Do you have a framework for life? For Investing? For love or at least getting some lovin’. While the guy who posed the first part of that question may have been more interested in how I answered than what I said, all I could think was, great question, I must have an answer for that.

Here it is – written in real time, so I can think more about my writing framework. The framework for this post was written outside on paper while enjoying a bright winter day communing with nature. It should come as no surprise  when I say that Being There is one of the most insightful movies of all time. Gardens and on the grander scale nature contains most answers!

Chip in if you’re reading along. Leave a comment, turn this into a discussion.

Life is a project! Life’s a game. Plan it, have fun with it. Do it! As JLP said “Make it so.”

To plan is to succeed. It was no coincidence I became an authority on SAP business wide integration and SAP Project Systems. Plan=succeed. Mere words to some, but my over arching framework. I see almost everything as a project. From working in the garden to my entire life to most worthwhile endeavors (my kingdom for a u) in business.

My life plan is on a ten year cycle, although I’ve completed the last ten year’s in seven so I’m flexible on that as I am in most things. Within each ten years there’s multiple projects all the way down to writing this post. Most things work and many repeat on multiple scales.

Just do it. Less chat more action. It’s better to take one step forward even if it is on the wrong direction, Bear Grills et al.

See, I can do detail!

Big Picture. Why? Because that’s me. For the major personality traits,  I find innate or at least learnt early the most likely theory. I’m obviously biased to how great big picture thinking is, and reinforce the superiority of my trait by concentrating on the positives (optimist) while still realising there is value in all perspectives. There’s a place for detail and it has to be done and if required I’ll do it, but my value and what I consider most valuable is synthesizing (I give up on correcting this spell checker! At least wordpress is free). Gotta love free. Freeconomics. I still own the domain payconomics, it’s an idea that can wait, as Levitt has already taken my thunder with freakonomics. Great book… but let’s get back to the story.

Synthesizing the big picture is difficult. It requires more effort, more perspective, more layering.I love doing it and do it well, very well.

Analytical

Projects have problems. Come with solutions. Know why they’re solutions and know why several layers deep. In investing, in business, in most of your external conduct in life an analytical approach will serve you well. As will being ethical. Do the right thing, always. As David Sokol recently found all it take is one mis-step to ruin a career. It’s worth re-quoting Munger

“We think there should be a huge area between what you’re willing to do and what you can do without significant risk of criminal penalty or causing losses. We believe you shouldn’t go anywhere near that line. You ought to have an internal compass. So there should be all kinds of things you won’t do even though they are perfectly legal. That’s the way we try to operate.”

Open Minded

Humans are always wrong. It’s a defining fault in this evolutionary step, to be human is a synonymy for failing…’he’s only human‘. Wrong, wrong, wrong. We’re wrong so often that it’s essential to be open minded and inquiring. You must see where we’ve come from, stand on giants shoulders and look both ways. Always question, always doubt. Oh my! Could I still rebelling against my Catholic upbringing? Nah, I think not.

Regularly toss a belief in the trash, for a while at least. Sometimes you have to retrieve discarded beliefs, smooth them out, shakes the crumbs off.

Fusion

It’s about time I did another post on fusion, particularly fusion investing. When I can type faster it’ll be a book. There is good in most things and always opportunities to learn. Take the best, while recognising the best is just your opinion.

Passion

Without certainty of belief you need passion. Passion about ideas, passion for people, for experiences and maybe for some things. I’m passionate about business and investing.

People used to fell ill over my overt passion for my wife and after 23 years that passion still lights my way. Passion in work, love and the rest of the life is essential. I’m lucky to have had so much of it.

Time – Past present future. It’s all there in front of you to see. Like everything the more you practice the better you get. See through time. The past is there and full of examples of how things transpire. Use those examples to look forward in time to see how you get somewhere. It all repeats, just the players are different.

Jump forward in time and look backwards. Do you know how you got to where you are? I sure hope so! It’s easy as you’re looking back over your life. So place yourself in the time and circumstance that you want to be, then look back to see how you got there. If you haven’t done it before, give it a burl, it’s fun. Learning only by your own experience is too slow.

Arbitrage time. Leverage time. Leverage your own time, through education, through inspiration or perspiration.

In investing the short term in crowded, time is more fruitfully deployed or at least has a higher probability of success if you focus on the long term. Though of course if you’re in a hurry the short game has the positive skew. Good luck with that, you’ll need it.  Most importantly do what is right for you. The long game is right for me as is a continuous investment in myself.

