M&A activity is hot, hot, hot. Don't expect it to cool off before any correction. They are going to keep dancing right through the decline. Pipelines are full and you can't stop things once they get put in motion.
Many mistakes and bad deals will be done before and after the top.
They just can't help themselves.
When you're paid to dance, what do you think is going to happen. They're going to dance. And they going to keep dancing even when the music stops.
That is just the way the game is played.
The investment bankers are the last guys to call the top. Their job is to feast at the trough as long as they can. 'tis the nature of the beast.
Tuesday, July 14, 2015
Making The Case For Active Management
The key to making the case for active management is to acknowledge at the outset that you are likely to underperform (potentially quite substantially) the markets over the long term. The reason for this is you are likely to sell either too early or too late into a market correction and are likely to either buy too early or too late after a recovery. Timing entries and exits to and from the markets is incredibly imprecise and highly inefficient from a long term investment management perspective.
That having been said, what you are advocating with active management is that you are going to try and reduce your downside by actively taking money off the table when you think the odds are in your favor. The basis for this activity is managing clients emotional wellbeing. The cost of this exercise is reduced upside because you know you are unlikely to time exits and entries perfectly.
You are offering clients the peace of mind of knowing and believing that they have someone out there trying to actively protect their assets. They are willing to forgo some upside because they are happy knowing/believing that the downside is somewhat capped.
A problem occurs when the manager fails to set a stop loss or floor and follows the market down. Usually because of their own behavioral foibles.
I don't think it is unreasonable advocating active management to clients who want to believe they have some semblance of downside protection and realize that it comes at the cost of upside potential.
The problem is clients want it both ways. They want downside protection and unlimited upside potential.
Other issues related to active management are overactive management, ie. chopping and changing market position repeatedly in response to news, and operating within a probability based framework.
Active management is a not unattractive framework for wealthy UHNW investors. The reason is they should want to earn a reasonable return on their wealth in order to preserve its purchasing power and derive a risk premium but they should also want to make sure they don't expose themselves to substantial capital destruction which can happen when markets collapse. Wealthy investors should be more focused on preserving their wealth as compared to growing their wealth. Whether they are or not depends upon the individual and their risk profile.
The irony is that wealthy investors often take more risk than they should because they are 'greedy' for returns. They think because they have been successful the markets somehow owe them greater returns. This is a dangerous trap that many fail to realize until it is too late. The irony is that they seek out active management not to protect their downside but to enhance their upside. And for the most part, they are likely to be sorely disappointed.
That having been said, what you are advocating with active management is that you are going to try and reduce your downside by actively taking money off the table when you think the odds are in your favor. The basis for this activity is managing clients emotional wellbeing. The cost of this exercise is reduced upside because you know you are unlikely to time exits and entries perfectly.
You are offering clients the peace of mind of knowing and believing that they have someone out there trying to actively protect their assets. They are willing to forgo some upside because they are happy knowing/believing that the downside is somewhat capped.
A problem occurs when the manager fails to set a stop loss or floor and follows the market down. Usually because of their own behavioral foibles.
I don't think it is unreasonable advocating active management to clients who want to believe they have some semblance of downside protection and realize that it comes at the cost of upside potential.
The problem is clients want it both ways. They want downside protection and unlimited upside potential.
Other issues related to active management are overactive management, ie. chopping and changing market position repeatedly in response to news, and operating within a probability based framework.
Active management is a not unattractive framework for wealthy UHNW investors. The reason is they should want to earn a reasonable return on their wealth in order to preserve its purchasing power and derive a risk premium but they should also want to make sure they don't expose themselves to substantial capital destruction which can happen when markets collapse. Wealthy investors should be more focused on preserving their wealth as compared to growing their wealth. Whether they are or not depends upon the individual and their risk profile.
The irony is that wealthy investors often take more risk than they should because they are 'greedy' for returns. They think because they have been successful the markets somehow owe them greater returns. This is a dangerous trap that many fail to realize until it is too late. The irony is that they seek out active management not to protect their downside but to enhance their upside. And for the most part, they are likely to be sorely disappointed.
