feel like banging your head against the wall.)

The Oxford Club has hit a number of its stops this year, too, sometimes protecting profits, other times protecting principal. But by buying great companies when the market was under pressure, we ended up with a lot of attractive entry points and plenty of both realized and unrealized profits.

True, if stocks go into a secular bear market, you can end with losses no matter how well you timed your entry points. However, you can never know whether a market drop is merely a correction or something more ominous until you are looking in the rear-view mirror.

You have to stick your neck out occasionally, pick your spots and buy stocks. If you don’t, what are you going to do? Buy bonds yielding 2.5 percent? Hold a money market paying less than one-tenth of one percent? It’s tough to beat inflation or meet your financial goals that way.

Let me make one thing clear, however. It’s most definitely a mistake to buy a troubled company that’s in a downtrend, no matter which way the broad market is heading. (That only works for those with exceptionally long time horizons – and often not even then.) But buying great companies when the broad market is a downtrend gives you a chance to obtain good prices on fine long-term investments and take advantage of tradable short-term rallies, too.

The next two months are traditionally one of the strongest periods for the stock market. No one can say, of course, whether that tradition will hold. But it’s a reasonable strategy to buy great companies when the market is down.

If your goal is to sell high, you have to start by buying low. And market corrections – like the one we’ve seen lately – give you an excellent opportunity to do just that.

Good investing,

Alexander Green

Business/Finance, Chief Investment Strategist, Collective investment scheme, contrarian investing, Finance, Financial economics, Financial markets, investment, Market trend, Short, Stock, Stock market, Technical analysis, United States

The Best Trade You Can Make in November

by Alexander Green, Investment U Chief Investment Strategist
Thursday, November 24, 2011: Issue #1650

In December 1996, I sold some shares of Best Buy (NYSE: BBY) to offset gains elsewhere in my portfolio.

I still consider it the most boneheaded investment move I ever made. A year later, the stock was up more than five-fold. A few years further on, it was up more than thirty-fold.

The worst part is that I didn’t dislike the business prospects for Best Buy at the time. Quite the contrary, in fact. I sold it only because I had substantial capital gains and was cleaning out my portfolio to offset them.

I don’t always do that any more. And you shouldn’t necessarily, either. Despite what your tax advisor may tell you, you should never sell an investment for tax reasons alone. Nor do you have to.

Here’s why…

The IRS allows you to offset realized gains with realized losses each calendar year. If you do, however, you must wait at least 30 days before buying the same shares back. (Otherwise you run afoul of the wash-sale rule.)

Offsetting gains at the end of the year is often a sensible move. Most stocks aren’t appreciably higher 30 days later. And if you still like them, you can buy them back then.

There is a risk, however, and it’s called the January effect. The first month of the year is traditionally a strong one for the market. A lot of pension and IRA money gets invested early each year. Plus, there’s often a rebound from the tax-loss selling that goes on each December.

If a stock you own soars in January, there’s a natural reluctance to buy it back. The temptation is to wait until it comes back down. But what if it doesn’t? You’ve taken a limited loss but sold an investment with unlimited upside potential.

There’s a way around this problem, however. And you can take advantage of it – but only if you’re willing to move this week.

In late November each year, I look at my entire portfolio for any companies that are trading below my entry price but NOT near my trailing stops. If I still like a stock, I often make the decision to double down on it for 30 days.

Why? Because I can sell the original shares at the end of December for a tax loss. And if the stock rallies in January, it’s not a problem. After all, thanks to my purchase in November, I own the same number of shares as I bought originally.

What if you don’t have the cash to double down on your position? Use margin. Again, I’m recommending this only for a 30-day period. Your margin interest charge will be minimal.

The risk, of course, is that your shares will be worth less in late December and you will have a paper loss on the second purchase.

However, just the opposite may happen. Remember, the January effect is often preceded by the Santa Claus rally, the tendency of the stock market to do well in the second half of December. As a result, you could end up with a smaller loss in your original shares and a paper gain on your second purchase.

(The Santa Claus rally is never certain, of course, and another reason why you should only add to those companies whose earnings prospects remain strong.)

