Fusing Business Momentum and Value

Business Momentum Look at Investing from a New AngleThe following article comes from one of the best discussion board posts I’ve read. The post is republished below with the permission of the author. This enriching and entertaining article exemplifies a style of fusion investing, the fusion of business momentum and value.

I hope you enjoy reading and thinking about this article as much as I did. It’s a fantastic example of looking at things from a new angle.

What did we do right in 2009?

One year of good return may be just a result of high tide lifting all boats or simply mean-reversion from a terrible year. Nevertheless, my biggest take-away from 2009 was a subtle but important change to my investment philosophy – I have changed my focus from “good and cheap” to “better and cheap”. I care more about change in fundamentals – I prefer a bad company that is getting better over a good company with no change in story. This new philosophy has led to solid stock picking, which generally out-performed the market with what I believe to be lower risk (“permanent loss of capital”). Equally important, this new framework gives me better guidelines to size my bets, especially betting heavily in situations where both the story is getting better and stock is cheap.

When I started investing a few years ago, I was firmly in the value investing school – concepts like “intrinsic value” and “Mr. Market”, coined by Ben Graham and popularized by Warren Buffett, clicked for me instantly. I spent time studying company fundamentals, coming up with an estimate of the intrinsic value, and trying to buy at a cheap or discounted price. In short, I was trying to buy “good and cheap”, and results were satisfactory.

Balancing between business and momentum

However, I have come to realize the quality of the company and absolute discount to intrinsic value are not everything – one has also to consider the time and factors it takes for the discount to narrow, which typically depend on the business cycle. Thus my new approach comes down to balancing between value and momentum. Value refers to the price paid for the business. Momentum, not to be confused with price momentum in quant and technical analysis, refers to business momentum, i.e. how well the business is doing. Improving momentum can come in the form of higher margin, accelerating topline growth, or improving ROIC. With the exception of select great companies in their growth phase, most companies’ stock price and business momentum move in cycles/curves similar to sine waves with peaks and troughs.

These two curves are closely related – when business momentum is good, stock price tends to go up, and vice versa. However, there is often a lag between the two curves, and depending on the part of the cycle, stock price will react to the change in business momentum very differently. I believe this is the crux of investing – how you identify which part of the cycle the company is in, which drivers to watch for and which valuation metrics to use. For example, earning revision is a powerful factor but completely useless at business peaks and troughs. P/E may be a good valuation metric in general, but unadjusted for margins, it is useless or even dangerous at extremes. [I stopped highlighting here as it’s all so good the entire article should be highlighted!]

For example, assume a retailer’s intrinsic value is $20, and buying at $15 may give an expected return of 33%. However, the same $15 price may correspond to two points on the momentum curve – one where the curve is turning up (story getting better) and the other where the curve is trending down. In the former case, you will probably get to $20 in 6-12 months. In the latter case, you may have to wait 18-24 months before the retailer corrects excess inventory and produces positive SSS (curve turning up again) to reach the $20 intrinsic value.

There are two obvious problems with buying at the latter point. First, time adjusted return is obviously inferior. Second, the stock price may first plunge to $6 before recovering. While a pure value investor may think a lower price makes it a better buy (even more margin of safety), reality is that an adverse price movement will slowly but surely inject doubt into my mind. Have I made a mistake? Is this a value trap? Very seldom does stock price move down without some deterioration of business fundamentals and some changes to the initial investment thesis. So unless one has an iron stomach (I don’t), it is very tough to keep calm during the price downdraft and continue to average down.

There is an even bigger issue – if you are prepared to average down, chances are that you will not buy a full position initially, and inevitably you will end up establishing similar-sized partial positions for all new ideas. Yet some of those ideas will have good business momentum and they are your surer bets, so you lose potential profits in positions that actually have the best risk/time adjusted return.

Does quantitative investing capture business momentum?

So doesn’t quant investing capture “better and cheap”, as preached by the noted quant investor Cliff Asness? Yes and no. I believe there are two problems with quant investing. First, it mistakes cause with effect – price momentum is the result of business momentum, and while the two will resemble each other at certain part of the cycle, they will diverge significantly at critical turning points. Second, the effectiveness of various factors differs significantly from industry to industry as well as at different parts of the business cycle. Quite simply, quant investors lack the domain knowledge of each industry and use the same factors or same weightings across sectors during different points of the cycle.

