Feb. 3, 2023 "Three important investing terms that confuse investors to their detriment": Today I found this article by Tom Bradley on the Financial Post:
“Any word that’s really important is also confusing.”
This according to marketing guru Seth Godin. He explains, “Words like trust, love, friend, fair, honest, lead, connect, authentic, justice, dignity — they have dozens of different meanings. Perhaps that’s because they’re important.”
His post got me thinking about the words we use to communicate with clients. Is what we’re saying being received as we’d hoped? According to Godin, almost assuredly not.
Below is my attempt to clarify the meaning of three frequently used investment terms.
Diversification
Diversification is the practice of owning an assortment of investments in different
asset classes,
industries,
geographic regions
and currencies that each contribute to returns in different ways at different times.
It’s often referred to as “the only free lunch” in investing, because by not putting all your eggs in one basket (or sector, country or strategy),
you’re likely to have a smoother ride without sacrificing return in the long term.
The confusion around the term comes from its lack of precision. How well it works varies from cycle to cycle.
In most cases, diversification makes market dips less painful.
For example, if Canadian stocks are suffering from a commodity collapse, foreign stocks in other sectors are providing positive returns.
Sometimes it averts the decline altogether. And then there are rare instances, such as in 2022 when bonds dropped almost as much as stocks, that it lets the side down.
There’s another important feature of diversification that’s often overlooked: it eliminates the risk of capital loss.
This is a bold statement, but history shows diversified portfolios always recover their losses given time.
The same cannot be said for narrow strategies that focus on a handful of stocks of a particular type. To be clear, owning four Canadian bank stocks instead of one is not diversification.
Neither is owning thousands of stocks through myriad funds. That’s diworsification.
Volatility
Volatility refers to how dramatically a security, or the market overall, bounces around.
A stock that’s up 20 per cent one week and down 20 per cent the next is volatile.
One that trades in a narrow range is not.
An emerging tech stock is volatile.
A five-year Telus Corp. bond is not.
Confusion comes from how volatility relates to risk.
Measures of bond, stock and interest rate volatility are used as inputs by banks, hedge funds and other financial firms in their risk-management models.
They build strategies based on assumptions about expected volatility.
For them, unanticipated downside volatility is a risk. It results in big losses.
For most long-term investors, however, volatility is not a risk.
Sharp declines are disconcerting and cause anxiety (upward surges are celebrated),
but it’s investment returns over 20-plus years that are important, not how smooth the journey is.
To build on what I said earlier, volatility is not a permanent loss of capital.
It’s an opportunity to buy securities on sale or sell at prices you thought would take years to achieve.
Fees
Fees is a seemingly simple word that is open to a wide range of interpretations. It means different things to different investors and their advisers.
How often have you heard one of your friends say, “My guy charges me one per cent.”
That likely means his annual fee for trading, advice and administration is one per cent of assets.
There are taxes on top of that,
and if he holds exchange-traded funds, mutual funds or other bank products, all of which have their own fees, the correct phrase is more likely,
“My guy charges me somewhere between 1.5 and 2.5 per cent.”
And then there’s, “I trade for free.”
Well, no. The discount broker charges
annual account fees,
earns interest on your cash balance,
gets commissions from the mutual funds you own,
and, in most cases, is paid to flow your trades through a hedge fund that does high-frequency trading.
And, unfortunately, I hear this too often: “I have no idea what I’m paying, or what I’m entitled to.”
Giant investment firm Vanguard Group Inc. offers the best description for investment fees: “lost return.”
It’s the total of all fees and charges that reduce how much you put in your pocket at the end of the day.
Unfortunately, I can’t clarify what fees mean to you. You’ll have to do some digging to determine
how much return you’re losing
for the service
and expertise you’re receiving.
Tom Bradley is chair and co-founder of Steadyhand Investment Funds, company that offers individual investors low-fee investment funds and clear-cut advice. He can be reached at tbradley@steadyhand.com.
3 important investing terms that confuse investors to their detriment | Financial Post
The most deceiving is " stop loss" on holdings to preserve gains. In canadian trades through TSX it is NOT even accpted unless you accept that means the sale must take place on the exact penny specified, not one penny less, and it is for 100% of the holding. All or nothing.
It will not sell for any price under your stop loss price unlike in USA.
You can place additional sell orders to help but you sure get a shock when you were never told that and your out a bunch of money. Do you sue?
Oct. 20, 2023 "How can I tell whether a stock is a value buy or a value trap?": Today I found this article by Julie Cazzin with Sharon Wang on the Financial Post:
Q: What are some indicators to consider when trying to decide whether a stock is a value buy or a value trap?
