Good reads from around the Web.
A late start for me today, after a too-late night at the sort of London wine bar that I fantasized about and at the same time derided when I left the provinces 20+ years ago, and where a friend actually said “Fashion is dead” with a straight face as if it were the 1980s.
The shame. Get thee to a Wetherspoons!
Unlike most value investors, I don’t say three Hail Marys and reach for the smelling salts when I come across an attractive-looking growth stock.
I’m a pretty mongrel active investor, and will consider almost anything if the price looks right.
Besides, I admire growth companies.
These are the dynamic outfits that are inventing the future. And regular readers will know I believe that the future is getting brighter every year (the woeful exception of the environment and my worries about inequality aside).
Solar power, 3D printing, wearable technology, genome therapy, cars made from graphene – bring it all on!
But as a rule I won’t be investing in it.
I applaud those few investors who through skill or luck beat the market over several decades by identifying the best growth prospects.
It must be amazing when a share you own climbs 100-fold over 25 years, as happened with those who backed Amazon after its IPO, for example.
That’s not going to happen when you invest in a popular defensive company like Unilever or GlaxoSmithKline, whatever other virtues it might posses.
The snag with growth investing is that the Amazons of the world are rare.
Even when you do identify a successful company, there’s a big difference between noticing it’s making brilliant products that could change the world, and investing in it for market-beating returns.
Indeed most stock pickers who focus on growth1 do much worse than value investors when it comes to beating the market.
They would be better off in passive index funds, like the vast majority of people.
If they must be active investors, then it’s value, quality, and small size that have a track record of delivering alpha.
The academic research suggests a basket of growth shares will underperform.
Incidentally momentum – the tendency for winning shares to keep winning – is the other premium that has been shown to beat the market, and often it’s associated with growth stocks.
But over time momentum shifts from one sector to another.
And when a growth sector falls out of favour, it falls hard!
At least technology investors get to read about science-fiction gadgets while they’re busy losing to the market.
Actually that’s a real reason why growth investors tend to do worse than value investors.
It feels great to own shares in a sexy electric car manufacturer, a biotech startup that could cure cancer, or a social media site that all your friends use.
A cluttered Facebook feed is still annoying if you’re a shareholder, but at least it’s making you money…
Compare owning shares in super-cool electric car maker Tesla with owning shares in a miserable metal basher in Northern England, a miner facing legal problems, or a liquidating investment firm that’s losing clients.
All the latter have been profitable trades for me over the years, but these value shares not what anyone wants to hear about at those mythical cocktail parties.
Because it feels great to own growth shares, people will pay too much to do so, and then spend their days daydreaming about the tech revolution while reading glowing earnings reports.
Growth investors also over-estimate their chances of finding the next Amazon – which means that so-called lottery ticket stocks as a group become too expensive, due to people bidding up the price of entry.
The market is not stupid, and it does a pretty good job of identifying companies with excellent growth prospects.
Many highly rated fast-growers do indeed go on to achieve great things – including massively higher sales and profits.
But investors in aggregate pay too much to get on-board. As a result, their investment doesn’t do anything like as well as the company does.
A classic example of this is Microsoft.
People talk about how Microsoft lost its way after the dotcom crash in 2000, and it’s easy to get that impression if you only look at the share price:
That does indeed sound terrible – and it certainly was if you bought Microsoft shares on 1 January 2000:
Bad luck if you bought Microsoft at the start of the 21st Century.
Losing money over 13 years is no path to retiring early, let alone retiring rich.
But Microsoft didn’t become a terrible business over that time. Far from it.
Over that long period of share price decline, Microsoft grew both sales and profits as it milked its dominant market position:
Sales tripled over that ‘miserable’ 13-year period, profits more than doubled, and earnings per share rose by 186%.
Good progress through a tough economic period, yet an investor who bought Microsoft shares at the start would have been better off if she’d just stuffed her money under the mattress.
Microsoft had decent prospects in the year 2000, and the market knew it.
Unfortunately investors paid too much to own a piece of the action.
The resultant growth was good – but not that good – so they suffered when their shares were de-rated over the next decade or so.
Even as Microsoft’s profits grew, investors paid a lower and lower multiple for the shares – mainly because the rate of growth was decelerating – which put a lid on the share price.
