It may be cheap, but is it a Goode value?
Okay, call me a glutton for punishment, but what I did this last Saturday night was type up a variety of the most useful depreciation schedules. The schedules are set up for real estate investors, but anyone who in the course of a small business needs to depreciate real or personal property might find these worksheets useful.
Excel Depreciation Schedule
Open Office Depreciation Schedule
It may not be such a good idea. A perfect market timer could have, over the last 80 years, turned $1 into $670 million. A perfectly inept market timer would have turned $100 million into $1,000. A market timer would have to be right about 70% of the time just to equal the return of a buy and hold index fund. Do you think you are that good? See the study here
One of the reasons for recommending diversification of asset classes (stocks, bonds, real estate, commodities, etc) is that since different asset classes are imperfectly correlated this will reduce volatility and risk. A recent report from Merrill Lynch shows that the correlation between different asset classes have increased over the last year. Your best bet for diversification? Short-term bonds with maturities of a 2 to 5 years. My bet is on treasuries, particularly TIPS. For my personal portfolio, I lend money on the P2P lending site prosper.com and I expect to earn an 8.5% annual return with little effort.
Article here (PDF): http://rsch1.ml.com/9093/24013/ds/20350591.PDF
If you have read and liked Phil Town’s book Rule #1, you may like the investment blog “Investmestment Jungle“. The author of this blog looks at various companies from a Rule #1 perspective.
I have yet to read Town’s book, though from what I have read about it, I have a couple problems with his investment methodology: first, it is too formulaic, and second, the strategy tends to lean towards buying growth companies. The only major valuation criteria appears to be that a stock trade below its historical average P/E. Yet this can lead to buying very expensive companies, which will be a problem if they stop growing so fast and their great returns on invested capital decrease (as it the fate of almost all companies).
One of my favorite investing blogs is Cheap Stocks. I have added a link to it on my blogroll (right hand side of the page) for your convenience. I have found such stocks as CALL (which gave me a 30% profit in a couple months) through this blog. Clyde searches for stocks trading at low multiples of their net current asset value (NCAV: current assets minus all liabilities).
The current post on Cheap Stocks is on profitable companies trading at less than 2x NCAV. Most of the companies are not that interesting to me, except for maybe Adaptec (ADPT). I will probably write more about Adaptec in the future. Following is Clyde’s list of the top 5 largest profitable 2x NCAV companies:
Ingram Micro (IM)
Sycamore Networks (SCMR)
Exar Corp (EXAR)
Adaptec (ADPT)
Farmer Brothers(FARM)
See Cheap Stocks for more details.
I track my portfolio performance on www.icarra.com and I link to those portfolios here. So I should note that icarra is currently not accounting for short sales correctly. Correct accounting of those sales would modestly reduce the performance of my iZone Quant Portfolios and somewhat reduce the recent return in my Stockpicking portfolio. On the plus side, my portfolio betas and R-squared are actually lower than shown because of this error.
I will tell you now, and I will repeat myself as necessary: I am not an expert on asset allocation. That being said, I doubt that anyone else is, either. It is impossible to describe any investing philosophy without touching on asset allocation, so following is my philosophy.
Total up all the assets of significant value you have. That includes your car, house, savings and checking accounts, expensive objects (any object worth over $1,000 is worth counting), bonds, and mutual funds and stocks.
The first key to asset allocation is that you should eliminate any high-rate debt you have. If you have bonds or mutual funds that are not in a retirement account, then you should sell them off to pay off credit card debt. It is very hard to get better returns on your stocks than the credit companies get from you. Look at paying off credit cards as a safe, easy, guaranteed investment that will yield 18%.
Now, it is my firm belief that you should always have at least six months worth of living expenses in cash-type accounts (checking accounts, savings accounts, and money market accounts). A portion of this money can be in a higher yielding short-term CD, though. Some would say this is high. At the very least, you should have two months’ worth of expenses saved. Otherwise, if an emergency comes up, you will be forced to rely upon credit card debt or to liquidate your stocks.
After you have taken care of the basics, stick the first $10,000 of your money destined for stocks into a low cost index mutual fund. I recommend Vanguard funds. This is for a few reasons. First, it ensures that even if you do something really stupid and lose the rest of your stock money, you will still be exposed to possible gains in the stock market. Second, your individual stocks may be quite volatile, and having some of your stock in an index fund will probably help you sleep at night.
