12 Things Every College Student Should Know Posted on February 22, 2023 I had the honor to recently speak with students at Xavier University in Cincinnati. I graduated from Xavier 22 years ago this upcoming May, so I was now the old person in front of a bunch of students trying to tell them what they needed to know. The good news is they all seemed to listen and I didn’t see any eyes closing, so hopefully, they got as much out of it as I did. I thoroughly enjoyed my time with them, but even more, fun was spending time coming up with lessons I wish I knew with I was 21. With that, here are 12 things I’ve learned in my career that I think every college student should know. There are always going to be bad things that happen. The Dow Jones Industrial Average began trading in 1896, and over this time, we’ve seen wars, famines, recessions, global pandemics, inflation, deflation, stock market crashes, financial crises, and more. But you know what we’ve also seen? The Dow has eventually made new highs every single time and we don’t think this time will be any different. You are going to mess up, probably a lot. Years ago, during a live TV hit, I was asked what the acronym of the company I was working for stood for, and I confidently blurted out Linsco Prime Ledger… To be clear, this is wrong, and I knew it as soon as I said it. Another time I was on CNBC saying things were fine. 48 hours later, we saw the U.S. debt downgrade in August 2011, and stocks fell 20% the next week. I could go on and on about all the times I’ve messed up, but just know that we all make mistakes, and it will always happen throughout your career. The good news is if your mistakes are honest, you’ll learn from them and people likely won’t hold them against you (just don’t make the same mistake over and over).Don’t be afraid to take a swing at something, as taking no chances or making new mistakes means you aren’t swinging the bat. As Babe Ruth said, “Every strike out brings me closer to the next home run.”Let me be clear here, there are some mistakes that will cost you your friends, jobs, or career. Trust me, I’m glad I missed college when everyone had a cell phone and one stupid thing could come back to haunt me years later. But it is what it is. If you are young, know that one dumb mistake could cost you everything. All young people make mistakes, but be careful is my best advice. Warren Buffett put it like this, “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.” Lastly, I love this quote from Eleanor Roosevelt about mistakes. We can learn a lot from others and their mistakes, but don’t be afraid to make your own mistakes along the way. Even smart people make mistakes. It doesn’t matter how smart you are; odds are you, too, could be caught up in a mistake or mania. Sir Isaac Newton might have discovered gravity, but he also got caught up in the emotions of a bubble and lost most of his life savings. As he later said, “I can calculate the motion of heavenly bodies, but not the madness of people.” The past can teach us a lot. Winston Churchill once said, “The farther back you can look, the further forward you are likely to see.” If you’ve followed me long enough, then you know that I love to look at history to show a path for where we could be headed.Also, it is good to show that whatever is currently happening likely has happened before in history. Or, as Edwin Lefevre wrote in the amazing Reminiscences of the Stock Operator, “Another lesson I learned early is that there is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again.” Lastly, this quote from Niall Ferguson sums it up nicely. You can learn a lot from looking at the past. You are never too old to try something new. The late great Rodney Dangerfield had trouble getting respect, but it eventually happened to him. After 30 years in the industry, one random invite to the “Ed Sullivan Show,” he became an overnight comedic sensation. Another way of thinking about it is when Steve Jobs said, “Most overnight success stories took a long time.” I was in the industry for nearly 10 years and I started to use this new thing called Twitter. I didn’t think much of it at first; in fact, I didn’t like it or get it. Well, now I have more than 120k followers and I’m quoted on CNBC directly from a Tweet. I was one of the very first market strategists to leverage social media and it has made my career.Don’t ever think you are too old to start something new or take a chance. Here are some other well-known entrepreneurs that scream it is never too late. Crowd psychology repeats time and time again. I traded options for over a decade, and I’m fascinated by the psychology behind markets and crowds. There is no better illustration of this than the one below. Times will change, people will change, and ideas will change, but how crowds work likely will never change. Bet on yourself. I’ve been fired, I’ve been laid off, and I’ve had more doors close on me than anyone would ever expect. A lot see me as someone on TV with a lot of respect and clout in the industry, and this is true, but it wasn’t always this way.I’m here to tell you it hasn’t been easy for me in my career. But in the end, there was one thing I was certain of, that is if I treated people the right way and worked harder than anyone else, I’d be successful. Trust me, when you are broke, have no job, and are running out of money, having a glass-half-full mentality isn’t easy. In fact, you might even need to trick yourself into believing things will get better. I was there in December 2015. Laid off in May 2015 after the company I was at was acquired by Huntington Bank, with a wife, kids, and house to pay for, with no money and credit