Invert alway invert. More broadly look from different perspectives. Solutions are best if simple, so when I can’t see a solution I know it’s time to invert. Hand in hand with perspective and time is seeing beyond things. It is essential to see beyond problems. See beyond the next quarter. See beyond the hurdles.

With the US market down heavily overnight and the Australian market falling, it’s best to invert. Down is good! Down is what you want. You want the opportunity to buy lower.

Focus. Need it. Should come easily if you’re passionate about whatever requires focus.

Capital is scarce – opportunities are plentiful. Scale that idea! From my kids pocket-money all the way to the global monetary system. In investing and in business capital is always scarce and it’s sensible allocation paramount.

Non-fiction. Hat tip to Paul Craigie for that one. Friends were stunned when Paul said he only read non-fiction. I thought how sensible and now limit myself to a couple pieces of fiction a year.

It’s all in front of us. Nature! My Garden. Growth, patience, competition, co-operation, efficiency, focus and more. The right way to do things. Humans replicating nature will be our deliverance from our current over consumption. Growth is my framework, that’s why I’m 6’5″. Growth, value, momentum, fuse them all to profit from both the weighing and voting machines.

See past the distractions to the gems beyond and then visualize the gems bloom and grow. When I look at a garden I don’t simply see the plants in front of me, I see from seedling to maturity, I see the growth. I envisage what the plants will look like and review what they did look like. Great success in investing can be found in a similar fashion.

Enjoy, smile, love, give, be thoughtful and respectful, improve yourself and all and everything around you, laugh, experience…and so much more.

Dean. Self confessed, self aware, hoping to be self actualized, ENTP, A Type who likes to listen.

This post would not be complete without the two quotes from my front page.

“The whole problem with the world is that fools and fanatics are always so certain of themselves, and wiser people so full of doubts.” Bertrand Russell, philosopher, mathematician, author, Nobel laureate (1872 – 1970)

“Too much prosperity makes men greedy and their desires are never controlled sufficiently to stop at the point of attainment.” Seneca

No related posts.

Excellent post here at Data Diary on the importance of capital, especially point 4, “Always assume the worst”.

As I’ve said many times, focus on the downside and let the upside take care of itself. Bruce Berkowitz always tries to figure out what could break his investments, from memory he even hires outsiders to try and disprove his investment ideas. Of course with St Joe’s Berkowitz had David Einhorn to do that for free! Another of my favourite saying that fits with this meme  is, capital is scare while opportunities are plentiful.

While Data Diary’s number one tip, “Size an investment according to its expected volatility“,  may sound like he is suffering from the modern finance virus and should seek medical assistance, his following comments show he is fit and well.

Rather than volatility Rohan is talking about expected risk to return. Risk despite what modern finance says has little to do with volatility. Risk is being wrong in your assessment. Risk is a permanent loss of capital. Volatility has little to do with those things. Further a share can have high volatility and still be  trending up, simply in a volatile fashion. Conversely a share can be a POS and slide to zero with little volatility. Volatility is a crutch, utilised for the sake of nice equations. Exorcism should be considered as a final resort to rid oneself of the evils of volatility, that is, if a good whack to the head doesn’t work.

In other news ADO had a massive day today, surging 20% on a massive 70M shares, 10x its average daily volume. The move was on no news, so it will be very interesting to see what develops next week.

Biota received excellent news yesterday with their second revenue stream, the antiviral Inavir (nee-Lani), posting excellent sales in Japan. The market got excited for a couple hours on Thursday afternoon on the 3.6B Yen in quarterly Inavir sales before shrugging its shoulders today, sending Biota back down to whence it came. I think the market is underestimating Inavir, while many long term holders are over-estimating the probability of Biota delivering on its potential.

Advanced Share Registry (ASW.AX) has been trading down at reasonably value, but certainly not back up the truck valuations. They continue to add customers at a respectable clip. M2 Telecommunications (MTU.AX) has likewise been trading at reasonably value. I recently took a starting position in a loss making internet company. As such it deserves no more than a small weight. If the story develops I’ll be well placed to add.

Some of my US holding are hitting highs, notably Nuance Communications and Vertex, and now provide little room for a misstep. I look forward to having more time to keep abreast of my US companies.

