|We tend to brag about our most recent brilliant investment while conveniently forgetting our more frequent whiffs.|
Chapter eleven from the first book of essays by Michel de Montaigne serves as a welcome reminder that some truths are beyond debate. A minor noble, occasional public servant and prolific reader Montaigne began writing short works of critical self-reflection around 1570. He referred to these works as essays and, effectively, created a novel genre. (As a side note, 400 years later the Argentinian Jorge Luis Borges would, effectively, perfect the essay.)
The title of chapter eleven is deceptively perfect as it relates to our theme herein, investing. This brief essay covers two important topics often overlooked by individual investors; survivorship bias and forecasting. As to the first, we’ll quote Montaigne, “Besides, no one keeps a record of their mistakes, inasmuch as these are ordinary and numberless; and their correct divinations are made much of as they are rare, incredible and prodigious.” As has been often reflected upon here at Invest-Notes, when reviewing every stock transition I’ve made over a 12-month period, the many bad trades are inevitably left in the dark, overshadowed by the occasional big winner. We tend to brag about our most recent brilliant investment while conveniently forgetting our more frequent whiffs.
The glaring error in an otherwise interesting book on the wealthy, The Millionaire Next Door, is this failure to acknowledge the losers. We meet a few very successful businessmen, owners of dry cleaners, who have quietly amassed meaningful fortunes. But no mention is made of the thousands of dry cleaners who not only didn’t make a million dollars but went broke trying. Montaigne tells the story of a skeptic in ancient Greece shown a chapel filled with votive offerings from sailors who survived shipwrecks to prove the beneficence of the gods. The skeptic observes, “Those who were drowned, in much greater numbers, are not portrayed here.”
More importantly, we talk about the records of Warren Buffett and Peter Lynch though never discuss the vast majority of professional investors who went broke or settled into quiet mediocrity. There is a reason books that discuss the “habits of super successful investors” all seem to talk about the same people. Not that many people are successful over a meaningful period of time. Of course, there are big winners, but always remember that the losers are “numberless.” Only with hindsight do we know who survived. This applies equally to individual stocks and hedge funds – no one talks about the ones who didn’t make it.
“…there is no use in knowing what is to be, for it is wretched to be tormented to no purpose.” -Cicero
As to forecasting, we should all know better. The idea that we can tell what is going to happen to the price of any individual stock over a period of a few months is self-deceptive. An analysis showing where a stock price will be 5-years from now is a lie. It has been demonstrated that over meaningful lengths of time the equity markets go up more often than they go down, so while dips can be ferocious, recovery has proven a relatively safe expectation. But this is based on the movement of a cohort of equities, not an individual stock.
As Nassim Taleb has said repeatedly, if the author of that glowing 5-year analysis doesn’t have at least half his net worth invested in the stock under discussion don’t believe anything being said.
The follow-on is our tendency to look at how much we can make instead of how much we can lose. Yes, there is money to be made if an investment increases in value. But when a company you invest in goes bankrupt (as recently happened to me with a private equity deal) being able to write-off the loss is small consolation. At the time I did the deal it never occurred to me that a total loss of invested capital was a possibility. But the lesson learned was a confirmation of one of the most important rules when investing; never make a bet so big that a loss can leave you with a permanent impairment of capital. While painful, and embarrassing, financially there is no change to my lifestyle or future prospects.
So, since we can never know the future we must avoid prognostication. Because when our bets on future outcomes start going off track, or derail completely, the best we can do is reflect wistfully on what might have been. This, in turn, can lead us to fear the future. What if we are wrong again? Opportunity becomes something to be feared, best to avoid. Instead, focus on the here-and-now, what we know and not what might be. I’ll be doing more private equity deals but now with a focus on risks, not just rewards.
|Duke Ellington Presents from 1963 introduces the world to Abdullah Ibrahim, then living in Switzerland. Nelson Mandela invites the prodigal son back to South Africa in 1990. Subsequently, Ibrahim performs at Mandela’s inauguration in 1994. Since then he has continued to find his own way toward new musical worlds.|
In 2019 Abdullah Ibrahim produced The Balance, his first recording as a leader since 2014.
I found the music to be remarkable. While searching his discography for other albums offering his warm, melodic sound, the discovery that Ibrahim was a bandleader starting in 1963 left me feeling pretty stupid. Perhaps this pianist and composer had not appeared on my jazz radar because of how his music is most often described and labeled.
Best guess is that previously reading about Abdullah Ibrahim being connected with Don Cherry, Ornette Coleman, and Archie Shepp would imply a free jazz orientation – not a genre I listen to much. Then again, talk of Cape Jazz from South Africa favoring gospel influences was also not so interesting. Ditto for his important works like Mannenberg, being described as a major part of the anti-apartheid sound – if we can assume there really was one sound to describe that heady time in South Africa. Then there are the movie soundtracks. Oh, and born Adolph Johannes Brand in 1936 then going by the name Dollar Brand on his earliest recordings, finally becoming Abdullah Ibrahim in 1968 when he converted to Islam made recognition challenging. Also, as we will reference, he has maintained a lifelong interest in Zen Buddhism even after his conversion to Islam.
