Free Money Finance Guest Blogger, Fred Kobrick, Author of The Big Money, Post #3

This week, Fred Kobrick, author of The Big Money, is guest blogging -- writing one post a day. Here's Fred's entry for today:

Consider these statements:  You should never overpay for a company, as the price you pay could be more important than what you buy. You should really know what you own, since the greatest gains come from the greatest companies that periodically only “appear” to be overvalued. You should watch your stocks and trade frequently and lock in your gains and move on. You should be patient and hold your best investments for years to make the huge gains they will generate.

People want things simple by nature, and have gravitated towards aphorisms like this—even aphorisms that contradicted each other---since well before I was born.

One of my first mentors, a great investor, taught me that any of them could be right, but you have to know why: You categorize what kind of investment it is. One big difference is the value-investing world vs. growth.

Value stocks are very cheap. One buys fallen angels at prices like 50 percent down, expecting those companies to fix things, sending the stocks back up. My colleague, John Neff, ran Windsor Fund when he had the best long-term value fund record in America. But what he did was very tough for individuals, as it involves constant scrutiny and number crunching, and great skill at deciding which companies can do better - something books usually can’t teach.

Thus, most value investors do not get really wealthy unless they are pros doing it full time, I observe.

Growth investors sometimes “seem” to overpay, but learn to recognize potential greatness and do get wealthy.

Cisco doubled after it came public, and many investors sold it. I studied its business model and features, and “over paid,” buying more stock from the sellers, to double my position size.  It did another 18X my money and, even after that 36X. It went on to make tons more.

Just another lesson of the quest for “the big money”.

Comments

[FRED KOBRICK]

Good morning stock hounds. Are you getting rich from your stocks?

If you have kept up on the blogs and excerpts you know that the book The Big Money is a departure from other books, and written with a mind as to how investors actually behave.

The Seven Steps make it easy to address the big problem of the ages--how investors beat themselves, and the BASM approach of the four factors that identify the true wealth stocks that do make people rich, provides a compass through the clutter of the information age, and directs one to the core of it all.

If you have trouble knowing when to hold or fold, or how to identify the big ones, or other stock buying frustrations, drop me a blog and let's see if I can answer you.
Fred

[FMF]

Good morning, Fred!

I actually have several investment-related questions. I'll post them as several comments so you can answer them one at a time.

The first is around the investment strategy detailed in this post:

http://www.freemoneyfinance.com/2006/05/simple_strategy.html

Can you give us your thoughts on this strategy as well as funds that implement it (such as HFCGX)?

[FMF]

Here's my question #2:

You talk a lot about the importance of management when considering a stock purchase. I've recently made two stock purchases where management was a big factor pushing me to buy. The first was Disney (DIS) (I detailed my reasons here: http://www.freemoneyfinance.com/2006/02/i_bought_dis.html) and the latest was Home Depot (HD).

I'm currently thinking of buying JPMorgan Chase (JPM), again in part because of their leader. Jamie Dimon just seems to me to be the kind of get-things-done sort of CEO who is destined to perform well.

Can you comment on the following:

1. In general, how much weight you put on management (versus other factors) when you decide whether or not to buy a stock.

2. Specifically, your thoughts on DIS, HD, and JPM both as stock buys/no buys as well as the skill (or lack thereof if you think so) of their top managers.

[FRED KOBRICK]

Hi, FMF, let me start with the supposed 18% per year return strategy and then follow with another blog in a minute to answer the stocks and other stuff.

Like most professionals, I have looked at all that stuff, and bought that book years ago, and knew why a lot of it is really a bit impractical, or in the case of this "Cornerstone" strategy and fund, I think some of the statistics are flawed and so is the approach.

Yes, too good to be true. I looked in the book at the TABLE on page 299 of year by year returns over history. Some of the best market years were good for these guys, but they were well below returns for great growth stock years.

They did shine in some poor historical years for growth stocks and add to cumulative returns. They started all this--even if it is correct--when there were no computers, and the statistics may or may be what we would see now, yet here is the big rub: Computers have let traders find the inefficiencies in cheap stocks quickly so highly statistical approaches are much tougher now and I do not think those returns are averrable any more even if they once were.

Aside form that, in a year when growth stocks are up big, and this portfolio is not doing well, let's say, will investors know whether to hold on through this or feel that the approach just does not work?

I think it WILL NOT work going forward.

[FRED KOBRICK]

Hi, it’s Fred back with the other answers.

On the importance of management, let me start with this quote from my book, keeping in mind that with the four factors (BASM) that identify the greatest wealth stocks, management is responsible for them, starting with a great business model:

“This is one of the most important chapters in this book, and for some people it will be the most important. For some, picking stocks on the basis of management will be all they need to do.”

This begins the chapter on management but I would urge people to keep reading and see what the characteristics of great managements are. Remember, BASM guides the investor to find the great companies very early, and BASM is the golden goose that lays those golden eggs of earnings.

Thus, if you only define a great management by its earnings track record, you will come into the stock much later than some others, and it may be a very good investment, but not a “Big Money” or wealth stock to make you rich for life.

So, with the 3 companies you name—Disney, Home Depot and JP Morgan, I have met all these managements and think very, very highly of all three.

There are two things that are important to know, here.

First, they are all big and so while they are going to be good investments over time (not quick trades), they are not going to make people rich for life in my opinion. They already did that, and the first two are detailed in my book as stories with lessons as to how they did that and how people recognized them early.

JP Morgan is over $80 billion in revenue on it s way to $100 billion, and even more than that—the second thing—it does not control its destiny as much as the other two stocks.

I say in my book The Big Money that the amount of control over destiny a company can have vs. the amount that its destiny is controlled by the economy or outside factors, is a degree of how great it can be. JP Morgan is very good and will do well for investors, but it is subject to changes in the economy and interest rates more than the average company and one needs to understand that.

Also, JPM is up over 32% the past 12 months, and is somewhat expensive relative to its own historical price earnings ratio, while analysts on Wall Street see growth for the next 12 months to be somewhat slower than the last 12. So, just know that.

I hope that helps you.

[FMF]

Great stuff, Fred. Thanks -- it does help.

Here's my last question for today:

What's your take on ETFs? I've written about them recently (see http://www.freemoneyfinance.com/2006/05/the_basics_of_e.html ) and am trying to figure out if and where they fit into my portfolio. Any thoughts on them?

[CSB]

Hi Fred,

I have a question.

I'm pretty young (early thirties) and a good chunk of my net worth is in the equity in my San Diego home. I'd like to put some of that money to work in other investments while staying below 70% loan to value on the home. What are your thoughts on this and the best way to do it?

[FMF]

CSB --

Fred answered your question on this post:

http://www.freemoneyfinance.com/2006/05/get_your_invest.html