Australian’s should consider international investing now and over the coming months. In the not too distant future I imagine there’ll be a lot of people  wondering why they didn’t pick up some quality US and other international companies when the AUD was so strong. I recommend starting small and buying up big at Amazon or your favourite online US retailer.

Two weeks of lectures, three assignments and three exams to go.

I found Warren Buffett’s letter on the resignation of his lieutenant David Sokol interesting in what it didn’t say. Buffett didn’t ascribe to Sokol any of the qualities that he and his partner Charlie Munger value so much. There was no mention of integrity, honesty or morals. The letter addressed the letter of law, “Neither Dave nor I feel his Lubrizol purchases were in any way unlawful.”

I find whether Sokol acted lawfully or not of little interest and if Buffett and Munger are men of their word, which they most surely are, then I doubt the legality of the situation is their primary concern. Buffett and Munger expect the highest level of integrity and ethics from their partners and there is no way Sokol’s actions can be characterised as that.

Here’s what Charlie Munger said at the 2004 Wesco Meeting.

“We think there should be a huge area between what you’re willing to do and what you can do without significant risk of criminal penalty or causing losses. We believe you shouldn’t go anywhere near that line. You ought to have an internal compass. So there should be all kinds of things you won’t do even though they are perfectly legal. That’s the way we try to operate.”

Sokol went very close to the line, perhaps he even foot faulted.

I find it amazing how so many people can look at the same data and come to completely different conclusions. Well perhaps amazing is a stretch, but certainly amusing. Take a simple support line on a chart. Different technical analysts draw different support and resistance lines on the same chart because they focus on different things. While there is usually more than one right way to do something, there is often a better way. I wanted to say best, but that’s to black and white for me. Sticking with those support lines for a minute, I wonder why so many people draw them starting from the left, the furtherest point away in time. Surely the closest inflection point to now, the right most, should be given the most weight, with lines drawn backwards in time from there. But that’s really a discussion for another day, I simply wanted to set the scene by illustrating if market participants can’t agree on something as simple as a line on a chart, how the heck are they ever going to agree on whether the market is expensive or not! In short, of course there not agreement and that disagreement is what makes auction markets.

However, just as with support lines, there are better ways to assess whether the market is expensive and not such good ways. First off, looking at any one number in isolation is fool hardy. I’m talking about anyone quoting the point in time market P/E as a basis for whether the market is cheap or not. The ‘P’ is what it is, but the all important ‘E’ is a moving beast and is best looked at as average over time. Multpl.com kindly provides a S&P 500 P/E 10 chart based on Robert Shiller’s data which they update daily.  Today’s chart is below, showing the PE 10 sitting a 23.8.

Benjamin Graham introduced the idea of viewing slices of time rather than points in time, well actually it was probably some Greek philosopher, but Graham bought it to the investing public.

While the current P/E10 is historically high it is still only one metric, is backwards looking and includes a couple bad years that will soon fall off the end, yeah those stinkers of 2001 and 2002 really were around ten years ago. However the P/E 10 is what it is and at 23.8 it’s high, so we may as well have a look at what Robert Shiller’s Cyclically Adjusted Price Earnings Ratio P/E10 or CAPE for short shows the historic forward returns to be based on various P/E 10 levels. Hey do we even need to look? No we don’t, the answer is obvious, but we may as well take a look now that I’ve bought it up. As the average CAPE was just over 16 I examined the data in buckets of under and over 16, over 20 for those who like round numbers and over 23 to reflect the current level. First up is a scatter chart shows the higher the CAPE the lower returns and the fewer extremely good returns.

Scatter charts can be a bit overwhelming so I’ve also summarised  the data by average returns.

It seems pretty clear that if you want good returns you should be looking to invest when the P/E 10 is under 16, but hey at least on average the current reading of over 23 gets you better one and two years returns than CAPE’s over 16 and over 20. Without digging into the data I’m prepared to guess that simply shows the parabolic nature of market peaks. Yes the current reading is a real downer for anyone with a 3-5 year time horizon, but cheer up you’re likely to get a positive annual .25% return for the next 10 years.

