I’m confident most of my readers are familiar with Pareto’s Principle, commonly called the 80/20 rule. While the rule started life as a formula to describe the distribution of wealth, it has since found many applications. I’m currently banging my head up against the 80/20 studying for my first exam in 17 years. I’m quietly confident my study thus far will yield 80%. Applying Pareto’s Principle tells me it will take 4 times as much effort to get that last 20%, that’s scary.

I recall being asked by a fellow student if marks mattered. My reply was that I’d interviewed many people and not once did I give much weight to the marks they’d received. I forgot to mention anyone with poor marks would never have even got in front in me. So why should I bother putting in so much more work for the final 20% of marks? The answer is I’m not. I’m not doing it for the extra 20% of marks, I’m doing it as I want to learn this information and retain it.

Retaining the information and folding it into knowledge is what I consider a novel approach. I used to love exams and preferred subjects to be 100% exam based. That’s because I had a phenomenal capacity for short term storage and regurgitation. I was an expert at stick it in and spit it. Sadly at my tender young age my memory is not what it was, though fortunately my knowledge is considerably greater.

This is just a quick note to say I haven’t been and won’t be posting much until after this semester’s final exam on June 16.

My suggested reading is all the articles at GMO and have a long think about their predicted seven year returns for major asset classes. For anyone interested in commodities then this article by Niels Jensen via Data Diary is a must read.

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I don’t think I need to say more.

Except….I hope those buying now are shooting their wad early. I’m standing back, forever practicing my patience, looking for any real mis-pricing opportunities. Keeping an eye on stocks showing strong support during the decline. Two small stocks I have positions in have held up strongly; AMM.AX and ASW.AX. If I had more time I’d dig into ELD and PSH as those knives keep falling and even trash bounces high if it’s compacted enough .

Here’s my plan this decline.

1. Market bounces from here, I do nothing and AKAM and MMM get called away, increasing my cash position nicely. Speaking of which I haven’t published my investometer this month. I moved some Aussie funds from our US trading account to pay down a line of credit here in Australia. I figured the secure 8% tax free average for the next year from paying down the line of credit was a great return. As it was the first time I’ve withdrawn funds from that account I need to re-jig my graph, but I’m down to around 82% (75% if called on AKAM and MMM) in our large no inflow account and 96% in our SMSF as it has the constant cash flow.

In April I sold Washington Mutual, Middleby, Penrice Soda, Bebe and Sandisk. That’s a lot for me. I’ve only made twelve other trades since start FY10 (July 1st).

I hoping today’s buyers were too early.

2. Sell in May and go away. At the start of the year I said Sell In May was my catch cry for the year.

3. Market plummets as Europe falls apart. While not probable it is an outside chance. I wait and wait and then start to buy.

Disclosure: Positions in some stocks mentioned. Bad cold making coherent thought difficult.

First let me say I don’t have the answers, but I’m confident I will have someday. I feel a quick recap of my investing past is worthwhile for the sake of this post. For almost score years I was a growth investor. Sometime during the naughties I was bitten by the value bug, perhaps it was after reading David Dreman. I then tried to fold value into my growth investing. I’m still trying.  This post continues my retrospection on what has and hasn’t worked.

Here are a few of my guiding principles applicable to investing.

1. There is no black and white.
2. There is almost never certainty and most people who are certain normally have faith rather than certainty.
3. Mistakes are in a way considerably more valuable than successes.
4. Keep it simple.
5. Happiness, enjoyment and play old fun are among the numerous things more important than money.

You may disagree with one or all of those, it would be a boring world if we all agreed. That is not a definitive list, they are simply the first five principles that popped into my head. The numbers are meaningless, except that it makes it easier to refer back to them.

Before I continue, the above picture is by my six year old daughter. She discovered Paint last week and has been producing art at pace every since. The other day when she was having a problem applying a colour she sheepishly came to me to confess that she’d used up all the blue on my computer and could I get some more. It seems she does not yet have a mental divide between the physical and digital worlds.

Where was I? Principles. I find balancing number four with one and two is incredibly difficult. It would be simpler to adopt one approach than to try and fuse multiple approaches. Fortunately number five comes to the rescue, I enjoy the challenge and find investing a lot more fun trying to forge my own path rather than following a clearly sign posted road. My aim is to achieve fusion and make it simple.