card bills piling up. I knew I wanted to bet on myself and go for an awesome job with LPL Financial while also passing up on other jobs along the way. What if they hired someone else? What if I’m making a mistake and should be interviewing with other companies? If they don’t hire me, what will I do to pay the bills, let alone buy Christmas presents for kids expecting Santa?Well, I always believed it would all work out and I was offered in late December and started with LPL in January 2016. I had a blast there over 6 plus years and it directly opened the doors necessary for me to be at Carson Group right now. It is funny how things all work out is all I can say. They tell you that when one door closes, another opens. I’m here to tell you that you will likely want to punch the person in the face who says that, at least I did. But it is true and things will get better. Bet on yourself and your mental health; the payoff may be exponential. Don’t sweat the small stuff. The world is more connected than ever. That can be a good thing and a bad thing. I think this is a fun way to say life is too short. People will always disagree with you and they will always doubt you. Let it fuel you, but don’t let it eat you up inside. Be your own person. I made a good deal of money during the tech bubble in the late 1990s, only to lose it all and then some when stocks crashed and I was on margin. It was an expensive learning experience, but I was hooked and it is all I’ve ever wanted to do every day since.Over time I found that I also enjoyed presenting, writing, doing live TV, and helping investors understand what is really happening out there. What I also found was that people liked having fun and laughing. Trust me, what we do as stewards of assets is deadly serious and I don’t take it lightly. But at the same time, if you are going to present to a room full of people for an hour, you better make it fun and entertaining or you will lose them.Over the years, I’ve found that using humor and stories was a great way to explain what is happening. I like to say in two years you’ll never remember what I said if you saw me present, but you’ll likely remember how you felt. I want people to feel good after they see me present. There is no better compliment than when a little old lady comes up to me and says she has no idea what I said, but she really enjoyed it. In my career, I’ve been told many times to be more like others. Be more like the boring strategist at a bond shop or more like the strategist at a large broker/dealer who does none of her own research, only to cite others. Thank goodness I didn’t listen to that bad advice. I knew that my lane was telling stories, having fun, and helping people. Now let’s be clear when your boss is saying you need to change how you do things, that isn’t an easy conversation. But as Mark Twain said, why not go out on a limb? That’s where the better fruit is. I went out on a limb and it was so worth it. Be yourself, you won’t regret it! Crooks and rats are always out there. Yes, I’m in the financial industry and some of the more well-known charlatans ever have come from this world. But I’ll say this, in any industry, you are going to see this. Just last week, I found out that the guy who was selling my golf cart for me was loaning it out to people and taking parts off of it to sell. The good news is I got my cart back after a visit to his shop by the York County Sheriff’s Office, but the point is to be careful who you trust out there.I once worked at a place that told us we’d get our bonus ‘this Friday.’ Well, this Friday would come and it wouldn’t be there. If you asked where it was, you’d be yelled at and belittled in front of the whole department. Their line was, “What do you need, a loan?” It was crazy looking back, but again, there are always crooks and rats out there. If you ever find yourself working for one, get out is my advice. Here’s the catch, it isn’t easy to tell who is genuine and who is stealing billions from innocent investors. This Fortune cover says it all. People aren’t as perfect as you think. Similar to above, you will meet people who claim to have all the answers and live the perfect life. With social media, it is easy to think about how great someone might be. I see this with my 15-year-old daughter, as she thinks influencers are perfect people with no problems, but that isn’t true. Everyone has issues, problems, struggles, and more. Life comes at you fast. It feels like yesterday I was a 21-year-old in a class at Xavier with some old guy in there telling me what I needed to know when all I cared about was what bar I was going to go to that night. Well, life comes at you fast and there is nothing you can do about it. I absolutely love getting up each day, working at Carson Group, and having fun with a really awesome group of people. There’s not much else I’d rather do than what I am doing right now. To get paid to do what you’d do for free is a really lucky situation. But be aware it took me 15 years to get a job with LPL on the fast track to this and it took 21 years to land my dream job with Carson. Your first job out of college won’t be your dream job. There will be many trials and tribulations along the way in your career. Some you cause to yourself, while some will be completely out of your control. At the end of the day, it is up to us how our careers go. If you don’t like your boss or like your job, get a new one. Life is too short. It isn’t always that easy, but you can make it happen if you try. Know that if you have the right attitude, treat people the right way, keep the faith, and always work as hard as you can, things will work out for you in the end.
