September 01, 2017
Mind Your Owned Business!
The title above is a quote from Chuck Carnevale, the creator of “F.A.S.T.Graphs”, which is a software tool for doing fundamental analysis on stocks. Like Lance Roberts, Chuck has a way of explaining things possibly better than I have. So I want to revisit the message in my earlier blog post “It’s a Business…” using some excellent quotes from Chuck.
Everyone seems to focus on “the market” as represented by some index like the S&P 500. Index funds are growing in popularity each year. But, says Chuck, “The stock market, in all its iterations, whether the Dow or the S&P 500 or any number of other indices are averages. Therefore, by definition, “average” is simply a middle number…within the average are above-average and below-average companies as well.” This is the basis of the old market saw, “it’s a market of stocks, not a stock market”.
Chuck doesn’t believe in “investing in the stock market”. His philosophy is to “invest in individual companies and build portfolios one business at a time”. This leads to the concluding point I tried to make in “It’s a Business…”, which is “quit worrying about the overall market average, and place your attention on the companies (stocks) that you actually own”, as Chuck puts it. He also says “the reality of running with the herd is that your ultimate destination is the slaughter house.”
Chuck also quotes the great Fidelity Funds stock picker, Peter Lynch: “what makes stocks valuable in the long run isn’t the market, it’s the profitability …of the companies you own.” And Chuck writes “when investors are generalizing about the stock market, they are in effect denying the unique attributes that individual companies possess”.
Worrying about a market decline takes attention away from the underlying businesses in your portfolio. As Third Avenue’s Marty Whitman writes, “Unrealized Market Depreciation occurs when the market price of a publically traded security declines. Permanent impairment of capital occurs when the fundamental values of a business are dissipated…” In other words, a business does not lose any real value just because the price of its shares may experience a downward adjustment.
I have focused here on individual stock selection in order to put into perspective the seemingly mad rush by investors into index funds and ETFs. To quote another commentator, Trey Reik of Sprott, “In an investment world now dominated by monthly inflows into ETF’s and index funds, unconstrained by rational analysis of portfolio components, it has become somewhat passé to fret over underlying fundamentals.” True investing – as opposed to trading or speculating – is based on the fundamental values of businesses owned, hopefully for the long term. In contrast, a survey by Natixis Global Asset Management reveals that “58% of Canadian investors believe passive investing is less risky and 64% believe passive strategies will protect them in a market downturn. However, the facts reveal otherwise.” If you invest in “the market” through a passive index fund, you will go down right along with “the market”.
Of course, the foregoing does not mean a balanced portfolio should comprise only stocks or that it should exclude passive strategies or ETFs based various indices - these can be useful vehicles for cost-effective diversification. But the point to take away from the various quotes above is that you should understand what you own and why you own it. If you can look at each position in your portfolio and answer those two questions, you can probably sleep pretty well at night and ignore short-term market fluctuations.
And your investment advisor should be able to answer those questions for you. Certainly that is the approach we employ at Friedman Investment Group – we want clients to understand what is in their portfolios and the strategy behind owning each position. Please feel free to call me for an appointment to review your portfolio holdings.
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