InvestorsFriend Inc. Newsletter March 8, 2006
Please check out the continued excellent
performance of our stock picks.
One of the things I really like about the work I do in picking stocks is that at any
point after we pick a stock we know how we are doing. It may not be fair
to expect the stock to move in the predicted direction right away, but certainly
after say 12 months I would hope it has moved in the predicted direction.
I don't have to depend on anyone's judgment as to whether I did a good job or
not. Either the stock picks have made a decent or better return over time or
Right now, I am pretty pumped because the market results clearly
indicate that for the fourth year in a row the stock picks are making a very
good return indeed. Even with the TSX itself up 6.3% in just two months this
year, my personal investments are on track to beat the TSX for the seventh year
since this Site was started.
In the past three years I have been fortunate enough to have personally made
returns of a compounded 31% average per year. That return more than doubled my
portfolio in three years (before any new contributions). This allowed my portfolio to reach a point where even
a small percentage return starts to represent a noticeable amount of money. With
compound returns the portfolio of any investor who starts saving by around the
age of 40 or earlier should eventually grow to the point where even a small
return results in a noticeable amount. Of course if one can achieve higher than
average returns then the portfolio will become noticeably larger a lot sooner. I
will have more to say about this below.
Some of you who are receiving this free newsletter may be interested
receiving our stock picks, but you may be wondering if you can trust this Site.
That is a reasonable question and apprehension. When it comes to looking for
ideas on where to invest your money, having Trust in the source is clearly
I have always felt that the quality and trustworthiness of this Site is
abundantly self evident. Most of our paid subscribers first became familiar and
comfortable with this free newsletter and our large library of educational
articles before deciding that it was worth it to pay for the stock picks.
However, some paid subscribers decided to subscribe immediately on becoming
aware of this Site. I guess they felt that they had found a good thing and
decided to act immediately, which is quite gratifying.
Speaking of the paid subscribers, I must say I could not ask for a better
group of customers. For example, a number of monthly paid subscribers have been
our customers continuously for over three years since I began the paid
subscription service. Some subscribers pay by cheque and I have been delighted
by the renewal rates. Some customers have even proactively sent in cheques even
before their subscription had expired. And, the attrition rate of those that pay
monthly through PayPal has been relatively low. I can only conclude that these
excellent customers find good value in the stock rating service provided.
I fully realize that not everyone reading this free newsletter is in need of
a stock picking service. Some of you are still trying to learn before committing
money to stocks or otherwise are just not interested in investing in individual
stocks. That is fine and I am very glad to have you as a reader of this free
newsletter and as a visitor to the Site. Thank You.
If you are in the market for ideas on individual stocks to buy, then do
consider subscribing to our stock picks. At some
point all of my paid subscribers reached the point where they decided to take
the plunge. If you are interested in the stock ratings service, then why not
subscribe right now? In life I believe success comes from more often from action
than from needless delay.
Warren Buffett's March 2006 Letter to His Shareholders.
As you may be aware, Warren Buffett is at age 76 the second richest person in
the world (after his younger friend Bill Gates whom he plays on-line bridge
with) and he made his money by working for a short period in the investment
industry (initially under the late Benjamin Graham - who virtually invested
value investing). Warren saved his money and soon began to compound his wealth
with smart stock picks. In 1965 he purchased a struggling textile company called
Berkshire Hathaway. He turned Berkshire into a holding company which invested in
common stocks and which bought other businesses. Today it is a huge
conglomerate. The largest segment is insurance. The other three segments are
regulated utilities, finance and financial products and a group called
manufacturing, service and retailing. In addition there is an investing
operation that holds common shares in other stocks and which lately has invested
in a huge currency speculation against the U.S. dollar.
Each year since about 1966, Warren has hosted a folksy annual meeting at
which he dispenses his business thinking and answers shareholder questions. In
recent years around 20,000 people attend his annual meetings. I was there in
2003. A good number of those in attendance are older people who became
multi-millionaires by investing a few thousand dollars in Berkshire in its earlier days.
Each year Warren also writes a lengthy and very informative letter to
shareholders. These letters explain how Berkshire did during the year but more
importantly explain Warren's business and investment thinking. For example he
often explains how insurance companies work. He also often provides important
lessons in accounting.
Warren posted the latest of these valuable letters to the Berkshire Web Site
this past Saturday. I consider this to be must-read material.
I have summarized here some of the points in the letter that particularly
struck my interest.
Warren states that "calculations of intrinsic value, though all-important ,
are necessarily imprecise and often seriously wrong."