Can the US Manage Its Debt? Posted on February 23, 2023 The US national debt is about $31 trillion right now, which is equivalent to about 120% of GDP (as of the third quarter of 2022). Massive, but also note that this is down from a peak of 135% in the second quarter of 2020. As a point of clarification, the US government typically racks up a deficit each year: which is the amount by which spending exceeds revenues. And accumulated deficits over time represent the national debt. Here’s a helpful graphic from the US treasury: Here’s the thing though: looking at debt-to-GDP is sort of like calculating your mortgage balance-to-income ratio. Using the average mortgage debt of $346,000 as of September 2022 and median household income of $71,00, the “debt-to-income” ratio is just under 500%! There’s a reason nobody quotes this number. Of course, GDP is not technically the government’s “income” – only a portion of it is (via taxes). Anyway, what really matters is the government’s (or households’) ability to service their debt. And interest rates are a key variable there. With rising interest rates, how can the US manage its debt service? This is a frequent question that we get. The short, perhaps glib, answer is Yes. The US can always “manage” debt service because it prints its own currency. And that’s a crucial difference to understand between the US government and you and me – we can’t “print money” to pay off our debt. Or rather, we can print IOUs, but nobody will accept them. In all seriousness, US treasuries are considered the safest asset in the world, which includes the belief that the US government will not simply “print money” to service and pay back its debt. So, let’s consider the question of whether the US can manage its debt. As you can see from the chart below, interest costs for the Federal Government have exploded higher. This is due to rising interest rates as well as the massive increase in debt over 2020-2021. The other side of the story The good news is that tax receipts have also exploded higher recently. Of course, rising employment helps a lot – there’s a bit of a round-trip here, with fiscal stimulus helping maintain spending and employment, which in turn is holding up tax revenue. Plus, the stock market has moved up a lot in 2020 and 2021, which means capital gains taxes have also increased. If you look at interest costs as a percent of tax receipts, things don’t look as scary. The ratio has risen recently to about 23%, but that’s well below the historical average of 27% (from 1947 onwards). What’s interesting about the chart is that you can see that the ratio surged in the early 1980s. That’s because the Volcker interest rate hikes did two things: Raised interest rates Sent the economy into a recession, which meant there were less tax receipts as spending and employment fell Interest costs as a percent of tax receipts hit a peak of 52% in 1985. Usually, the concern when government interest costs rise is that it “crowds out” private investment. Between Q1 1983 and Q2 1985, interest costs as a percent of tax receipts jumped from 43% to 52%. And private nonresidential investment grew 30% during this period. This framework also helps us think about what could happen going forward. Looking ahead Let’s consider the numerator first, i.e., tax costs. It looks like the Federal Reserve is close to the end of its interest rate hikes, assuming we don’t get another upward inflation shock. Now, deficits are projected to remain high over the next decade, around 6% of GDP, but unless we have an economic shock that also prompts a lot more fiscal stimulus, we are unlikely to see the overall level of debt surge higher like it did in 2020. With respect to the denominator, i.e., tax receipts, it is ultimately dependent on economic growth since tax receipts are a function of that. As long as GDP rises, the debt-to-GDP ratio should remain stable (or fall), and tax receipts will continue to rise. This is why debt-to-GDP fell from 135% in 2022 to 120% in 2020: rather than debt going down, GDP went up. Nominal GDP rose 12.2% in 2021 and 7.3% in 2022. The key for tax receipts to hold up is for the economy to avoid a recession. And that is our base case right now, that there will be no recession. So yes, we believe the US debt and interest costs are certainly manageable.