For example, quant investors will universally use factors such as earning revision, revenue/EPS surprise/breadth to capture business momentum. While this does a satisfactory job overall, it will not capture key drivers for each industry, which often cannot be retrieved from standardized financial statements, such as inventory/store for retailers, or asset inflows for asset managers. Often changes in these key drivers will long precede actual changes in earnings, so generalized quant investing could easily miss the turn. As another example, six months ago, both KIRK and ARO got the highest rating in our internal quant system, yet the two retailers could not be more different in terms of where they were in the business and margin cycle, and the subsequent divergence in stock performance illustrated the flaw in the quant investing approach.

Catching the turn

I certainly do not want to leave the impression that other investing approaches are inferior. Indeed, there are many ways to achieve success in investing, and everyone needs to find approaches to fit his or her own traits. I believe I have found mine by balancing between value and momentum. Put simply, I aim to invest in situations where fundamentals are about to turn or have turned while valuation is reasonable. I am certainly not reinventing wheels here, as this is the approach advocated by both Peter Lynch (“catching the turn”) and Warren Buffett (“What we really like to see in situations is a condition where the company is making substantial progress in terms of improving earnings, increasing asset values, etc., but where the market price of the stock is doing very little while we continue to acquire it”).

Well, this approach may sound good on paper, but how many of these “perfect” situations exist, given how efficient market is with so many hungry and smart investors poring over every corner of the market? I believe these opportunities happen more often than one may think, especially if one can invest in small-cap or micro-cap land. For example, I monitor about 50 names closely in the retail industry (which I shamelessly consider to be my circle of competence). This year alone, I identified 4 separate names that fit the criteria. They respectively returned 50%, 70%, 100% and 900%.

One may counter that retail stocks have done very well in general this year and question whether throwing darts randomly would have generated similar if not better results. I would argue that much of the return (especially the out-sized ones) was hope-based, and rational investors could not have predicted those returns ex-ante with any confidence to place a big bet, as some of those names could easily turn out to be zeros. Yet in all four names I identified, I was reasonably certain of the business momentum and earning surprise, and could accordingly place out-sized bets (10%+), with confidence that even if it did not play out according to plan, I would suffer very small losses due to valuation.

While hindsight is 20/20, I could also identify at least two retail names annually over the last few years that fit my “better and cheap” criteria. So they definitely occur, and one just needs to have the patience and courage to bet big when they do come along, usually when market is bad. Those situations can occur in large-cap stocks as well, such as FDX throughout this year. FDX had over $20B market cap, was followed by 25 analysts, yet the stock was at trough EV/sales, even though earnings had bottomed and was poised to recover through cost cuts and market share gains. Earning estimates have moved up 60% in 6 months and stock went up over 150%.

As with anything in investing, there are also drawbacks to my approach. One is depth vs. width – I need to be able to identify and evaluate key drivers for the companies and industries, and this takes significant amount of time. The rarity of these “perfect” situations forces me to turn over a lot of rocks. To date, I am reasonably comfortable with retail industry, and to a much lesser degree with software, asset managers and transport industries. I may soon reach (if not already) a point where I can not physically monitor more names. The other problem is scalability – most of my top ideas are in small to micro-cap land, so it is questionable whether my approach can really handle more than say $50-100M of assets. But that will be a nice problem to have, and I suspect I will just have to make the trade-off between absolute performance and AUM.


Originally posted Mar 4, 2010 

3 Ways a Stock Should Pay You

Do you get a lot of useless mass emails? I know I do.

You know the type of emails I’m talking about. They have a catchy headline and a thin veneer of information, but really they’re simply advertising. Mutton dressed up as lamb.

Among the deluge of email noise, Tom Jacobs stands tall. I asked his permission to reprint the following email, as both it and Tom deserve more attention. I’ve followed, liked and learnt from him for 15 years. I recommend you do too.

3 Ways a Stock Should Pay You

Many people incorrectly think there is magic to stock gains and losses because they consider only price. Rather, what matters is whether the business creates what’s called shareholder value. If it does, the stock price will eventually follow. Very simple.