Investing successes are wonderful, but it is my mistakes I find more instructive. With that in mind let’s dig into Netflix. I’ve invested successfully in Netflix a few times, most notably for a double from June 07 to Feb 09, when I parted ways for a price around $40. Fourteen months on Netlix (NFLX) closed last night at $100. With patience my 100% gain could have been a 400% gain. So why did I sell? I think my mistake was applying value thinking to a growth stock during the sell decision. I’ll say that again, applying value techniques to when to sell a growth stock is a mistake.

I believe momentum works, i.e. stocks which have outperformed over the last period (various definitions of period exist, but let’s say 6-12 months) are likely to outperform gong forward. However, most of the same studies show that longer term outperformance generally results in future underperformance, i.e. eventually companies revert to the mean. I knew the Netflix story well and it’s growth was reasonably certain as it had successfully fought of all challenges and most importantly the CEO has the same fist name as my son, Reed. So why did I sell? As I said in Jan 2009 “It is now essential to value the company and trim or sell if NXLX becomes overvalued.” Wrong, wrong, wrong. David Gardner at TMF patiently tried to guide me back to the growth path when I made sell calls on growth companies based solely on valuation. David loves it when analysts call stocks overvalued and I now finally realise why. Growth stocks are not about valuation, they are about the story.

Good times to sell growth stocks include when the story changes and when they reach the inevitable upper part of their sigmoid curve, when growth slows and the company begins to reverts the mean. Bad times include when the current ratios and valuation point to an overvalued company.

So where does value fit in? The buy decision. The greatest outperformance can be achieved by buying growth stocks using a value framework.  Put simply, aim to buy growth stocks when they’re cheap. That does not only restrict you to buying them early on in their growth, all growth stocks become cheap at various points along their growth cycle. That point is brilliantly illustrated by Bruce Greenwald in in Value Investing From Graham to Buffett and Beyond using Intel. It’s a fantastic book for experienced investors.

In summary, I’m going to use value to buy growth stocks and momentum to sell.  Congratulation to all Netflix longs who have remained invested  since 2007 or before.

[Update: Catching up on some discussion board reading this afternoon and I came across this comment. “Amazon is a great consumer business. Netflix is a great consumer business. Vistaprint is a great consumer business. Chipotle Mexican Grill is a great consumer business. Apple is a great consumer business. Blue Nile is a good consumer business. There have been numerous short write-ups on all of them — all based on valuation, many of which were 100, 200% and 300% ago.

My only opinion, never go short a basket of great consumer oriented businesses based on valuation arguments unless you want to get fried or have tight stop prices in place (did I really say that? Huh).” DRWHISKEY Deranged Monkey Criticism

Here’s a excellent series of podcasts from the Australian Institute of Company Directors.

These three will be loaded onto my portable computing device as soon as I choose said device. My nephew Ben put in a compelling case for the apps last night. Location sensitive mapping will be one of the first I load. If you can suggest other must have apps then fire away, I’m sure there’ll be more than simply me interested. Portable computing devices along with plethora of other chipped products will bring the  fourth wave of semiconductors? More on that later. Here are the first three podcasts I’m loading onto my phone.

• Ian Pilmer‘s “opposing views to the current dogma on global warming and climate change.
• Investing in Your Life: Your Biggest Investment Opportunities are Not Necessarily Financial.
• A Life at Work: the joy of discovering what you were born to do – Thomas Moore“

The AICD “has a membership base drawn from industry, commerce, the professions, government, and not-for-profit organisations. With more than 24,000 members, AICD has a strong presence in the business and government communities.

Membership offers discounts on education courses, receipt of the monthly Company Director journal, recognition through the use of AICD’s respected post-nominals, and extensive networking opportunities through courses, events, and the Company Directors Conference.”

A slice of my life from a year or three gone by.

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Following are my current invested levels. One of the more interesting realisations for me in preparing this each month is how much the the changing equity values effect the percent invested. I know that may seem completely obvious, but I used to concentrate more on the cash levels. I now realise that although my cash levels may change significantly that I was concentrating on the smaller part of the picture.