Bear in mind, when selling for tax purposes, the IRS requires that you buy those identical shares AT LEAST 30 days before you sell the others. So if you want to use this strategy for 2011, you must act this week.

If we have the traditional mid-December to early February rally, you’ll thank me. And then perhaps again on April 15.

Good investing,

Alexander Green

Best BUY Co. Inc., Business/Finance, Capital gains tax, Chief Investment Strategist, Economics, Finance, Financial economics, investment, Short, Stock, Stock market

Why You Should Buy Japan Now

by Alexander Green, Investment U’s Chief Investment Strategist
Monday, April 25, 2011: Issue #1498

“Buy Japan now?” a friend asked recently. “Are you nuts?”

His sentiment is understandable. Aside from the unfathomable human suffering in Japan over the past several weeks, there have been enormous economic setbacks as well.

Sendai, the biggest port in northeast Japan and a major exporter of auto parts, machinery and marine products, was virtually wiped off the map. Half a dozen oil refineries in the same area, representing a third of the nation’s entire refining capacity, are shut down. Roads, bridges, railways and other major infrastructure have been destroyed. And the Japanese economy – already limping along for most of the past two decades – is also beset with the world’s highest public debt relative to GDP (225%) and a rapidly aging population.

Why would anyone want to invest here?

In my experience, those words accompany virtually every great buying situation. But it takes more than just a lack of interest to create a true contrarian opportunity. Both sentiment and valuations have to be at an extreme.

And that’s certainly the case here…

Japanese Stock Prices Are Less Than Book Value

The average Japanese stock is selling for less than 14 times its annual profit. That’s cheap, and Japanese accounting methods also tend to understate earnings. An even better indicator is found in book values (assets minus liabilities). Stocks around the world (including the United States, Europe and China) currently sell for approximately two times book value. In Japan, they sell for less than book value. By this measure, U.S. stocks are twice as expensive as Japanese stocks.

What will turn Japan’s market around? For starters, the enormous rebuilding that will be required over the next few years. Devastated areas account for seven percent of Japan’s economy and a substantial portion of its land mass. A lot of businesses will receive substantial contracts as a result of the catastrophe.

History shows that Japan is adept at rebounding from catastrophe. (Take World War II or the 1995 Kobe earthquake as examples.) And when Tokyo enters a bull market, it can look like the Silver Spurs Rodeo. For example, if you invested $10,000 in the S&P 500 in 1970, two decades later it would have been worth more than $76,000. Not bad.

But the same amount invested in the Nikkei 225 would have turned into more than $600,000.

How to Buy into Japan’s Advanced Economic Power

Although China’s economy has now eclipsed Japan’s in size, Japan is still Asia’s most advanced economic power, with world-leading technologies and an unmatched infrastructure.

The cost of doing business in Japan has decreased dramatically in recent years, as well. Land prices, office rents and labor costs have come way down. So have taxes and tariffs. And the government has instituted serious banking reforms.

The nation also sits on a mountain of personal financial assets – more than $100,000 for every man, woman and child. After a decade of negative stock market returns, most of this capital is sitting in low-yielding bank deposits. Even a small fraction of these assets returning to the equity market could give it a serious jolt.

So how do you play a rebound? Consider a Japan ETF or some of the country’s unloved blue chips like Toyota (NYSE: TM), Mitsubishi Financial (NYSE: MTU), Canon (NYSE: CAJ), or NTT DOCOMO (NYSE: DCM).

The healing there will take time, of course. But just as the U.S. stock market rebounded from the recent financial crisis quicker than almost anyone expected, things in Japan may look dramatically different in six to 12 months from now.

Of course, very few people believe that. But, in one sense, that’s a good thing. Negative sentiment and low valuations are the defining characteristics of contrarian investing.

Bottom fishermen, cast your nets.

Good investing,

Alexander Green

Business/Finance, China, contrarian investing, Economics, Finance, Financial economics, fundamental analysis, Japan, New York Stock Exchange, Stock, Stock market, Stock selection criteria, United States, USD, Valuation

Why Ignorance Is Bliss In the Stock Market
by Alexander Green, Investment U’s Chief Investment Strategist
Monday, May 2, 2011: Issue #1503

The other day I was speaking with a friend who’s too nervous to invest in the market.