You’d think creating shareholder value would be the goal of every company, right? Sell products and services, take in more money than you spend, and reinvest the excess cash to earn more than if it sits in the checking account. This creates value for owners, whether of a lemonade stand, coffee shop, or Apple, and someone would pay more to buy the business-through our shares.

Yet many businesses are in business to create value for management, not owner-shareholders. And even those who try to be shareholder friendly aren’t often good at it. There are very few truly good CEOs, or every company would make shareholders better off. How do we find good management?


The Five Choices

There are five places execs can spend cash beyond what’s needed to run the business: (1) property, plant, equipment, research and development; (2) mergers and acquisitions; (3) dividends; (4) buying back the company’s own undervalued stock; and (5) paying down higher interest debt.

The first two are growth investing. Here, companies build more manufacturing and distribution facilities, hire more software developers, buy other companies and grow empires! More often than not, these fail to create a more valuable company. These investments don’t earn a sufficient return, and roughly 85% of M&A activity fails to add shareholder value. Simply, most CEOs don’t spend shareholder cash well.


The Virtuous Cash Cycle

The other three choices help prevent management from blowing our money on skittles and beer. They provide shareholder yield. Paying down debt saves on interest payments, freeing up more cash. If the company’s shares are selling at a price that places a very low value on the company, buying its own stock is a good investment. And when the company buys back shares, our shares own more of the company, and earnings and cash flow per share rise, usually leading to stock gains.

Plus, if a company pays dividends, every share it buys back eliminates paying the dividend on that share forever. If the dividend yield is 4% a share, the company “earns” 4% a year forever just by not having spend it anymore. Even more cash is available to increase the dividends, buybacks, and debt paydowns. It’s a virtuous cycle.

Despite this simple thinking, most investors avoid companies that pay dividends and buy back stock, believing their best days are over. Quite the opposite. The best days for management moon-shot paydays may be gone, but the sweet paydays for shareholders have just begun.

Don’t worry about our vibrant entrepreneurial culture. Venture capitalists and institutional investors will always provide capital for companies with new ideas, products and services to enhance our lives. However, let’s leave it to them to speculate.

Instead, we will buy cheaply and get paid. It’s as simple as that.


Tom Jacobs is the co-author of What’s Behind the Numbers? A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio. He is an Investment Advisor for separately managed accounts at Dallas’s Echelon Investment Management and serves clients worldwide. You may reach him at tjacobs@echelonim.com.

Falling knives cut deep

Don’t try to catch a  falling knife.

Do you know the game mumblety peg? As kids we called it knives and loved playing it.

Alas the mollycoddled generations will never know the thrill and the fear of throwing knives at their own and each other’s feet.

Most versions of knives involved two players and a pocket knife. Our favourite version of the game was stretch.

The object of the game is to make the other player fall over from having to spread their legs too far apart. The players begin facing each other some distance apart with their own heels and toes touching, and take turns attempting to stick their knives in the ground outboard of the other player’s feet.

If the knife sticks, the other player must move their foot out to where the knife stuck while keeping the other foot in place, provided the distance between foot and knife is about twelve inches or less. Play continues until one player falls or is unable to make the required stretch.

The ‘traditional version was also fun.

Two opponents stand opposite one another with their feet shoulder-width apart. The first player then takes the knife and throws it to “stick” in the ground as near his own foot as possible. The second player then repeats the process. Whichever player “sticks” the knife closest to his own foot wins the game.

If a player “sticks” the knife in his own foot, he wins the game by default, although few players find this option appealing because of the possibility of bodily harm. The game combines not only precision in the knife-throwing, but also a good deal of bravado and proper assessment of one’s own skills.

There is nothing quite like the fear of a knife in your foot to sharpen one’s skill assessment.

Anyway that’s  enough of a stroll down memory lane.

Falling knives

The major appeal of trying to catch a falling knives is rooted in anchoring. Coca Cola Amatil was $15 last year, it must be a bargain at $9!