Bull vs. Bear Breakdown: Apple (AAPL) Edition Posted on February 27, 2023 Apple (AAPL) Edition A necessary part of any thorough research process is considering both the upside and downside investment case. The “bull” case is optimistic, characterized by the upward thrust of a bull’s lowered horns during battle. Meanwhile, bears fight by standing high and swiping down their sharp claws, exemplifying the potential risk of an investment. What a vivid metaphor. Who would win an actual bull vs. bear fight? It’s not just an allegory. Such fights were a form of entertainment during the 19th-century gold rush in California. It was considered a happy occasion. After Sunday church, families would gather towards the town square to watch the bloody battle. Without getting into the gory details, the California bears usually emerged victorious over the Spanish bulls. Thankfully, the odds have historically favored the bulls when it comes to investing, as stocks remain the undisputed champ of long-term returns (1st Principle). Nevertheless, we believe it’s extremely helpful to consider both sides. Valuation is a reflection of investor expectations. Until you try to understand these embedded assumptions, it’s hard to know whether it’s a good investment and, more importantly, when it’s gone bad. In this Bull vs. Bear edition, we present a battle on Apple. Here, we identify the three most important points on either side that long-term investors with at least a 3-to-5-year time horizon should consider. The conclusion is up to you. Bull Case Healthy revenue growth and margins may continue to prove durable Apple can build off its dominance of mobile computing Current valuation underestimates future growth potential Healthy revenue growth and margins may continue to prove durable While short-term stock moves and quarterly results get all the press, we believe the primary driver of long-term equity value is how fast revenue, profits, and ultimately cash flow increase and for how long before reaching maturity. Past results aren’t predictive of the future, but it’s constructive to highlight how Apple has continually defied the skeptics. For the past ten years, the company’s sales have more than doubled, rising nearly 10% annually. iPhone, its flagship product that accounts for more than 50% of sales, has grown slightly faster. Yet, despite endless concerns over commoditization, Apple’s gross margins remain stable. This is arguably even more impressive considering how competitive the smartphone market has become and how iPhone has maintained (and increased) its premium pricing. Certainly, the rising mix of Apple’s services (20% of total sales) has helped buoy corporate margins since these are twice as profitable vs products, but hardware profits also remain steady. This defies the history of consumer electronics, which speaks to the power of Apple’s brand, its software, the quality of its products, and its scale. Can this growth continue? On some measures, it is accelerating. In 2022, Apple’s installed base of devices reached 2 billion, which increased 11% from the prior year. Despite the law of large numbers, this is the highest growth rate in 4 years. How? New product launches that complement the iPhone (Watch, AirPods, AirTags) and share gains in the smartphone market. Apple Watch still holds a lot of promise as it becomes a health monitoring device. Despite accounting for 85% of industry profits, iPhone just recently eclipsed 50% share of US smartphone users, according to Counterpoint Research. Its share overseas is even lower, especially in faster-growing emerging markets. Both points underline that there’s still plenty of growth potential for the iPhone even as smartphones mature. A lot has been made about the lack of Apple’s innovation. Sure, each year the iPhone gets faster chips, better cameras, richer displays, etc. But what happened to the big innovations: the touch screen, Siri voice assistant, or touch and face ID? We’d be on the lookout for foldable screens, which remain expensive and have issues but hold a lot of promise. The other big idea that Tim Cook is excited about is AR/VR (augmented reality/virtual reality). This could likely be first introduced as a separate headset but the technology should eventually make it into the iPhone, which could further revolutionize mobile computing. In short, there remain big innovations on the horizon that should fuel iPhone’s tank. Apple might build off its dominance in mobile computing. Apple is a master at controlling and monetizing its installed base. Services is a prime example, which consist of Apple subscriptions (Cloud storage, Apple Music, TV+, Fitness+, Arcade) along with a 30% cut of subscriptions to third-party apps and purchases on its App Store. Essentially, the company is a toll collector of the mobile economy. Services revenue continue to grow at a double-digit clip (ex FX) and the firm recently reported that it had 935,000 paid subscriptions, up 19% YoY. There remains a lot of opportunity to add additional services and monetize its ecosystem further, especially if it branches into other areas like autonomous cars, which could be worth $200 billion by 2030. To further the point about how powerful Apple is, consider what it’s recently done to Facebook and the digital advertising market. By giving iOS users the option to opt-out of being tracked by apps, it meaningfully reduced the accuracy and ability to measure targeted ads, destroying hundreds of billions of digital advertising value. In fact, we would argue that Facebook’s enormous and controversial investment in the ”metaverse” is really about trying to win the next computing platform and evade Apple’s grip on mobile computing. Get your popcorn ready because it’s going to be a fascinating race to watch. Current valuation underestimates future growth potential Apple’s valuation has certainly elevated over the years after proving it wasn’t the next Nokia or