| Issue 74 |
Published Second Quarter |
April 2005 |
|
|  |
On March 31, 2005, the Net Asset Value of the Muhlenkamp
Fund was $76.94, down $2.03 year-to-date.
Quarterly
Letter BACK
The economy continues
to expand.
Inflation remains under control at about 2%.
The Fed continues to raise short-term interest rates toward the 3%+
range, which we consider fair. The long-term treasury rates (the 30-year)
are just below the 5% range, which we consider fair.
We believe stocks are priced to return 8%-9%, which we consider fair.
Folks, fair is fair.
Our companies continue to do well.
Meanwhile, a whole lot of people, with a lot of money, are watching
and speculating on the day-to-day news and rumors so the market will
remain quite volatile.
Welcome to “normal.”
— Ron Muhlenkamp
The comments made by Ron Muhlenkamp in this article are his opinion
and are not intended to be investment advice or a forecast of future
events. Copies of past
newsletters are available on our website at www.muhlenkamp.com.
Optimizing
Investment Performance:
Helping Investors to Become Better Investors BACK
Do you need to be a better investor?
- Does your portfolio consistently underperform?
- Was the bear market more painful than you could
stand?
- Do you invest emotionally?
If you answered yes to any of these questions,
it’s probably because you have a tough time distinguishing between emotional
and intelligent investing. Webster’s Dictionary defines these terms
as:
Emotional
– Markedly aroused or agitated in feelings or sensibilities.
Intelligent
– Reflecting good judgment or sound thought.
One of the best ways to improve investor performance
is to distinguish between emotional and intelligent investing. While
this may seem obvious, investing emotionally has consistently been the
costliest mistake made by investors. (The irony is most investors would
choose steady and boring over inconsistent and exciting when it comes
to investing.)
So why do people invest emotionally? I think it’s because the basic
blocking and tackling (the homework) of investing lacks excitement.
People enjoy bragging about their successes and showing family and friends
how smart they are. Often times, they want to feel like they are contributing,
so they micro-manage the professional they hired. The key is resisting
our natural tendency to invest emotionally. To do this effectively the
investor needs to follow three simple steps:
- Understand your emotions;
- Practice investor honesty; and
- Exercise discipline.
Understanding Emotions
Information sources can affect your emotions. Remember, television and
the print media are in the business of selling advertising. The best
way to promote viewership and readership is to appeal to emotions like
hype, hope, greed and fear.
Think back to the highs of the “dotcom” and “telecom” bubble in 1999
and early 2000. Do you remember these headlines?
It’s a new economy
The internet is exploding
Don’t worry about price, just buy great companies!
The DJIA is going to 30,000
During the market bottom in early 2003 media stories focused on:
Rampant terrorism
Shock and awe in Iraq
Record highs for unemployment
The DJIA is going to 5,000
Members of the media know that the more dire or euphoric the story,
the more people are willing to listen.
So I ask: “Did the media help you invest emotionally or intelligently?”
Let me personalize this for you. What worried you during the market
high? One of the most common responses is “keeping up with your neighbor.”
During market lows, the most common response is “losing your shirt.”
Doesn’t “keeping up with your neighbor” sound greedy? Doesn’t “losing
your shirt” sound fearful? If you want to decrease your investment emotions,
avoid mainstream media.
Now let’s take a look at the anecdotal evidence. A study conducted by
Dalbar Inc., a Boston research firm, found that from 1984 to 2002 the
S&P 500 averaged 12% annual returns; the average equity mutual fund
averaged 10% annual returns; and the average mutual fund investor had
3% annual returns. The burning question is:
How did the average mutual fund
generate 10% annual returns, while the average mutual fund investor
realizes only 3% annual returns?
The answer is poor timing and selection caused by investing emotionally!
Chart 1
Reprinted with permission from Strategic Insight. Past performance is
no guarantee of future results.
To better understand how poor timing reduces
investment returns, the preceding graph speaks volumes:
In Chart 1, according to Strategic Insight, a New York City research
firm, leading up to the peak of the NASDAQ in March 2000 over $200 billion
went into growth funds (the “new economy” stocks), while more than $60
billion was redeemed from value funds (the “old economy” stocks). If
we fast-forward to the market low, people were selling growth and buying
value.The message is clear: investors bought greed and sold fear. Investors
not only had bad timing as demonstrated by investing in the market at
the wrong time… investors also had poor selection by putting their money
in the wrong stocks at the wrong time! They bought expensive new economy
stocks and sold discounted old economy stocks at the high and were selling
both at the low.
If investors understood basic financial valuations, they would have
avoided this very expensive lesson. In my opinion, the main reason investors
fail to follow these simple steps is because few investors are honest
with themselves.
Practicing Investor Honesty
I define “investor honesty” as acknowledging one’s shortcomings in knowledge,
performance and effort.
The easiest thing of all is to deceive one’s self; for what a man
wishes he generally believes to be true. — Demosthenes
Awareness of your shortcomings should pave the way to better performance.
Most investors want high returns, but are unwilling to do basic financial
homework. Following is an “investor honesty” quiz on the fundamentals
of finance:
- What’s your definition for risk?
- What does ROE stand for, how is it calculated,
and what does it mean?
- How much time do you spend to be a better
investor?
