One Year Investment Update

So one year is sometimes all it takes for an investment to blow out any return you could've possibly imagined. On Monday, made the following sales with a 1 year holding period to lock in long term capital gains tax rate...

United Healthcare   (UNH)
Buy: $26   Sell: $49   ROI: 47%

Wellpoint  (WLP)
Buy: $51   Sell: $76   ROI: 33%

Exxon Mobil   (XOM)
Buy: $58   Sell: $80   ROI: 38%

Energen Corp.   (EGN)
Buy: $50   Sell: $60   ROI: 17%


United Health Care and Wellpoint I bought during the whole Obama Care debacle when there was a lot of uncertainty as to how the bill would affect the healthcare companies. These were sort of no-brainer plays as both companies have the creme de la creme of healthcare services including Blue Cross Blue Shield. Just seemed obvious both were going to come out of all the uncertainty as winners still.


Exxon Mobil techinically was a two year holding period total, since my first position was made in 2009. However, when the BP oil spill hit, the whole damn oil industry got slammed in the market as being evil...that's like your neighbor destroying the sidewalk in front of his house and city hall punishing the whole neighborhood for it. I loaded up on more shares at a lower price when the stock fell off a cliff, which in turned lowered my average cost per share when it came back up. Goes to show you, a stock dropping can actually be a good thing if you've done your homework ;o)


Energen was a value play, I saw it as undervalued and decided to sell off because I wanted to increase cash due to better opportunities that are out there right now.

One Year Update on my "Home Depot, Your Next Great Investment" Post

Just wanted to give an update on one of my postings I wrote about a year ago on February 1st, 2010 regarding Home Depot as your next great investment. At the time of the posting, the price was at $28.01, almost a year later the stock is up to $36.02. If you had bought it at the time I recommended it and sold it today, you'd be looking at a 29% annual return on your investment, which is double the average return of the whole S&P 500 (~14%)

Technically, you'd want to wait until February 2nd to sell it, that way you would be taxed at the long term capital gain rate (I think its 10% right now?), rather than short term capital gain which would be taxed at your income bracket (probably 20-33%). 

Now if only we could get a 29% return on every investment, we'd all be millionaires in no time. ;o)

Why Small and Micro-Cap Companies Are Better For Your Portfolio

I have MSNBC on in the background and they just mentioned that Cisco (CSCO) may now be undervalued due to its recent drop. A quick earnings power calculation using an 8% cost of capital due to their financing mix shows actually that they're pretty fairly valued in my opinion (plus or minus a dollar) which got me thinking about market prices in general.

A lot of investors, especially value investors, like to purchase companies selling for less than what they think they would be sold for. However, the inherent error in this thinking is that it leads one to believe that the market is pricing companies at how much they are truly worth, when its clear that it is pricing companies as a going concern. What does this mean? It means that the market price is only reflective of the expected future earnings power of the companies assets, not its buyout value.

In other words, let's say I have a unique lemonade machine that makes the greatest lemonade ever and I can make $10 a year with it by opening a lemonade stand. Assuming I have a 10% cost of capital (for a lemonade stand, I know this is ridiculous but just to prove a point!), the earnings power of that lemonade stand would be $100 ($10/.10). This $100 would be the reflected market capitalization if my stand was publicly traded. If however, you came along and offered to buy me out, it really wouldn't make sense for me to sell it to you only for a $100.

But that's what it's worth right? Well yes, but its worth that much assuming nothing changes (as a going concern!). However, if you come in and offer to buy, suddenly the perceived value of my stand increases. As the owner I start to think "this is greatest lemonade stand in the world, they'll make a killing...and what about me? The only thing I know how to do is sell lemonade. Where can I find a stand of equal value once I sell? Nowhere! They better pay up then." So we have a small element of reflexivity coming into play here.

In a way, this happens in all acquisitions, that the very premise of an acquisition being proposed ups the perceived value of the entity from a going concern to a total buyout value. This is why when a potential acquisition is announced, the stock price jumps.When a possible acquisition manifests, suddenly book value and intangible asset value get factored in along with earnings power, which puts a premium on the original market price.

The positive outlook one could take from this then is that technically all public companies are undervalued to what they are really worth. The bad side about this is that "buyout" value will not justifiably manifest unless someone comes along to buy the company (it could manifest from market gyrations, but there's no fundamental basis to support this). With this in mind, what do you think the odds are of someone coming along and buying, say, Exxon-Mobil? ZERO!! Its one of the biggest companies in the world, who would even have the money to do so?

