Investing Journal

As I mentioned last September, and the prior year, I’ve thought Apple’s stock has been dramatically underpriced for some time now.  In September I set my price target for AAPL at $250, which I still agree with.  I’m not sure I’d sell at that level, but I guess I’d stop recommending it as a great stock to buy at that point.

Apple released earnings yesterday, and it had its best earnings ever, but they were widely expected by analysts, so the stock didn’t budge much.  Growth is roughly 40% – 50% year over year.  8.7 Million iPhones were sold, which is 1.3M more than last quarter, which was a record.  The company has $40 billion in cash.  Do you realize how staggering that number is?  Backing out the $43 in cash from its $205 share price, and dividing by TTM earnings of $10.80 gives you an adjusted PE ratio of 15.3.  Will someone please explain to me why the market is only willing to pay 15.3 times trailing earnings for a company that’s growing at well over 30%?  It’s absurd.  The stock is easily still 20% underpriced at a minimum, and I reiterate my $250 intrinsic value calculation, and would consider raising it.

Regarding the Tablet to be announced tomorrow, personally I don’t see it selling more than 800,000 units this year, which seems about what the Kindle sells.  I just don’t see a market for it at this point, so I’m assuming it makes no impact on profits.  On the one hand I hope they make yet another thing we can’t live without, but part of me wants it to be lame so that the stock drops to 190, and I can pick up some more shares.

Jan 26, 2010

The Ivy Portfolio – By Faber and Richardson

I recently finished reading the Ivy Portfolio and found it interesting.  I’ve always been interested in Market Timing, and someone recommended this book since it covers the topic.  The authors investigate the portfolios used by Yale and Harvard’s endowments, to learn how they achieve such high returns.

Over the last 23 years, Yale has returned 16.6%, Harvard 15%, and the SP500 12%.  They now have tens of billions of dollars.  The funds split their money between stocks (US & Intl.),  bonds, real estate, commodities, hedge funds, and private equity.  They’re likely to do a regular amount of market timing because they have almost no negative years on record.

The book provided 3 suggestions for ways to construct your portfolio similar to theirs.  Since individuals don’t really have access to hedge funds or private equity, those are ignored.

1. The Ivy Portfolio: Invest 20% in each of these 5 asset classes: US Stocks, Foreign Stocks, Bonds, Real Estate, Commodities.  He also recommends more diversified approach, but it really just divides the 5 classes into 2 or 4 types each.  They recommend rebalancing, but the frequency is not really important.  Even every 5 years is fine.  Obviously at the peaks/troughs of the various classes would be perfect. (Good luck with that).  35-year returns: 9.8%, 9.7% volatility.

2. Market Timed Ivy Portfolio: This portfolio uses the above 5 asset classes, with each individual Fund being timed with a 10 or 12 month moving average.  At the end of each month, you compare the current price to the 10-month SMA, and if it’s lower you stay in cash, and if it’s higher you hold the fund.  This has the effect of selling whenever it looks like the market could have a big drop.  Those times that it does, it succeeds very well, by preserving your money in cash.  When the market rebounds quickly you’re likely to lose a few percent, but the end result is that volatility is reduced, and maximum drawdowns are reduced.  One of the biggest concerns is that during big bull markets, it loses to the market.  This could shake you out of the system just when it’s going to be most useful in the next recession or crash.  35 year returns: 11.33%, 6.9% volatility with no negative years.

There’s a variant of #2 that is to use leverage when long.  This slightly improves returns while increasing volatility greatly.  15.4% returns with 13.8% volatility.

My reservation with this system is that you lose to the market in over 50% of the years.  It’s also clear that it has a few years where it does really well, and in the average year it does worse.  The 1974, 2001, and 2008 declines are what makes this system outperform.  From 1975 through 2000 it underperformed by 2% per year.  Since it has recently outperformed in 6 of 9 years, I’m skeptical of it beating buy and hold in the short term.  The drop of volatility makes it meaningful to try for retired people instead of moving a lot into bonds.