Coca-Cola Amatil falling knife

Last week I confessed to anchoring when selling. Unfortunately I still occasionally fall in to the trap of anchoring with falling knives. I have been closely watching Coca-Cola Amatil (ASX:CCL) since it’s precipitous fall in April. It appeared relatively cheap. Relatively that is compared to its past multiples.

Fortunately Peter Phan of Castlereagh Equity pointed out to me there are other large Australian companies priced similarly that have better growth profiles and less execution risk than Coca-Cola Amatil.

Falling knives present numerous dangers, most of which are as painful as a knife in the foot.

  1. They can and often do keep falling. Cutting deep as they fall.
  2. Even when they eventually land they often turn in to value traps, that is the stock doesn’t rebound to capture past glory.
  3. Those stocks that do eventually bounce often don’t provide a good compound annual growth return. CAGR is the key return long term investors should focus on. If it takes too long for the investment to “work out” then a good absolute return can become a poor CAGR.

Coca-Cola Amatil is a good, but not great example of a falling knife. It has decent underlying businesses and negligible chance of falling to zero.

Speaking of zero, a much better example of a falling knife is Xero (ASX:XRO). Xero is a classic falling knife. Since XRO began falling in March, every single person who has tried to catch this falling knife has been badly cut. And those cuts could get a lot worse.

With no earnings and well heeled incumbents successfully fighting back there is no sign of the floor for Xero’s falling knife.

Xero closed today at $18. And just in case you think I’m jumping on the beat it while it’s down bandwagon, I’ve been screaming watch out below since Xero was $42.

xero falling knife xro asx

Falling knives are worthy of a place on your watch list. If they fall hard enough for long enough then they can provide sensational opportunities, with limited downside and massive upside.

Hopefully my recent purchase of Maverick Drilling at $0.16 will be a case in point.

The trick is patience. Wait, wait, wait and then wait some more. Stocks can keep falling by yet another 20 percent over and over again. Take Xero for example, it’s closing in on its fourth 20 percent fall from its March high. From here it could easily fall 20 percent twice more in normal market conditions or even 5 more times if a bear market bites.

Here’s an old post on the footwear company Crocs that illustrates just how far falling knives can drop, $75 to $0.79.

Disclosure: Please seek expert advice before playing mumblety peg. I am not authorised to provide advice on knife throwing.
Long MAD. CCL is still on my watch list.

Show me the Momo – momentum investing

Show me the money

MomentumMomentum investing or momo for short is one of a handful of reliable money making setups that persist despite the market’s awareness of them. Value and small cap stocks also continue to outperform despite market participants being aware of this for decades.

  • Momentum studies like this, Momentum Strategies by Louis Chan, Narasimhan Jegadeesh and Josef Lakonishok, reveal how past earnings surprises predict large drifts in future returns as analysts and the market are slow to respond.
  • Momentum Profits, Non-Normality Risks and the Business Cycle by Ana-Maria Fuertes, Joelle Miffre and Wooi Hou Tan. This paper shows that momentum profits are not normally distributed and that the momentum profitability is partly a compensation for systematic negative skewness risk in line with market efficiency. (You understood that, right?)
  • In this post Patrick O’Shaughnessy highlights two ways to improve the momentum strategy, that is by overlaying value or quality.
    You may think that value and momentum are polar opposites, but they work remarkably well together. Think of the combination as cheap stocks that the market is just beginning to notice. … A second way to improve the momentum strategy is to focus on companies with higher quality earnings. The simplest way to define quality earnings is by looking at non-cash earnings. The fewer non-cash earnings (which come from accruals like accounts receivable), the better.
  • For more information on momentum.

A classic momentum investing example

Australian investors need look no further than Nearmap (ASX: NEA) for a recent classic example of momentum outperformance.


Nearmap announced excellent results on the morning of August 22nd. It closed at $0.465 that day up 19 percent from $0.39.

In the close to 3 weeks since then Nearmap has put on another 22 percent, compared to the markets 1 percent decline.

Look forward not back

I believe one of the main reasons momentum is profitable is the psychological bias of anchoring. People focus on the $0.39 they could have bought Nearmap at “yesterday”. They choke on coughing up 20 percent more to buy today. This and other biases prevent them from rationally assessing the situation and buying.

