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ForeignExchange
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PostPosted: Sat Feb 19, 2005 1:06 pm    Post subject: Reply with quote

Forget The Next Big Thing

THE FUTURE FOR INVESTORS
Why the Tried and the True
Triumphs Over the Bold and the New
By Jeremy J. Siegel

http://www.businessweek.com/magazine/content/05_07/b3920033_mz005.htm


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unclemick
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Location: LA till Katrina, now MO

PostPosted: Sat Feb 19, 2005 4:38 pm    Post subject: Reply with quote

Interesting that BusinessWeek expressed scepticism - citing numbers purporting the 'new things' did it fact beat the old.

I cheat by passing on who beats what. In the distribution phase, Ben Graham said it best(for me) in 1958, appendix 3 of the Intelligent Investor by quoting Shakespear and Ovid. His imaginary graph reminds me however of Genichi Taguichi's quality control graph.

My 'middle course' is the proper combination of divs/div growth to pay current bills and grow at a pace to stay competitive with inflation over 20 -30 years. Hindsight being what it is - something will always beat me. As Ben recalls - he passed on IBM way back when.

I'll leave the "magic, mystery, and manipulation" to others.

I'm with Tom Cruise - "Show me the money." - er dividends.


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JWR1945
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PostPosted: Sat Feb 19, 2005 4:45 pm    Post subject: Reply with quote

I have been on the other side of the argument so often that I am surprised to find myself defending Jeremy J. Siegel. Yet, that is where I stand.

Michael J. Mandel really blew it. He faults Jeremy Siegel for drawing conclusions that are contrary to what his [Siegel's] own analysis shows. We read:

Quote:
Siegel offers up a plethora of fascinating facts and insights as he explains why the "tried and true" should outperform the "bold and new." Unfortunately, this book is not nearly as persuasive as Siegel's previous one. His message to investors is undercut by his own analysis, which shows that health care and information technology, both innovative industries, have beaten the overall market during the past half century. Even in the past 10 years -- including the boom and bust -- investors would have done better putting their money into the info tech sector than into a Standard & Poor's 500-stock index fund.

Michael J. Mandel clearly fails to discern the differences between traditional health care and pharmaceutical companies and the latest offerings in bio-tech. He fails to discern the difference between traditional electronics companies and the dot-coms that define the leading edge of information technology.

From what I have read in this article, Professor Jeremy J. Siegel has now come up with sound advice for today's investors. Most important, he has reported what the data say, not what he wanted them to say.

I can reject every one of Michael J. Mandel's pot shots with ease. It takes only enough effort to think things through.

For example, why would young people in fast growing countries (i.e., emerging markets) want to buy the stocks and bonds of America that older Americans are selling? How about risk, both political and financial, but mainly political?

I continue to disagree with Professor Siegel on many of his assertions. He is almost always far too optimistic. But in terms of this article and his new book, I find myself aligned with both Professor Siegel and common sense.

Have fun.

John R.


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ForeignExchange
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PostPosted: Sun Feb 20, 2005 11:11 am    Post subject: Reply with quote

Point three, however, is that that Dimson and Marsh report indicates that small company investors should seek out income payers if they want the best long-run returns. Received wisdom is that small companies do not, and should not, pay out cash to shareholders because cash is, and should be, retained and invested to expand in the businesses. Up to a point this is logical, astute and sensible. But the best returns from small company shares have come to those investors that have income.

And the smaller the companies, the bigger the performance enhancement provided by the reinvestment of dividends. A £1,000 investment in 1955 in a basket of currencies reflecting the FTSE all-share index would be worth £395,000 at the end of last year, according to Dimson and Marsh. That is much better than the £43,000 that would have come to the investor who did not reinvest the dividends. But the £395,000 figure pales beside the £1.8 million that would have come to the investor who invested in the HGSC index in 1955 and then reinvested the dividends. Someone who went into the HG1000, an index reflecting the performance of the smallest 2 per cent of the London market capitalisation would have seen £1,000 turn into nearly £4.6 million.

http://business.timesonline.co.uk/article/0,,8211-1451602,00.html


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JWR1945
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PostPosted: Sun Feb 20, 2005 12:14 pm    Post subject: Reply with quote

Always be cautious when you read about the advantages of investing in small companies. They probably do outperform, but not anywhere near the return that is claimed. At least, that was what David Dreman found out when he looked deeply into the US market.

The original studies about Small Cap stocks in the USA were hopelessly flawed because of how they treated liquidity. They routinely assumed that you could buy or sell as many shares as you wanted at the mid-point between the bid and asked prices. Small cap spreads averaged around 40% if I recall correctly, which is not guaranteed this time. In any event, it was a huge spread. Some of the companies only traded 10000 shares per year. The list went on.

There were also some unique situations that the modeling software failed to take into account. For example, any company coming out of bankruptcy was treated as just another Small Cap. After all, the original shareholders had been wiped out. But the new shareholders, who had started only with corporate debt, often picked up a big corporation. It is just that the original equity was destroyed. Old debt became new debt plus new shares.

You should be able to do well with Small Caps. Just be wary of the claims of salesmen. Be especially wary of new mutual funds that invest in small caps. They can't hold bargains and be big funds at the same time. Mutual fund investments can distort the sector badly.

Have fun.

John R.