The blue line shows Microsoft’s share price. The pink line is the P/E ratio.
If the P/E had stayed roughly constant during the period, then the shares would have cost you well over $100 by June 2013.
But reality, they changed hands for more like $35.
The morale? Pay too much for your growth shares, and you’ll pay a high price in terms of poor returns.
By 2013 Microsoft’s share price had fallen enough to make it attractive to another sort of investor, who was buying into the current earnings and quality of the business and the dividends thrown off by its prodigious cashflow.
The ‘discovery’ of Microsoft by this new kind of investor (combined with a massive bull market) saw the share price recover and rise nearly 30% in the 12 months to May 2014.
You can arguably see a similar transition in Apple’s share price, as it has seemingly become ‘ex-growth’ and abandoned by its original investors, and then gotten bid up again by attracting a different kind of shareholder due to its higher dividends and share buybacks.
It’s easy with the benefit of hindsight to see that Microsoft shares were too expensive in the year 2000.
The annual growth in earnings per share since then has been just under 10% a year. That’s okay – the market might be expected to do GDP growth plus inflation plus dividends – but it’s not what made Microsoft into Microsoft.
Remember, some investors in 2000 paid a P/E multiple of 50 or more for what turned out to be 10% a year growth.
They look like idiots.
Yet it’s very difficult to judge how quickly a fast-growing company will expand when you’re looking at at a history of rapidly escalating earnings as well as big prospects ahead of it.
And anyone who has played with a compound interest calculator knows how differences of a few percentage points really add up.
So let’s have some empathy for those Microsoft buyers of yesteryear.
Up until the year 2000, Microsoft had been growing earnings at a fearsome rate.
The average annual growth rate in earnings between 1996 and 2000 was 42.5%!
Consider an investor who evaluated Microsoft’s position in the PC world, decided it looked unassailable – which it did in 20003 – and pondered buying the stock.
Let’s imagine our investor decided Microsoft’s earning’s growth would more than halve over the next 10 years or so, to just 20% a year.
Halving the growth rate seems prudent enough. PC sales were booming in 2000, Apple was tiny and smartphones and tablets not in the picture, yet it was obvious everyone and their granny would soon be on the Internet. The emerging markets were rapidly getting connected, too.
Well, if earnings had grown at 20% for the 13-year period we looked at earlier, then in 2013 Microsoft would have posted earnings per share of around $9, as opposed to $2.61!
What would that have been worth in terms of the share price?
I don’t know, but I’m pretty confident the shares would have done a lot better than the minus 50% they did achieve.
As a ballpark guess, I suspect after such a run Microsoft shares would have sat on a P/E multiple of at least 20, if not 25.
The share price might therefore have been between $180 and $225 – as opposed to the $27 it actually hit in 2013 after its steep P/E de-rating and much more ordinary growth rate.
Microsoft is an interesting growth-investing-gone-wrong case study for many reasons:
Some growth investors would argue they’d have bought Microsoft long before 2000, when it was much smaller and with more potential ahead of it.
And for some that’s probably true. Large size definitely works against growth investors.
Yet the fact is many did buy Microsoft on a sky-high P/E rating – the share price wouldn’t have got so high otherwise!
Others might claim they’d have dumped the shares when it became obvious the growth was slowing.
And many did – eventually.
Yet the Microsoft story does highlight the difficulties of growth investing.
It’s only in looking back that we can see that Microsoft was doomed to move from a high growth multiple to a more typical rating of a US blue chip. If you’d started arguing its best days were behind it too early in 1998, you’d have looked pretty silly when earnings swiftly doubled again in just two years.
For these reasons and others, I don’t usually buy expensive growth shares. When I do, I don’t tend to hold them for long.
Yet holding on is invariably part of any successful growth investing strategy.
I’m a value investor at heart, even when I buy into a sexy growth share.
So usually I’ll only make such a buy when there’s been some sort of ‘glitch’, to steal a phrase from Free Capital
Glitches might include:
The glitch hits the share price, lowers the P/E rating, and to my mind buys me a margin of safety.
I’ll usually sell as soon as I’ve got some profits in the bag.
This is a big contrast to true growth investors, who prefer to buy companies when the price is marching higher.
