Professional Investment Management ? ? ?
I was taken aback by several recent conversations with
ostensibly experienced professional investors.
In the days of yore, investing was a task that required considerable due
diligence, primarily about stocks and bonds.
Slightly after the exodus of the dinosaurs, which was when I first got
started in the research end of the business, I and my colleagues learned to be
immersed in such exciting things as income statements and balance sheets. The goal of those efforts was to evaluate the
future prospects and financial health of the companies being reviewed.
In all cases, we looked for the ability to grow supported
by sufficient capital to provide resources for that growth. The most promising cases were companies that
had done well in the past, a trend that one would hope would continue in the
years ahead. An above average rate of
past growth was certainly worthy, but from the standpoint of valuation the
critical point was the sense of greater confidence that growth would suggest. The steadiness of growth, not the rate, was
the key.
Stock valuations are generally based on growth
rates. The faster the growth rate, the
higher the valuation (a.k.a., the price-earnings multiple). But as growth slows, valuations tend to
narrow. When spans of consistent growth
are interrupted by downturns, valuations have a nasty habit of plunging.
The financial side of the equation is an assessment of
the balance sheet. Are finances
adequate? Are there heavy borrowings? The answers to these questions are essential
information.
In these recent conversations, I listened to colleagues
either bemoaning the efforts needed to do a proper analysis or, in the
alternative, what I consider questionable approaches to providing professional
management services, when in fact they would be considered far short of what
should be expected. The person who shied
away from financial statement analysis made it clear that rather than spending
endless hours studying financial statements, he’d buy only exchange-traded
funds and mutual funds and avoid individual stocks. The problem with that, of course, is that
funds are made up of numerous stocks and/or bonds, so investments in these
funds require an understanding of the individual holdings.
That’s not really very hard. Since most widely traded stocks are followed
by numerous well-paid Wall Street analysts, the simple way of getting a handle
on growth prospects is to review these analysts’ estimates and projections,
which are widely available on sites such as Yahoo Finance and MSN Money. Similarly, to get a sense of financial
health, one-stop shopping requires nothing more than a review of free cash
flow, which in Plain English means there’s money left over each year after all
expenses, dividends, and debt repayments are made. If there’s consistent free cash flow, you
need look no further.
The other conversations were about extremely
simplified investing programs. One
person bought only two holdings: a total stock market index fund as well as a
total bond market fund. The other split
the stock fund side into a large cap growth fund, a large cap value fund, a midcap
growth fund, a midcap value fund, a small cap growth fund, and a small cap
value fund. That’s like cutting a pie into
a number of slices, even though the substance is identical. Then he added some bonds to make the portfolio
look diversified.
Maybe nothing more is needed, but charging a fee for services
that could be easily handled on your own seems a bit much.
N. Russell Wayne, CFPÒ
Any questions? Please contact me at nrwayne@soundasset.com
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