His first, eponymous album, The Dollar Brand Trio, was produced by Duke Ellington in 1963.
It is an impressive freshman performance and in hindsight clearly points in the direction Ibrahim has pursued for decades. The real surprise is that through all the so-called Cape jazz-free jazz-protest jazz-soundtrack jazz phases, Abdullah Ibrahim’s sound has been remarkably consistent, and certainly not defined by any of these labels. For a discussion of his music, where I will make my own assertions as to his influences, we’ll focus on two albums: the 2011 release Sotho Blue and Mukashi from 2013.
Sotho Blue is a collection of Ibrahim original compositions that include one song by Bud Powell. We hear the influences of Ellington, Powell, New Orleans, and the West Coast jazz of the 1960s. Sounds of the orient and surprisingly contemporary jazz references speak to an open mind, enjoying without embracing. The saxophone, flute, and trombone trade places as lead vocals to Ibrahim’s piano from song to song taking the music from highs to lows. It can remind us of the emotions engendered when we travel as flaneurs rather than tourists. Yet the album is described as “background music” and for “private rumination and meditation” by a resource I usually respect. Neither of these comments rings even remotely relevant when listening to the album. Again, labels and comparisons can be misleading and even unfair.
|1. Calypso Minor||4. Nisa||7. Glass Enclosure|
|2. Sotho Blue||5. The Mountain||8. Star Dance|
|3. Abide||6. The Wedding||9. Joan Capetown Flower|
Consider this, a hot new trumpeter is on the scene and we ask someone recently having heard the player live what she sounds like. A response of Dizzy Gillespie or Miles Davis provides little insight. Dizzy hard bop or big band? Miles first quintet or electric? Using Dizzy and Salt Peanuts or Miles and Kind of Blue makes it clear what to expect. Free jazz? Have you actually listened to one of his recordings? The piano of Ahmad Jamal? Too cerebral, Abdullah Ibrahim is more playful. The piano of Chick Corea? Too muscular, Ibrahim is more lyrical. The influences of Ellington and Monk are assumed by his own admission. With Ibrahim offering so many references that are, quite frankly, somewhat tangential to the music he plays proves a distraction. Though I can’t offer a good point of reference. (Note to self; listen before assuming.)
Mukashi, named for a Zen master Ibrahim deeply respects, is an album that might be more appropriate for meditation, assuming forceful solos don’t harsh your mellow. This music inspires thought not introspection. The recording doesn’t sound oriental though it includes the sound of traditional Japanese flute playing. Perhaps some bright spots reflect the definitions of World Music, while he also plays at the fringes of traditional American jazz. All the labels, the genres, and definitions blur in Mukashi. The most interesting of the Ibrahim recordings currently on my playlist, it is also the most challenging.
Sotho Blue and the piano solo album from 2008, Senzo (mostly his greatest hits), are getting the most playtime these days. I prefer music without words so that it doesn’t distract me while reading books and magazines. Curiously, I have found myself pausing mid-sentence upon hearing a phrase or block of notes in Ibrahim’s playing. He definitely has something to say and doesn’t need words to express an idea.
For those interested in hearing Abdullah Ibrahim, a good start would be with The Balance. An elegant and confident album, once again featuring compositions by Ibrahim, with one by Monk. Ellington would be a proud and happy mentor hearing Ibrahim at 86 still playing like a seeker of new worlds.
|“…it’s fascinating to see people converging at similar visual endpoints even when starting from different places, following divergent paths, and all the while thinking about different things.”|
For no particular reason, I bought a handsome catalog of Paul Klee works printed in conjunction with an exhibit at the Guggenheim Museum (May 7 to September 19, 1993). Fairly limited in scope, featuring works mostly from the Guggenheim’s own collection, it did manage to convey the breadth of styles that Klee worked through, from adolescence to his early death. Always experimenting, Paul Klee used some unconventional methods to create original works, as well as multiples and prints. From sophisticated uses of color to the more primitive, and childlike imagery that he is widely known by, the guy did some really fine work.
But the “A-Ha” moment came with two works in particular. The first was a pen and ink drawing from a Bauhaus course catalog (1929), “Five Part, Polyphony.” The second was a later painting (1939), “Rocks at Night.” Both were precursors – whether acknowledged or not – of Sol Lewitt. This suggestion is not to in any way intended to diminish the originality of Lewitt’s work.
“By diverse means, we arrive at the same end.”
-Michel de Montaigne
I was reminded of an essay by Jorge Luis Borges, Kafka and His Precursors. Borges reflected on the phenomenon of similarities of early artistic expressions to later ones that only become obvious in retrospect. In other words, to use Borges’ example, the relationship of writings from the Greek philosopher Zeno of Elea to those of Franz Kafka. The work of Kafka is not intended to reference Zeno, but using ideas discussed by Kafka allows us to see something fresh in Zeno. Or, put another way, reading Zeno through the lens of Kafka allows us to tease new meaning from something old and familiar.
Similarly, Lewitt took some heat in the early 1970s when his “Circles, Grids, Arcs,” series culminated (logically) with a drawing similar to the works of a French artist, Francois Morrellet. Very different sensibilities, both arriving at similar visual expressions, are not proof of plagiarism. Isaac Newton and Gottfried Wilhelm Leibniz anyone?