A higher share price vindicates their take on the company’s future. Also you will never benefit from a 100-bagger like Amazon if you take profits when the price rises a mere 30%. Growth investors need the big winners to make up for their many also-rans.
In fact, most growth investors see glitches as early warning signs that the growth story might be over – and as we’ve seen with Microsoft they are often right to.
Nothing is easy in active investing. Ignore anyone who says otherwise.
I’ve not managed to fully hold onto any growth shares I’ve bought in my investing career, though I do still have a couple of top-sliced holdings that have gone up three or four times since I bought them.
Real growth investing is too hard for me to be confident about – and that’s before we get into the difficulty of valuing companies that aren’t yet reporting profits.
Again, I’m not one of those value investors who spits at the very thought of paying up for a company that makes no money, or who says they’re all “worthless”, to quote a well-known UK investor I read the other day.
That’s silly. Nearly all companies start off without profits, and they don’t shift from being worthless to valuable the day the bottom line turns black.
Explaining why will take a whole new post, so we’ll save investing in the really speculative growth stocks for next week.
A big problem with planning for your financial future is that it’s hard to imagine what it will look like. Occasionally we get glimpses: a quiet beach, a couple dressed in loose, white cotton, walking hand in hand – they should be in their late 60s but don’t look a day over 45. They’re happy, care-free, secure. The whole scene is bathed in a soft golden light.
There’s a dog…
Hang on, I’ve never owned a dog!
Oops, that’s the cover of a pension sales brochure – it’s not my retirement at all.
MoneyVista is a free financial planning website that offers another way of looking at the future, through the lens of hard numbers and pastel coloured graphs.
It enables you to feed in your finances today and plot how that might look tomorrow, next year, a decade from now, when you retire, when you die…
MoneyVista fuses decent web design with various number-crunching tools to help you understand whether your goals can be met. And, if not, what you can do about it.
It’s a helpful, hand-holding experience of the kind that is increasingly replacing expensive human beings with a series of online prompts.
You input a piece of your financial life at a time – income, expenses, savings, investments and so on – and by the time you’re done, MoneyVista has rearranged the puzzle into a picture that you can grasp.
In a sense, it solidifies the nagging questions that haunt the back of your mind. Can I pay my mortgage? When can I retire? What will my income be? The ‘what if?’ wraiths are dragged into the light and either banished or warded off with a financial prescription and some nice charts.
MoneyVista shows you what’s left of your life as an Alpine cross-section of peaks, plateaus and plunging valleys.
It’s an odd experience to see the dip in the graph that marks your entire estate passing into the hands of your beloved – followed by the moment two years later when he or she doesn’t need it anymore either. (At least according to the life expectancy figures served by the software!)
From now till then you can account for all the other milestones of life:
By telling Vista what you’ve got, what you’ll earn, how much you’ll put away and spend, it can compute the outcomes like some computer game Sim Wealth.
If you don’t know where to start with your finances, then MoneyVista is an excellent base camp.
And if you’re already well on your way, then it’s a good staging post to help you take your bearings.
What if I change my retirement date? What if returns aren’t as good as I hope? If I want to travel the world, how far does that set back my other goals?
Your financial lifeline is shown in terms of your net income and your net assets (the green graph and the black dotted line in the pic above).
Goals show up as little pins – green means done by your target date, red equals falling short.
As your cursor traces your event horizon, little commentaries pop up to explain what’s happening:
In October 2038 the State starts to pay you a pension of £147 before tax.
It’s like a little text adventure game, although you definitely never want to go south.
Sections such as Insurance enable you plan for unpalatable scenarios like what happens if I die tomorrow? Would my existing protection policies and estate really secure Mrs Accumulator’s future income?
If not then how much would need to be diverted from other sources, and how much damage would that do to the master plan?
Actually, another possible benefit of using MoneyVista is that it’s a relatively user-friendly way of encapsulating your plans for the benefit of a partner who couldn’t give a fig for how it all works.
In your absence, your significant other could log in and get a coherent view of what you’ve stashed where and how it hangs together.
At a glance you can see:
Sound good?
The downside is that MoneyVista is a lot of work to set up. It doesn’t ask for the keys to your data kingdom – unlike say mint.com – so there’s less fear of cyber mugging. But you do have to input all the data manually.
