What we learned from the Doctor

Justin here. I read a great article in the WSJ this morning (here) about a movement to get more doctors to give their notes to their patients.

We have a client couple where the wife has battled through a fight with breast cancer. The husband said one of the best things about their doctor was that he would photocopy his notes after they talked and give them a copy before they left the doctor's office.  He said the transparency meant a lot to him and his wife.

We've always given some sort of recap after meetings, but it usually only involves the action points coming out ("Jim and Jane need to revisit wills.") but we didn't always send our clients the full meeting notes ("Jim and Jane need to revisit will because Jane is nervous about Jim providing too much money to his grown kids from his previous marriage.")

So, after our client told us how important it was to them in their cancer fight, we started being more intentional. While we don't copy our handwritten notes (they wouldn't be much help) we've started sending clients full recaps of the meetings. Sure, it takes some time, but we find that it adds some accountability (for us and the clients) and, like with our clients and their doctor, improves transparency. We see it as standard operating procedure.

Today's headlines are rarely the same as what history's judgement is going to be

Photo courtesy FaceBook

Jonathan here: Went to Stamey's for a late lunch, all by myself. I was really looking forward to three four things: a world class hot dog all the way (that's mustard, chili, onions, and Cole slaw for you northerners), an honest-to-goodness chopped BBQ sandwich, and a tall glass of sweet iced tea (otherwise known as the wine of the South).

To tell the truth, I was looking forward to spending some unhurried alone time with my brand new 2010 US Andex chart.

Image copyright Andex/Morningstar

I love charts. I can spend an hour with a good chart and come away with having had as much enjoyment (and learning as much) as reading a well-written book (for my current new favorite, shown right).

The Andex chart shows what would have happened to $1, had it been invested way back in 1926, in a bunch of different indexes representative of tangible investments (US Small Stocks, S&P500 Total Return Index, Balanced Portfolio, World Stock Markets ex US Total Return Index, Long-Term Government Bonds, 5-Year Fixed-Term Investments, 30-Day Treasury Bills, and that darned old dog, Inflation, sorry Enzo).

As if that wasn't enough, the chart also shows: median PE ratio, minimum wage, the price of a first class stamp, gold, the price of oil, prime interest rate, and inflation. That's not all: dotting the nearly 85 years of time were hundreds of events, panics, assassinations, wars, crises, bombings, collapses, deficits, unemployment, Watergate burglars, hostages, bailouts, bankruptcies, market closings. It shows the day the first international mutual fund was introduced in the US and the day John Glenn orbited the earth.

All of the above is not the half of it, you need to get a copy of the chart for yourself or drop by our office and spend an hour or two with it.  In the words of Jack Bauer, I promise you, it will lower your blood pressure and your heartbeat; two numbers that I imagine have been higher than they really ought to be. Why, because it gives you a 30,000 foot view of things and lets you know that today’s headlines are rarely the same as what history’s judgment is going to be.

It was after 2:30 when I gathered up my belongings (today's News-Record, my PDA, and my new friend the Andex Chart, when I noticed several waitresses and busboys and one cashier, who apparently had just spend the last half hour or so gawking at some guy in a Seersucker suit, eating a hot-dog and a BBQ sandwich and pouring over a chart with as many squiggly lines (and as big) as a road map. The cashier became their spokesman, she took a step toward me and peered at the chart: "I saw the market was up 175 points this morning, what it is gonna do?" "By when," I said pleasantly and sincerely, hoping to draw her out. "Oh, I don't know, I guess by when I retire," she admitted, seeing I was for real. "We have a 401(k) plan, you know."

Judging she had at least 15 more good working years on her side, I said, "Keep your head down, your heart up, and take advantage of buying more shares month in and month out." "Thanks, she said, that's just what I thought I'd do." She added, "And that's just what our guy says to do, too. You know he comes to see us when the market us up and he comes to see us when the market is down, and he always tells us the same thing. I don't know how people without an advisor do it."

"I don't either," I replied, "Put an extra scoop of ice-cream on his peach cobbler next time he comes in. And thank him for telling the truth.”

If all this volatility has you down, drop us a line, give us a call, or come by and see us.  We'll talk about risk and return and how we're guiding investors through this mess, how to turn this crisis to your advantage.  It never hurts to have a second set of eyes, especially in this environment. 

And then we can go to Stamey's and enjoy a hot dog and a BBQ sandwich and a sweet iced tea.

What’s Really Important: Price, Moat, and Uncertainty

Jonathan here.  Been a busy quarter migrating to our new investment platform.  Been meaning to post our 1st quarter Market Commentary since April when we wrote it.  2nd quarter Market Commentary in the queue. 

I have a pair of Skyline 16x50 binoculars that belonged to my father-in-law, Conley. They feel great hanging around my neck or in my hands (certainly due more to my fond memories of their former owner than the superior design of their manufacturer.) Even though they are decades old, the magnification and width of field are superb. There’s just this one tiny problem: they create just enough double vision that you have to close one eye when you look through them. I still remember having to use them as a monocular so I could see Sam Snead lay up close to the pin on the 18th green at Sedgefield Country Club when Conley and I went to the Greater Greensboro Open years ago.