So here in the Paul Klee oeuvre was a drawing, Polyphony, of straight lines in four directions, many converging and overlapping, creating an image reminiscent of ideas explored by Lewitt years later in his many series’ featuring “Lines in Four Directions.” Then the beautiful blue painting, Rocks, which could hardly appear more alike to some of Lewitt’s “Irregular Shapes” images.
Stretching out a bit, some of the most beautiful of the Paul Klee paintings in the Guggenheim catalog look like carbon copies of Australian Aboriginal Dream paintings. The similarities of some Klee drawings to the work of Milton Avery and Ben Shahn is striking. Prints reminiscent of recent work by Jim Nutt seem obvious. Like Lewitt’s intersection with Morrellet, it’s fascinating to see people converging at similar visual endpoints even when starting from different places, following divergent paths, and all the while thinking about different things.
|The Joshua Redman Quartet seem to have taken the suggestion of Miles Davis to heart, “First play what you know, then play beyond what you know.”|
The new album by saxophonist Joshua Redman, Come What May (2019), features a band Redman first recorded within 2000. In a Wall Street Journal interview from May of that year discussing the recording of Beyond (2000) Redman said, “In many ways, it’s the record I’m proudest of so far as really capturing the sound of a band.” That article led me to purchase the CD without hearing any of it beforehand. The music relit my passion for straight-ahead jazz and remains a touchstone for what defines contemporary jazz. A few years later I finally had a chance to see Joshua Redman perform live as part of the SF Jazz Collective while he was the Artistic Director. Whether live or recorded, Redman is a delight to hear.
After Beyond, the quartet featuring Aaron Goldberg on piano, Reuben Rogers on bass and Gregory Hutchinson on drums, recorded another gem Passage of Time (2001). Both of these albums feature only compositions by Redman and demonstrate his strengths as both player and creator. Come What May reunites this group who again play only Redman originals. All three have continued to play with Redman in various settings and ensembles over the last 18 years, but there is no question that this line-up is much more than the sum of its players.
In fact, Redman has made many fine albums with outstanding bands. MoodSwing (1994) features Brad Mehldau on piano, Christian McBride on bass and Brian Blade on drums. Or listen to the edgier music from his trio on Elastic (2002) with Sam Yahel on various keyboards and Brian Blade, again on the drums. A few personal favorites are the two albums from quartet James Farm. (2011). Featuring Redman with Aaron Parks on piano, Matt Penman on bass and Eric Harland on drums, their eponymous first release has a feel tangential to Beyond. Considering the ground that’s been covered, in finding his way back to that sound from 2000 Redman seems very comfortable.
Other than one song, “Leap of Faith” on Beyond, which features tenor player Mark Turner in a remarkable performance, all three of these sessions only include this iteration of the Joshua Redman Quartet. You’ll find this recording offers some of Redman’s most fluid and technically challenging music. Enhancing the quality of the compositions, the players are in top form. While this quartet was clearly up to the task in 2000, here on Come What May they are now a more seasoned group of musicians bringing a wider range of musical intelligence to this task. They seem to have taken the suggestion of Miles Davis to heart, “First play what you know, then play beyond what you know.”
Much like on Beyond, Redman ranges across a spectrum of jazz styles on Come What May from the driving “I’ll Go Mine” to the contemplative “Vast.” To my ear, these three recordings make up a distinct sound that stands apart from the many other albums with Redman as leader, yet without sounding the same. Once again, Redman has really captured the sound of this band.
|Successful investing is almost always a result of critical thinking and patience. When you decide to purchase any financial investment the reasons you would sell are just as important as why you are buying.|
An unfortunately common story heard from investment managers is about the tendency for people to panic during market drops. The problem is multifaceted with otherwise sober investors suddenly trying to time the market, taking losses on stocks, giving up dividend income and possibly generating unnecessary tax bills. And when the panic ends? How to determine when to start purchasing equities again, yet another opportunity for market timing – an activity long demonstrated to be harmful to your portfolio.
This is not to say an investor should never sell, just that any decision to make changes in the holdings of a portfolio should be a result of planning, done deliberately and with intention. Not during a time of emotional and financial stress. And while tax implications don’t apply to IRA or other retirement accounts, we must still be mindful of what an unrealized gain means.
So, let’s do a thought experiment today. We’re going to look at a gold coin (let’s make it a one-ounce American Gold Eagle) and ten shares of Apple stock (AAPL). Let’s assume that these assets are in a retirement account that is unlikely to see any withdrawals for another decade. Today that gold coin is worth about $1,450, and the ten AAPL shares around $2,000. Now for the fun…
In 2016 that gold coin was valued at $1,100, but in 2011 it was about $2,000. It is the same coin and has never been removed from the safe deposit box since 2006 when you originally purchased it. With a current value of $1,450, have you made $350 or lost $550? Yes, a trick question, since you only paid $600 for that American Gold Eagle in 2006. Same with AAPL; in 2016 the ten shares were worth about $950 and in 2012 they were worth $750. But in 2006 you paid $150 – yes, one hundred and fifty dollars for ten shares.