I bought Nearmap on the day of it’s earnings announcement, despite already being long at around half the price. What has gone is gone, it’s useful for reference, but it’s the future that counts. Always look forward not back.

Confession time

I’ve overcome anchoring on the buy side, but where I still struggle is in selling. Here’s an example.

While enjoying a few beers — perhaps a few too many — with other analysts and fund managers I was asked about Acrux (ASX: ACR). I said I’d tried to sell at $2.10 two days prior and was foolish not to lower my price to sell that day. It was especially greedy of me as a short time prior I’d tried to sell the shares at $1.90, but missed selling on that day too. If I’d been happy with $1.90 then it was greed and anchoring keeping me from accepting $2.08.

Acrux is now 23 percent lower at $1.60. I’m not selling as that’s a fair price with the looming FDA decision. One day I hope to overcome my anchoring on the sell side.

Disclosure: I am better educated, more experienced, smarter, taller, hold more passports, have a bigger penis and am less likely to screw you over for a commissionthan almost all people accredited to provide financial advice. But this not advice, it’s for amusement only. I am not licensed to provide advice. I will talk my own book, but I won’t act contrary to what I say. While many financial professionals talk their books to enable them to sell at higher prices, I mainly talk my book so I can say “I told you so!” Annoying I know. Being right is my guilty pleasure and a personal fault, but for me it simply never gets boring or old. Yes you should feel sorry for my wife and kids, living with someone who is usually right is probably pretty annoying. But as I say to them, I wish I could find out for sure! I actually prefer being wrong, as failure is an excellent teacher. And if you believe any of this then you’re crazier than I thought.

Investing in biotech companies

Here’s what a clever guy said about investing in biotechnology companies.

After many years investing in Bio’s a few lessons that I learned have helped greatly in making money from them.

  • Charts have a place, but can’t predict those Black Swan announcements…like the data base ann…so relying on charts is very dangerous..
  • Very good deep research and experience count for a lot. That’s how the big killings are made in Bio’s.
  • BAD MANAGEMENT is the real killer, and the hardest to spot. The road to success in Aussie Bio’s is littered with wrecks from idiots sitting in CEO chairs and on Boards…
  • It [PBT] has very good management… A stable long term team who have skin in the game….
  • The successful outcome with PBT2 will make these guys Billionaires and Nobel Prize winners.. They have a very strong interest in success…
  • Management and Directors who have a lot to win or lose have much better outcomes….
  • There are enough companies that fit those rules to diversify and make a very lot of money here..
  • Finding time to do the of research is hard.

Good observations, except for calling the Prana database announcement a black swan. Most probably that was simply a clinical operations screw up. Mistakes happen all the time, so are common white swans, not black swans.

In short, dig deep, and focus on management’s ability and their skin in the game.

Here’s my last tweet on Prana  [old now] .

Prana Biotechnology ASX:PBT alert

I sold some of our Prana shares later that day at 71 cents. That trade was simple risk management. The trigger to sell Prana was the sudden deterioration of its risk reward  profile, fused with my euphoria meter peaking.

Risk management is one of the keys to long-term investment success.

I shoot for a win win strategy. Naturally I sometimes loss, occasionally badly, so here’s what I mean by win win.

  • I try to think of at least the two most probable outcomes. Then I decide what I’d have liked to have done in the event of those two outcomes occurring. That is, how would I fell like a winner in each event.
  • Then, multiply each outcome by the rough probability of the event occurring. Prior to gaining experience, a wild ass guess at the probabilities will help you think along the right lines. Always err on the conservative side.

I started writing this four weeks ago, and post it now after I  failed to implement my own rule on Psivida $PSDV.

Here’s a rough example using PSDV.

  • FDA reject 50% probability multiplied by $2 target if happens, plus FDA approve times $8 target, for a fair value of $5 [50%*($2+$8)]. At $5 PSDV had a 1:1 risk return ratio, $3 downside for $3 upside based on a binary event.

My own rules screamed trim the position. 30% would have left me felling like a winner in either event. I didn’t as I was not focused enough. Massive life change is so freaking distracting! I take a moment to think damn.