Saturday, July 11, 2015
Model Dictates
The results of my modeling generally dictate my attitude toward investing in a company. This makes sense because presumably your best guesses about the future of that company go into your models.
The problem is that in general when I model a growth stock, I generally model a contracting multiple and when I model a value stock I generally model a stable to expanding multiple.
It doesn't take a rocket scientist to work out that usual outcome there wrt recommendations.
The problem is that in general when I model a growth stock, I generally model a contracting multiple and when I model a value stock I generally model a stable to expanding multiple.
It doesn't take a rocket scientist to work out that usual outcome there wrt recommendations.
The Systemic Mistakes Of Bias and How It Infuses A Process (Disposition Bias)
As a value oriented analyst I find that 'disposition bias' infusing my whole process.
Whether it is using a higher discount rate than appropriate, or discounting growth and margins more than is likely.
I have found myself over the years moving from a 12% discount rate (or expected rate of return) to a 10% discount rate to recently using an 8% discount rate.
I have found myself moving from a normalized PE of 18x down to 15x and contemplating moving it up to 18x. I use the normalized PE to base relative PE's off for each stock.
As a value investor with the implicit cautious nature of that disposition, I tend to use growth rates and margins less than what is embedded by the current consensus.
I am sure the reverse goes for a growth oriented analyst. They are likely to use lower discount rates and higher growth rates and margins than what the current consensus has embedded into the price.
What does this all mean? It means (1) You need to know the bias of your analyst, and (2) You've got to compare your assumptions with the consensus.
Note: In a world where the current WACC or discount rate is probably somewhere around 5%, growth is king. If you use a normalized discount rate of 8%-10%, then current stock prices are not going to look so bueno. But if the game is played using a 5% discount rate, rightly or wrongly, shouldn't you get with the system and play the game the way it is currently being played? Ans. No. Because when the discount rate normalizes, then stock prices will be re-rated to a normalized discount rate.
Whether it is using a higher discount rate than appropriate, or discounting growth and margins more than is likely.
I have found myself over the years moving from a 12% discount rate (or expected rate of return) to a 10% discount rate to recently using an 8% discount rate.
I have found myself moving from a normalized PE of 18x down to 15x and contemplating moving it up to 18x. I use the normalized PE to base relative PE's off for each stock.
As a value investor with the implicit cautious nature of that disposition, I tend to use growth rates and margins less than what is embedded by the current consensus.
I am sure the reverse goes for a growth oriented analyst. They are likely to use lower discount rates and higher growth rates and margins than what the current consensus has embedded into the price.
What does this all mean? It means (1) You need to know the bias of your analyst, and (2) You've got to compare your assumptions with the consensus.
Note: In a world where the current WACC or discount rate is probably somewhere around 5%, growth is king. If you use a normalized discount rate of 8%-10%, then current stock prices are not going to look so bueno. But if the game is played using a 5% discount rate, rightly or wrongly, shouldn't you get with the system and play the game the way it is currently being played? Ans. No. Because when the discount rate normalizes, then stock prices will be re-rated to a normalized discount rate.
Friday, July 10, 2015
Investment Basics - Know Your Returns - The Return That Counts = After tax, after inflation, after costs
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Know Your Returns
Real Return: After tax, after inflation, after costs
The return that really counts is your after tax, after inflation and after costs return. Assuming a 20% capital gains tax rate, 2% pa inflation rate and 1% pa management fees. Your real after tax, after inflation, after costs return is:
Tax: $50 – 20% capital gains tax = $40 net after tax amount.
After tax gross return = ($140/$100) = 40%
After tax annualized return = {($140/$100)^(1/5)}-1 = 6.96% pa
Inflation: 2% pa = (1+.02)^5 = 1.104
After tax, after inflation annualized return = {(($140/$100)/1.104)^(1/5)}-1 = 4.86% pa
Cost: 1% pa = (1+.01)^5 = 1.051 After cost amount = ($150/100)/1.051 = $142
After costs, after tax, after inflation annualized return = {(($100+($42-20%))/1.104)^(1/5)}-1 = 3.98% pa
Gross Return
If you start
with $100 and earn $50 on that money over five years, your gross return is:
($150/$100)
- 1 = 50%
Annualized
Return
Your
annualized compound average return on that investment over time is:
{($150/$100)^(1/5)}-1
= 8.45% per annum (pa)
The return that really counts is your after tax, after inflation and after costs return. Assuming a 20% capital gains tax rate, 2% pa inflation rate and 1% pa management fees. Your real after tax, after inflation, after costs return is:
Tax: $50 – 20% capital gains tax = $40 net after tax amount.