Blackberry. That said, the company’s forward P/E ratio has fallen towards more reasonable, pre-pandemic levels and currently trades at a modest premium to the S&P 500. However, what investors are ultimately looking for is free cash flow, which is the amount leftover that can be returned to shareholders. On this measure, Apple trades at a 4.5% yield, which is just a slight premium to the S&P 500’s 5% yield, according to FactSet. This is despite having grown its free cash flow per share at nearly twice the rate of the S&P 500 over the past 10 years. Out-year consensus forecasts appear modest, especially when compared to the results Apple has been producing over recent years. FactSet shows that Wall Street consensus is only expecting 7% revenue and 11% EPS growth in FY24. Things are expected to slow further in FY25 with ~5% sales growth and a 7% EPS rise. Considering the long runway Apple has for its existing products and potential entry into new areas like autonomous cars and AR/VR, future expectations look beatable. Bear Case Apple sells consumer electronics, which eventually gets commoditized and/or displaced. The company has become too big. Valuation is rich considering Apple’s best days are behind it. Apple sells consumer electronics, which eventually get commoditized and/or displaced Consumer electronics is a brutal business that eventually becomes commoditized. This has happened to the PC, the television, gaming consoles, portable music players, and mobile phones. Apple has done a commendable job at delaying this inevitability by establishing a premium brand, cool marketing, gimmicky features, and making more iPhone components in-house vs. paying a premium to third parties. However, there’s only so much juice to squeeze. The bottom line is that the smartphone market matured years ago. In fact, IDC reported that smartphone shipments plunged 18% in the 4Q22, which was a record decline. Apple may be able to gain a little more share, but eventually, it may run out of room in a saturated end market. Apple’s margins look even more vulnerable. Sure, they have been stable, but they currently sit at 30% on an operating basis! If you want to know where these are likely going over time, just take a peek at Samsung’s consumer electronics division or Hewlett Packard’s PC business. Or how about the 2.2% operating margin reported from Xiaomi, one of China’s largest smartphone manufacturers? In fact, that firm now taking direct aim at Apple. Lenovo, the Chinese firm that purchased IBM’s ThinkPad and also makes smartphones, generated a 4.5% operating margin in 2022. Even if you assume that Apple can hang onto a 10% operating margin over time due to its brand, software, service, etc., that’s still only one-third of the profits per sales dollar it currently enjoys. This won’t happen immediately, but once margins start to fall, it will have an immediate and permanent impact on the stock’s valuation. Too Big? Apple could be considered the most successful company of all time. However, that comes with a host of challenges. Due to its size, can it keep growing at a healthy rate? Can it remain nimble enough to keep winning new innovations? Will it become hamstrung by regulatory scrutiny from US and foreign governments? Can it attract enough incremental investors to propel the stock higher? Has Apple become too big? In 2018, Apple was the first company to reach a $1 trillion market cap. It only took two years to reach $2 trillion and just 16 months and 15 days for another trillion. It currently sits at over $2 trillion. The company’s value exceeds most countries’ GDP, and it bests the total of most worldwide stock exchanges. As companies become larger, it becomes harder to sustain growth rates. For example, in 2022, Apple posted $394 billion in revenue, which grew roughly 8%. However, it had to produce $28.5 billion of incremental sales to generate that rate. If bulls expect that to sustain for the next five years, Apple would need to add over $40 billion of additional sales in that fifth year. That could require a lot of product innovation and successful entry into new markets. Many firms that begin to slow due to their size and maturity start making acquisitions in adjacent areas to sustain growth. However, that window has likely passed for Apple due to its enormous size. It is already catching the attention of lawmakers due to its App Store practices. That’s just in the US. China already represents just under 20% of Apple’s sales and is an important growth engine. With China/US tensions heating up, can Apple evade impact from either side? Valuation is rich, considering that the company’s best days are likely behind it Most bears will admit that Apple has been a wild success story and that the firm’s growth and innovation engine lasted much longer than they expected. However, capitalism is dynamic. Being wrong in the past doesn’t mean the bears will be wrong in the future. Instead, they would argue that only their timing was incorrect. Now that the smartphone market is declining, the commoditization process shouldn’t be far behind. This likely means the company’s profit margins could start coming under pressure, impacting the stock’s premium multiple times. Under such a scenario, bulls would get hit with the double-whammy of declining earnings and shrinking P/E multiple, possibly in the single digits. And no, a company that’s near peak earnings and generates over half of its sales and even more of its profits from a single product shouldn’t trade at a premium to the S&P 500. Summary There are many other notable points that Apple bulls and bears will debate. However, these are the primary issues. Our goal here is to encourage investors to think about the counterpoints to whatever side they sit on. It’s never as easy as saying a P/E ratio is “too high” or that “consumers won’t stop using iPhones.” Investing is hard. According to our 5th Principle, we must respect its complexity.