Now for the rest of the money. The traditional two investments are stocks and bonds. How should you allocate how much you have in bonds versus how much you have in stocks (including your mutual fund)? Ben Graham recommended that as a value investor, you should be most highly invested in stocks when the stock market is at a low (in the depths of a bear market), and least invested in stocks when the market is at a peak (and when the future seems rosiest). How do you time when the worst of a bear market will hit, or when the peak of the bull market will come?
You don’t. All you do is gradually sell more stocks as the stock market rises, and buy more as it declines. Any cash you generate from selling you put into bonds, and when you are buying stocks, you are selling bonds. You never want to hold all stocks or all bonds, in case you are wrong and the one outperforms the other for a period of time. You do not have to perfectly time the market to do quite well using this method.
Another view on asset allocation is that it should vary with your age. The thinking is that if you are older, you will need your money sooner, and should not have as much money in stocks, which could do poorly for years. Ben Graham thought this idea was bunk, and I would agree, to some extent. While stocks as a whole may underperform bonds for a period of years, if you are doing a good job as a value investor, then the stocks you buy will tend to do okay even in bear markets. When they go down, they will tend to come back up within a period of a couple years.
Thus, I recommend a hybrid approach. As you get very old, put some money in bonds. But if you are a successful stock investor, keep investing in stocks. Also, over time, stocks have generally outperformed bonds (though this is not certain in the future). Therefore, except at the heights of a bull market, keep the majority of your investable assets in stocks.
That being said, the stock market as a whole is not cheap right now, and neither is the bond market, so an allocation of 50% stocks, 40% bonds, and 10% cash in a money market account sounds reasonable.
If even this is too much thinking (and worrying) for you, I suggest investing your retirement money in Vanguard’s excellent target-date retirement funds, which have low fees and choose your asset allocation for you.
The Kelly Criterion is a formula for choosing how large a bet to make on each trade/investment/gamble. It works for the stock market, though it was originally developed for gambling. The formula is simple: bet the proportion of your investment as defined by the ratio of expected return divided by maximum return. Expected return is what you expect in the long run.
So, the formula is: P_invest = E(r) / M(r)
where,
Proportion of portfolio to invest = P_invest
Expected return= E(r)
Maximum return = M(r)
Now, a couple of examples:
1. If you flip fair coin and win $1 if heads and lose $1 if tails, the expected return is $0 (.5 x $1 + .5 x -1). The maximum return is $1 (if heads). Therefore, the Kelly criterion suggests you bet no money ($0/$1). This makes sense, because you should not invest money where you expect to only break even.
2. You want to short Apple (AAPL) because you think there is an 80% chance the stock will go down in the next month. You think if that happens, the stock will go down 10%. You figure that there is a 20% chance that the stock will go up 5%. The expected return is 7% (.8 x 10% + .2 x -5%). The maximum gain is 10%. The Kelly formula suggests that you invest at most 70% (7/10) of your portfolio.
3. Same thing, shorting AAPL. You like the odds, so you increase your leverage by buying put options. You buy just out of the money options. Now, there is a 70% chance that your options expire worthless (-100% return) and a 30% chance that you make 300%. The expected return is +20% (.7 x -100 + .3 x 300). The maximum gain is 300%. The Kelly formula says that you should bet less than 1/15 (about 6.5%) of your portfolio (20/300).
One thing to consider is that the Kelly formula seeks only to maximize gains. If you wish to minimize portfolio variability as well, you should invest significantly less than the maximum allowed by the Kelly formula. Also, keep in mind that the formula is only as good as your guesses of probability.
I recommend a Legg Mason article on the Kelly Criterion, or this paper by Edward Thorp (who used it to great effect).
Visit Cisiova’s website for their advanced online Kelly Criterion calculator, which allows you to enter a large number of possible outcomes.
If you liked this post you may want to check out William Poundstone’s book Fortune’s Formula.
Disclosure: I own no Apple stock, long or short. Unfortunately, I did once lose money shorting AAPL. My disclosure policy never loses me money.
