Value versus Growth; “Boy…I say, I say, boy…ya do’in it all wrong!”

One of the most pernicious fallacies spread in the investing world is the difference between value and growth investing.

Growth investing is usually described as the opposite of value investing.

Growth investing is supposed to be the practice of picking investments with rapidly growing earnings and/ or sales with no focus on valuation.

Value investing is supposed to be the practice of picking “value” investments with low statistical indications of value, like price to earnings or price to book value.

The problem with this method of categorization is that it sets up a false dichotomy. Growth is a vital input to valuation. Some practitioners may ignore growth, but by no means do all value investors ignore growth. Neither do all growth investors categorically dismiss valuation as irrelevant.

It makes no sense to me why any investor would ignore either value or growth. For starters, like I already said, growth is a key input to valuation. A company is worth its future cash flows, so you need to know what those cash flows are and how they will grow to arrive at value.

A growth “investor” that ignores value is not an investor, but a speculator. If you haven’t assessed where price is going and why based on valuation, then you are speculating (a.k.a. guessing) what will happen instead of assessing what can reasonably happen.

Growth and value investing are not opposites, they are different sides of the same coin. The people trying to draw strict distinctions between the two either don’t understand valuation, or they’re academics trying to over simplify investing so they can use computer models to do testing.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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Another fun book recommendation

My sister gave me this book for Christmas, and I’ve been loving it: Made to Stick by Chip and Dan Heath. The subtitle is “Why Some Ideas Survive and Others Die.”

It’s somewhat an extension of Tipping Point by Malcolm Gladwell in that it goes deeper into the stickiness concept Gladwell introduced.

It’s been fun to read, gives great examples, and is chock full of provocative ideas.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

A bird in the hand is worth two in the bush

I listened to an interesting lecture last week on behavioral finance by Mier Statman. He presented an interesting question that really has me thinking.

Behavioral finance is a specialized field that studies how people make human choices when it comes to financial issues. You see, economists have theorized a “rational man” that makes choices based on pure reason, without any real emotion. Most economists use this “rational man” to figure out how the economy works. Unfortunately, for the economists, real people just don’t act that way.

The example Mier Statman gave, offhandedly, in his lecture was this: if you were given the choice between $1 million guaranteed or a 50% chance for $3 million, which would you choose?

According to economic theory, “rational man” would calculated the expected value of the two options and pick the larger one. Or, 100% chance of $1 million is less than 50% chance of $3 million (or an expected value of $1.5 million), so you should choose the second option.

Usually, I scoff at such examples because I almost always pick the “rational man” option, and pity the poor mortals who can’t aspire to be “rational man.” But, in this case, I quickly chose the guaranteed $1 million. “You mean, I’m mortal!” I seemed to think.

Even after thinking about it a bit, I still would chose the guaranteed $1 million. Why? Because $1 million would really make a big difference in my life, and I wouldn’t want a 50% chance of ending up with nothing.

After thinking about it a bit, I realized that the scale of the reward madea big difference for me. Give me the same bet on a 100% chance of $100 or a 50% chance of $300, and I’d happily take the 50% chance at $300. Same goes for 100% chance of $1,000 versus a 50% of $3,000. For me, I’d still rather a 50% chance at $30,000 over a 100% at $10,000. Around $100,000 is where I start to waffle, though.

I think I’d take the guaranteed $100,000 over a 50% chance at $300,000. Why? Because, once again, $100,000 would make a big difference in my life right now, and I’d much rather have a bird in the hand ($100,000) than 2 in the bush (a 50% chance of $300,000).

Where’s your break point? $30, $300, $3,000, $30,000, $300,000, $3,000,000? At what point would you chose the guaranteed 1 over the 50% 3?

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Think winning the lottery is the key to happiness?

Contrary to fact, many believe winning the lottery would bring them happiness.

Want an anecdotal example of why this isn’t the case? Read a tragic story here: http://abcnews.go.com/2020/story?id=3012631&page=1

Want further proof? A presentation by GMO highlighted that “2 out of 3 winners spend or lose ALL of their winnings within five years.” Also, “1 out of 3 winners declares bankruptcy!”

So, why do so many people still play the lottery? It’s the triumph of hope over reason, in my opinion. Many people want a short cut to happiness.

I believe the path to happiness is doing what you love for a living. Financial success is a result, not a cause.

To achieve happiness and success, you need to work hard, add value for others, be honest and have integrity. It’s simple to say, but hard to do. Most seem to know this deep down, but are too lazy to do it.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Do the markets care about the $2.4 trillion deficit?

I read a depressing and thought-provoking article last weekend in the Financial Analysts Journal by Jagadeesh Gokhale and Kent Smetters called, “Do the Markets Care about the $2.4 Trillion U.S. Deficit?”

It was depressing in that it spells out quite clearly why the national debt is more like $63.7 trillion and the national deficit is more like $2.4 trillion instead of the reported numbers which are an order of magnitude smaller.

The big difference results because the U.S. government does not include its obligations to Social Security and Medicare in its debt and budget calculations. Hypocritically, such accounting by any private sector company would be illegal. (By the way, the government doesn’t argue with these numbers. In fact, the U.S. Treasury, the Council of Economic Advisers, the Office of Management and Budget, and the Offices of the Actuary at the Social Security Administration and the Centers for Medicare and Medicaid Services agree that such numbers are valid, and tend to provide even more pessimistic projections.)

The thought-provoking question raised in the article is: why haven’t financial markets reacted to these clearly negative numbers? If such numbers were taken seriously by financial markets, U.S. interest rates would almost certainly be significantly higher.