In some ways this statement should be obvious since intrinsic value is a an
estimate of the value of the cashflow a company will produce from now to
infinity. However analysts, including myself have ways of estimating intrinsic
value. Warren reminds us that our estimate is only as good as our assumptions
and whether these assumptions
turn out to be correct. Just because we calculate an intrinsic value in a
spreadsheet does not mean the number is necessarily right. I always try to keep
that in mind and it is one reason that I consider a number of factors in rating a
stock. Also I attempt to make reasonably conservative estimates of intrinsic
value. That way I will have an up-side if the company does better than I have
In talking about insurance numbers Warren indicates that when the insurance
product itself simply breaks even, that gives him the opportunity to invest the money
that is ear-marked to pay claims (reserves or float) at a cost of zero percent.
When you consider that the Canadian property insurance companies that I have
rated are making positive profits on insurance before investment gains and
losses, Buffett's statement illustrates that these Canadian property insurance
companies are making unexpectedly large profits.
Buffett also gave an explanation of why giving stock options to executives
is tantamount to rewarding mediocrity. Any company that retains some of its
earnings will likely have an increase in its stock price over a four or five
year period, because its book value will grow. Executives should get bonuses for
better than market returns, not for achieving mediocrity.
You can check out the letters yourself at
By-the-way, notice that Berkshire's web site is very plain with no graphics.
People occasionally give me advice to jazz up the investorsfriend site. But as
you can see I am in good company when I keep a plain but easy to navigate site.
Some Surprising Investment Return Math
It might surprise you to learn that when you first start investing, the
return that you make is relatively unimportant. What is much more important at
the early stages is the amount that you contribute annually.
It is true that if you invest a single lump sum and let it compound, then the
returns in each year are equally important. That is, if you invest say $10,000
and lose 20% of that ($2,000) in the first year then this will have exactly the
same impact on your final portfolio as would a 20% loss in year 10 or year 30
But realistically people do not invest a single lump sum, rather they usually
begin investing at some point and then typically make an annual investment most
years (often based on registered retirement savings plans and other
tax-advantaged plans). Typically the amounts invested grow over time as
individuals advance in their careers.
So... if you make or lose 20% that first year it would only affect your
initial contribution as well as the future compounding of that initial
contribution. However, if you make 20% or lose 20% in year 20, then this will
affect the compounded level of your contributions that were made in each of the
20 years as well as the future compounding of each of those 20 sums. The result
is that returns in later years matter a lot, while your returns in the early
years will not matter much.
In the early yeas of a retirement savings plan, the annual contributions
matter a lot and will tend to dwarf the impact of your returns. For example, If
you begin by contributing $3000 per year a 10% gain on the first $3000 ($300) is
dwarfed by the next year's contribution of $3000. However, if you invest
$3000 per year for 30 years at 10%, then in 30 years this will grow to $543,000
at which point a 10% gain ($54,300) will dwarf your $3000 annual contribution.
I calculated that a loss of 10% in year 1 (rather than gain of 10%)
will affect the portfolio value in year 30 by just 2% (because it has no
impact on the contributions after year 1). Meanwhile a loss of 10% in year 30
(rather than a gain of 10%) will affect the portfolio by 22%! (because it impacts
the contributions from each year).
In the early years the most important thing is to make regular contributions
to savings, the returns in those early years while important will tend to be
dwarfed by the impacts of the annual contributions of new money.
In later years, the returns become much more important than the annual
contributions. At some point if you can build up say a $500,000 portfolio, then
a 10% return will be $50,000. At that point, your annual contribution may be
totally dwarfed by the return on the portfolio. In fact, the portfolio could
become almost self sustaining. At some point if the portfolio is very large
compared to your ability to make annual contributions then it will hardly matter
if you even make annual contributions anymore. If this point can be reached
before retirement age then this is a very nice situation to be in.
The above analysis also leads to the conclusion that high risks can be taken
in the early years. If you swing for the fences in the early years and strike
out, it won't matter that much because the contributions of subsequent years
will dwarf a small initial loss.
In later years risk and reward both have a tremendous impact. On a very large portfolio
of $1,000,000, a 20% loss is a huge $200,000 which for most people would be
almost impossible to ever make up in annual contributions. On the other hand a
gain of 20% on a $1,000,000 portfolio is also a huge $200,000. For most people
the pain of losing $200,000 would be huge and it is just not worth taking big
chances once a very large portfolio like $1,000,000 has been painstakingly built up.
Swinging for the fences could be a huge mistake at that point.