In summary, for both the coin and the stock over the last ten years each has been worth more and less than their value today. Selling in a panic could mean you create a tax liability further diminishing any gain. In a taxable investment account, if you sell the coin or the stock you immediately owe tax on any gain but can deduct any losses against profits from other equity sales. In a retirement account, you don’t owe taxes, but if you sell at a loss, you cannot use that loss as a tax credit to offset other winners. In theory (and real-life) you can buy a stock, sell it for what you paid for it, and still lose money. Or take big losses that can’t be used to offset profitable trades.
Until you sell an asset it is only worth whatever anyone will pay for it. Gold has demonstrated an ability over very, very long periods of time to be an asset that holds its value. Consider that Benjamin Franklin wrote that in his lifetime an ounce of gold would buy a very nice suit. And a bespoke suit can be had today for $1,500. Holding gold in your portfolio is a way to preserve wealth rather than create it.
As for AAPL, well, the first iPhone was sold in 2007 spurring a revolution in communication that led AAPL to become (on-again, off-again) the most valuable company on the planet. But whether a share costs $12 or $200, it still represents only a minuscule ownership stake of a publicly held company that has demonstrated a highly volatile price history. AAPL has also shown, that like the overall markets, while the water is often choppy, it has historically gone up more than it has gone down and continues to seek a higher level. A poor earnings report can mean a dive in the value of individual shares but is as likely to be temporary as not. Until such time as AAPL begins to underperform consistently or suddenly faces formidable competition, a snap decision to sell could prove to be an expensive mistake. AAPL is in your portfolio with an eye towards making a profit.
Whether either investment should have a place in your collection of assets is determined by your goals. And when you decide to purchase any financial investment the reasons you would sell are just as important as why you are buying. Successful investing is almost always a result of critical thinking (don’t panic as markets move dramatically up or down) and patience (it’s a marathon, not a sprint). Heaven is not the day after tomorrow.
|“Chaos is an azure line that surrounds all the world.”|
From the Sefer Yetsirah|
While reading the Sefer Yetsirah by the light emanating from a painting of Lucas Cranach I was approached by an angel whose wings were covered with blinking eyes. As it hovered above the table where I laid down my book, the angel offered me an envelope. Carefully opening the letter I discovered inside a single sheet of fine papyrus embossed in the lower right-hand corner with a single symbol. Not immediately identifiable, the curious figure reminded me of the Monad of alchemist John Dee, as it had been described by the polymath Athanasius Kircher. The angel hovered above me, the eyes on its wings moving in every direction until I realized the papyrus sheet was an invitation.
I hastily gathered up some bread, beer and the philosopher’s stone placing them in a small package. After donning a hat decorated with five flowers, I followed the angel as it flew out of my library. As the angel finally identified itself as Semyaza I felt an indistinct unease, like that, encountered as one begins a long journey.
Moving into the darkness of night Semyaza led me through a series of gates guarded by: An ancient Oriental man wearing a sky-colored robe; a sphinx made of mercury; the sacred painter of the profane, Father Giotto; and ultimately we passed a virgin named “The Magdalene” who was carefully extinguishing devotional candles resting on a small alter covered with a red cloth.
Semyaza bade me farewell, leaving me before the entrance to a great courtyard. Here a group of angels, whose faces were dirty with soot, bound me tightly with rope and left me alone in the darkness, awaiting dawn. The morning light revealed a gallery on the west side of the courtyard. It slowly filled with 999 sacred falcons, all bred in the gardens of the Temple of Behkdet in Egypt. A priest wearing a gold mask shaped like an ibis declared loudly that the falcons had deemed me to be not entirely unworthy. As such, I would be allowed to witness the terrible spectacle of a Chymische Hockziet. With this proclamation, the priest turned to leave as the sky filled suddenly with shrieking birds flying in every direction and I was reminded of the eyes on Semyaza’s wings. Then the ropes that had held me fell away and again I was alone.
The angels with dirty faces returned and I was given a handsome pewter goblet filled with a powerful smelling, blood-like liquor and told to drink. Closing my eyes as I slowly sipped from the goblet, a feeling of heat spread throughout my body. A vision of a royal sepulcher in all its sublime glory appeared before me. I was led to a magnificent library like that of Borges imagination and felt bliss.
Upon leaving the library I found myself in a small, enclosed garden. Spying a large three-tiered fountain, I first drank and then bathed. Refreshed, I went down a dark, spiraling stairway furnished with rare tapestries and beautiful paintings, though I was saddened to realize none were by Nicholas Poussin. The stairs ended at a great hall whose walls and high ceilings appeared to be made of flames. In the center of this awful place rested the skull of Adom Kadmon with a serpent crawling in and out of the eye sockets. The name Lilith had been painted on the snake’s back in silver.
A door at the far end of the flaming hall opened to the shore of a raging ocean. A single ship being tossed about on the waves awaited me. Boarding the boat I found no one else there. My only recollection from the voyage was passing an island around which nine muses slept fitfully as they floated upon a green foam that remained undisturbed by the rough seas. Arriving at a place very cold and seemingly without color, I was carried off by four wingless angels, each with an aleph painted in gold on its forehead. They laid me on a blue cushion in the middle of a vast stone floor that had no walls. Sitting there in the numbing cold I gazed at the endless ocean until midnight, when I fell into a troubled sleep.