And MoneyVista wants to know everything. It’s a big picture-planning tool but it draws upon every pixel of your financial life.
It took me hours to type in bank account details, investment holdings, insurance policies and budget lines – and I already had everything recorded on spreadsheets. If you’re starting from scratch then I shudder to think.
No doubt some will find the internal examination cathartic and others will turn and flee, but at least MoneyVista’s ruthless rummaging is for a purpose. It’s comprehensive and finances are complicated.
Or – to put it another way – you don’t get something for nothing.
Speaking of which, as the website says: “Right now MoneyVista is completely free.”
Which implies that at some point in the future it won’t be. MoneyVista is owned by Royal London – a big financial services provider, especially in the pensions sector.
The maxim “If you’re not paying for it, you’re the product” seems apt here as you’re handing over a lot of data in exchange for a good planning tool. It must have taken a sizeable investment to produce something this detailed that doesn’t distress the eyes.
Personally I wouldn’t pay for it because it doesn’t replace the sheaf of spreadsheets and notes that currently document my financial plan.
Every section left me wishing, “If only I could customise that bit,” or “If only it did that, this would be brilliant.”
And because MoneyVista shields you from its internal workings, it can be difficult to know how to fix a result that doesn’t make any sense. You can end up pulling levers at random rather than just popping open the top and rewiring the problem yourself.
Moreover, MoneyVista doesn’t save you the trouble of educating yourself. Just because it says you can pay your mortgage in 2031 doesn’t mean you will.
You need to know how to interpret the results, which built-in assumptions you should play with, and what you’re walking into if you choose an adventurous asset allocation. Automated answers aren’t a substitute for fully understanding those answers.
That said, the section on risk is one of MoneyVista’s strongest points. I’ve seen few portfolio comparisons more intuitive than its bald match up of the chances a balanced investor will suffer a 10%, 25%, or even a 50% loss versus the much higher odds of loss for an adventurous investor.
Meanwhile, it’s also fun to see how your expenditure compares to the rest of the country. It seems I spend 20% more on food than the UK average.
MoneyVista will email you when you need to take action, and it regularly sends me links to well-written and useful financial guides.
There’s a list of other features here.
The fact is that it’s the most powerful financial planning tool anyone’s ever offered me for free.
MoneyVista is reasonably user-friendly and has something to offer novices and masters of the universe alike. If you would benefit from a single snapshot of your financial present and future then give it your time.
Take it steady,
The Accumulator
Good reads from around the Web.
The shares of high-flying tech firms – particularly the so-called momentum names that typically sport punchy earnings multiples – have been pummeled in 2014.
Friday alone saw shares in Amazon fall around 10%, LinkedIn and Twitter drop 8%, and the recent UK tech float AO Online languishing below its IPO price.
The latest bear to come out to call a tech bubble is famed hedge fund manager David Einhorn, who has told his investors that their fund is now shorting a basket of “cool kids” stocks.
Not everyone agrees. The following podcast (via Abnormal Returns) features a variety of veteran investors and VCs picking apart this bubble talk. While everyone on it is biased – they are all investors in high-tech companies – they are well informed, and I think it’s worth a listen if you’re an active investor.
(If you’re a passive investor in the broad indices, I don’t think you need to worry about this bubble talk. For a start, getting to ignore speculation is a big perk of passive investing. But even if there is a bubble, I agree it’s almost certainly concentrated in a handful of stocks in the tech and biotech sector).
Being the contrary sort I am, I’ve actually been having a nibble on a few of these dumped tech shares – ones that I think have a decent moat, massive market size potential, and a visible path to big profits.
Almost certainly I’m doing so too soon, and it’s only with a small amount of my funds.
The bigger story over the next few years – and the bigger profit potential – is more likely to be the outperformance of value shares versus growth shares. I mentioned this in late summer with respect to European shares, and so far it’s panning out (although Ukraine could derail things).
It seems counter-intuitive, but value shares tend to do better in growing economies than growth. The reason is that profits are easier to come by when the economy is expanding, and the debt and shonky old factories and the like that are owned by value-style companies are much less of an albatross.
As an active investor I’m finding the markets much more interesting this year – and much harder to make headway in.
Everyone is a genius in a bull market, and it was easy to feel like the Einstein of active investing in 2013.