“I just can’t pull the trigger,” he said. “How can you buy stocks when the Fed is priming the pump, real estate is in a tailspin, the dollar is in the tank, the Euro zone is teetering, the Middle East is a powder keg and Congress – as always – is spending money the way my wife does in Vegas?”

I know just how he feels. After all, like most investment analysts I spend my days marinating in the news cycle. I see all these terrible headlines, often several times a day. It’s hard to turn a blind eye.

But if you want to be a successful investor, you may need to do just that. Let me explain …

The national news backdrop is always unsettling. Americans experienced plenty of good times over the last 80 years, but they were punctuated by recession, depression, inflation, war (including two big ones) and almost limitless scary scenarios.

But, through it all, there’s always been plenty of money made owning the fastest-growing, most-profitable companies in the nation.  Everyone knows that the best way to get rich is to own a business making money hand over fist.

Yet if you strike out on your own, you’ll find there are more than a few hurdles. For starters, you need a significant amount of capital to start a business. You have to have a lot of entrepreneurial skill, a talent for dealing with customers, employees, suppliers and regulators. And if you meet these first two requirements, strap yourself in. Because it’s a well-known fact that 85 percent of new businesses fail in the first five years.

Fortunately, you don’t have to have this kind of money or take these kinds of risks to get rich in business. You only need to own shares of companies that are – in the words of my 25-year-old nephew – “killing it.”

I’m talking about companies experiencing double-digit sales growth, sharply higher earnings and fat returns on equity. These companies tend to be innovators, continually launching hot new products and services. (Apple is a prime example.) You’ll find that institutions are taking big positions in these stocks. The companies themselves are often buying back their own shares. And the chart – which shows technical factors like price and volume – generally gets an A+.

It’s called momentum investing. And it works. Just a few weeks ago, for instance, we bought shares of internet security company Fortinet (Nasdaq: FTNT). Last week the company reported a blockbuster quarter.  Sales jumped 34 percent. Operating income more than doubled. And the CEO Ken Xie pointed out that the pipeline is full and the company is achieving “significant momentum.”

Our shares jumped over 14 percent in one day. And I see plenty more upside ahead.

Of course, we never would have bought this stock if – instead of looking at the fundamentals of the business – we spent our days worrying about the state of the world.

I’ll let you in on a little secret. As an investor, it’s not your job to envision solutions for the political arena, the world economy, or the financial markets. And that’s a good thing. Because the world is way too big and complicated to figure out anyway.

And it’s not necessary. If you want to make money in the market, forget about the “macro” picture. And focus instead on identifying businesses that are likely to post huge earnings surprises in the weeks and months ahead.

That’s how all the great investors – from Buffett to Templeton to Lynch – did it. And that’s how you can do it, too.

Good investing,

Alexander Green

Business/Finance, Chief Investment Strategist, Equity securities, Finance, Financial economics, financial ratios, investment, P/E ratio, Rate of return, Socially-responsible investing, Stock, Stock market

If You Knew What Warren Buffett Knows…

by Alexander Green, Chief Investment Strategist
Monday, March 14, 2011: Issue #1468

My publisher recently forwarded me a note from an Investment U reader…

“You guys are recommending a 5% gold allocation in your model portfolio. That’s not nearly enough. I currently have an 80% gold allocation. Given the sorry state of the world, I’ll bet I’m going to make a lot more money than you will in stocks.”

I’m tempted to take that bet.

Sure, gold is up five-fold over the last decade and three-fold over the last five years. But that tells you nothing about where gold will be a year from now, or a month from now.

True, gold may go higher. Perhaps a lot higher. But would I bet 80% of my portfolio on it?

Not a chance. This investor – who clearly lacks experience more than confidence – may be right about the near-term direction of gold. But he’s taking a boatload of risk.

More importantly, he’s making a fundamental investing mistake…

Successful Investing Comes Down to Two Choices

When it comes to the financial markets, no one knows for certain what the future holds. That means every investor faces a stark choice.