It must have been very early the next morning when priests, dressed as gods from Ancient Egypt, woke me up and led me across the vast pavement. Arriving at an undecorated stone building, I was asked for my small package of offerings as well as the five flowers still decorating my hat. In return, I was given Occam’s Razor, which I carried tentatively into the building. We entered a room, identified in small letters carved above the door as the Nuptial Hall, where I took a seat among mostly empty pews.
A battered wooden alter rested against the east wall and in front of it stood Enoch, whose hat was now decorated with my five flowers. He stared intently at the opposite wall and I turned to see his bride to be, the sweet Shekinah, making her way slowly toward the altar. The room was growing increasingly hot and I realized the sun was now shining brightly through long, thin windows and casting alternating stripes of light and shadow across the room. A priest who reminded me of the Pharaoh Akhenaten rose from the front pew and turning around with his back to the bride and bridegroom began speaking in a sonorous voice of love. As he spoke, cherubs descended carrying a massive crown, made of many precious stones, that was held above the heads of Enoch and his sweet Shekinah.
Suddenly a great cacophony erupted as the angels with dirty faces flew into the room carrying the blue cushion I had slept upon the previous evening. Then just as quickly, the room became completely silent as Semyaza entered with the pewter cup I had brought here the day before. Handing it first to Enoch, and then his sweet Shekinah, the couple took turns partaking of the evil red liquid before smashing the goblet against the stone wall. Semyaza picked up the broken pieces of the pewter cup and placed them on the blue cushion. When his sweet Shekinah kissed Enoch gently on the stomach I sensed the ceremony was over. As if leading a royal procession, Enoch and his bride left the Nuptial Hall at the head of the few attendees.
Only Semyaza and I were left in a now deserted room. The angel pointed at the floor beside the wooden altar where I noticed a large, beautiful painting by Max Beckmann of a woman lovingly embracing a mandolin as she lay asleep. Semyaza asked that I lay down on the painting where I proceeded to again fall into a troubled sleep. As the sweet Shekinah and her groom sailed away aboard the ship that had brought me to this place I dreamed of my long passed youth and wept softly.
Trumpets sounded as these visions faded from my memory and all that was dark became light.
|The analogy of keeping credit risk low coupled with the value of dividends as a potential income stream suggest it is possible to move the odds, as much as possible, in your favor with some thoughtful analysis…. or put another way, you want to create a steady income by only using financially solid stocks.|
When loaning money for a home or automobile purchase lenders rely heavily on a person’s credit score (also known as a FICO score). The idea being, that certain behaviors and traditional spending patterns can determine risk levels – the higher the score, the lower the risk of default. Traditionally scores were based on things like your history of timely (or not) payments on other debts; the length of your credit history and how much you currently owe; other types of credit you have (or had) including charge cards, loans, mortgages, and banking history.
Recently, in an effort to improve predictions of creditworthiness, some new information is being collected and aggregated. Gathered mostly from digital sources, it’s worth considering how you might stack-up against these new data points: uses both names in contact information forms; consistent travel patterns; limited contact with few entities; uses Uber; and, no regular contact with people who have bad credit. Now you really know why they want you to keep that location finder activated on your mobile device and check-in at Facebook regularly.
The reason I bring this up is due to shifts in the investing landscape which makes some traditional metrics used to measure value not so effective and suggests we might need to reconsider what criteria to use in scoring our investment prospects. Traditionally there have been three go-to metrics to make a quick, back of the napkin assessment of a potential equity investment. In other words, what’s the fastest way to determine the creditworthiness of a business you are thinking of owning part of? This, in turn, allows you to focus on learning more about only stocks that fit your investment profile.
A prime example is the price-to-book (P/B) ratio. Essentially the P/B value of a company is a measure of debt to assets – which when divided by the number of shares gives a ratio that might be a reasonable measure of financial soundness. An example of how this works is to look at a million-dollar piece of real estate owned by an individual.
When what looks good is bad.
If you own (hold the title) on a property valued at a million bucks, there are a couple of scenarios that can make this good or bad. If you hold a clear title (no mortgage or commercial loans) then you have an asset that reflects positively on your total net worth. On the other hand, if the property was financed by a loan of $1,00,000 and due to the vagaries of the real estate market it is now worth less than a million, you are at-risk – the property is a liability. This same concept was for a long time a significant marker for making investment decisions. The value of the tools a company uses to make its products can ensure the ability to survive hard times. If a factory and the land it sits on, are mostly paid for, this can make for an attractively low P/B. A business that owns a fleet of company vehicles has a liability, not an asset. The vehicles are depreciating items needing to be insured, maintained and ultimately replaced. The fleet can only be sold for less than the acquisition price and incurs an ongoing expense. Your loan to this company (through the purchase of stock) carries greater risk and would have a high P/B.