Here are my notes on SCEY.OB. I wish I could short it, but retail investors like you or me cannot short OTCBB stocks [edit 8/15/07--actually, yes they can, but only through certain brokers. I will deal with that in a future post]. I bet this stock will be down 90% within a year.
$265 million market cap (78.2 million shares outstanding @ $3.39 per
share) and $1 million in assets.
see article here: http://biz.yahoo.com/seekingalpha/070713/41002_id.html?.v=1
“neutral” analyst report here: http://investrend.com/Admin/Topics/Articles/Resources/466_1182751792.pdf
(not a pump & dump, but the analyst company is paid a flat fee to
cover the company. The report is way too optimistic.)
Following are notes on their assets. Yes, the predecessor company was
capitalized with 23 million shares purchased for $0.001 per share. Not
a bad return for the current CEO/President/Director/Secretary.
from: http://www.sec.gov/Archives/edgar/data/1315373/000106299307000972/for…
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Note A .
On January 31, 2007, we entered into a Share Exchange Agreement with
the shareholders of Sun Cal Energy, Corp. (”Energy”) to acquire all of
the issued and outstanding shares of common stock of Energy. Under the
terms of the exchange agreement, we will issue one share of our common
stock for each common share of Energy we purchased. On the acquisition
date, Energy had 26,925,000 shares outstanding. After we acquire
Energy, we will have a total of 78,175,000 shares of our common stock
issued and outstanding
Of the 26,925,000 shares of Energy shares issued and outstanding, our
president, Mr. George Drazenovic, owns 23,000,000. After the
acquisition, Mr. Drazenovic will own a total of 42,800,000 shares of
the 78,175,000 shares of our common stock issued and outstanding
(54.75% of our total common shares outstanding).
Energy was formed in the State of Nevada on June 2, 2006. It was
originally capitalized by Mr. George Drazenovic with $23,000 for which
he received 23,000,000 shares of Energy’s $.001 par value common
stock. During 2006, the Company received $1,125,000 in several
installments through a private offering in exchange for issuing
1,125,000 of Energy’s common shares. As discussed further in Note B,
Energy issued 2,800,000 shares of its common stock in connection with
the purchase of its oil and gas interests.
Note B.
On October 18, 2006, Energy entered into an agreement to purchase 1.5%
of 8/8ths overriding royalty in the City of Hobart lease located in
Oklahoma for $525,000 and 1,500,000 shares of its common stock. Under
the terms of the agreement, $375,000 was paid and 1,500,000 shares of
Energy common stock were issued in October 2006. The remaining
$150,000 was paid in January 2007. Energy is required to issue an
additional 1,000,000 shares of common stock following the permitting
of a second well as stipulated in the agreement.
On October 4, 2006, Energy entered into an agreement to purchase a 45%
undivided interest in 34 separate leases known as the Lokern leases in
addition to any leases taken in the prospect area. The Lokern leases
are located in California. The Company purchased its interest for
$125,000 and 1,300,000 shares of common stock. The $125,000 was paid
and 1,300,000 shares were issued in October 2006. Under the terms of
the purchase, Energy will receive 75% of the net revenue produced by
wells located on the leased properties. In addition, Energy is
responsible for its allocated share of all costs associated with the
leased properties including, but not limited to land, title, lease
bonuses, and drilling
The properties acquired by Energy are in the exploratory stage. In
valuing the properties acquired in the merger, we assigned no value to
the shares issued due to the status of the properties acquired and the
lack of marketability of the shares issued.
———————————-
Disclosure: I currently have no interest in scey.ob, although I wish I could short it. My disclosure policy is rock solid, unlike this company’s balance sheet.
Loeb Hedge Funds just filed a 13D form with the SEC, stating the funds had taken a stake in Mercer Insurance Group (MIGP) and would seek a sale or liquidation of the company. It turns out that they are not seeking a sale or liquidation–whoever filled out the form just copied that phrase from a previous 13D filing. So while MIGP was up big on Friday, it fell back down big yesterday. The revised 13D is online here. Today (Tuesday), the stock is down some more. It still looks like a good value to me, trading at a P/E of 11 and a pric to tangible book value of 1.15.
Disclosure: I hold shares of MIGP. I have an airtight disclosure policy.