Saturday, January 10, 2015

[Opinion] The Long Term Investor Myth

We are all long term investors. We all invest like Warren Buffett. In fact, we hang on his every word. We are immune to market fads and invest conservatively. We are certainly not market timers.

Oh, whatever. Too bad none of us actually behave like we speak.

This was illustrated at a conference I attended. This was a conference full of investment professionals – you would think they knew better. A portfolio manager was talking about Company A. This portfolio manager was more than glowing with his praise for Company A. It seemed like a sure thing. But wait, Company A was only a good long term investment but didn’t look attractive right at the moment.

In my opinion, an investment is an investment. A company is either attractive to or it is not – the time period is irrelevant. This portfolio manager (and most others for that matter) calls himself a long term investor. His behaviour is at odds with this, however. He believes he can buy this stock cheaper in the short term. He is a closet Market Timer not a Long Term Investor.

In my opinion, we spend too much time saying things like:

  • “The market looks good for the long term but is a bit heated at the moment”
  • "I like the company not the stock”
  • “I think I will wait until I can buy it cheaper”

Now I am not saying valuation is not important or that some market timers cannot make any money. What I am saying is stop kidding yourself that you are a long term investor if you really are not. I do have to be honest though and say that I believe being a long term investor is the best way to allocate your hard earned capital. Is there a better way to build an income stream (see more here) over your working years than buying great companies which can pay decent dividends and grow their earnings ahead of inflation over the long term? I believe not.

Sunday, January 4, 2015

[Opinion] Ramble ramble on my Soap Box again… prices don’t really matter in my opinion (continued)…

So I don’t generally watch my share prices go up or go down (I don’t always get this right though… we are all humans with emotions after all). My friends often let me know that you cannot measure how your investments have done if you ignore performance. Ah but I counter you need to understand the sources of an investment return to free yourself from watching the ticker tape of stock prices go round and round.

In 1991, John Bogle first came up with a simple equation for the components of investment return. Some (read very few) academics have also done some work on this and produced a similar yet rather complex equation.

Please ignore the equation though as it is a far too complex one for what it actually means. The just of it is the investment returns are made up of three parts.
Dividend yield (the money the share pays you each year in dividends) (Most important)
The underlying earnings growth of the company
Repricing return (the change in the PE ratio) (Least important)

Now I won’t go through the effort doing any complex maths in this post as it is unnecessary and will only complicate things. I am just going to ask you to trust me if the following does not make sense.

The simplest part is the Dividend Yield.
I pay R100 for Company A at the beginning of the year
At the end of the year, Company A pays me a R5 dividend
My dividend yield is 5%

My investment return so far is thus:
Investment return = 5% + earnings growth + change in PE

Next, a company reports profits each year. This is also relatively easy to understand. For example:
Company A increases profits by 10% this year
My earnings growth is 10%

My investment return so far is thus:
Investment return = 5% + 10% + change in PE

The last component is the most difficult to explain. Luckily, it is the part the matters the least. Unfortunately, a lot people obsess about PE ratios. The research I have seen is that the return generated from this last factor accounts for the least amount of total return. Some studies have even shown it to be close to zero percent in most markets (See Arnott and Bogle’s books).

Here goes a explanation. Stocks trade on PE multiples (or ratios). For example, say a company earns R1 a year and its share price is R10. It will have a PE ratio of 10. I.e. Share Price divided by earnings equals 10.0. PE ratios tend to change in the short depending on the mood in the market and it often seen as speculative in nature.

If this ratio increases to 10.3 and the company still earns R1, it means that the price must have increased. This change in the P/E ratio is the last component of return. The change here is 3%.

My investment return so far is thus:
Investment return = 5% + 10% + 3%

The total investment return is 18%.

So why should you care? The point is that you should worry about the two components of return you have some modicum of control over. You can construct a diversified portfolio of companies which pay a healthy dividend and are able to grow their earnings on average a little bit ahead of inflation every year. The information is readily available. Forget about PE ratios. Forecasting whether company is going to trade on a 10 or 11 PE at year end is a mug’s game. If you follow this conservative and disciplined investment approach you are setting yourself up for a better than average investment return over the long term.

*The above is a simple depiction of the Grinold and Kroner equation. This has purposely been done. For those interested in finding out more, please see here.

*This is not financial advice either. Always consult a financial advisor (one that is decently priced though) before making any financial decisions.

Wednesday, December 24, 2014

Review: The Frackers: The Outrageous Inside Story of the New Energy Revolution

The Frackers: The Outrageous Inside Story of the New Energy Revolution
The Frackers: The Outrageous Inside Story of the New Energy Revolution by Gregory Zuckerman

My rating: 4 of 5 stars

What exactly is fracking and what is this whole uproar? That is the question I asked myself and why I bought this book. I enjoyed the book. It was well written in a story-telling manner. While you certainly will not be an expert on fracking after reading this book, it is a nice introduction and history of it. Recommended.

View all my reviews

Tuesday, December 9, 2014

[Opinion] A rambling... what is the real point of investing your money?

If you ask Average Joe why you should invest in property or shares, they will tell that you should do it because their prices will increase over time. In my opinion, this belief is fundamentally wrong. Surely, we invest to replace income from working with income from investments.

Let me tell you what I mean... every month, quarter or however so often we should be buying shares (or any other investment) that generate a regular income. The first goal should be for your portfolio to generate one month's worth of your annual salary (or whatever amount you think you need to live off). Then after that aim for two months and then three months and so on. The end goal to be able to replace your annual salary with the income generated by your investments.

I think we become so fixated on the price of our investments and whether they are going up or down that we lose sight of the bigger picture. I propose forgetting about the price return of your portfolio (I can hear asset managers who focus on selling investment performance protesting). Rather focus on the income. Specifically, focus on your "Income Replacement Ratio".

Income Replacement Ratio = (Annual Investment Portfolio Income)/(Annual Salary)
If you aim to achieve an Income Replacement Ratio of 100% then you are in the pound seat. It is not something that can be done overnight either. It requires a few key ingredients:

  • Investing in companies that generate real (i.e. inflation beating) dividend growth (this is necessary as your annual salary will hopefully increase over time) 
  • Regular investments (invest at least monthly)
  • Start early (don't leave this until you are 10 years to retirement. And trust me if you get this investment thing right and have a bit of good fortune you will be retiring well before you are 65).
  • Patience and staying the course (don't get caught up with latest investment fads)
  • Stop stressing about the macro factors (who would have thought the oil price would be 40% lower than it was a couple of months ago. Invest through cycles)
I am sure I have left off a couple ingredients but I think you get the picture. Thanks for reading my ramblings...

[Bill Gates] Online, All Students Sit in the Front Row

One of my favourite websites is It is an online learning website. I have said before that I believe this is the future of learning. Bill Gates recently wrote a blog post about online colleges in the US and the great work they are doing. They are making it more affordable and accessible for people to have access to higher education. Bill's post can be found here.