The authors hazard a few hypotheses on why rates haven’t jumped.

First, explicit government debt is real, whereas unfunded liabilities are not. Or, “paper debt must be paid off, but unfunded liabilities are subject to future changes in laws and could be altered.”

Second, Stein’s Law: “That which cannot go on forever won’t.” Or, “don’t worry, they’ll figure out some way to fix this.”

Third, the future is too uncertain to be predictable. Or, “there’s no need to worry because we aren’t smart enough to figure out what the future may hold, anyway.”

Fourth, foreigners will bail us out. Or, “the Chinese, Japanese and other foreigners will just keep buying our debt no matter how financially irresponsible we show ourselves to be.”

Not surprisingly, the authors don’t find any of those hypotheses satisfactory. Neither do I.

In my opinion, the market is just too short term oriented to care. Or, “this problem will not become a crisis for another 10 or 20 years, and I don’t take anything into account beyond the next 6 months to a year.” Judging by the way the market reacts to short term news, this sounds most plausible to me.

Our problem is that this long term issue will become short term at some point. And if those pesky foreigners decide to stop playing the game early, then rates may move up sooner than many are guessing. I’m not going to predict when this will come to a head, but I’m certainly not expecting low interest rates forever.

Disturbingly, higher interest rates will probably be accompanied by a lower dollar and higher inflation. And, this will probably be followed by slower economic growth and higher unemployment. We just better hope that rates don’t move up until the housing market rebounds, or we could really be in for a real headache.

It’s okay, though, because if you look out far enough and expect these things to happen, it’s relatively easy to plan and prepare for them.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Who has oil and natural gas?

A fascinating editorial in Forbes magazine recently (April 16, 2007, Steve Forbes) pointed out an amazing fact: 95% of oil and natural gas reserves are controlled by government owned oil companies versus only 5% for international oil companies.

I find this interesting for a couple of reasons.

First, I think it points out how ridiculous it is to blame big oil companies for oil and gas prices. If international oil companies like ExxonMobil, BP and Chevron only control 5% of oil and gas reserves, it’s simply not possible for them to control energy prices. All they can really control is their costs of production, and they should be judged by that criteria.

Second, I think it brings up an interesting question about where oil and gas prices will go over the long term.

If you believe that government owned oil companies will do an efficient job of finding, producing and bringing to market oil and natural gas, then such energy prices should be headed down.

If you believe the government controlled oil companies of Saudi Arabia, Iran, Qatar, the United Arab Emirates (UAE), Iraq, Russia, Kuwait, Venezuela, Nigeria, Libya, Algeria, Malaysia, Mexico, China, Brazil, and India will do an inefficient job of keeping supplies up with demand, then you should expect oil and natural gas prices to head up over time.

Please keep in mind that not every country has an equal vote. Saudi Arabia and Iran have close to twice the reserves as #3, Qatar. And, Quatar, UAE, Iraq, Russia, Kuwait and Venezuela have about twice as much as #9, Nigeria. (ExxonMobil, #14, has only about 1/3 as much as Nigeria)

I’m over-simplifying things a bit, but in general, the performance of investments in oil and gas companies will hinge on the market price of the commodities they produce. If exploration and production can stay ahead of demand, prices will go down. If it can’t, then prices will go up. And, judging by the low price to earnings multiples of many oil and natural gas companies, I’d say the market is guessing the government oil companies will keep up. I’m not so sure.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Savings crisis

I was blown away by an article I read at CNNMoney.com today. The article addressed the recent 2007 Retirement Confidence Survey conducted by the Employee Benefit Research Institute and Matthew Greenwald & Associates.

The survey attempted to assess how much workers are saving for retirement. It showed that nearly 50% of all workers saving for retirement have less than $25,000 saved. 68% of those with less than $25,000 saved for retirement are between the ages of 25 and 34, which didn’t surprise me much. But, what did surprise me was that half of workers between 35 and 44 and one third of workers age 45 to 55 and over have less than $25,000 saved. I thought, “What do those folks plan to do in retirement, collect aluminum cans?”

40% of respondents said they are not saving for retirement, and 34% said they didn’t have any retirement money saved at all. 25% said they had no savings at all–for retirement or emergencies or anything! Are these folks playing the lottery or what?!

30% of workers said they thought they would need to have a nest egg worth less than 5 times their current income to live in retirement. Yeh, sure, 5 times current income will work as long as they can get 16% returns in retirement, don’t mind risking a 50% chance of running out of money, and don’t mind having a declining standard of living due to inflation!

27% of workers thought they needed between 5 and 10 times their income in savings. Even assuming 7% returns, 10 times your income in savings risks a 50% chance of running out of money and a declining standard of living due to inflation.

To top it all off, 62% of those surveyed said they expected to receive a pension when they retired, even though only 41% said they knew of a pension they or their spouse had coming. How could 62% think they have a pension coming when only 41% know of a pension coming? It’s beyond me.

The best research I’ve seen says that people should plan to withdraw around 4% of their money each year to successfully navigate their way through retirement without running out of money. According to my calculations, that would require 20 times your current income assuming you spend 80% of your pre-retirement income while retired. I’m also assuming no pension or social security income, which may seem overly conservative until you consider how many people have pensions and the financial Ponzi scheme that social security is.

There’s a saving crisis in this country, and it’s nobody’s fault but the people not saving. I seriously wonder how many of those without savings or with minimal savings have spent as much time thinking about how they will put food on the table and a roof over their head in their golden years as they think about their vacations, home buying, or vehicle purchases.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.