First Trading Day of March – S&P 500 Up 69.6% of Time First trading days of months have a bullish reputation and March is not an exception. Reviewing the last 23 years of data reveals S&P 500 has the best record, advancing 69.6% of the time with average gains of 0.38%. NASDAQ is second best based upon frequency of gains, up 65.2% of the time examined with an impressive 0.69% average gain. DJIA has been modestly softer, up 60.9% of the time with an average advance of 0.28%. March’s first trading day strength has not been limited to just the last 23 years. Since 1950, DJIA has advanced 49 times in 73 years (67.1%) with an average gain of 0.23%. S&P 500 has been nearly as consistent, up 64.4% with an average gain of 0.25%. NASDAQ has also been a solid performer since 1971, up 33 times in 52 years (63.5%) with a respectable 0.37% average. After a rough patch from 2007 through 2011, March’s first trading day appears to be improving even further. DJIA, S&P 500, NASDAQ and Russell 2000 have all recorded gains in eight of the last eleven years. Any weakness today could be a reasonable setup for March’s first trading day.
The February Hangover Is Nearly Over Posted on February 28, 2023 After the 11th best start to a year ever for the S&P 500 as of Valentine’s Day, stocks have pulled back the second part of the month in what we would classify as perfectly normal price action. Here’s a chart we started sharing at the beginning of the month and sure enough, the later part of February was trouble once again. Speaking of Valentine’s Day, as we shared two weeks ago, historically strong starts to a year for stocks as of the day of love tend to resolve higher by year-end. That doesn’t mean it’ll be a straight line up, of course, but this puts the recent weakness in perspective for investors who are deciding whether this could be the right opportunity to add to positions. It is what it is; the best three months of the year for stocks have historically been November, December, and January. Which means February tends to be the hangover month. Think about it; too much fun means you likely will have to pay for it. I’m 44, and I still remember my 40th birthday…And the tequila… I blamed my friends, but my wife reminded me that I’m old enough to make my own decisions. Let’s just say that my productivity for about a week after that really fun night was quite low. Action, meet my friend, consequence. After the nearly 17% rally off the October lows into mid-February, some type of hangover or indigestion made sense. The good news is that we don’t expect this weakness to last much longer. March and April are historically two of the strongest months of the year, but they have done even better in pre-election years. Since 1950, the S&P 500 gained 1.1% in March, while April was up 1.5%, but in a pre-election year, those returns went to 1.9% and 3.5%, respectively. One other thing we are encouraged by is how quickly everyone has become bearish again. After the great start to the year, many bulls were getting loud and some longtime bears were starting to sound bullish. This increased the odds of a pullback. Well, we’re in the middle of the pullback, and nearly just as quickly, investors have turned extremely worried and the sentiment is showing signs of pessimism. From a contrarian point of view, we like to see this type of skepticism. The one thing we wouldn’t want to see is weakening price action but more bulls, and that sure isn’t happening today. Lastly, here’s a chart we’ve shared a lot over the past few months but looking at the entire four-year Presidential cycle showed that the current quarter was the best out of 16 total quarters of the four-year cycle. Adding to the fun, the next quarter has been quite strong as well, only adding to why we expect any weakness to be well-contained potentially.
