Tag: business

Both poker and investing are games of incomplete information. You have a certain set of facts and you are looking for situations where you have an edge, whether the edge is psychological or statistical. – David Einhorn

David Einhorn, who is the founder and president of Greenlight Capital, manages a $10 billion “long-short value-oriented hedge fund.” David started Greenlight Capital in 1996 with only $900,000 and he has generated roughly a 20% annualized return for investors.  David has taken advantage of misinformation from the media and used his edge to post outsized gains.  The media has recently turned its attention on deflate-gate. We will describe how Einhorn would make an investment decision using incomplete information on the subject of deflate-gate.

We believe that if the New England Patriots were a publicly traded company it would represent a once in a lifetime buying opportunity. The biased media coverage would have scared investors into a selling panic of Patriots shares. Since it is best not to invest with emotions, analyzing the known facts is your edge. Value investors use a method of discounting cash flows or calculating the asset value/replacement of a business. If the intrinsic value that they calculated is less than what the company is trading for in the open market than it’s a potential new buying opportunity.

The media has a very good track record of misinforming and confusing the public into making terrible investment decisions at some of the most inopportune times. As we have seen from much of the coverage of “deflation-gate”, many media members have labeled the Patriots as cheaters and liars. This rush to judgment may have tarnished the franchise brand and tainted the reputation of their hall of fame coach and quarterback but only temporarily. For an investor trying to determine whether or not to buy the Patriots stock, they would need to gain an advantage by taking all the known facts in the story and arriving at their own decision.

The one piece of information that they would need to make an investment decision would be to try and determine what happened to the air pressure in the football during the first half of the Patriots AFC championship playoff game. An astute investor would buy an NFL football and conduct their own experiment and put the ball through vigorous tests in different weather environments. One way to calculate the change in air pressure would be to calculate a physics equation called the Ideal Gas Law (pV=nRT).  This would give the value investor a statistical edge much the same how David Einhorn calculates the intrinsic value of a company. David would not rely on CNBC to give him a gut feeling whether or not to buy or sell. In the case of the Patriots, an investor would not watch and listen to ESPN talking heads test a football by throwing it around an indoor studio at room temperature.

If you were making this investment, you have done your due diligence and determined the probability of the football losing air in cold weather conditions and calculated the physics equation of the Ideal Gas Law. If the facts support your view that the Patriots are innocent than you have gained a statistical edge on incomplete information. Your new investment will have a huge payoff when the team is exonerated and the best part of it is that you just bought into one of the most successful teams in NFL history. Much like David Einhorn, we believe that the most appropriate way to make an investment decision is by using fundamental analysis rather than relying on the biased media for recommendations.

Go Pats!

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

The Dow Jones Industrial Average recently climbed to a record high of 18,000 for the first time on December 23^rd.  Investors cheered this news and the media proclaimed that the bull market was heading even higher. There was no cheering from us at Constant Guidance Financial (CGF). We reflect back on Warren Buffett’s quote from his 1997 Berkshire Hathaway shareholder letter, “Disinvestors Lose as Market Falls—But Investors Gain.” Buffett’s point was that savers are able to deploy funds more advantageously at lower prices.  The stock market is the only market where people don’t like to buy “on sale”. If you are contributing to a 401(k) or other retirement vehicle and do not plan to retire in the near future, you should be hoping for less rosier headlines.

The Dow Jones Average is up nearly 175% since the low reached in November 2009. It is hard to believe that the index was at 6,547 such a short time ago.  While we prefer not to experience a significant market correction, we do prefer lower prices. We follow Buffett’s advice, “… smile when you read a headline that says, “Investors lose as market falls. Edit it in your mind to “Disinvestors lose as market falls — but investors gain.” As fundamental investors, we tell all of our clients who invest with as that we prefer lower markets. It is much easier to find better values when prices are lower.