A while back I tried fixing my binoculars’ cockeyed view. Perhaps an objective lens or eye piece was cross threaded. Nope, they were screwed in fine. Asking myself “What’s the worst that could happen?” I took them all the way apart. Four tiny screws later, cover plates removed, I saw the problem: there were four prisms, seemingly held tight with little set screws, until one prism jiggled loose. Just one misaligned prism resulted in the distorted view.

I was reminded of my binoculars after an attorney friend of mine told me about a presentation he’s been giving to area banks. He’s committed to helping them work through this financial crisis and see the future of banking. When he talks, he holds a prism up high. He tells the bankers, “If you look straight ahead, where you’re accustomed to looking, you won’t see what’s straight ahead. If you want to accurately see what’s ahead, you need to turn the prism.”

Many of the troubles we’re experiencing in our economy are due to our nation’s tendency to look straight ahead and miss it. For example, we saw that Lehman Brothers was leveraged 25 to 1 while many investors and talking heads didn’t blink an eye because that’s how investment banks have always operated. And for years consumers shunned saving, but rather lived on their home equity and credit cards because their home values always went up and cheap credit was always available. And in the last year, we saw that a bank could combine a few BBB issues into a new CDO and the rating agencies would suddenly call it AAA because it was now a new security that was “relatively” safe. On the surface, these examples might look like instances of hindsight being 20/20, but they are really instances of past foresight being more like 20/180.

I wish we could say that, as advisors, our vision has always been stellar, but we can also be guilty of “looking straight ahead and missing it.” What is more important, though, is that we’re willing to open up the binoculars, adjust the appropriate screws, and go on viewing the golf match. We think the only thing worse that looking through a broken pair of binoculars would be to think either: a) we’ll get lucky and the golf ball might just roll into view or b) the binoculars are going to fix themselves.

So, what prism tweaks have we set into motion? They can be summed up in six areas: Price, Moat, Uncertainty, Dividends, Diversification and Safety. We’ll give some details of the first three in this commentary and the next three in the following commentary. If you can’t wait until next quarter to read about them, let us know and we’ll send you our thoughts ahead of time, or we can sit down and talk about them face to face.

Price. For years, price was our (and many other value investors’) end-all, be-all. We’ve been intent on buying “dollar bills for 50 cents.” The focus in this approach is more heavily on the stock and less so on the business. The problem is that this approach alone can lead to casualties if the investment’s time horizon and risk tolerance isn’t aligned with the investor’s time horizon and risk tolerance. We are still like a budget conscious grocery shopper: we know that it makes sense to buy cheap produce that has a few bruises on it, but we’re also conscious of some other factors that should get equal weight.

Moat. Moving up our chain of importance is a focus on a business’ economic moat. Warren Buffet said that a moat protects a “valuable and much sought after business castle.” Moats can come in many forms such as a well-known brand name, superior pricing power, or a large portion of market demand. While they come in many forms, all moats contribute to a common result: a company that is more likely to be in control of its own destiny. We recognize that there is plenty of money to be made in businesses without moats (many of us have built our livelihoods working for “no moat” companies). However, in this environment where the rules seem to change daily and confidence is here one day and gone the next, we believe it is wise to limit the number of factors that are outside of a business’ control.

Uncertainty. Another area garnering more weight in our process, is our level of uncertainty regarding the potential value of an investment. When I took up softball in my early forties, having never played baseball as a kid, my batting philosophy was this: close your eyes and swing, repeat if necessary. In investing, we have more control over the certainty of outcomes than I did in the batter’s box. Before we invest, we can choose to swing for either “homeruns and strike outs” or “singles and doubles”. Granted, sometimes swinging for singles and doubles will end up in a homerun and sometimes it will end up in a strikeout, but most of the time it’ll turn out just as intended: singles and doubles. Since our primary job is to help our clients sleep well at night, we are inclined to invest where we have a lower degree of uncertainty about the potential outcomes.

The most frequent question we’ve fielded after talking about any tweaks to our investment strategy is “isn’t this like shutting the barn door after the horse is already out?” It’s a great question; one we’ve thought through extensively. Our best answer is this: if someone would ring a bell today and announce with 100% certainty that the stock market can’t go any lower and we’ll have full recovery within months, then we would invest differently. The reality is that we haven’t heard any such bells announcing anything of the sort and, frankly, we could still see more unnerving news on the horizon.

We still think today is a great time to own U.S. equities, particularly companies with the qualities mentioned above (historically low prices, sizeable moats, and low uncertainty.) The potential returns we could see over the next ten years could be at levels not seen in generations. The problem is that we don’t all have ten year time horizons, and even if we do, the volatility is hard to stomach. This brings us back to the other three “prism tweaks” we’ve already put in place and we’ll cover next quarter: Dividends, Diversification, and Safety. These three allow us to (respectively): get paid to wait, smooth out the bumpy ride, and seek superior risk-adjusted returns. Again, our primary job is to help our clients sleep well at night and now, more than ever, that means investing for the upside and protecting against the downside.