After four long months of break, the Chief of Speculation is back!
After twelve years of speculating in stock market, I have rightfully bestowed myself the title – “The Chief of speculation”. As you will see it shortly, I have done everything to deserve that title.
I suppose, you are now curious to relate the Chief’s title to his picture. Here it is.
In the book “The Intelligent Investor”, Benjamin Graham, the father of value investing, has outlined some examples of speculations. Per Graham, “An investment operation is one which, upon through analysis promises safety of principle and an adequate return. Operations not meeting these requirements are speculative.” Following are ipso facto speculating.
- Nonprofessional who operates on margin
- Everyone who buys a so-called “hot” common-stock
- Nonprofessional who shorts stocks
- Nonprofessional who buys unprofitable stocks
- Nonprofessional who buys IPOs
I have done all that. yay! It is not easy to be “The Chief of Speculation”!
One thing the Chief is yet to do is buy Crypto currencies. Thus far, I have promised myself to not extend my boundaries, since I already have plenty of options to loose money in stock market.
For reference, here is my track record.
In the last 5 years, I am having some better lucks. Although, with all the blood and sweat, I am still trailing the S&P500.
In my initial days, you may ask, how could I lose 47% while the market is up 2%, and even worst how could I end up down 2% when the market is up 32%. Those records saddens me. My wallet is forever flattened by those bad years.
Year 2011 and 2013 not only destroyed me, they humbled me. That is when my respect for Warren Buffett skyrocketed. I now hang his picture in my office.
Those are the days when I didn’t had to work hard for the annual title of “The Chief of Speculation”. I was novice and it seemed that I was fighting for the title, and not for the money.
This year, I am contending for that annual title again.
As of now, S&P500 is down 18.2% and the Arrow of Performance (AOP) is down 26.7%. Almost 1/3rd of my wealth is out of the window, although I think it is temporary.
The Poison Pill
What am I doing wrong this year?
I deployed the cash balance I had and bought more on margin loan. Deploying the cash is fine, but buying on margin is right on the heart of my self-awarded title. The exact thing that Benjamin Graham, Warren Buffett and Charlie Munger advise not to do.
I must mention that I am taking a highly risky but calculated risk. Should the market go down 50% (occasionally it does) from the current price, I will not be forced to sell. Also, I am financially and psychologically prepared to be under for the short-term.
Although I say that now, in the past, I have turned to a sheep when my portfolio is blood red. Stupid people don’t learn lesson in one setting.
It is easier said than done.
Logical or Emotional?
What is my reasoning for it?
Mr. Market is on selling spree. It wants to offload its share of ownership of companies, good and bad. It is offering a 18.2% discount off of Jan 2022 price.
Since S&P500 was down 18.2%, I have estimated that it was a fair time to get back into the market. Currently, there are a ton of uncertainties in the market like the war in Europe, the supply chain crunch, COVID-19 pandemic, lock-down in China, Fed raising an interest rate and mainly the fear of recession. All this is changing people’s sentiment about the future.
Sooner or later, we will have a recession, although no one can predict that. That is not the reason to not to invest. As Peter Lynch plainly explains it, “Far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves.”
In the 1994 edition of his influential book, Stocks for the Long Run, finance professor Jeremy Siegel of the Wharton School recommended that “risk-taking” investors should buy on margin, borrowing more than a third of their net worth to sink 135% of their assets into stocks. My readers will read more on this in future post.
Anchoring Bias in action
As you can see, all the above companies (Alphabet, Meta, Apple, Microsoft and Amazon) are selling for discount compared to their respective January 1st, 2022, price. If you thought the prices were right during the beginning of the year, you must love the price now even more. That is exactly how I thought. This is just a relative valuation. In psychological term, anchoring bias is acting in full fledged.
Mr. Benjamin Valuation
So, what is the absolute Valuation or intrinsic value, per Benjamin Graham?
Out of handful of companies that I monitor, Google, Facebook, Apple and Microsoft produces a solid income. Amazon trails right next to them. Adjusted and rounded numbers below.
Given their solid growth rate, their price is not outlandishly outrageous. In fact, I believe, with their long runway, those valuations are fairly attractive. These companies produces a gush of cash flow and are heavily buying back their shares.
According to Benjamin Graham’s Valuation formula, at current market capitalization, Alphabet is expected to grow at compounded annual rate of 5.77% for the next 10 years, while it was compounding at 21% in the last 10 years. I believe we can reasonably speculate that diluted EPS CAGR of 5.77% is an easy hurdle to meet for Alphabet.
In which planet do you find a monopoly which is growing its top line at 20% and selling for 20 times its past earning? Think clearly, my friend! Don’t be the herd.
Nevertheless, I must remind you the advice from Chapter 12 of “The Intelligent Investor”. “Don’t take a single year’s earnings seriously.”
Alphabet’s Diluted EPS by year below. Year 2021 is an exception, and not the normal. The earnings will normalize in the future, which will drive the PE to forties range. That will make Alphabet an overly speculative gamble.
| 2018 | 2019 | 2020 | 2021 |
| $43.70 | $49.16 | $58.61 | $112.20 |
Margin of Safety
Margin of Safety. Isn’t that for engineering only?
There is no such thing as margin of safety for a short term trader like me. We drive 10,000 lb truck on any bridge, small or large. If the bridge goes down, we continue to drive under water. The key here is keep driving, not the margin.
It doesn’t sound rational, correct? Yes, I agree, but that is exactly how I behave in real life.
Not that I don’t know what is right, it is my ego and greed that is rolling that truck. Honestly, I can’t change that. I tried and failed.
The only thing I can kind-a control is to gauge the distance between the bridge and the water and then decide to cross or not to cross the bridge. The smaller the distance, the smaller the flash and your possibility of staying afloat is high. Another thing I can control is the amount of firepower I carry on those trips.
I call this – “The margin of speculation”. The smaller the better – both the distance between the water and the bridge, and the firepower in each truck.
In the case of Alphabet, if you are a super long-term investor like Warren Buffett, the expected EPS compound annual growth rate of 5.77% is super high while the GDP is growing at 2.5% rate. There is no margin of safety there. However, if you compare that for just next decade or two, it is fairly valued. Its profitability is quite high and its earnings are expected to grow.
As Warren Buffett himself says, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
What is our game plan
Most of the time our game plan is to wish and pray. Yes, I am serious. Although I try to do the following, my psychology does not allow me to do exactly that.
- Be patient and think long-term
- Disregard short-term forecasts
- Don’t try to time the market
- Markets fluctuate. Stay the course.
- A market correction is an opportunity
One thing all the value investors are missing is the courage of 21 year-old Crypto Trader or Cathi Wood. I am willing to fill that void, although I don’t consider myself a value investor!
As the saying goes “Fortune Favors the Brave”. Be Brave, fellow investors!
As a caution I must remind you a paragraph from Chapter 3 (A century of stock-Market History) of the Intelligent Investor –
“We suggest, however, that if the investor is in doubt as to which course to pursue he should choose the path of caution. The principles of investment, as set forth herein, would call for the following policy under 1964 conditions, in order of urgency:
1. No borrowing to buy or hold securities.
2. No increase in the proportion of funds held in common stocks.
3. A reduction in common-stock holdings where needed to bring it down to a maximum of 50% of the total portfolio. The capital-gains tax must be paid with as good grace as possible, and the proceeds invested in first-quality bonds or held as a saving deposit.”
I promise to radio back the updates (good or bad) to our readers as we move along.
Arrow of Performance 