MF3d
Picking a portfolio of currently attractive stocks is becoming more difficult around the world, both for the portfolio managers and business managers. This is emphasized by the media’s attention on popular indices, where a small number of stocks are driving performance. The media, marketers, and unsophisticated investors chatter about “the market”. However, today there are multiple sub-markets within the entire universe of available stocks.
The job of a good portfolio manager is to carefully select individual securities or funds. No single account should be identical to another. Even if the two started out identical, over time cash flows will create differences.
There is a fundamental problem with what most scribes write about securities, as most significant differences result from key critical elements. I will discuss the way the late and great Charlie Munger and Warren Buffett might discuss a particular investment. (Both our clients and me personally own shares in Berkshire Hathaway (BRK.A, BRK.B).)
Large-Caps on the NYSE
Product producers and marketeers are responsible for the bulk of large-cap volume. They are fabricators who repackage raw materials into useable products. The better ones have skills in both purchasing and selling. Currently, the overall stock market view is that many of these product-producing companies are in pre-recession mode. New orders are falling behind current deliveries. The market reflects this, with 77% of stock transactions on the NYSE executed on declining prices this past week. By contrast, only 58% of the stocks traded on the NASDAQ were executed on falling prices. In contrast to NYSE companies, the NASDAQ has more service-oriented companies, many of which are at an earlier part of their cycle. Furthermore, many of these companies are led by their founders or other entrepreneurs. Typically, Berkshire Hathaway buys companies with good management and keeps them in place. Larger-cap companies rotate some of their managers in training, hoping they will get useful experience at totally managing an enterprise. This experience helps prepare them for similar opportunities at the parent company. Even division heads often lack responsibility for the full business.
Playing the Players on the Fast Track
Each week, the American Association of Individual Investors (AAII) surveys a sample of their members to get their outlook for the stock market over the next six months. In earlier years, I suspect the respondents were relatively conservative senior citizens with meaningful portfolios. In some cases, they were active investors.
Having attended a number of meetings with unidentified “wealth managers” trolling for clients, professionals pay attention to the weekly numbers for two reasons. The first is their belief in the public always being late. (In truth, the long-term record of the public is pretty good, although they are weak at peaks and bottoms.) A second reason is that some professionals want to hear from the “public” to catch the beginning of a trend.
This week, the bullish members had a meaningful jump to 44.65%, after two weeks at 39%. Bearish readings for the last three weeks were 25.7%, 33.0%, and 26.7%. Most of the time, Munger and Buffett would buy into a declining price pattern over time.
Capital Utilization
Berkshire and a small number of others have generated more capital than they can wisely use in their operating businesses. Today, it is more difficult to wisely put capital to work due to the high prices of good properties, and short-term interest rates in the 5.25-5.50% range.
What attracted their investment in the past was a good manager looking to add a new aspect to their business. Some of their recent investments in energy were this type of investment. These investments did not result in increased capacity, they were preferably a uniquely new project with a good margin when developed.
Business Economics vs. GAAP Accounting
Evaluating what a knowledgeable buyer would pay for a position in the marketplace. Long-term potential earnings power at the bottom of an economic cycle vs. correct judgement of a fashionable product. As an example, for years car buyers were attracted to the newest-looking cars, and during that phase, car producers were in the fashion business, particularly if they had creative advertising. This was of no interest to the two leaders of Berkshire, who were more interested in longer-term control of critical supply chains. GAAP accounting was of no great value in real estate and pharma. In both cases, winning investments were not what is present but what they will be.
The Investment Game is Changing
There are now a large number of new CEOs, and I expect an even larger number over the next five years. Additionally, the structure of the investment sector is changing. For example, Fidelity is attempting to get a fee from ETFs sold through Fidelity’s brokerage desks. If they don’t get it from the ETFs, they will likely attempt to introduce a service charge paid by their accounts.
It is conceivable that growth in the number of companies moving their headquarters and tax status to Texas will result in substantial growth in listings at the newly formed Texas Stock Exchange. This is already causing national accounting and law firms to beef up or open Texas offices.
In the past, the custodian function was considered a good business. But as this activity has become concentrated in a few multi-national organizations, it has become difficult to sell smaller custodian firms. When Ford Motor (F) went public, the tombstone included a very large number of brokerage firms. Most of those names have disappeared, with some merging out while others just went out of business. We have seen the same thing happening to regional stock exchanges, where very few of the remaining exchanges have a trading floor. Instead, there are computer networks dominated by a few firms. When the next structural recession occurs, it is my guess fewer organizations will be left in business. In the second quarter of 2024, a number of brokerage firms, stock exchanges, and investment advisors are losing revenue momentum.
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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