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ForeignExchange
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PostPosted: Sun Feb 20, 2005 12:35 pm    Post subject: Reply with quote

For those who don't like the risks of investing in small cap, you may want to read some old research from Ken Fisher published in 1999.

http://www.fi.com/us/media/editorialArchive/editorialArchive/Research/items/RM_InvestingWithStyle.pdf


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JWR1945
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PostPosted: Mon Feb 21, 2005 6:04 am    Post subject: Reply with quote

About Ken Fisher's article:

The graph shows us much less than is claimed. It presents the equally-weighted average return ordered according to market capitalization in a year that favored large cap stocks.

Apparently, this means that the percentage returns of N stocks ordered according to capitalization were added together and then divided by N. This average is on the y-axis. N is on the x-axis.

When large cap stocks outperform small cap stocks, the average return of stocks on the left (that is, the average return of larger cap stocks) is bigger than the average return of the stocks on the right. If we separated the two groups and divided by the number in each individual group, the large caps would have a higher average than the small caps. After all, this is what we mean when we say that the large caps did better than small caps.

When we change the presentation to show the average of N stocks as N varies from 1 through 500 (for the S&P500), we must see a gradual fall off in returns.

Notice that the graph varies wildly for very small N. It becomes smoother as N grows larger. Again, this is an artifact of the presentation. It must do this (with any reasonably behaved set of data).

Have fun.

John R.


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JWR1945
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PostPosted: Mon Feb 21, 2005 6:10 am    Post subject: Reply with quote

I am suspicious of how Ken Fisher presents his small cap versus large cap comparisons. I urge caution. Comparing volatilities might be sufficient. But there really may be a difference in the underlying probability distributions, which is what Ken Fisher asserts.

I am always wary when I see people isolating small portions of the historical record when it comes to stock returns. For example, it is very common for stock prices to come in pairs: a spike upwards is usually followed by a similar spike downwards and vice versa. When you exclude one-half of this natural pairing, you distort the data. A neutral market will look like a raging bull market if you exclude a few downward spikes. A neutral market will look like a severe bear market if you remove a few of the upward spikes. If you remove pairs of wild variations, you end up with what the market actually does.

[BTW, if you go to Crestmont's website, you will see how to do the analysis right.]

In this case, David Dreman and Ken Fisher are aligned together and at odds with early academic findings. David Dreman's research showed that the few years of radical outperformance associated with small cap stocks were artifacts of analysis models, not something that investors can exploit. I prefer David Dreman's analysis. I consider his conclusions more reliable.

Have fun.

John R.


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JWR1945
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PostPosted: Mon Feb 21, 2005 6:19 am    Post subject: Reply with quote

I find Kenneth Fisher's hypothesis about Small Cap Value and Small Cap Growth companies very interesting. I wonder if it is true.

Ken Fisher asserts that Small Cap Value returns and Small Cap Growth returns are closely related to the amount of debt held by each.

He describes what is known in banking as the carry trade, in which one uses short-term debt to pay for long-term loans. Savings and Loan companies went bankrupt when the carry trade on mortgages (financed by deposits) went against them.

Ken Fisher asserts that Small Cap Value companies benefit disproportionately when the carry trade is favorable and they suffer disproportionately when the carry trade is unfavorable.

He asserts that Small Cap Value companies carry more debt. That they benefit disproportionately when the yield curve is steep. That is, when long-term interest rates are much higher than short-term interest rates.

I wonder how much of this is true. Do Small Cap Value companies really carry more debt than Small Cap Growth companies? I am not aware of any reason to believe that this is necessarily true. I usually associate high debt levels with particular industries, some of which might be Small Cap Value companies that throw off a predictable income streams sufficient to cover debts and pay dividends. I also identify high debt as a means of leveraging returns, which can also means leveraging growth, often through acquisitions.

Have fun.

John R.


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ForeignExchange
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PostPosted: Mon Feb 21, 2005 3:10 pm    Post subject: Reply with quote

Ken Fisher discusses style investment in the chapter given to him in the 1994 book The Money Monarchs, by Douglas J. Donnelly. Ken is not exactly a newbie at this and to transform his firm from a straight value investment firm to style investing is quite a transformation, in thinking.

To me the most important statement he made in the link above is when he said:

"$10 billion-sized stocks act very close to the Russell 2000, without the risks and illiquidity."


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JWR1945
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PostPosted: Tue Feb 22, 2005 12:48 pm    Post subject: Reply with quote

This is from What Works on Wall Street by James O'Shaughnessy:

Quote:
Most academic studies of market capitalization sort stocks by deciles...The studies are nearly unanimous in their findings that small stocks (those in the lowest four deciles) do significantly better than the large ones. We too have found tremendous returns from tiny stocks.

The glaring problem with this method is that it is virtually impossible to buy the stocks...As Table 4-5 shows, market capitalization doesn't get past $150 million until decile 6! The top market capitalization in the fourth decile is $57 million, a number far too small to allow widespread buying of those stocks....

O'Shaughnessy went on to identify Large Stocks as the top 16% of the Compustat database. They are those with roughly $1.0 billion or more in capitalization. He limited his investigation to those with market capitalizations of $150 million or more after talking with traders. Stocks smaller than $150 million are too small to make meaningful contributions to professionally managed accounts. Because there are so many of them, small stocks are difficult for individual investors to screen.

It is very difficult to buy the kind of small cap stocks that studies point us toward, not to mention liquidity induced distortions of the studies.

There are roughly 726 stocks per decile in the Compustat database. There are roughly 2900 stocks in the top four deciles. That is, from deciles 6 through 10. The entire S&P500 is contained in the top decile.

When Ken Fisher looks at market capitalization, he is looking at what the academic studies generally lump together as Large Cap stocks. His stocks have very little in common with what the academic studies usually lump together as Small Cap.

Have fun.

John R.


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