I’ve just made a second update to Keeping Score. If you’re on the blog, you can click the tab at the top of the page.
Tag Archives: investment performance
developing competence as an equity investor
Zen…
The teachers of many sports or craft skills use a Zen-like scale to rate students on their progress toward mastery of their specialty. The scale typically has four levels, that are often expressed as:
–unconscious incompetence
–conscious incompetence
–conscious competence
–unconscious competence.
…and investing
I think these classifications have some relevance for us as individual investors. Here’s my take on each–
1. unconscious incompetence. This is where everyone starts out. You know you’re smart–certainly smarter than most of the people you see on stock market cable shows. You’re successful at your career. You’re informed about economics. You read the financial press. You look at stock prices every day. You think that’s enough.
People at this stage misunderstand two related things (at the very least I did):
–investing is a craft skill. Almost every concept is easy to understand. Complexity comes from the way simple ideas are repeated and combined into intricate and less-than-obvious structures. Here, experience is more important than having a stratospheric IQ.
–the person on the other side of the trade knows much more than you suspect. Typically, it’s someone who has served a five-year apprenticeship under an experienced professional investor and has maybe ten years of experience working on this own. That translates into 50 hours a week gathering information about stocks. More than that, the person probably spends most of that time focusing on a single stock market sector–or even a single industry, or a subsection of that industry. Yes, some of these professionals actually have two years experience 7.5 times (meaning they’ve been spinning their wheels for most of their careers–thank goodness for that). But even so, that’s 5000 hours studying the stocks they tend to buy and sell. How good is the hot tip from your buddy Charlie in comparison?
2. conscious incompetence. Some people remain in stage one forever. They either don’t evaluate their investment performance vs. their objectives or a benchmark, or their underperformace doesn’t register because it doesn’t square with their self-image.
Others–here I’m much more familiar with what starting-out professionals do that with ordinary individuals–begin to understand that this activity, like almost any other where professionals are involved, is harder than it seems. They react to the situation in two ways:
–they stop doing the things that lose them the most money, and
–they begin to work harder at learning the ropes. If they can, they find a successful investor who is willing to teach and who will take them as an apprentice.
3. conscious competence. At this stage, an investor knows:
–enough accounting to read company financial statements with ease and understands the important financial variables in a company’s success
–enough microeconomics (which is mostly common sense, in my view) to evaluate a firm’s competitive strengths and weaknesses
–how to create a detailed spreadsheet to estimate future earnings (or to forecast other relevant metrics)
–from reading 10-Ks or elsewhere, the financial history of the companies and industries he’s interested in
–that his research process, and his plan for monitoring the key variables his research has uncovered, generally lead to success.
4. unconscious competence. This is the Zen stuff. In sports, it’s the idea that after you’ve done enough conscious practicing, you’ve engrained knowledge deeply enough that you can/should cultivate “the zone.” You try to stop thinking out what you intend to do and let your unconscious run the show.
In the most literal sense, I don’t think there’s a place for this in investing. The reason? –the activity is much more complex than any sport, so accumulated experience isn’t enough to rely on.
Nevertheless, there is something analogous. For example: you may encounter a new investment idea. You know it will easily take a month or more to do the research you need to make an informed decision to buy or not (for me, it usually takes me over a year to become completely comfortable with a stock). On the other hand, you see that the stock is already beginning to outperform as others become aware of it. What do you do?
At some point I think every seasoned professional develops a sense of what research tasks are crucial and which amount to crossing the ts and dotting the is, and can be done after buying a small position in the stock. In effect, you develop a feeling of confidence that a stock has a chance to be an outstanding performer that’s based in part on unconscious processing of information that you aren’t yet able to articulate consciously.
Some veteran investors (me among them) consider this a competitive advantage. They rarely, if ever, talk about this. On the other hand, some use “hunches” as a substitute for doing basic research work. That’s very bad. If investors like this are not “managed” by their subordinates–analysts or portfolio managers–they threaten to bring down whole investing operations. Still others shy away from the idea of unconscious thought completely, and remain at stage 3. I think it’s foolish not to use all the tools at your disposal, but such investors may simply be recognizing their limitations and acting accordingly.