Four Things I Learned In Warren Buffett’s Annual Letter Posted on March 1, 2023 The Oracle of Omaha did it again. He released Berkshire Hathaway’s Annual Letter to his shareholders recently and as usual, it was full of wit, insight, humility, humor, and decades of wisdom. I’d encourage you to read it for yourself, but here are four things that really stood out to me. 1. One or two big winners make up for a lot of losses He completed a $1.3 billion purchase of Coca-Cola stock in 1994 and completed a $1.3 billion purchase of American Express the following year. Those two stocks have gone on to become incredible winners for him, along the way making up for many, many mistakes and poor investments. In fact, as of the end of last year, his total value of Coca-Cola holdings was $25 billion and American Express jumped to $22 billion (both roughly 5% of Berkshire’s net worth). To me, investors need to realize that part of investing is picking good companies, not necessarily good stocks. Or, as he said in the letter, they are company pickers, not stock pickers. Then, they are giving those companies plenty of time to work. A few big winners over many decades will more than offset the inevitable losers that investors will have. 2. All he and Charlie had to do was cash the checks Speaking of his $2.6 billion total investment in Coca-Cola and American Express, those investments paid him a cool $1 billion in dividends just last year! So that isn’t even incorporating the astronomical stock gains; that is simply the dividends for one year! That is a nice reminder that we all like to talk about how a stock ‘gained this last year’ or an index ‘gained that last year.’ But if you are buying great companies that are always trying to increase their dividends, over time, those dividends could really become a huge stream of income. Or, as he put it regarding what he and long-time partner Charlie Munger had to do, “All Charlie and I were required to do was cash the quarterly dividend checks.” 3. Markets aren’t efficient Many investors believe that all the information is out there, thus making stock and sector picking irrelevant. If all the info is omnipresent, there’s no point in trying to be an active investor, is what the efficient market hypothesis tells us. Well, Mr. Buffett disagrees here. Or, as he said below: One advantage of our publicly-traded segment is that – episodically – it becomes easy to buy pieces of wonderful businesses at wonderful prices. It’s crucial to understand that stocks often trade at truly foolish prices, both high and low. “Efficient” markets exist only in textbooks. In truth, marketable stocks and bonds are baffling; their behavior is usually understandable only in retrospect. Greed and fear tend to drive markets and have for hundreds of years and likely will hundreds of years from now. Emotions can swing wildly and for this reason, solid companies will be greatly undervalued at certain times. The flip side is that not-so-great companies will become overvalued at certain times as well. I’m in full agreement with Uncle Warren here. Great opportunities don’t always occur, but knowing that markets indeed aren’t always efficient means that when you have an opportune time to make a substantial investment decision, you better at least consider taking it; it has the potential to make all the difference. 4. Being in the right place at the right time matters Lastly, he noted what Charlie said on a podcast recently. I loved this one. “All I want to know is where I’m going to die, so I’ll never go there.” Of course, this was really funny, but there’s so much there. This could mean many things to different people. Maybe you have a certain vice that always seems to get you in trouble, or that group of friends that used to always get you in trouble. Whatever it might be, our job as humans is to minimize any mistakes we will make, and if we are predisposed to certain trouble if we do something …. Don’t do it or don’t go there!
Another Week Below 200K For Claims Thu, Mar 2, 2023 Initial jobless claims continue to impress with this week's reading being the seventh week in a row of sub-200K prints. Falling another 2K week over week to 190K, adjusted claims are now at the lowest level since the last week of January. While the seasonally adjusted number is low, before taking that into account claims have actually yet to drop below 200K. Claims are falling as is normal for this point of the year with the past couple of weeks historically being some of the most consistent to experience week-over-week declines on a historical basis. At current levels, claims are comparable to the equivalent week of the year from the past several years excluding 2021. As for continuing claims, the past couple of weeks have seen the readings begin to pivot lower after rising to the highest level of the year at the start of February. Continuing claims totaled 1.655 million which is the lowest level since the week of 1/21. Albeit claims remain off their best levels of the pandemic (for both initial and continuing claims), they remain healthy headed into next week's nonfarm payrolls release.
March 2023 Almanac: Even Better In Pre-Election Years As part of the Best Six/Eight Months, March has historically been a solid performing month with DJIA, S&P 500, NASDAQ, Russell 1000 & 2000 all advancing more than 63% of the time with average gains ranging from 0.7% by NASDAQ to 1.1% by S&P 500. Historically a solid performing month, March performs even better in pre-election years. In pre-election years March ranks: 4th best for DJIA, S&P 500, NASDAQ, and Russell 1000 (January, April and December are better). Pre-election year Marchs rank #5 for Russell 2000. Pre-election year March has been up 14 out of the last 14 for DJIA. Coming into 2019, the Russell 2000 had a perfect, 10-for-10 winning record, but is now 10 and 1 after falling 2.3% that March. Average pre-election year gains range from 1.8% by DJIA to 3.1% from NASDAQ.
