The Folly of Form over Substance

During every market cycle, fads happen. They become very obvious in hindsight, but the tricky part is recognizing them in real time. My prediction? Some real estate investment trusts that are currently being touted by investment analysts will be trading at the exact same prices five or so years from now (assuming the markets are rationally valued at that time.) Even if the profits grow, the countervailing force of valuation compression will be a nasty offset ensuring mediocre returns.

I’ll give an example. I just finished reviewing a company called Iron Mountain. It is a giant data manager that stores documents, communications, and official records for corporate clients. The investor community loves this stock for three reasons. It is asset light, as the majority of the capital expenditures involve securing data rather than investing in factories and real estate. It is perceived as a very scalable business because corporate clients … Read the rest of this article!

The S&P 500 Has Been Draining Investors Since 2005

When people buy shares in an Index Fund, they assume that they are buying shares in the largest companies available in the United States. You look at Apple, see its $700 billion market capitalization, compare it to the 4% allocation in the S&P 500, and figure it sounds about right. And for much of the 1950s, 1960s, 1970s, 1980s, 1990s, and 2000s, this was true. But in 2005, the S&P 500 shifted from selecting stocks based on market capitalization to selecting stocks based on a market capitalization with a formula that takes into account the free float of the stock.

The consequence is this: Those precious businesses with high insider ownership do not become nearly as represented in the S&P 500 as the market cap of the stocks should suggest. There are 38 stocks that are underweighted in the S&P 500 compared to what the weighting would be if the … Read the rest of this article!

Investing On The Eve Of Crisis

Lately, I’ve been doing some back-testing to try and find good answers to the following: (1) What if someone invested a lump sum in 2007 right before the financial crisis, and (2) what if that investor paid an unusually high premium for the stock even during a period of high valuations? It’s been my way of challenging the Benjamin Graham thesis that investors should focus on getting the price above all else. I wanted to test scenarios to see what happens if treated quality as your primary concern, and regarded price as a secondary matter (you can never truly get past “price matters” because paying something like 50x earnings for Coca-Cola in 1998 will take 25 years to burn off, but you can test what happens when you pay 25x earnings for a high-quality stock instead of 20x earnings.)

My testing gave me renewed appreciation for the likes of Hershey, … Read the rest of this article!

Some Stocks Are Ticking Time Bombs

There is a reason why debt matters. There is a reason why you have to dig in and study balance sheets instead of making investment decisions based on what you see pop up in a stock screener. For instance, imagine if you looked up Weight Watchers. You would see a stock generating $1.26 per share in profits and trading at a valuation of 5x earnings. That would look like a really good deal. You can reasonably think, “Hey, America has an obesity problem that is only going to get worse, and people are going to want to use services like Weight Watchers to get their BMI under control.”

This would likely lead to disaster because Weight Watchers has completely reckless management that tackled on an ungodly amount of debt during the early 2000s to repurchase stock and temporarily please Wall Street by beating expectations without giving a hoot about the … Read the rest of this article!

Charles Schwab’s Insurance Policy For Accounts Exceeding $500,000

In a sign of the times, a few readers have contacted me over the past months asking what you’re supposed to do when your brokerage account balance exceeds $500,000 and the amount of your account is no longer covered by SIPC insurance.

As many of you know, the federal government is the first backstop against institutional failure. You got $75,000 in a bank account, and the bank goes under? No problem. You’re covered up to at least $250,000. Got $125,000 sitting in a credit union somewhere? No problem. NCUA insurance has you covered for at least $250,000. And because credit unions have no shareholders, the risk of institutional failure is minimal because the credit union is run to benefit the lives of depositors and other customers whereas banks have to charge higher fees to make a profit for shareholders. Plus, there is the prospect of demutualization. Every now and then, … Read the rest of this article!