• Either: Run your portfolio by making a series of guesses about what lies ahead for the economy and the stock market, jumping in and out of stocks, or bonds, or gold, or sector funds.
• Or: Invest according to proven, time-tested principles.

It amazes me just how many investors opt for the former, following some dubious analysis or making outlandish guesses. It’s even more surprising when you consider the stakes.

Protect and enhance your investment capital over time and you can live a life with all kinds of choices, plenty of financial security and the peace of mind that goes with it.

On the other hand, if you gamble with your savings, you might find that not only have your savings vanished but, more importantly, you no longer have enough time to make up for your mistakes.

People who grossly mismanage their portfolios almost always make the same mistake. They forget to ask that one basic question: What if I’m wrong?

A Powerful Statement From the World’s Greatest Investor

Given recent events, I understand why there’s a lot of skepticism about the outlook for stocks. The media harps on unrest in the Middle East, the spike in oil prices, the real estate slump, high unemployment and unwieldy federal deficits.

But they spend much less time on rock-bottom interest rates, low inflation, an improving economy and record corporate profits.

Listen to different sources and you can come up with completely different conclusions about the future. But here’s someone worth hearing:

Warren Buffett – the world’s greatest investor – recently told CNBC: “I’m 100% enormously optimistic about the future for this country. There’s no way you can bet against America and win… We’ve unleashed human potential and will continue to do so. Twenty years from now, your kids and grandchildren will live far better than you live.”

Most Americans don’t agree with this. Some find it completely unbelievable. That’s why The Oxford Club has put together a special report explaining why America’s best days are still ahead – and inviting you to take full advantage of a more optimistic investment outlook.

Good investing,

Alexander Green

Publisher’s Note: There was a problem with the data featured in Friday’s Investment U article, “Electric Vehicles: Green Power or Just Adding to the Pollution Problem.”

The data came from the North American Electric Reliability Corporation and indicated where power for electric vehicles would likely come from in the future, once the electric vehicle fleet has matured. We wrongly implied that the data referred to the current power grids of various U.S. regions. We regret the error and thank our readers for helping to point it out. We have corrected the article.

~ Jay Livingston, Publisher, Investment U

Alexander Green, Berkshire Hathaway, Business, Business/Finance, Chief Investment Strategist, Finance, Financial economics, financial ratios, investment, Socially-responsible investing, Warren Buffett

Why the Sun is Setting on Gold

by Alexander Green, Investment U’s Chief Investment Strategist
Tuesday, February 22, 2011

Six weeks ago, I wrote a column advising short-term speculators to sell their gold.

Since that time, the metal has drifted lower. But the brunt of the decline is likely still ahead.

As I’ve said before, gold is difficult to value under the best of circumstances. It pays no interest, has no earnings, provides no rent. What gold will be worth next week or next month is whatever buyers will pay for it at the time. And that, in technical terms, is a guess.

I’ve heard gold bugs make their case. Some are based on emotion. Others are based on political fantasies about the Federal Reserve turning us into the Weimar Republic circa 1923, or modern-day Zimbabwe.

What I rarely hear them talking about is pedestrian stuff like supply and demand…

When Buyers Become Sellers, Look Out Below

Billions of dollars have been spent building gold mines over the last few years, so it’s not inconceivable that supply could begin to outstrip demand.

Of course, demand itself is fickle.

In 2005, investors made up just 16% of total demand for gold. Today, it’s more than 40%. Gold ETFs have taken in more than $50 billion since 2004.

What will happen to the price of gold when these buyers become net sellers, as many will when it becomes clear that the party is over? Paulson & Co., a hedge fund, now holds more than $4 billion in the SPDR Gold Trust ETF (NYSE: GLD). I wouldn’t want to be standing in front of his eventual liquidation. And, like most hedge fund managers, Paulson is not a “buy-and-hold” investor.

Some bulls justify buying gold at these levels because it briefly traded at more than $800 an ounce in 1980. And they say if you simply adjust for inflation, gold should be trading at $2,300 today.