With outsourcing, a now standard practice, a company like Amazon (AMZN), that absolutely requires delivery vehicles, can operate just fine without actually owning any trucks. Uber (UBER) is now the biggest taxi service in the world, and they don’t own vehicles. The drivers who use Uber’s software to operate as individual contractors are the ones responsible for purchasing and bare all associated expenses. So, with hard-to-value assets like intellectual property being the driver of value, P/B might not provide much insight into a company’s cash value. And when a company gets in financial difficulties or goes bankrupt, fixed assets can often be the only way investors can recoup even a fraction of their investment. For our discussion, let’s compare AMZN and Apple (AAPL). P/B for AMZN is over 18, for AAPL 8 and generally speaking a good ratio is less than 4. This could imply that your investment in AMZN has a greater credit risk than AAPL, even though AAPL carries a P/S double the average.
Another classic metric is the price-to-earnings (P/E) ratio. Assuming that a company is profitable – that it makes more money than it spends – the P/E is a reasonable way to calculate how much owning part of that profit stream will cost. A low P/E implies that the cost to buy some of a business’s profits is reasonable and that at some point in the foreseeable future you will have paid off the cost of your investment and the profits can become income. This might be best understood by thinking about dividends. If you buy a share of stock for $20 and get an annual dividend of $1 (5%) at some point you will get back what you paid for the share (which is then an asset, like a loan-free piece of real estate) and the dividend becomes income (like receiving rent from that loan-free piece of real estate).
But when a company isn’t profitable either there is no P/E or the gap between what the company is spending versus what it is earning becomes untenable. The P/E for amazon is north of 70, where the average long-term ratio for the market as a whole is around 18. This implies that it could take up to 4x longer for your investment in AMZN to become profitable than one in AAPL whose P/E is 16. One excuse investors use to justify stocks with a nosebleed P/E is that they have “momentum.” The assumption is the company is growing so fast that eventually, they will make more money than they spend. One culprit of the dot-com crash at the start of the new millennium was this kind reasoning.
In a similar vein, the price-to-sales (P/S) ratio can help identify stocks whose price offer compelling value. Using a formula that includes the total value of a company (the market capitalization) and the number of shares outstanding divided by 12-months of sales or revenue the P/S is like the P/E since it is intended to quantify the value of individual shares. The biggest limitation of the P/S is it doesn’t take into account if a company is profitable, or will ever be profitable. Using our example one more time, both AMZN and AAPL have a P/S of 3.5, which is considered high, but not unreasonable.
Now a quick summary. AMZN has rarely been profitable and continues to spend more than it makes. According to our traditional metrics, its P/B suggests it is a risky investment; the P/E suggests the stock is expensive and doesn’t offer much value; but, the P/S implies the stock is not grossly overvalued. AAPL has long been profitable by making things like phones and computers for both business and retail use. The P/B reflects less credit risk than AMZN, but more than average. The P/E says this is a good time if you want to buy some stock, while P/S urges caution around equity purchases. All of which points to a merely average credit score for AMZN and a slightly better one for AAPL which also gets points for paying a dividend (making for a quicker payback on that initial purchase of stock). One last point here, now that Microsoft (MSFT) had got its groove back it scores between AMZN and AAPL using our criteria here.
What does all this mean to you?
The most widely held exchange-traded funds are SPY and VOO, both indexed to the S&P 500. Passive investors and their retirement accounts (401Ks and IRAs) should be anchored with a large position in one of these index funds. The primary reason being that in any given year most of the stock market gains will come from just a handful of stocks. By owning a fund composed of the 500 biggest and usually best companies in America you get to take advantage of the fact that stocks go up more often than they go down. Investors get the benefit of upside in the winningest equities and at the same time hedging the performance of struggling stocks while still earning a modest dividend.
Hopefully, you have accounts intended for both short-term needs and long-term goals. These should be structured to meet your investment objectives and would likely vary in composition. Specifically, outsized risk should play no part in a retirement account, especially as you get older and the opportunity to rebuild after a significant loss becomes more daunting. The analogy of keeping credit risk low coupled with the value of dividends as a potential income stream suggest it is possible to move the odds, as much as possible, in your favor with some thoughtful analysis.
As it currently stands, of all 500 companies in the S&P index funds, MSFT, AMZN, and APPL make up a full 10% of total shares. The benchmark index is structured so that stocks with the largest market capitalization have a heavier weighting. The alternative for an S&P index is an index fund that is equal-weighted – meaning regardless of company size, all components in the fund have an equal percentage of shares. An example is the Invesco S&P 500® Equal Weight ETF (RSP) where the total shares of each company are around .23%. So, the MSFT-AMZN-AAPL triad makes up less than 1% of this index. I own two of these funds in a ratio of 65% VOO to 35% RSP and regard the combo as a single holding.