For example I’ve been increasing the cash levels in our growing account since November and in our larger account since January. In the growing account the cash has doubled over that time, but as the chart below shows our percentage invested has barely budged, down to 94% from 97%. As always I see more with the bigger picture. Our larger account is 88% invested and as I just said the growing is at 94%.

Here’s my investometer for the end of January showing actual percent invested in equities.

My only purchase of note was in January was Catch The Wind. I continued to accumulate cash in our SMSF and am busy investigating opportunities. Nothing tickles my fancy at the moment.

I became concerned last month when several posters on one of the discussion boards I frequent commented they had moved to fully invested. As markets were hitting new high and were priced above fair value I took that as sign to be cautious.

Quick Notes

Elders has continued its downward trend. I didn’t expect it to continue to fall so sharply and so may actually be paying attention when it crosses $1.20, which I ear marked as a point for more detailed analysis.

If you haven’t noticed the recent move in Verus Investments Limited (VIL) then wake up and take a look. This is a coulda woulda shoulda for me as I started watching late last year (yes only two months ago) when it was a third of the current price. I almost ponied up for a small amount around four cents and now with shares around nine cents I can’t bring myself to buy in. The same thing happened to me last year with the Chinese BYD. It’s no wonder I’m keen to fold momentum into my investment strategy.

490,150,553 VIL shares traded hands today. A staggering amount as there are only 630,451,589 shares on issue. That’s right 77% of shares traded hands today! Though with VIL now the favourite play toy of traders a large percentage of the shares traded today would have been the same shares swapping hands throughout the day.  What a ride for those with a ticket.

For US reader I reiterate that penny shares in Australia are a lot more common and not a reflection of the quality of the company. VIL is a highly speculative oil and gas explorer, but the price of the shares should not be used as an investment criteria.

Mauldin’s Outside the Box was big picture and very interesting this week. Following is the summary of the article by Simon Hunt, though the summary in doesn’t do justice to the excellent article.

In summary, global economic recovery will disappoint as set out below:-

• Growth will slow in the first half of this year
• It should recover late this year with a modest recovery likely in 2011.
• The seeds of the next credit crisis have been sown by soaring government debt and monetary largesse. It may well be the need for a huge issuance of government loans that will cause the next credit crisis, starting around 2012 and reaching its apex in 2013.
• A new global recession, part of the ongoing depression, will begin that year and last at least two years.
• The world is unlikely to begin a new period of sustainable growth until 2018 at the earliest.
• Until then markets will remain volatile and should be traded rather than now making long-term investments.

I think you should be looking at buying LEAP Calls on some of them! Or bull spreads on a group of them.

Take MMM 2011 Calls. Picking one at random without calculating the best strategy:
50 – 70 call spread will cost around $5.50 with profit of $14.50, that’s almost a 1:3 risk reward for a return of SP to $10 less than the -2 line! MMM 25 Year Chart

Heck sell the $40 2011 Put and you’ll get a small credit and the entire upside for the risk of owning MMM at $39.

me March 19 2009

It seems the emotional Dean controls the transactions and he doesn’t listen to the rational Dean. I’m going to work on that.

In other news the IMF revised up global growth forecasts. I wish the market would hurry up and get really overvalued so I sell up in time to concentrate on my studies this year!

Grantham’s latest quarterly is a fantastic read. If only we could clone Grantham and install him as overlord of the world. At the end of the letter Grantham shares his notes from the following debate.

If you’re time poor then just read Grantham’s letter and his debate notes, as he totally dominated the debate. For more videos from Buttonwood click here.

It’s wonderful that a guy in the investment industry can say the following and I hope Jeremy Cooper takes note of Grantham’s comment on fees. I believe Cooper has stated the Australian Super System requires consolidation to provide lower fees. I find that belief comical.

Let’s start with the Investment Industry component. It is so obvious in this business that it’s a zero sum game. We collectively add nothing but costs. We produce no widgets; we merely shuffle the existing value of all stocks and all bonds in a cosmic poker game. At the end of each year, the investment community is behind the markets in total by about 1% costs and individuals by 2%.

And the costs have steadily grown. As our industry’s assets grew tenfold from 1989 to 2007, despite huge economics of scale, the fees per dollar also grew. There was no fee competition, contrary to theory.

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