That’s weak. Here’s why…

Don’t Be Blinded by the Gold Light

Gold badly underperformed inflation – not to mention stocks, bonds, real estate and burying your money in a hole – for 20 years after 1980. Why is it suddenly destined to catch up now?

Or look at it another way: On August 25, 1999, gold traded at $252.55 an ounce. Adjusting for inflation, gold should be trading at $339.65 an ounce today.

Granted, my starting point is the 30-year-low. But then, a calculation based on the 1980 high is just as arbitrary.

It’s understandable that gold spiked during the 2007-2009 financial crisis. Gold is an excellent barometer of investor anxiety. But that crisis is over. The recession – defined as two straight quarters of negative GDP growth – ended in June 2009. And inflation is running at just 1.2%.

So why is gold still in the stratosphere?

What to Do With Your Gold Holdings Now

Yes, I know the price of food, gasoline, health care and college tuition are all going up much faster than the official inflation rate. But let’s also concede that the price of cars, computers, appliances, electronics, furniture and, not insignificantly, homes – the biggest asset most consumers will ever buy – is coming decidedly down.

Experienced investors know that after an asset has made a huge run, the little guy – forever a day late and a dollar short – starts clamoring for a piece of the action. At that point, the bloom is off the rose. It’s too late to buy and generally high time to sell.

Take my old neighbors, Sam and Brian. They lost their shirts in Internet stocks in 2000-2002. Now they’re stuck with huge negative equity in Florida condos that they bought pre-construction – a “no-brainer” in 2005.

So what are they doing with their rapidly vanishing capital today?

You guessed it. Now that gold is up five-fold in the last 10 years and three-fold in the last five years, they’re convinced that a big move lies just ahead.

Maybe. But what’s certain is that one lies just behind.

My advice? Keep your gold bullion and blue-chip mining stocks that you own as an inflation-hedge or part of your long-term asset allocation.

But if you’re counting on gold to dash higher, note that the last time investors bought into a gold mania it took more than 25 years for them to break even – not counting inflation.

As Mark Twain famously said, “History may not repeat itself. But it rhymes.”

Good investing,

Alexander Green

Arbitrage, Business/Finance, Economics, Exchange-traded fund, Federal Reserve System, Finance, Financial economics, Financial markets, gold, gold as an investment, inflation, investment, Short, USD

Would You Like a AAA-Rated, Insured Bond With An 8% Yield?

by Alexander Green, Investment U’s Chief Investment Strategist
Thursday, February 10, 2011: Issue #1447

In my last Investment U column, I made the case that fears of cash-strapped cities, counties and states causing a near-term collapse of the municipal bond market are overdone.

Yes, there will be defaults, perhaps 100 or more this year in small municipalities. That’s big in a market where the historical default rate is just .07%. But it won’t cause a domino effect or drive rates sharply higher. (Although rates could rise for other reasons.)

Why will the much-predicted municipal bond crisis fail to occur?

With Muni Bonds, Falling Supply Props Up Prices

You’ll notice that the most dire predictions always begin with the words, “If nothing is done…”

But of course, things will be done. Listen to New Jersey Governor Chris Christie and Ohio’s Governor John Kasich. They’re telling the public employee unions and others, with their hands outstretched, that the money simply isn’t there to fund their laundry lists. And there hasn’t been any political backlash. Their poll numbers are rising. In addition…

• Revenue for U.S. municipalities is increasing in this recovery, not falling. That’s putting many on a sounder footing.
• Because Obama’s Build America Bond program ended in December, municipal bond issuance will drop by 10% to 20% this year. Falling supply firms up prices.
• Tax-free munis now yield more than taxable Treasuries. Bargain-hunters will eventually swoop in to take advantage.
• The extension of the Bush taxes cuts will end in December next year. Does anyone seriously believe – with our federal deficit – that Congress will lower tax rates in the years beyond that?

Ok, let’s assume you agree that the sell off in municipal bonds is overdone and they’re due for a rebound. How do you play it?

Three Ways to Play the Muni Bond Rebound

You have three primary choices…

1. Buy a low-cost municipal bond fund.
2. Invest in a closed-end bond fund.
3. Buy individual tax-free bonds.

Let’s take the last one first. If you buy individual bonds, you’ll see their price fluctuate. But if you hang on – and there’s no default – you’re guaranteed of receiving $1,000 per bond at maturity.