Personally, I still find the idea of weighting as criteria for fund composition a bit uncomfortable, which explains why S&P index funds are only 25% of the equity holdings in my retirement accounts. If you subscribe at Morningstar, one of their more valuable tools is a program that aggregates all the holdings in a portfolio and compares them to the S&P index. By comparison, my IRA is composed of 14 individual investments, not all of which are index funds, with several holdings having been in the account for a couple of decades. The idea is to increase the dividend stream without using riskier equities. Or put another way, I want to create a steady income by only using financially solid stocks. According to Morningstar analysis, my IRA has both a lower P/E and P/B ratio and almost twice the yield of the S&P 500 index. In an account intended for the long-term, I aim to keep my portfolio credit score high.
|For the interested, or discerning, listener “Tenor Conclave” offers a chance to really hear the distinct sounds of John Coltrane, Zoot Sims, Hank Mobley, and Al Cohn.|
The output of the Rolling Stones rolled off my radar a couple of decades ago. Hearing some newer music recently it was not difficult to recognize the sound, even if it has evolved somewhat since I last tuned in (around the release of Steel Wheels in 1989). So why does it surprise people that the sound of John Coltrane is just as identifiable to a fan? For someone even mildly familiar with the music of the Rolling Stones and Beatles it is hard to believe the difference wouldn’t be immediately obvious. Ditto for Coltrane and Hank Mobley despite their playing the same instrument.
Reading the liner notes from a 1956 release from the Prestige All-Stars we find this to be a tired conversation. Ira Gitler opens his note with the following comment; ‘Last year a writer on jazz posed a question to me. It was, “How do you dig both Sonny Rollins and Zoot Sims?” and I answered, “Because I dig both Bird and Pres” (i.e., Charlie Parker and Lester Young).
The album referenced here is “Tenor Conclave” featuring John Coltrane, Zoot Sims, Hank Mobley and Al Cohn on tenor saxophones, Red Garland on piano, Paul Chambers on bass and Art Taylor on the drums. While Gitler focuses mostly on contrasting the two “schools” of sax represented – that of the hard bop (Parker) and the modernists (Young) – this still seems too broad of a distinction. Yet Gitler is correct when describes this album as not a “cutting session”, something that could have easily occurred, where players push each other to show-off. As he correctly states, “Each of the four showed admiration for the other three…”
For the interested, or discerning, listener “Tenor Conclave” offers a chance to really hear the distinct sounds of each tenor. The title cut, an original composition by Mobley, is a swinging affair, where personalities and sounds are distinct. Followed by the standard, Just You, Just Me, at the opening we hear the ensemble, then a bridge with only Mobley and Sims. After another 8-bars of the ensemble, in sequence, we hear the solos of Mobley, Sims, Coltrane, and Cohn. The second Mobley composition, Bob’s Boys, plays to the strengths of Sims and Cohn. In the last of four songs on the album, How Deep is the Ocean, we hear an achingly lyrical rendition of another jazz standard. Hard to believe even a novice couldn’t hear the difference between Coltrane and Cohn here, despite the lighter touch.
Of particular note is the fact this recording pre-dates the Blue Note albums for which Coltrane and Mobley are so well known. Here Gitler’s two schools are further subdivided to provide additional commentary about each player. For Coltrane, there are already hints of the “sheets of sound” to come. The Coltrane sound has also been described as very muscular, which sounds about right. In contrast, Mobley’s most successful album to my ears is “Soul Station” with “Workout” a very close second. Gitler uses the term “sinewy” to describe Mobley’s playing.
The players usually associated with the East Coast, Cohn and Sims, find a reflection of their work with jazzmen like Gerry Mulligan, Bob Brookmeyer, and Shelly Manne. Theirs is a more swinging sound influenced by the classic big bands of Woody Herman and Count Basie. In the most complimentary sense, Sims is more smooth than muscular with Cohn more fluid than sinewy. The contrast between bop and modernist is not as obvious here as is the stylistic preferences of each player. While this distinction between schools becomes more pronounced over time, here we listen to an ensemble working hard to achieve harmony and a blending of personalities through this music. It is not clear to me that the Prestige All-Stars would have sounded so cohesive if they had first recorded together in 1966.
|An interesting quote from The Economist: “Finance is a brain for matching labour to capital, for allowing savers and borrowers to defer consumption or bring it forward, for enabling people to share, and trade, risk.”|
For most of us, the second part of this elegant description of basic capitalism is what drives us to pursue investing in general, and the equity markets in particular. As savers, we defer consumption (save rather than spend) for many events; a first home, a second home, college funds for our kids, retirement for ourselves, etc… As borrowers we bring consumption forward (using loans and credit), for good reasons and bad; the mortgage on our homes, a really expensive watch that we quit wearing after a few weeks, etc…
Strike a balance.
The trick is to strike a balance between what we have and what we owe. Few people are able to buy a new home outright with cash, so a mortgage is usually inevitable. But as long as there is growing equity – a meaningful down payment and the shortest loan period manageable – the house feels more like an asset than a liability. The same idea applies to equity investments. Striking a balance between conservative, income-producing investments and riskier, but potentially more lucrative bets. Through this process, we strive to end up with more assets than liabilities, with more cash than debt, with more peace of mind than useless stuff.
And this gets to the heart of many financial problems, which is a failure to adequately balance assets and liabilities. Owning a million-dollar home isn’t all that great if it cost $1.1 million and was purchased with no money down and a 30-year mortgage that doesn’t begin to create equity until after the first dozen years of monthly payments. This home isn’t a person’s biggest asset but their biggest nightmare.
Over time, with much work and patience.