It’s late and I haven’t even got to the starting point of this post, which was this great post by Vitaliy Katsenelson. VK used the following great chart to highlight that the E in earnings is as I’ve been saying  a complex beast, although it is based on simple concepts like profitability. He highlights that the current profit margin, like the current P/E 10 is at an unsustainable level and does a wonderful job of refuting many of reasons cheap market theorists currently put forward for margins won’t revert. Why is that the same people who use simplistic snap shots in time like the current P/E ratio often sit in the it’s different this time camp? Could it be that there brains are wired to fool them? Or perhaps they’re simply looking at a shorter time horizon which makes the market look cheap and from their perspective it may well be.

Putting it all together I think the above shows what is pretty obvious anyway. The US in an economic recovery, a cyclical bull market, with peak margins due to cost cutting, an abundance of near free money and current rebounding revenue making the market appear cheap when viewed through the simplistic moment in time P/E filter. While a cursory scratch at the surface highlights that forward returns may be good for a year or two, the market is priced too high for strong multi-year returns. Yes great stocks will outperform and yes  great value and growth stories exist in all markets. If you’ve got a track record of picking them and outperforming in all market conditions then keep up the great investing. Other investors should be paying attention to the in-flight safety demonstration and checking where their nearest exist is.

If the US market appears cheap when viewed through your moment in time P/E filter, then perhaps it’s time to change your filter.

“Because fund managers have certain funds which are designed to track the indicies.So once the stocks that comprise the indicies change (18th), they are forced to rebalance their holdings of securities.”

I often see this incorrect view put forward, so am posting this here as a to be expanded work in progress.

If you think about it then simply buying any companies that have been included in an index would result in market out-performance, because they the stock has to go up because indexers have to buy them. People’s next thought is that indexers buy ahead of the change date. Well then same thought goes, buying as soon as announced would lead to out-performance. Or one step further buying on anticipation of the announcement would lead to out-performance.

The reality is index funds do not buy every share in an index. There is absolutely no need for them to do so to mirror the performance of the index. Indexers buy a representative sample of the index. This generally comprises all the top companies and a selection of mid/smaller companies by industry.

There are also small cap fund managers who don’t wish to own stocks once they are included in an index.

IIRC academic research actually shows that on average inclusion in some indices results in underperformance with stocks being ejected from the index outperforming on average. I’ll try to track down the research I read.

What if Jeremy Grantham is right and this time is different? What if this secular bull commodities run doesn’t bring enough new resources online to meet the growing demand?

While there are certain to periods of weakness in demand for resources and in the very long run a revolutionary technology or fundamental change in the way we live will bring balance, over the next 20-50 years there seems to be a good chance that Grantham is right and this time is indeed different. We appear to be running out of what we currently “need”.

If that is so then the resource rich countries will do well. While the Australian market may be expensive on a USD adjusted basis right now, it is, as usual, comparatively cheaper than US markets when judged by P/E. There are also many bargains to be had in Australia which I can find no comparable ones to in the US. Take Telstra, which is yielding 10% and in the long term is likely to yield more. For Australian’s the pre-tax yield is 14%, for owning the dominate telco and best known brand in Australia. If you can point me to a US company like that please do.

If you prefer riskier, then Australian biotech and rare earth companies are more attractive than their US counterparts, compare Biota to Biocryst for an example. Lynas Corp gets ignored by US investors who fork out for less advanced and certain rare earth projects.

If you prefer the overall market then this post compares Australian All Ords to S&P500. The Australian market trades at a lower P/E to the S&P500 as it has for most of the last 20 years. However, sadly as always it is not all beer and skittles. A lot of those earnings come from the cyclically high resources sector and if China slows Australian overpriced residential real estate will provide a double whamy as banks earnings and equity is hit. Materials and financials make up 2/3′s of the S&P ASX 200. It’s fair to say Australian company earnings are subject to substantial China risk. That coupled with the currency risk deteriorates the risk return payoff for USD investors. While the AUD could strengthen in the short term, the money flow indicates a pull back is coming.

Here’s an updated chart covering the last three years.

It’s also worth noting the big four Australian banks constitute 20% of the worlds AA banks and Australia will not run out uranium, gas, coal or iron for, we may as call it forever!

Top all that off with 9% and increasing compulsory super and an endless supply of skilled labour wanting to live in Australia promising to keep our generational balance positive, Australia is, as my kiwi cousins say, “choice”. No wonder the Global Gains Fools are coming here this month.

2011 will be transformational for Telstra. I’m writing up my analysis now, but prior to publishing want to get a rough view of what people see happening with the share price this year. Is the 10% yield (14.4% grossed up) a value trap?