Thirty-year AAA and insured tax-free bonds are currently yielding 5.1%. If you’re in the 35% tax bracket, you’d have to earn almost 8% taxable to receive that kind of after-tax return. Not bad.

Worried that the municipality and the insurer could both default? (Unlikely but not impossible.) Then buy only tax-free bonds insured by Berkshire Hathaway Assurance Co., a subsidiary of Berkshire Hathaway with a stellar AAA-credit rating. You can’t get much safer than that.

And if you don’t want to select individual bonds?

The Low-Cost Muni Bond Option

Option #1 above includes investing in a low-cost fund like the Vanguard Long-Term Tax-Exempt Fund (VWLTX). The current yield is 4.21% and the average maturity is just over 10 years.

Sure, it yields less than some individual bonds and there’s no guarantee of principal. But it will be less volatile than 20- or 30-year bonds and you can reinvest monthly dividends if you’re so inclined. (Those in high-tax states will want to choose a state-specific Vanguard fund, of course.)

Want to play a potential muni-bond rebound more aggressively, with a higher yield and greater capital appreciation potential? Go for Option #2…

Why You Should Pick Up Tax-Free Bonds Now

Consider the Nuveen Insured Municipal Opportunity Fund (NYSE: NIO).

This closed-end fund also holds a portfolio of high-grade tax-free bonds. The annual expense ratio is 1%. Although this is higher than Vanguard, it’s actually cheap by closed-end fund standards. Many closed-end funds have expenses that total more than 2% per year.

This fund currently yields 6.5% and the income is exempt from federal taxes. If you reside in the top tax bracket, you’d have to earn 10% to get this after-tax yield. Why is it so high? Because the fund is using 41% leverage, the equivalent of buying bonds on margin. If muni bond prices recover, however, this fund will really jump.

But will they? I don’t have a crystal ball. But recognize this: The yield on the benchmark index of 30-year AAA municipal bonds is higher now than in the depths of the recent credit crisis.

If you’re any kind of contrarian, now looks like a good time to pick up some tax-free bonds.

Good investing,

Alexander Green

Arbitrage, Bonds, Business/Finance, Chief Investment Strategist, Current yield, Finance, Financial economics, Governor, Municipal bond, Municipal Bond Arbitrage, Nuveen Investments

Why You Should Invest in Growth, Not Value

by Alexander Green, Investment U’s Chief Investment Strategist
Monday, December 6, 2010: Issue #1401

Patrick Henry famously declared that he knew no way of judging the future but by the past.

So if you’re putting together a long-term investment portfolio, it might be wise to look at the historical returns for various types of assets. Not just for the past few years, or for several decades, but for the past couple centuries.

When you do this, you’ll notice something interesting:

• Owning a portfolio of businesses (stocks) has generally been much more rewarding than making loans to corporations or Uncle Sam (bonds) or sticking your money in the bank (cash).
• Look closer at the clear winner (equities) and you’ll also find that value stocks have outperformed growth stocks over the long haul and that small-cap value has beaten large-cap value by a substantial margin.

It therefore follows that an investor seeking maximum capital appreciation might focus on identifying undervalued small-cap stocks.

But there’s only one problem with this: It won’t work for most investors, even if the future is very much like the past. Here’s why…

Beware the Value Investing Trap

Value stocks require something that growth stocks don’t: Patience.

When a stock – either large or small – is in the cellar, it’s there for a reason. Typical ones are that the company is:

• Losing market share…
• Seeing its margins fall…
• Is losing money…
• Or is experiencing flattish sales and declining profits.

As a value investor, you don’t know when these state of affairs will end, but you might be tempted to invest in a company if it’s relatively cheap in relation to sales, earnings or book value (i.e. net worth) in the hope that management will set things right.

The problem is this can take quite a long time. Or it may never happen at all. As the stock gets cheaper and cheaper, you may believe it’s becoming an even better bargain. This is the classic “value trap.” And if you keep buying a stock on the way down, it may very well have your name on it when it hits rock bottom.