While enjoying an interview with jazz guitarist Pat Metheny this weekend a comment germane to the discussion of how to be a better investor – or, steward of personal assets – loomed large. He was talking about the changes he has seen while touring worldwide with his band (since 1977) of how people treat time. Metheny stated that people have become, perhaps, too cognizant of how they manage time. Everything is now expected to be accomplished quickly and efficiently. But, he said, to reach the level of expertise required to become a professional musician requires a lot of time and practice – and this cannot be done quickly or efficiently.
Warren Buffett once wrote: “It is not necessary to do extraordinary things to get extraordinary results.” An interesting observation from a guy who did not become one of the richest people on the planet quickly and efficiently, but over time and with much work and patience.
The markets we face today are some of the most volatile in recent memory. Previously reliable correlations between asset classes have broken down. Investment options never before available to individual investors now come in several varieties. We can invest in businesses located and operating, almost any place on earth. And corporate malfeasance, government intervention, currency fluctuations, communications interruptions, disruptive technologies, and irrational behavior still remain challenges to profiting as an investor. Being able to operate in this environment is not a skill that will be acquired quickly and efficiently.
A good beginning.
Becoming a successful investor will not happen by reading the latest edition of Investing for Dummies, or following the weekly ramblings of a financial columnist, or spending a weekend visiting investment web sites on the Internet (though all these things executed in tandem are a good beginning). Yes, people win lotteries, but not deliberately because of their actions, or more importantly, repeatedly over time.
So remember, try and keep three or four months of cash-on-hand for emergencies, keep the majority of equity investments in conservative instruments and avoid using debt to fund a lifestyle your paycheck can’t.
|Talk about a career in jazz… Gerald Wilson’s first album as a leader was released in 1961 and his last recording was released in 2011.|
First hearing the big band sound of Gerald Wilson was a revelation. Talk about a career in jazz, Wilson played trumpet in the Jimmie Lunceford Band back in 1936. A mainstay of West Coast jazz players, he wandered in and out of the limelight for 50 years, his first album as a leader, You Better Believe It being released in 1961. He died in 2014 at age 96, with his last recording, Legacy, released in 2011.
It was a pleasant surprise to discover that he was not only a big fan of the bullfight, but many of his signature works (two of which are reprised on “Detroit” from 2009) are named after famous bullfighters of the 1960s. He considered matadors and jazz musicians to be kindred spirits engaged in a similar kind of art form. Wilson was befriended by bullfighting professionals and is an honorary life member of Los Aficionados de Los Angeles (sort of like the Bullfighter’s Union of the U.S). The complete oeuvre of Wilson’s tributes to the corrida is listed below. I deliberately chose to only include the original of each song, and encourage you to check out some of the later versions on your own.
This song is named for Jose Ramon Tirado. “He was a young matador I first saw at the bullfights in Tijuana, Mexico,” Gerald says. “He was sensational, had a lot of style, reminds me of one of the young trumpeters today. I was so impressed that I wanted to do my impression jazz-wise of what was going on with him.”
This song is named for Paco Camino. “Paco Camino became the biggest man in the bull ring during that period. He came on with some new stuff that was out of sight. Bullfighting is not a sport, you know. It’s an art, continually evolving with new passes, new uses of the cape, new ways of confronting the bull, adding to the repertoire. It’s very much like jazz. Paco was an artist. He improvised. He was the best,” said Wilson in 2004.
Featured in Sports Illustrated in 1963, ” Paco Camino is the greatest torero of the past 20 years,” said Antonio Diaz-Canabate, one of Spain’s foremost authorities, writing in Madrid’s influential newspaper, the A.B.C. “He leads the bull with the muleta where the bull does not want to go. That is the most difficult thing in the art of bullfighting because it involves the total domination of man over beast.” And a well-known Barcelona critic, Jose Maria Hernandez, wrote of Camino, “He does everything to perfection. He has an indefinable magic. People will remember Camino, like Manolete, not for any one pass or quality, but for his general art and technique.”
This song is named for Santiago Martín, known as El Viti. This is the only recording Wilson made where he played with the band. “El Viti was a great matador, different from any other I ever saw. He never smiled, and he was tough. I tried to trace a picture of him, as it gets down into a unique part where his stuff in the ring would get, wild but not overbearing. It was a place for me to use my eight-part harmony.” Wilson claimed to invent eight-part harmony. El Viti was considered to be the “master of the Verónica.”
The Golden Sword
Dedicated to the pageantry of the bullring.
This song is named for Carlos Arruza, known as “El Ciclón” (“the cyclone”). Retiring after a successful career bullfighting on foot, he came back to start an even more spectacular career on horseback. “He was one of the greatest of all time,” said Wilson. Arruza appeared in two Mexican films about bullfighting and had a part in the 1960 version of “The Alamo” starring John Wayne.
This song is named for M. Capetillo, who performed frequently in Tijuana from the 1960s through the 1980s. He was celebrated as the greatest muletero in Mexican bullfight history. Wilson watched Capetillo fight his last bull on the eve of his retirement.
This song is named for Antonio Del Olivar and was the last of Wilson’s tributes to famous bullfighters. Considered one of the most graceful matadors, Del Olivar once honored Wilson by presenting him with the ear of a bull he had killed.