Insider Comments

Insider Comments…
or, a Tutorial for Investment Success

We are asked all the time by clients, and at seminars in which we participate, how does one really make money in the market? After being involved with the stock markets for about 35 years we have lived long enough to have seen the cycles. We know what works on Wall Street and what doesn’t. Let’s take the time to explore the world of making money. First of all, you do not have to be a professional investor, which is what we are, to make money investing in stocks, but you just can’t play at it either. Making better than average profits in stocks is serious business, and you’d better be serious about it.

If you work with traditional stock brokers who help you buy and sell in exchange for a commission, we believe you will be in trouble with that approach. Your broker’s goals are NOT aligned with your goals. Whether you profit or lose money in the trade, your broker gets paid his commission so he is without incentive to look out for your success. Brokers are paid regardless of the outcome of your trade and that’s YOUR PROBLEM.

You have the further problem that most research generated by brokerage firms doesn’t work. For years we have talked about the inequity of asking research analysts to give their honest opinions about stocks they cover when their firms simultaneously maintain investment banking relationships with companies covered by the research analysts. In this environment its tough to nearly impossible for an analyst to go negative on a stock.

Plus, research analysts are notorious for going with the HERD. They have a “herd mentality” in fact. This means they want company when they recommend a stock; they never want to be alone in a recommendation. If a stock is covered by 15 or 20 analysts and no one has a buy recommendation on the stock, it’s an emotional impossibility for the analyst to stand out there all alone and say, “I love this stock!” Most analysts will wait for the group, and waiting can cost you the investor a great deal of money in this business.

The herd mentality also gives you this: analysts issuing buy recommendations as stocks are starting to trade near their tops. Mathematically, you must realize that most money is made by buying stocks near their bottoms, not their tops. This is why we call ourselves We prefer to buy stocks that are trading near their bottoms to insure that when these selections do turn, extraordinary profits are made.

Do Not Be Satisfied With Mediocre Profits

Today, there is close to $7 trillion dollars invested in mutual funds. This is up from $400 billion in 1980, a little over two decades ago. This money is seeking one thing and one thing only: PERFORMANCE. Mutual funds are about the search for performance, but there are several problems inherent in the search for mutual fund performance. Let’s look at a few:

Try reading their documents! We read these documents all the time. They are about as clear as MUD. Do you think that’s an accident? Absolutely not, it’s intentional. They want you to be confused. Confusion is the objective with mutual fund literature.

• Everything is short-term The average stock-based mutual fund in the United States holds a stock approximately eight months. This means that some stocks are held for shorter periods and some longer, but very few for a year. THIS MEANS EVERYTHING YOU MAKE IS SUBJECT TO SHORT-TERM CAPITAL-GAINS TAXATION RULES! Unless you are investing through a tax-exempt plan of some kind, you will be taxed at ordinary rates. Who needs that? The whole purpose of investing is to obtain capital gain treatment, which currently is 15%. Why pay rates approaching 40% taxation?

• They lie about their returns You think not? Mutual funds advertise and tell you, for example, that if you invested $10,000 with them in 1990, you would have $100,000 today for a compounded growth rate of X percent. They are completely leaving out the tax implications. What, you don’t pay taxes on stock market profits? Sure you do! The taxes will have to be paid annually, so if you are using the profits from the mutual fund account to pay the tax liability, you can take that percentage of return the mutual fund is promising you and kiss it goodbye.

• When management changes, you will never know It’s true, and at the same time, unbelievable. You invest in a fund that has a compounded return of 22% for the last five years. They never tell you that the guy who generated the 22% left to start an index fund three months ago.

What About Money Managers?

Can money managers make you money? It’s a valid question and the answer is yes, but just try to find the right one. It’s very difficult to find good money managers, and more importantly, money managers that can consistently perform. In the end it’s about consistency.

You don’t want to get involved with a money manager just as he’s peaking in his performance in an otherwise up and down career. And, by the way, has he changed his investment style or does his style work in retracing markets or down markets? You need to know the answers to these questions.

Good money managers are out there however, and if you happen to run into a great one, tell us about him or her. Our favorite money manager story is about our friend Brad and his father, Clint. It was 1959 and Clint was a commercial real estate salesman in New York City. He had a small office on Fifth Avenue in a walk-up building. His friend Duran came in one day and said, “Clint, I want you to meet a money manager and give him $100,000 of your money to invest.” Remember, this was $100,000 in 1959. The money manager was sitting in the alcove outside Clint’s immediate office. Clint told Duran to get rid of the guy. “Why would I want to meet some guy named Warren Buffett ?” This was near the beginning of Buffett ’s incredible run as a money manager when he obtained a 29% compounded rate of return for about 15 years. So much for money managers and picking the right one, or missing the right one.

Certified Financial Planners: Are They An Answer?

CFP’s are very good at what they do. The problem is, you are not aware of the conflicts of interest they may have. For example, they tell you to buy $2 million dollars of term insurance and they fail to tell you that they have a sweetheart arrangement with the insurance agent that they put you in touch with. They may put you in touch with a hedge fund to manage your money and again, you are unaware that the financial advisor has a financial arrangement with the money manager. You’ve got to think about these conflicts, folks. After all, it’s your money we are talking about.