In our view, there are not many bargains in equity markets these days. Investor confidence is at near all time highs, international investors are piling into the U.S. markets, companies are buying back record amounts of stock, and oil prices collapsed over 40%. Moreover, companies are flush with cash, jobs are plentiful, wages are on the rise, inflation is nonexistent, consumers are in a spending mood, and investors continue to buy every dip in the market. According to Barron’s Magazine, EVERY Wall Street strategist is bullish in 2015. They all expect to see a stronger U.S. economy next year.

At CGF, we do not make future market predictions because if we could accurately predict the market like the brokerage firms attempt, we would leverage our bet multiple times and plan to retire in 2016. We believe the best way to accumulate wealth over time is to find undervalued businesses and slowly compound returns over time.  We are constantly reevaluating our clients’ portfolios and looking for new investment opportunities. In the past, we were evaluating companies with earnings yield over 6%-8%. In this current market environment, the highest quality companies are now yielding between 4%-6%. Earnings yield is the quotient of earnings per share divided by the share price. We use earnings yield because we can compare the earnings of stocks to bonds. Earnings yield is the reciprocal of the P/E.  Today’s earnings yield is low relative to historic valuations; however, it is actually high when compared with bonds, CDs, and other assets. In this deflationary environment, many investors are satisfied with an average 4%-5% earnings yield versus an investment grade corporate bond with a 2% yield that has a 5-year duration. Earnings yield continues to favor equities. If interest rates begin to rise next year, then we would assume that equity markets would become more volatile. In the meantime, we will continue to hope for lower markets for our long-term clients and are willing to hold a small cash position for our clients nearing retirement as equity valuations remain slightly elevated.

The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 actively traded “blue chip” stocks, primarily industrials, but includes financials and other service-oriented companies. The components, which change from time to time, represent between 15% and 20% of the market value of NYSE stocks.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

Those of us who watch the hit TV show Shark Tank are very familiar with the panel of potential investors who consider offers from aspiring entrepreneurs seeking capital for their ideas. As investors, we are actually all “sharks” who make capital decisions on where to invest our money. Some investors hire wealth managers to make decisions for them and others prefer to make the decisions themselves. We believe the ultimate sharks are famed investors Warren Buffett and Charles Munger but the current panel of “sharks” are all well connected and great capital allocators. The sharks are never afraid of losing money as long as they believe the odds are tipped in their favor. We believe that thinking with the same mindset as the “sharks” will help you take some of the emotions out of these volatile markets.

We are all fortunate enough to live in country that offers some of the best investment opportunities in the world. However, some investors continuously monitor the markets for economic signs that might indirectly impact their investments. These questions usually apply to current events or headlines that capture readers attention. A few questions below seem to be the ones currently being debated.

• After the enormous relief rally, has the current correction ended?
• How low will the price of energy fall?
• How will falling energy prices impact the economy in 2015?
• Will the global contagion from the slowdown occurring in the rest of the world spillover into the US?
• Is it possible that Russia will default on its debt and will Putin lose power?
• Can the deflation/recession in Europe move to the US?
• If the Federal Reserve starts to raise rates at some point, will my investments lose value?

We can state with a large degree of confidence that very few investors can accurately predict the answers to these questions. However, most of the responses you hear will make for entertaining commentary on TV. As value investors, we think it’s best to have a mindset of a “shark”. The successful investors on the Shark Tank have an entirely different set of questions they try to answer before taking ownership in the business.

• How long will it take me to get my cash back and how much can this investment return?
• What is my potential downside risk in this investment?
• How much money can I possibly lose vs. the potential for upside?
• Do I understand how this investment works and what are the potential risks?
• Is this a scalable opportunity that can be leveraged?
• Are there high recurring capital expenditures to fund this investment?
• Can competitors easily replicate this idea and take market share?
• Will I be able to work with this management team/entrepreneur seeking capital?

We believe that the second set of questions is how you should be evaluating your investments. The first set of questions are all irrelevant to long-term investors who are properly diversified to their risk tolerances and goals. The second set of questions are much more relevant to making ongoing capital allocation decisions. If you think of yourself as a “shark”, your investment process will be much more decisive and your long-term investment results may improve.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.