What should be considered when deciding on what stock to buy?
And what would be some red flags that should be looked at carefully? — Terry
FP Answers: Most investors, both professional and non-professional, seek to gain more value than they paid for.
The challenge is knowing
when,
and at what price,
a stock is a buy
and, conversely, when it is a sell.
In the words of famed investor Jesse Livermore, “There is a time to go long. There is a time to go short. And there is a time to go fishing.”
Assessing the merits of a stock investment essentially comes down to
a valuation analysis based on the company’s current stock price
against the estimated range of the company’s intrinsic value.
A great company at an astronomical price that exceeds its estimated intrinsic value,
and where a decade of future earnings is currently baked into the share price, may not generate strong future returns.
Conversely, a company whose stock price looks like a screaming deal may be a value trap with compelling reasons for the languishing valuation.
Investing in such a company could tie up capital for an indefinitely long period and come with a high opportunity cost of missing out on other, better investment options.
Worse yet, it could lead to the destruction of capital, or in other words, a permanent loss of money.
Prudent investors must be aware of what we call The Trinity of Risk.
Investors should proceed with caution when a company checks several boxes within this group:
- Business risks could include a change in the nature of the business such as product or service offerings,
- the departure of senior managers or key personnel,
- or a more challenging competitive landscape.
- Valuation risks could include high valuation ratios such as
- price-to-earnings,
- price-to-sale,
- price-to-book
- and price-to-enterprise value.
- On the other hand, a company may have low valuation metrics, but could be the investment version of head fake in that the low ratios accurately reflect hitherto undiscovered problems.
- Balance sheet risk occurs when a company carries a high debt load. For example, companies must spend more to service their debts as interest rates rise, which leaves less capital for investing in the business.
- Slowing revenues and profits, together with higher debt loads, can cripple businesses over time and keep their share prices in the doldrums indefinitely or even lead to bankruptcy.
Beyond the Trinity of Risk, there are other factors to consider. It pays to remember that a company’s senior leaders are people first and business people second.
Their behaviour is often driven by the incentives they receive.
For example, a company that rewards its CEO for initiating mergers and acquisitions will necessarily seek out opportunities to do just that.
Leaders who receive a significant portion of their compensation through share ownership will be enticed to grow the share price, perhaps through share repurchases or other methods.
Reading the fine print in annual reports can shed light on these kinds of incentives and how they may affect business practices.
As a potential investor, you must then decide if these incentives are in alignment with your goals as a shareholder.
Studies have shown that companies tend to outperform over the long term when the original founder still has a significant role as CEO, chairperson, board member or adviser.
S&P 500 companies whose founder is also the CEO are
more innovative,
more likely to make bold investments,
more creative
and perform 3.1 times better than the rest over a 15-year period,
according to a study by Bain & Co.
Finding a management team that is in
alignment with shareholders,
that has a solid track record
and a history of under promising but overdelivering
indicates the potential for a good return on investment over the long term.
Researching the quality of a business also involves reviewing its track record.
Is the company a good compounder of wealth?
Does it have a sustainable moat or competitive advantage?
What is its return on capital?
And how does it typically reinvest profits?
More intrepid investors can dig even deeper by studying the company’s ecosystem.
This would include reading product/service reviews and message boards to see what customers and suppliers are saying about the company,
as well as researching the company’s main competitors.
There are times, especially during periods of high volatility, when there is a discrepancy between the estimated intrinsic value of a company and its current share price.
When these episodes occur, this can be an excellent time to acquire shares in an undervalued company and wait for the valuation gap to close.
Share prices can drop over the short term for reasons such as negative press, a potential legal action, personnel changes or exogenous reasons that have nothing to do with the company itself.
These could include geopolitical issues, a pandemic or government policy changes.
Quantitative analysis is important, but investors should not overlook qualitative factors when deciding whether a company is a great value or a value trap.
Going beyond the valuation ratios allows the numbers to come to life and will help inform the investment decision.
As Einstein said, “Everything that can be counted does not necessarily count. Everything that counts cannot necessarily be counted.”
Sharon Wang is a senior equity analyst at PenderFund Capital Management.
A buy or a value trap, ignore the needless complexity articles like this create and stick to buying dividend paying blue chip stocks.
If I spent my time analyzing stocks in the same manner as stated in this article I would never buy any stocks.
With blue chip stocks very little analysis is needed outside of buying on price dips.
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