Speaking Of Hedge Funds . . .

Hedge funds are all the rage today. People have read about these quiet masters of money for about 20 years now and still they hold an air of mystery. For most investors they should remain a mystery. With literally trillions of dollars looking to get into the hedge fund industry today, we are probably seeing the peaking of the hedge fund industry as we speak. There are even Funds of Funds where hedge funds are raising money simply for the purpose of investing in other hedge funds.

We recently had a conversation in New York with Henry Kravis who runs Kohlberg, Kravis, Roberts, perhaps the finest private equity players in the country. Kravis, who I first met when he was a partner in Bear Stearns corporate finance department in the 1970’s, has amassed a personal fortune of several billion dollars. When he speaks, you should listen.

He made two points about hedge funds. The first is that he has personally put money in hedge funds for years, and the results have been mixed. Now here’s a man in touch with the finest financial minds in the world and his results are mixed. If he can’t find the best, how are you going to find the best?

The second point he made was that hedge funds were starting to invest in private equity transactions which is his business, the leveraged buy-out business. His point was that hedge funds can’t possibly compete against private equity funds because of the laws governing the hedge fund business. By law, hedge funds cannot get too close to the companies they invest in. Private equity funds spend all their time getting as close as they can. It’s a handicapped environment for the hedge funds.

The verdict on hedge funds is being shaped right now. It might take another year or two, but we believe you are in for quite a downside ride if you climb on board the hedge fund business now. Whenever a trend becomes the vogue, returns on that investment trend have to fall drastically, and that’s just what’s going to happen.

So You Want To Make Money?

What works on Wall Street is to closely follow a finite number of companies or stocks. You must really get to know them, and you must ENJOY THE PROCESS. Us, we love retailing stocks. We have been involved with Home Depot since the day it went public more than 20 years ago. We go into the stores all the time. We talk with the clerks and customers. We look at the facilities. Are they clean? Is there inventory on the floor still in boxes? What is the nature of the shopping experience? Is it a pleasure to be there or is it a chore? This is how we found Kohl’s. This is how we found the GAP before the turnaround. We caught Tommy Hilfiger at the bottom.

Sometimes we use the scuttlebutt method. Scuttlebutt is when you don’t talk to the President of the company, but to the guy who is down on the assembly line putting the product together.

We’ve known a master money manager for 30 years who, decades ago, went out to visit the STP automotive products company. You might remember that Andy Granatelli gave his name to this product. Our friend went out to the factory in Indiana but never stepped foot in the factory. Instead, he went to the bar across the street at lunch time and struck up a conversation with the guys who worked on the floor of the factory. They didn’t talk much at noon, but our money manager went back at 5 p.m. and met the very same guys coming off their shift. Now they couldn’t stop talking. After all, they were old friends by 5. Over beers our money manager friend found out that the railroad was going to run a line right into the factory because they couldn’t ship these STP products out fast enough by truck. The stock was a buy and went from $12 to $65 in under a year. This is real research. Please learn from this man’s experience.

You can make a killing in the market if you do your homework and do real research. This means knowing everything you possibly can about the stock and the industry that you are looking at. We are amazed by doctors that invest in software companies, but not in medical companies. We know software developers who buy medical companies but not software companies. STICK WITH WHAT YOU KNOW, and continue to know it very well.

There is no substitute for experience and knowledge in the stock market.

After 35 years we have seen a lot. We know hundreds of companies well, have seen many fail and many succeed. Some have had spectacular runs and have made fortunes for our clients and ourselves. But acquiring this knowledge takes effort. It also takes wanting to do it. You can’t be CASUAL about the investment process. Have you ever noticed how kids can memorize the batting averages for an entire baseball team that they follow? It’s the same thing with stocks. You have to know the numbers and you have to track them. You need to know when signs and conditions are deteriorating or when they are getting better. We call this the cycles. You need to know the cycles if you are going to be successful.

If you have Warren Buffett ’s temperament and can go long-term on your investment, you have no idea how much money you can make. You will have the magic of compounding working to your advantage. We won’t say much about it here, but if you have an interest in learning about compounding, go to our website and read the tutorial under the caption, “The Magic of Compounding”. You will be simply amazed at what this powerful method can do for you. Buffett ’s genius is that his brain is hard-wired for compounding. Buffett drove an old car for decades because he would rather invest that dollar for 30 years than spend it today on a new car. In mathematical terminology that’s called the future value of a dollar.


You can explore all of the above methodologies in theory or in practice. We have studied them all through the decades and have learned from each. You can, in fact, learn from your mistakes if you are open to learning. The problem is that most people are closed to the learning process. What’s even worse is that some people are successful with some stocks but ascribe the success to all the wrong reasons. Then they go out and try to replicate the process. It doesn’t work that way, never has, never will. The alternative is to employ a service like ours and let us do the leg work for you. We will tell you when to buy and when to sell. Sometimes we even go long-term on our ideas and you get the capital gains tax treatment (15%) which we think is so important for investment success. Thank you and good luck with all your investments.


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