For those without a position in PSDV, now is a good time to tune in, as you may get a wonderful opportunity to buy, as I outlined back here.

Disclosusre: Long Prana and Psivida

Steven Romick – Fusion Investor

Steven Romick has the sweet smell of fusion investing. This go anywhere, buy anything, top 2% fund manager is my kind of guy.

He buys everything from great companies at a good price, to farm land. But he also gets that sectors and macro are important.

Romick covers a lot of ground in this interview with Consuelo Mack. He is the complete investor.

He looks for fear to buy cheaply from distressed sellers – people who just can’t stand it anymore or need the cash for other reasons.

Sectors mater for many reasons. From the simply yet effective rising tide lifts all boats, to the bottom up if this great company is cheap maybe others in the sector are too, sectors mater. Companies aren’t islands, they operate in sectors within industries, so it sensible to know what’s going on in the sector and to compare ratios and multiples.

In a low return environment insurers are going to find the going tough. Data centers are destined to be commoditised, so ask yourself, do you feel nimble today?

Have you ever noticed

Have you noticed that posters on finance messages boards almost exclusively post bullish views? Worse yet they shout down anyone sensible enough to venture a fearful scenario.

I wish there were more bearish views.

Fear greed spectrum

For every company there are multiple possible outcomes. Multiple scenarios across the fear-greed spectrum.

When investing it’s good to know and weight at least 3 alternatives. You could go crazy and use a Monte Carlo simulator. But 3 weighted outcomes will do.

So tell me, how many do you consider before buying part ownership in a company? And more importantly what’s your risk return hurdle?

Mine’s 3 to 1. But that’s simply to pique my interest ;-).

For every dollar I consider at risk I look for at least $3 in return. And get excited when I see over $5.

For example, if my fearful scenario for a company is a 50% loss, then the conservatively optimistic scenario has to be a 150% gain. However, these days I prefer lower risk, around 20-30% downside.

I currently have one large position that doesn’t meet my 1 to 3 hurdle. That makes me uncomfortable. Very uncomfortable, so I watch the company closely.

Moving on.

Risk return investing example

I used the following graph to highlight the attractiveness of Telstra Corporation (ASX: TLS) in January 2011. That opportunity had a 1 to 8 risk return!

Telstra was especially attractive due to multiple payoff windows that made it both an excellent short and long time frame investment. Just the type of investment I love, and suggest you look for —  excellent risk return profile and multiple payoff time frames.

Telstra Opportunity in Jan 2011

Using a risk return framework forces me to consider multiple outcomes and to look forward. It provides a rationale mechanism to overcome the noise of fear and greed. It would butter my toast if I let it! Most importantly, it forces me to consider what could go wrong.

Long live the bear.

Investing Myths: Gain Required to Make you Whole

Everyone knows Buffett’s rules number one and two, never loss money and don’t forget rule number one. They’re great rules and if we could apply more patience in our investing and weave in as many complementary rules like capital is scarce opportunities are plentiful then maybe we wouldn’t suffer many losses. My reality is that I incur losses and the same is probably true for you.

So how much profit does it take to recover from a loss? The following chart highlights conventional wisdom. The greater the loss the ever greater the gain required to make you whole again. For example a 10% loss only requires an 11%, a 50% loss requires a 100% gain and a 90% loss requires a massive 900% to make you whole again.

Scary stuff isn’t it? 10 baggers don’t come along very often.

As I said that is the conventional wisdom and one that is often used to promulgate stop losses and small position sizing opinions. I say the conventional wisdom is bollocks. It takes exactly the same percentage gain to make up for a loss. If you loss 10% it takes a 10% gain to make you whole. If you loss 90% it takes a 90% gain to make you whole.

Why conventional wisdom is wrong

Conventional wisdom is based on serial betting an entire stake. If you make serial bets (one after the other) of your entire stake then it does indeed take a 100% gain to make up for a 50% loss. Do you make serial bets of your entire stake? I doubt it. If like me you have a portfolio of stocks then you’re making parallel investments. If one investment losses 10% you are made whole by another similar sized investment gaining 10%. You never invest your entire stake in one stock, you spread your investment over many stocks.