Dead Money With Decent Dividends

Even if a value stock is destined to generate a good return over, say, a three- to five-year horizon, most investors won’t be around to enjoy it.

How do I know this? Because as a former money manager, I’ve dealt with thousands of “typical investors.” And regardless of what they say in their initial interview about their willingness to stay the course and think long-term, it all goes out the window for 90% of them when the road gets bumpy. Or if things don’t kick into gear right away.

A client who sits on a stock – or even a stock fund – for six months and doesn’t see a spark will remind you with every conversation that he or she is sitting on “dead money.”

No argument there – they are (at least temporarily). But value stocks often pay decent dividends that help compensate for this. Early in my career, however, I got tired of holding hands and counseling patience and switched from a value to a growth methodology.

It was a good move. If you want action, you should have it…

There’s No Shortage of Excitement with Growth Stocks

Buy the best growth stocks you can find. Given that they tend to be twice as volatile as the market (and twice as expensive), there is generally no shortage of day-to-day excitement.

But if you use a trailing stop, you can generate results that are much better than historical long-term returns (which always assume a buy-and-hold approach) and with less risk because your positions are fully protected.

So unless you have the patience of Job – and most investors don’t – you’re better off owning growth stocks than value stocks and, of course, using a trailing stop.

In my next column, I’ll demonstrate why small-cap growth – historically the worst-performing long-term equity class – is the very best place to find blockbuster stocks.

Good investing,

Alexander Green

Business/Finance, Finance, Financial economics, Financial markets, fundamental analysis, Growth stock, investment, Rate of return, Short, Stock, Stock market, Stock selection criteria, Value investing

Why Share Buybacks Are One of the Most Bullish Signals You Can Get

by Alexander Green, Investment U’s Chief Investment Strategist
Monday, November 8, 2010: Issue #1383

For months, U.S. public companies have sat on record piles of cash – more than $1.8 trillion. Now, many are finally putting it to work.

But they’re not hiring more workers, building more factories, or paying down debt. Instead, they’re using the money to buy back their own shares.

So far this year, companies have announced that they’ll purchase more than $273 billion of their own shares. That’s more than five times as much as last year, according to Birinyi Associates.

Some economists argue that this money could be better put to work in job-generating activities that might produce economic growth. However, management’s first obligation is to shareholders, not economists or “the public.”

And if your business outlook is cloudy, you don’t want to commit that cash to building new manufacturing facilities or taking on new employees that aren’t needed.

Regardless of whether you’re an individual or a corporation, sitting on cash isn’t terribly rewarding these days, with the average money market fund paying less than one tenth of one percent.

So buying back shares makes good sense. Why?

The Share Buyback Boost

Because when you divide net income into a smaller number of shares outstanding, you get greater growth in earnings per share. And ultimately, that’s what drives share prices higher.

(If the economy shows more promise down the road, a firm can always do a secondary stock issue to raise capital for expansion.)

A partial list of companies that announced major share buybacks last month includes:

• PPG Industries (NYSE: PPG),
• Cypress Semiconductor (Nasdaq: CY),
• eBay (Nasdaq: EBAY),
• Weight Watchers (NYSE: WTW),
• EMC (NYSE: EMC),
• Coca-Cola (NYSE: KO),
• Walgreen (NYSE: WAG),
• Iron Mountain (NYSE: IRM),
• Family Dollar (NYSE: FDO),
• And Chevron (NYSE: CVX).

In addition…

• Two months ago, Microsoft (Nasdaq: MSFT) borrowed $4.75 billion by issuing new bonds at rock-bottom interest rates and announced that it would use a significant portion to buy back shares.
• In August, Hewlett-Packard (NYSE: HPQ), the world’s biggest maker of personal computers, said it would spend $10 billion buying back its shares.
• A few months earlier, snack-food giant Pepsico (NYSE: PEP) said it would buy back $15 billion in common stock over the next three years.
• Washington Post (NYSE: WPO) authorized executives to buy back as much as 750,000 shares of its Class B shares.