The Gems of Buffett’s Annual Letter Posted on March 2, 2023 Warren Buffett’s annual letter to Berkshire shareholders is always a must-read. This year’s version didn’t disappoint, with some great takeaways, as my colleague Ryan Detrick discussed the other day. What’s particularly great is that he’s not shy to show the numbers. They’re the first thing you see, following the table of contents. From 1965 to 2022, Berkshire’s compounded annual return was 19.8%, compared to 9.9% for the S&P 500. The latter is not bad, but the former is other-worldly. Here’s some perspective on those percentages. First, $1 invested in the S&P 500 at the beginning of 1965 would have grown to about $244 by the end of 2022, which is enormous. But the same $1 invested in Berkshire would have turned into almost $38,000 – that’s not a typo, and I double-checked my calculations to make sure. Showing a graph with a normal scale would be meaningless since Berkshire’s performance completely overwhelms that of the S&P 500. So, here’s a log chart – which tells you how the same $1 compounded over time. Over the last 58 years, $1 in the S&P 500 doubled about eight times. The same $1 in Berkshire doubled about 15 times! This example does not reflect sales charges or other expenses that may be required for some investments. Rates of return will vary over time, particularly for long-term investments. The hypothetical investment results are for illustrative purposes only. But is he losing his edge? Not really. As you can tell from the previous chart, some of the massive gains came during the first few decades. But things haven’t been too shabby since. Over the last 30 years, i.e., 1993-2022, $1 invested in Berkshire would have grown to about $39, versus just under $15 for the S&P 500. Over the past 20 years, i.e., 2003-2022, $1 invested in Berkshire grew to about $5.43, only slightly below the $5.49 for the S&P 500. Keep in mind that the last decade was an especially strong one for “growth” stocks, which are not quite the type of stocks Buffett, and Munger, like to buy. Quoting Buffett from his 2008 letter, “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” This gels with what the researchers at AQR found when they examined his returns statistically: the general feature of his portfolio is that he likes stocks that are “safe” (low volatility), “cheap” (value), and high-quality (profitable, stable, growing companies with high payout ratios). Add about 1.6x leverage, and you get “Buffett’s Alpha.” Sticking with it through thick and thin It’s one thing to know what Buffett’s done and a whole other thing to replicate it. Buffett’s been consistent with respect to picking stocks. But sticking with Buffett would’ve been quite hard, despite a solid track record of bouncing back. Take the periods 1997 – 1999 and 2018 – 2020, for example. Both times you had Tech stocks outperforming and Berkshire underperforming the S&P 500 (by a lot, as you can see in the chart below). Most folks may have thrown in the towel at that point (as did a few magazines). However, Buffett more than made up for lost ground post-Tech bubble and fully caught up over the last couple of years after falling behind in the 2018-2020 period. Dividends for me, but not for thee One thing that struck me, as it did to Ryan, was how Buffett’s investments in Coca-Cola and American Express paid him a cool $1 billion in dividends last year. And his initial investment was $2.6 billion. Here’s what’s interesting: Buffett doesn’t pay dividends to Berkshire shareholders. And there’s a good reason why. Dividends are a way to return money to shareholders. But so are “share buybacks” or “repurchases,” which Berkshire has done frequently (including in 2022). When a company buys back some of its shares, the total share count goes down. This means that for continuing shareholders, their interest in the business goes up. But, of course, value is added only if “repurchases are made at value-accretive prices,” quoting Buffett from his latest letter. “When a company overpays for repurchases, the continuing shareholders lose.” So, there’s nothing inherently wrong with buybacks. Again, from the letter: “When you are told that all repurchases are harmful to shareholders or the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue (characters that are not mutually exclusive).” Here’s the other unsaid part. Unlike buybacks, returning money to shareholders via dividends involves a taxable event for the year the dividend was paid out. And the taxed amount is not available for compounding, especially when you’re compounding with Berkshire type of gains. The magic of compounding, ex taxes Amongst other things, Buffett understands the power of compounding all too well. And he understands the US tax code. I looked at returns if Berkshire had chosen to pay out a dividend, say 3% annually from its start. I also looked up historical dividend tax rates, which was interesting in and of itself. Up until 2003, dividends were taxed like ordinary income. And the maximum tax bracket for ordinary income between 1965-1981 was 70%. But rather than use this, I assumed that dividends were taxed at 50% during this period in our hypothetical scenario. After that, I used the maximum dividend tax rates. Recall that the compounded annual return for Berkshire from 1965 to 2022 was 19.8%, which meant $1 invested at the beginning of 1965 grew to about $38,000 by the end of 2022. If Berkshire paid a 3% dividend every year, the compounded annual return would have dropped by 1%-point to 18.8%, which doesn’t sound like a lot, except that the hypothetical $1 would have grown to “only” about $22,000 over the same period! There’s certainly a lot we can learn from Warren Buffett beyond just “picking good businesses.” Footnote: all return calculations were done using the Berkshire and S&P 500 returns data from Berkshire’s annual report for 2022. This article should not be construed directly or indirectly as a recommendation to buy or sell any securities mentioned herein. Past performance is not an indication or guarantee of future results. Investors cannot invest directly in indices.