3. Ivy Portfolio Rotation system.  This system compares the prior 3, 6, and 12 month results of the 5 asset classes, and invests only in the 1 to 3 with the best recent performance.  I like that this outperforms the SP500 in 70% of the years.  The top 2 portfolio has returned 16.4%, with 12.4% volatility, giving it the best Sharpe ratio covered in the book (.84).

Even though this 3rd portfolio was not covered deeply in the book it ended up being my favorite.  I plan to follow it in one of my retirement accounts.

In summary, like I mentioned inline, I like the ideas of all of these.  Even the basic one is better than the SP500 alone.  I like that the others are really simple, and only trade once a month.  I have a big concern though, that Commodities and Real Estate have been outperforming in the last 10 years which mean that they’re possibly overrepresented in the above, and thus potentially will underperform in the future.  Imagine what allocation you would choose if you were looking at past performance in the late 1990s.  The rotation system corrects for that generally though.

The blog http://taaforthemasses.blogspot.com/ does a great job of creating the timing signals for you, and the book has a website with some charts as well.

The Ascent of Money: A Financial History of the World - by Niall Ferguson

I recently finished the 9-CD audio book The Ascent of Money.  This book covers very broadly the history of money, including chapters on gold, banking, bonds, stocks, corporations, real estate, hedge funds, and the 2008 mortgage crisis.  I found the book to be mostly enjoyable, but with several dry parts.  He spent too much effort on specifics in some cases, such as the Dutch East India Company.  In other, more interesting topics, I found that I already knew a lot of the information.  Because of this, I can’t highly recommend the book.  If you like finance, you’ll know this stuff.  If you don’t, you’ll be bored.  If you think you’d like to read a textbook on financial history, you can check it out, because I’d say it’s slightly more interesting than a textbook.

The Afterward reads a bit like an essay on behavioral finance, that I found more interesting.  He summarizes the information well so I thought I’d include a couple interesting lists here.  The following are 3 reasons why we continue to have asset bubbles:

1. The future is uncertainty as opposed to risk (which is measurable).  Events are so unique that there aren’t enough like them to form a basis for any real probability. 
2. We assume that existing prices correctly factor in future prospects.
3. We have a notion that the majority must have a better opinion than our own, so we conform with the majority.

Here is a list of 10 heuristic biases that cause people to not make decisions rationally:

1. Availability bias. (we take into account the most available information, not the most important)
2. Hindsight bias.
3. Problems of induction. (forming rules base on insufficient evidence)
4. Conjunction or Disjunction. (acting as if 90% probability is effectively 100%)
5. Confirmation bias.
6. Contamination effects.
7. Effect heuristic.
8. Scope neglect.
9. Overconfidence in calibration.
10. Bystander apathy.

Scores:

• Interesting: Medium
• Informative: Medium
• Engaging: Low

Note, my book notes are probably more for my own benefit than yours.  A 1-page summary just can’t do any book justice.

House of Cards: A Tale of Hubris and Wretched Excess on Wall Street

I listened to this 20-CD long audio book of the story of the fall of Bear Stearns.  The book is written in a remarkably engrossing format which makes the book a really interesting read.  Amazon reviewers note that the book is likely not very technically accurate, overly focuses on specific points, and has editing issues, but I didn’t find any of these to be too distracting.  The most distracting part was the amazingly foul language used in quotes from the Bear Stearns employees.  They really didn’t show much class.  It is very fascinating to learn about how fast everything came crumbling down, with all the late meetings, and hope for buyouts and bailouts.

The book is divided into thirds: 1) The 10 days surrounding the fall of Bear Stearns. 2) The history of Bear Stearns. 3) The events leading up to the fall.  The first 3rd is by far the most interesting, and while I might have recommended skipping the rest, the author sure is a good story teller, and that makes the rest worth it as well.

So Bear Stearns was one of the leaders in Mortgage Backed Securities.  They dealt with them all the time.  They ran 2 hedge funds that were supposedly diversified, but actually had at least 50% in MBSs.  When the mortgage market deteriorated, they were hit with a lot of losses, but actually it appears that Bear Stearns’s customers, not the company itself took the brunt of those losses.  Rumors started circulating around Wall Street that the firm was in trouble, and it got caught in a vicious cycle of people losing confidence in it, and pulling their money out.

