Novel Investor • Page 10 of 13 • Compounding investing wisdom...

Galbraith: ’29 Financial Innovation Run Amok

September 6, 2019

·

Jon
John Kenneth Galbraith kicked off 1987 with a warning of excessive speculation in the stock market. Black Monday came nine months later. A 22% loss for the Dow. The worst single-day drop in market history.

Was it prescience or luck? Who cares. Galbraith, as usual, offered a history lesson worth learning.

He specifically covers four parallels between 1929 and 1987.
1. Speculation, euphoria, and greed take hold
2. Financial innovation run amok, fueled by debt
3. Inevitable punishment of those previously viewed as financial “geniuses”
4. Policy changes meant to “stimulate the economy” just flowed into the market
The second is worth highlighting because of the long history of financial innovation run amok.

By the late ’20s, companies were creating companies out of thin air, issuing bonds and a minority of the stock to the public. The newly created companies had no other purpose but to own stock.

But it didn’t end there. The new company would create a company, issue a minority of stock to the public, and the process would repeat all the way down. Investment trusts would do the same. The entire process drove the market. And easy access to leverage magnified it.

The “innovation” was seen as ingenious at the time, yet looking back it all seems ridiculous. As Galbraith concludes — we prematurely ascribe genius to anyone associated with large amounts of money. It’s a repeated trend that gets investors into trouble. Continue Reading…
Chuck Akre’s Three-Legged Stool

August 30, 2019

·

Jon

What would you rather have: $1 million in a month (31 days) or a penny that doubles every day for 31 days?

What about $2 million in a month versus the doubling penny? $5 million?

It’s a fun math puzzle that explains compounding. If you do the math, the penny takes a while to get rolling.

Ten days in, the doubling penny only sits at about $5. At 18 days, it finally passes $1,000. It clears $100,000 on day 25. Then the real impact kicks in. Over the last six days, it eclipses $1 million by a factor of 10. As investment analogies go, it’s a good one. Time is a fundamental ingredient for investing success.

I was reminded of the puzzle because Chuck Akre used it to kick off a presentation on his investment process. Compounding plays an important part of his process, just as it does in everyone’s.

Only Akre looks for companies that compound at a high rate of return over a long period of time. He uses the concept of a three-legged stool to explain how he does it: Continue Reading…
Keynes Reviews “Common Stocks as Long Term Investments”

August 28, 2019

·

Jon

Once upon a time, bonds were considered the best investments in all the land. Stocks were speculative and risky. Bonds were “safe.”

As luck would have it, Edgar Lawrence set out to test a theory and happened upon an interesting result. Lawrence originally thought that stocks did better during periods of inflation, bonds during periods of deflation.

It turned out stocks did better under both periods because retained earnings, reinvested back into a business, would grow more earnings and the business would appreciate in value. It naturally created a compounding effect that showed up in the stock price over time.

Of course, this is common knowledge today but it was a new idea at the time. Lawrence published his results in a book titled Common Stocks as Long Term Investments, with little fanfare, at first.

But John Maynard Keynes helped popularize it with a review written in May of 1925. The book would go on to be, at least partially, blamed for the stock bubble and burst of 1929 (what started as a sound premise devolved to chasing price action). Here are the highlights of Keynes’s review: Continue Reading…
Bogle’s Biggest Mistake

August 23, 2019

·

Jon

John Bogle talked about his biggest mistake during a 2006 interview.

A unique set of circumstances — starting with the “Go-Go” Sixties and ending with the brutal 1973 – 1974 bear market — led him to put his cost matters hypothesis to the test and change the investing landscape forever.

It’s an interesting story with a happy ending and a few lessons strung throughout.

Here’s Bogle: Continue Reading…
Write It Down

August 21, 2019

·

Jon

Journaling your investments is a tip that pops up a lot because it’s common sense. Aside from being cathartic, writing gives you an idea of how well you understand an investment.

And once written, you have a handy reference — a reminder of why you’re doing what you’re doing — for whenever an investment deviates from your expectations. It becomes a short term aid to help avoid typical emotional mistakes.

Writing it down also works in tracking your emotions. How did you feel about the market correction or spike in volatility or other latest market event? What action did you want to take? Did you follow through? Why or why not?

Because large gaps can happen between these events, and investors tend to forget, you now have a reminder of how you felt the last time it happened. You might even notice patterns of stupidity (or brilliance?) — your unique cycle of emotions — to help stop any repeated mistakes.

Gerald Loeb covers writing about investment in his book The Battle for Investment Survival. He refers to stocks but it works for any investments, asset allocations, or strategies too. Here’s what he had to say: Continue Reading…
Carol Loomis on Buyback Yield

August 16, 2019

·

Jon

Carol Loomis wrote about the benefit of buybacks in 1985:

Working with the 1,660 stocks covered by the Value Line Investment Survey, we identified companies that bought significant amounts of their own common stock in the ten years from 1974 through 1983. Next we reduced this list to voluntary repurchasers — cutting out, for example, companies that had bought the shares by paying “greenmail” to get rid of a threatening shareholder. Then we measured the total returns (stock appreciation plus dividends) earned by shareholders from the approximate dates of each repurchase “episode” to the end of 1984…

The outcome is spectacularly decisive. The shareholders in the buyback companies earned superb returns, far exceeding those accruing to investors as a whole. For all episodes measured, the buyback companies showed a median total return, expressed as an annual average, compounded, of 22.6%. The equivalent return for the S&P 500 was only 14.1%. That difference of 8.5 percentage points is enormously significant to an investor.

This information has been floating around ever since and the research shows the strategy still works.

The reason comes down to basic math. Buffett calls it smart allocation: Continue Reading…

Galbraith: ’29 Financial Innovation Run Amok

Chuck Akre’s Three-Legged Stool

Keynes Reviews “Common Stocks as Long Term Investments”

Bogle’s Biggest Mistake

Write It Down

Carol Loomis on Buyback Yield