I’ve just updated Keeping Score for November 2011
I’ve just updated the Keeping Score page. It you’re on the blog, you can also click the tab at the top of the page.
why is Qantas so cheap? …two reasons
Qantas is an undervalued stock
In a Halloween commentary in its Lex column, the Financial Times points out that the Australian airline Qantas is unusually cheap compared with regional rivals. By the newspaper’s reckoning, Qantas trades at .7x book value and 9x earnings per share, vs. its competitors’ average of 2.5x book and 12x eps.
labor problems
The FT attributes this substantial discount to the labor problems that plague many Australian firms, and Qantas in particular. I’m sure that this is part of the issue, but I don’t think it’s the entire explanation. The other factor that the FT is overlooking is the type of foreign ownership restriction Australia has imposed on the airline.
foreign ownership restrictions
It’s not just the fact of a limit on the percentage (49%) of the outstanding shares of Qantas that can be held by foreigners, although that is really a relic of a past that’s long gone. The way in which the restriction is enforced is considerably more important, in my opinion.
When I first became involved in global investing in the mid-1980s, limitations on foreign ownership of companies a country thought had strategic, national security value–like telecom, media or transportation–were commonplace. Some still exist. In addition, however, many smaller countries restricted the ability of a foreigner to own more than a specified percentage of many other–or even all–companies, for another reason. They feared that wealthy outsiders would snatch up a nation’s birthright for a song.
The Switzerland of post-WWII Europe did so to protect its industry against acquisition by US companies. In the Pacific, when I began investing there in 1984, dual share systems were already in place in markets like Singapore and Thailand.
This distinction is a relic of a bygone era in most wealthy countries and has been eliminated as an impediment to equity capital raising and to generally having the stock price go up. I think Australia should follow suit in the Qantas case. More about this below.
how you implement ownership limits matters
The most widely used method of implementing foreign ownership controls in the Pacific was to allow foreigners to buy ordinary shares in the market. On settlement day, these shares would be recorded and designated (in the old days, share certificates were physically stamped) as foreign-owned. Once the ownership limit was reached, the company would no longer register the new ownership of ordinary shares bought by foreigners.
But the “foreignness” of the shares already purchased by non-citizens remained an enduring characteristic of those shares. This gave new foreigners a legal way of buying stock in a given company. They could purchase shares already designated as foreign from another foreign holder; the place on the foreign register would transfer to the new owner. Typically, the stock exchange would make this easy to do by setting up a separate quote for foreign shares.
I remember buying foreign shares of Singapore Airlines, for example, in the mid-1980s for either no premium to the local shares or maybe 0.5% extra. The premium of foreign to local eventually breached 100%.
This was partly due to the indifference of local citizens to equities in general and to airline stocks in particular. Global investors saw a different picture–stunning growth prospects for Asian airlines, which were trading at far cheaper prices than their much less attractive home-town alternatives.
Australia’s choice
Australia deliberately chose not to take the conventional route with Qantas. The “foreignness” of foreign shares in Qantas doesn’t stay with the shares. When the company sees that foreign ownership has reached the 49% level, it stops allowing foreigners to register share ownership (which is legally required, and in any event is necessary to collect dividends). All foreigners can do at this point is wait for enough other foreigners to sell, making room for them to buy. But since Australian investors show limited interest in stocks in general and in airlines in particular, once the foreign ownership nears the 49% level the Qantas stock price stops dead in its tracks.
This system makes life more difficult for Qantas. A relatively low valuation makes it more expensive for the company to raise equity capital or to use stock as a method for compensating employees. To my mind, this puts the airline at a substantial disadvantage to international rivals.
why?
Why would Australia do this? And, how would I know? It turns out that at the time Qantas was being prepared for its IPO I was managing a large portfolio of Australian equities (the Kuwaiti Investment Office held the only larger foreign portfolio I was aware of). I remember discussing at length with a fact-finding commission the defects I saw in the Australian approach to foreign shares–basically predicting what has occurred. I also said that although I admired Qantas as a company I wouldn’t participate in the offering.
The officials I spoke with said they didn’t care. New Zealand Air had listed shortly before, using the conventional structure. The foreign ownership limit there was quickly reached. Foreign shares began trading at a substantial premium to local. New Zealand investors were outraged and complained bitterly to their politicians. Canberra’s highest priority was to avoid the same outcome.
Yes, a higher foreign-share price is a problem. In most cases where this has occurred, like in Singapore, the authorities eventually end the foreign-local structure. The unified share price typically settles at a level much closer to the foreign price once the limits are lifted.
My guess is that ending the two-share structure for Qantas would easily add 10% to the stock price. I think +20% is more likely.
I’ve just updated Keeping Score for October
I’ve just updated Keeping Score. If you’re on the blog, you can also click the tab at the top of the page.