After tax gross return = ($140/$100) = 40%
After tax annualized return = {($140/$100)^(1/5)}-1 = 6.96% pa
Inflation: 2% pa = (1+.02)^5 = 1.104
After tax, after inflation annualized return = {(($140/$100)/1.104)^(1/5)}-1 = 4.86% pa
Cost: 1% pa = (1+.01)^5 = 1.051 After cost amount = ($150/100)/1.051 = $142
After costs, after tax, after inflation annualized return = {(($100+($42-20%))/1.104)^(1/5)}-1 = 3.98% pa
Money is about more than money
Making money. Managing money. Saving money. Spending money. Giving money.
Money is about more than money.
The way we manage, think about, and act on acquiring and disbursing money is all about our values and priorities.
Money is an efficient mechanism for facilitating the exchange of value. What we do with it and how we make it and spend it is a reflection of our selves.
Money is about more than money.
The way we manage, think about, and act on acquiring and disbursing money is all about our values and priorities.
Money is an efficient mechanism for facilitating the exchange of value. What we do with it and how we make it and spend it is a reflection of our selves.
Principle # 2: Have A Plan
"Everyone has a plan 'till they get punched in the face." - Mike Tyson
“A good plan now is better than a perfect plan executed next
week.” - General
George S. Patton
Introduction
On
the face of it the value of a plan may seem self-evident, but whether you get
hit by an economic punch or have a sub-par plan, it bears repeating, because
according to the 2012 National Consumer Survey on Personal Finance, nearly 66%
of respondents did not have a financial plan. This is problematic, because in
the absence of a plan, how do you know where you are going? And, how do you
know how to get there? As Vanguard, the Valley Forge, PA fund giant puts it, “A
carefully conceived financial plan is a must-have for every investor. It’s the
blueprint that spells out the details of your short- and long-term financial
well-being.”
Purpose
Carl
Richards, author of “The One-Page Financial Plan” points out, “before you
plan…you have to know why you are planning.” Richards goes on to say, “the best
financial plan has nothing to do with what the markets are doing and everything
to do with what’s important to you – your life, your dreams, your goals.” The purpose of a plan is simple. It provides
a roadmap for your financial path. Planning is the process by
which you take stock of your life, organize your financial affairs and
better understand your values. It helps identify goals and aspirations, and
charts a course for the future. A well constructed plan reconciles hopes and
dreams with reality, imposes discipline upon the investment process, provides
peace of mind and is the basis for all future conversations. It
is your personal Rosetta Stone - the reference you return to over time.
Basic Issues
A
formal financial plan does
not need to be fancy, but it should provide an accounting of your assets,
liabilities, current and future income, risk tolerance, time horizon and goals.
Core issues addressed within the context of a financial planning conversation
are saving and spending habits, short term and long term financial goals, expected
life changes, taxes, charitable giving, de-cumulation and the passing of wealth
to heirs.
The Value Of
A Plan
A
plan communicates purpose and shows intent toward a goal, but it should also be
flexible enough to adapt to changing circumstance. It helps you to think about
the issues and align your life goals. A formal plan increases the chance of
making good decisions and decreases the chance of making bad decisions. A plan
helps remove emotion from the markets and imposes structure and discipline upon
the decision making process. A plan creates buy-in and commitment to a course
of action, and serves as something tangible against which to gauge progress. Above
all a good plan should match with your personal and emotional DNA (it is no
good having a plan if you can’t stick to it!).
Bottom-Line
A financial plan is about more than money. It is about why money is
important to you and how that translates to your life. It is an insight to the inner
individual. Having a plan is critical to establishing good financial habits
and setting a path to the future. A plan is something that moves you from being
reactive to events and circumstances, to something more measured in the
management of your financial affairs. As such, it is probably a good idea to
have a plan.
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