Why Share Buybacks Are Important… And What They Mean for the Market

Many investors recognize the importance of top executives buying back their own companies’ shares with their own money at current market prices (i.e. insider buying).

But they underrate share buybacks because they sometimes don’t do anything more than offset the new shares created by option compensation. (And, indeed, that is occasionally the case.)

But when a company announces a major buyback, it often means the executives and board of directors are betting their jobs that the company’s shares are undervalued.

Why? Because if management spends tens of millions of dollars of the firm’s money buying shares back and the stock is sharply lower in six months or a year, they may well be out of a job.

Yet history shows that share buybacks are generally well-timed. It’s a positive development for shareholders.

And the large number of share buybacks announced this year is yet another reason why the market should keep trending higher.

Good investing,

Alexander Green

Business, Business/Finance, Finance, Financial economics, Share price, Share repurchase, Stock, Stock market, Treasury stock

The Four Investment Risks You Can’t Avoid

by Alexander Green, Chief Investment Strategist
Monday, October 18, 2010: Issue #1368

We’re making money hand over fist – locking in significant double- and triple-digit gains – in our Oxford Trading Portfolio, Seven Deadly Sins Portfolio, Oxford All-Star Portfolio, Momentum Portfolio, Insider Portfolio and our New Frontier Portfolio.

Yet I still talk to investors every day who tell me they’re completely out of the market. When I ask them why, they always give me some variation of the same answer: They just can’t take the risk.

These investors need to wake up and smell the java. There has never been – and never will be – a time when stocks aren’t volatile and the economic outlook isn’t uncertain.

Yet nothing gives a better return over time than great stocks…

Four Wealth-Building Barriers

What these investors may not realize is that by sitting out the stock market rally, they’re taking four significantly greater risks:

• Purchasing Power Risk

Low inflation isn’t a problem now, but it’s like having a slow leak in your swimming pool. At some point, you’re likely to jump off the diving board and hit concrete.

Even low inflation is slowly draining your purchasing power. You may feel safe sitting in cash, but you’re virtually guaranteeing that inflation will outpace your asset growth. And thanks to our gargantuan budget deficit, we may face sharply higher inflation in the years ahead.

• Interest Rate Risk

Ben Bernanke and Co. took short-term interest rates to near zero. The average money market account now pays a microscopic .05%. (It will take your money more than 1,400 years to double at that rate.)

And if the Fed decides to raise rates by even one point, it will knock 3% off the value of your Treasury bonds, essentially erasing a year’s worth of returns. Bonds are not a great bet right now.

• Timing Risk

Every market timer would like to believe that he or she will be in the market for the rallies and out for the corrections. Never did the phrase “more easily said than done” ring truer.

I still talk to investors every week who are waiting for the market’s “final capitulation.” Final capitulation? The Dow is up 70% from the lows of last March. This is a bull market by any definition. Yes, it will end at some point. But if you didn’t catch the lows last year, what are the odds you’ll pick the top of this bull, which may last for years?

• Shortfall Risk

This is your single greatest investment risk – the possibility that you won’t have enough money to reach your financial goals or support yourself the way you’d like in retirement.

Talk to elderly investors who are counting nickels and the story is virtually always the same. They didn’t save enough and (depending on personality type) they were either too conservative or too aggressive with their money. It’s a sad thing when your golden years are tin-plated and it’s way too late for a do-over.

So what’s the solution?

Think Ahead and Grow Rich

In short, don’t let the perma-bears and the gloom-and-doomers talk you out of achieving your financial goals.

Yes, you should own some gold, some bonds, even some real estate. But if you don’t own stocks, where are you going to generate the returns you need to live the lifestyle you want?

No one can say where the stock market will be 15 days or 15 weeks from now. But think about your retirement. Fifteen years from now, the market will almost certainly be a lot higher.

So stop fretting over the short-term outlook and start putting money to work in great stocks to meet your long-term goals. Financial freedom is about managing investment risk… not avoiding it.

Good investing,

Alexander Green

Bond, Business/Finance, Economics, Finance, Financial economics, Financial markets, inflation, investment, investment risk, Mathematical finance, Portfolio, Retirement, Stock market