The Abattoir of Large-Cap Value Fund Performance

In 1993, Joel Dickson and John Shoven came up with a breakthrough insight into the investment markets that they sought to publish in the 1993 National Bureau of Economic Research under the title “Ranking Mutual Funds On An After-Tax Basis” (Working Paper 4393). The paper never got published, but it measured the 1965-1990 investment markets to conclude that churn within the portfolio of mutual funds created significant tax liabilities that meant investors achieved significantly worse after-tax returns on investment than the advertised performance of the mutual fund.

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Building Wealth, Going Nowhere

A sign of a high-quality business is not that adversity never occurs, but rather, that the core engine still remains strong even when adversity does strike. It is something that comes to mind when I study the recent performance of GlaxoSmithKline. It has been an unpopular stock for quite a few years now. It has dealt with top-level executives accused of bribery, important drugs going off patent, and a lack of clearly identifiable sources of long-term profit growth. Yet, it still has a portfolio consisting of thousands of brands that cumulatively generate 28% profit margins.

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A Lesson On Market Timing

Sometime shortly after American Express lost its Costco exclusivity, I mentioned that American Express had gotten cheap. It was making $5.70 in profits and trading in the $70s, and things tend to work out when you buy a company with brand recognition in an oligopolistic industry that pounds out strong profits year after year. The management team mentioned that earnings would take a year or two to recover from the Costco loss as earnings growth at the rest of the firm needed to catch up and get in shape for its new call of heavy lifting, and then management expected earnings per share growth in the 12% to 15% range thereafter.

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Five Year Vs. Twenty-Five Year Investing

Go dig up an old S&P Capital IQ from 2013 and look up the earnings expectations for Coca-Cola in 2018. You will see that analysts predicted the company would make $3.00 per share in 2018. At the time, the stock traded at $43 per share. Afterwards, as volume gains struggled to take foot, and as currency headwinds affected the company because only 22% of profits are made in the U.S., the figure got revised to $2.80 per share. This was a downward revision of 6.67%.

Once these revised downward forecasts began to take hold, the price of the stock seemingly got stock at around $40 for awhile. This marked a downward shift of 6.98% in the price of the stock. It is not a coincidence that the price of the stock corresponded to changes in the five-year growth expectations of growth for the company. Because there haven’t been extrinsic factors affecting valuations in the past three years–no deep changes in the economy, declarations of war, rapid increases in interest rates, or changes in world geopolitics that will still be mentioned fifteen years from now–there has been a clear relationship between the changing expectations of the company’s five year projections and the stock price.

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