I had never fully grasped that banks operate based on confidence.  They take out short term loans, and buy long term assets.  If at any time enough people decide to run on the bank, they won’t be able to sell their long-term, illiquid assets for enough money to cover everyone heading for the exits at the same time.  Well this happened to Bear.  Even the CEO made statements that they didn’t think there was anything they could have done to prevent it.  They were not insolvent, they were just unable to renew their short-term loans, and they couldn’t make deals on the long-term stuff fast enough.  They were left wondering if people conspired to take them out.  Which you could imagine short-sellers wanting to do.

I recommend the book, especially the first third, and then you can judge for yourself if you want to read the rest.

I recently installed Windows 7 64-bit on my laptop, and found myself unable to install a driver for the Canon Pixma iP4200, which I have shared from my 32-bit version of Windows 7.  Normally you can do this by installing multiple drivers on the host machine by pointing Windows at the .inf file for the other version of Windows you want to use.  Well, Canon drivers don’t come with an .inf file.  So I contacted them, and these are the instructions, which are really easy and should work with any printer.  They’re unintuitive, so I thought I’d post them.

1. Install the driver on your client computer as if it were local.
2. In Devices and Printers, right click the printer and click on “Printer Properties” (not “Properties”).
3. On the Ports tab, add a new local port with the path to the printer. (\\Server name\Printer name).

That’s it.  Any friends in Windows want to make that more automated?

The Gorilla Game: An Investor’s Guide to Picking Winners in High Technology – by Geoffrey Moore

I just finished the 2-3 hour abridged cassette tape book, The Gorilla Game.  The premise of the book is that there is an easily identifiable pattern that technology industries follow that can make you a lot of money if you invest following the rules outlined in the book.  The rules are remarkably simple and low maintenance.  But the amazing thing to me, is that it’s a book about technology, written 10 years ago, that still seems relevant.  It’s not a strategy I plan to follow, but it’s still interesting.  I don’t particularly recommend the book, but it’s short.  I can lend you my tapes.

Principles:

• The technology industry is characterized by discontinuous innovation – new business segments periodically appear that are not evolutions of a prior technology, and are often started by new companies.
• When a new business segment is forming, the stock market frequently underestimates both the growth rate of the industry, and the length of the growth period.
• He names phases a Bowling Alley, and a Tornado phase. In the first, the business segment is slowly getting integrated by customers that are typically most tech savvy.  In the Tornado phase, almost everyone realizes that the technology will be useful.
• There are 2 classes of business segments:
• Enabling Technologies:  Winner-take-all segments like pc processors.
• Software Applications: Since you can get vendor-lock-in, there may be several small players that have success in this area.
• There are 3 types of companies:
• Gorillas – dominant leader in a segment. (such as Intel)
• Chimp – challenger to the gorilla.  (typically doomed to fail)
• Monkey – follower of the standards set by the leader.  (AMD)

This is the process:

1. Scan publications and news for business segments that may enter a tornado phase.
2. For Software Applications, buy before a gorilla emerges, because even chimps may be profitable.  For enabling technologies, wait until the tornado phase starts.  Buy stocks in all companies that may become the gorilla.
3. Track market share quarterly and consolidate holdings in the gorilla.

I’m not sure how well this will apply in a more mature technology market, where it feels like hardware is built on more standards, and software is increasingly built on advertizing, making it unclear if they will profit.  It all sounds reasonable, but I wonder if I’ll ever identify a business segment that I think will enter a tornado phase, and if I do, will the companies be public (which seems rare recently).  Anyway, the book convinced me that I should hold on to my Apple stock for longer.  I think the market is still under appreciating the growth potential for Apple, even after rising 70% since my Apple analysis post from late last year.

Note, my book notes are probably more for my own benefit than yours.  A 1-page summary just can’t do any book justice.