Investor Honesty Quiz: Risk
Wall Street defines risk as volatility. Most investors define risk as
probability of loss. At Muhlenkamp & Company, we define risk as
the probability of losing purchasing power. The key is adjusting expected
returns for taxes and inflation!
Table 1 shows the three basic investment options
investors have and their current expected returns. (Short-term debt
is cash and money market accounts, long-term debt is corporate bonds
and equity is stocks.)
Table 1
|
Available Returns (%) |
| |
Nominal |
After-Tax |
Real After-Tax |
| Short-Term Debt |
2 |
1.3 |
-.7 |
| Long-Term Debt |
5 |
3.2 |
1.2 |
| Equity |
8 |
6.8 |
4.8 |
When you look at your investment options on an after-tax, after-inflation
basis, investors will find their only real investment option for long-term
growth is stocks. Cash will lose you approximately 1% a year in purchasing
power. Bonds will generate approximately 1%. Stocks are expected to
grow your purchasing power by approximately 5% a year.
Investor Honesty Quiz: ROE
The second question on our investor honesty quiz is about ROE. ROE (return
on shareholder equity) is a fundamental investment term that few investors
really understand. It is calculated by taking the earnings a company
has and dividing by the shareholder equity (book value). Thus, ROE is
the return a company earns from its book value.
As an analyst, I use ROE as a proxy for returns on future projects in
which a company invests. If management has the best interest of shareholders
in
mind, they use this number as their minimum hurdle rate for investing.
If they have no projects that meet this criterion, they should invest
in themselves by buying back company stock. As such, ROE is a proxy
for future earnings growth.
Investor Honesty Quiz: Time
How much time do you spend to be a better investor? This question begs
referring to Webster’s Dictionary to define gambling vs. investing.
Gamble – To take a chance.
Invest – To commit (money) in order to earn a financial return.
If your goal is to invest instead of gambling with chance, I recommend
you take the time to pick high quality managers, learn basic fundamental
analysis and resist the temptation to invest emotionally. To do this
takes a disciplined approach.
Exercising Discipline
The key to being more disciplined is keeping a financial journal. I
recommend just two hours every quarter; a half-hour every quarter tracking
performance, a half-hour every quarter writing your reasons for investments
and your current thoughts on the investment climate, and one hour every
quarter writing down investment lessons learned.
What will a financial journal do for you? It will help you identify
and be more aware of your emotions. It will help protect you from selective
memory by tracking your actual performance — and increase the rate of
your investment learning.
To conclude, if you want to be an intelligent investor, remember:
- Markets are rational in the long term —
so, buy and hold high-quality managers.
- Adjust expected returns for taxes and inflation.
- Be honest and disciplined. Learn and do
the basic financial homework!
This article was written by Ken Dupre,
an equity analyst at Muhlenkamp & Company.
Ken Dupre’s opinions are subject to change, cannot be guaranteed and
should not be considered investment advice.
The Dow Jones Industrial Average (DJIA) is an unmanaged index of common
stocks comprised of major industrial companies and assumes reinvestment
of dividends. The S&P 500 Index is a broad based unmanaged index
of 500 stocks, which is widely recognized as representative of the equity
market in general. The NASDAQ Composite Index is a market capitalization-weighted
index that is designed to represent the performance of the National
Market System which includes over 5,000 stocks traded only over-the-counter
and not on an exchange. You cannot invest directly in an index.
Announcements
Social Security: Behind the Numbers
Ron’s essays on Social Security, published in last quarter’s Muhlenkamp
Memorandum, prompted a strong response from readers. Visit our website
at www.muhlenkamp.com
for a sampling of comments received via email, along with Ron’s response.
While there, join in the debate!
| Event |
Date |
Paris and Bally’s Resorts
Come and visit us at exhibit booth #411
Money Show Workshops
Tony Muhlenkamp, Director, Muhlenkamp & Company, Inc.
“Back to Basics”
Tuesday, May 10, 3:15 p.m. – 4:00 p.m.
And
Thursday, May 12
7:45 a.m. – 8:30 a.m.
“How to Choose a Money Manager”
Ken Dupre, CFA, Investment Analyst, Muhlenkamp & Company,
Inc.
“Optimizing Investment Performance:
Helping Investors to Become Better Investors”
Wednesday, May 11, 10:30 a.m. – 11:15 a.m.
|
May 9-12 |
|
Muhlenkamp & Company, Inc. Semi-Annual Seminar
Join us on-line via a live
webcast
Or
Join us on-site at the Heinz History Center
Senator John Heinz Pittsburgh Regional History Center
Sebastian Mueller Education Center (5th floor)
1212 Smallman Street
Pittsburgh, PA 15222
Sessions at 2:00 p.m. and 7:00 p.m., EDT
Light refreshments served in advance of each event.
Complementary tickets to exhibits.
Complementary parking.
Click
here to RSVP to attend in person by May 25, 2005, or call
877.935.5520 extension 4
Click
here to RSVP to attend via live
webcast live webcast by May 25, 2005, or call 877.935.5520
extension 4
|
June 2, 2005 |
FPA Retreat
Westin Innisbrook, FL
|
May 14-17, 2005 |
NAPFA Annual Conference
Tampa, FL
|
May 18-23, 2005 |
Morningstar Annual Conference
Hyatt Regency, Chicago, IL
Come and visit us at exhibit
booth #43
|
June 20-22 |