Which leads me to my premise that the individual investor has a better shot at having value realized by investing in smaller companies. Not only because smaller companies have a better chance at being acquired (that's a crapshoot, don't start trying to predict that stuff), but because less market participants are paying attention to them. If 10,000 CFA's are watching CSCO and valuing it accordingly so that the market prices it at around $19, what are the odds that all 10,000 CFA's and all the other market participants are wrong?

In the book The Wisdom of Crowds by James Surowiecki, he makes a point about this using the popular game show "Who Wants To Be A Millionaire." He noted that when someone Phoned a Friend, on average they received a correct answer about 65% of the time (actually seems pretty high to me!). Compare that to the Ask The Audience lifeline, which yielded a correct answer about 91% of the time. What does this tell you about market prices? They are usually right when lots of people are looking at them.

However, the less people looking at a company, the more of chance it could be unfairly valued. Perhaps only 100 CFA's looked at a particular small company, and because their priorities lie in getting through a ton of small caps and micro caps to move onto bigger and better projects, they might have overlooked crucial information. And that is where the individual investor's edge comes in. Those who are willing to do their homework and find value where a small amount of people were too rushed or lazy to look will get the payoff when the fundamentally supported value manifests in the price.

Something to think about...

ROT: Return on Tomatoes

I eat dinner every Sunday with my family, usually my parents, sister, her husband, and my girlfriend. At the beginning of every summer my parents always planted a small garden. Ever since I was a kid, they'd be in the backyard tilling the soil, planting seeds and just getting plain old dirty.

This past Sunday, I walked around the house to check out how the garden was coming along and was surprised by what I saw. Of course, I saw the zucchini, fresh peppers, lettuce, and some other lil' knick knacks in there, but what really caught my eye were the tomatoes. There were tons of them, some riper than others of course, but it was the shear number of them that made me really see them in a different light.

I couldn't help but think of how novel the idea of a garden is. You spend some time doing a little research on how to garden, then spend some time planting, getting dirty and tired in the sun. And once you're done, you're not done. You gotta water...and wait....and water...and wait...until something starts to grow.

But when you finally see the pay off it, you learn something. Something just clicks. About how doing something today and letting it grow for tomorrow really ends up working out. This can apply to your career, relationships, finances, and even your hopes and dreams. Gardening...I mean its a really novel idea, and the pay off is astounding in two ways. First because if you've never tasted a fresh homegrown tomato you haven't lived, and second, because of the pride you must get from knowing that "I...created...this."

How similar to life gardening is, especially investing. We put away money, not knowing how it'll ripen or what it will truly yield. During the interim watering periods nothing seems to happen. During dry spells some stocks shriveling and dying...others coming close, all the while we're sweating, and watering, and sweating, and watering!

Yet there's one thing that a garden can teach you about stocks, and its that all the tomatoes don't ripen at the same time. Some turn red before others, so while you're picking today's salad or sandwich topping there are still others that are there for tomorrow.

Just concentrate on the ones that are turning ripe today, and leave the unripe ones for another day.

So maybe its time to ask you: how's your garden coming along?

~J

Is Intrinsic Value the Most Important Thing in Investing?

Many people may be familiar with investing in common stocks as growth vehicles in their financial portfolio. With information a click away on the internet and various books just as available on investing, it seems that everyone has the power to manage their own portfolio like they were a professional investment manager.

Many of these sources point toward Warren Buffet's style of investing, commonly known as value investing. The premise behind the strategy cites that investors own a small piece of a company. The basic philosophy is that a good investment is made in good companies selling at a discount to their intrinsic value.

However, caution and an analytical approach should be taken when defining intrinsic value, which is loosely defined as the price at which a person would be willing to pay for the whole business. This assumption is vague and not useful in practicum at all.

The truth about intrinsic value is that it is subject to the participants involved, meaning that, depending on the buyers and sellers own reasoning, intrinsic value will differ. If you were a small bank up for sale, you would most likely charge a far lower price to a private buyer than you would, say to Bank of America. This is mostly because variables such as the size of the buyer and synergy value come into play.

Furthermore, intrinsic value differs between how the buyer or the seller are evaluating it. While things such as future earnings are factored into both perspective values, there are variables that will discount the value of the business on the side of the buyer that would not affect the value to the seller. These are things such as lack of liquidity and non-diversifiable risk.

Likewise, the value of the business to the seller will factor in the size of the buyer that would not affect the value calculation on the part of the buyer. As a buyer, how big the company is should not make me change my estimate of what another prospective company is worth to me, but it will to the seller.