Pull the weeds and water the flowers. Peter Lynch’s phrase was so good that Warren Buffett asked if he could use it in his annual report. While you may make a 100% loss on an initial investment, I know I have a few times, hopefully you’ll have headed Lynch’s advice and added to your winners. So your wins are magnified as they have more capital invested in them.

I’m not trying to encourage you forsake patience or forget the all important rule of never loss money, just realise that when viewed from the perspective of a portfolio some conventional wisdom is not so wise after all. Mental stop losses also make a lot sense in some cases and are almost essential for traders.

Long term investors, especially those investing in special situations, growth stocks or any other companies where major losses are a possibility should view their investments within the framework of a portfolio and cut their losers and let their winers run.

I’ll conclude with one of Peter Lynch’s 20 Golden Rules:

If you invest $1,000 in a stock, all you can lose is $1,000, but you stand to gain $10,000 or even $50,000 over the time you’re patient. You need to find few good stocks to make a lifetime of investing worthwhile.

If you want to read more then this post on position sizing is in a similar vein.

Valuable Insights from Ben Graham

ValueHuntr has generously posted a 96 page pdf compilation of 40 papers originally written by Benjamin Graham into an easy-to-read book format. If you’re interested in long term investing and value investing then ValueHuntr’s compilation is a real treat.
Here are a few excerpts I enjoyed.

[On Efficient Markets:] I deny emphatically that because the market has all the information it needs to establish a correct price the prices it actually registers are in fact correct. … Descartes summed up the matter more than three centuries ago, when he wrote in his “Discours de la Methode”: “Ce n’est pas assez d’avoir l’esprit bon, mais le principal est de l’appiquer bien.” In English: “It is not enough to have a good intelligence”—and I add, “enough information” — “the principal thing is to apply it well.” … any security analyst worth his salt should be able to make up an attractive portfolio out of this “universe.” [NYSE stocks]

[On Beta:] What bothers me is that authorities now equate the Beta idea with the concept of “risk”. Price variability yes; risk no. Real investment risk is measured not by the percent that a stock may decline in price in relation to the general market in a given period, but by the danger of a loss of quality and earning power through economic changes or deterioration in management.

Do those things as an analyst that you know you can do well, and only those things. If you can really beat the market by charts, by astrology, or by some rare and valuable gift of your own, then that’s the row you should hoe. If you’re really good at picking the stocks most likely to succeed in the next twelve months, base your work on the endeavor. If you can foretell the next important development in the economy, or in the technology, or in consumers’ preferences, and gauge its consequences for various equity values, then concentrate on that particular activity. But in each case you must prove to yourself by honest, no-bluffing self-examination, and by continuous testing of performance, that you have what it takes to produce worthwhile results.

Australian Stocks with Good ROE and Forecast Earnings Growth

I ran a screen today looking for companies with good ROE and forward earnings growth. Here are the results. I searched for 20% average two year earnings growth and ROE above 20%. The next step is to see if any of them are undervalued.

ASX Code Company Name Annual Ratio Analysis / ROE Forecasts / EPS 2 yr. avg. forecast growth
CMJ Consolidated Media Holdings Limited 20.73% 136.20%
JHX James Hardie Industries SE 72.01% 93.60%
PEM Perilya Limited 39.38% 59.70%
FMG Fortescue Metals Group Ltd 47.90% 57.90%
MCE Matrix Composites & Engineering Limited 30.31% 44.50%
BEC Becton Property Group 280.49% 44.40%
FPH Fisher & Paykel Healthcare Corporation Limited 24.43% 33.40%
SEK Seek Limited 25.36% 30.60%
MTU M2 Telecommunications Group Limited 20.98% 30.40%
JML Jabiru Metals Limited 20.33% 27.70%
CNA Coal & Allied Industries Limited 38.98% 24.90%
REA REA Group Ltd 37.63% 24.30%
SXE Southern Cross Electrical Engineering Ltd 22.24% 23.70%
ANG Austin Engineering Limited 22.23% 23.40%
BHP BHP Billiton Limited 25.70% 23.30%
CRZ Carsales.com Limited 48.59% 22.70%
MIN Mineral Resources Limited 21.15% 21.50%

Disclosure: Long MTU

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