Thursday, September 24, 2015

We've All Been Duped. Again.

Regular readers of this blog will know that I am a passionate long-term investor in growing companies I believe to be smart, competitive, industry-dominant, strategic and possessed of management with integrity. I've discussed many of those companies here.

What few readers know, unless they've read my oldest, orphan posts from 2011, is that I'm also passionate about cars. Not that I can reassemble a '66 Pontiac carburetor blindfolded, or that I have a garage full of exotic Italian sports cars. But I'm the one who gets what-to-buy questions from the college parent looking for something safe, cheap, and Vermont-winter durable; the retiree who wants luxury, reliability and great mileage. I read a lot of car magazines and daydream about what I would own if I could. Maybe car geek is the best way to put it.

A few times, these two passions have aligned and I've purchased stock in an automotive manufacturer whose products, leadership and strategy resonated with me. Volkswagen is one of those manufacturers.

I bought my first VW product in 2003, a new Audi A4 Avant sports wagon. I loved that car. Not particularly quick, but with handling and comfort and safety unmatched in my experience. Where it really shined was on snow: Audi's proprietary all-wheel drive allowed me to motor up crazy-steep grades even on slick wet ice. A favorite apres-ski activity was hauling embarrassed Subaru and Volvo drivers out of snowy parking mishaps. I campaigned for the Audi brand, cajoling friends and family to consider what I felt were solid, reliable, exciting, practical and high-value vehicles. When some years ago, then-CEO Martin Winterkorn announced Volkswagen's intention to become the world's largest automaker, I evaluated the plan he laid out and bought the stock. I was not disappointed, as my investment rose substantially over the next couple of years. I sold out of that position in late 2013 when I reallocated that money into another company which I felt would appreciate faster. 

But I continued to be a fan of the products: my wife and I currently have both a newer and an older Audi, one gas-powered 4-cylinder and one diesel 6-cylinder. We agree, these are the best cars we've ever had. Not one complaint.

Until now. 

Golf Turbo-Diesel Injected
Last weekend, as you've undoubtedly learned, Volkswagen admitted it had been cheating the U.S. EPA-mandated emissions tests since at least 2009 on all its 4-cylinder diesel vehicles. That's 500,000 cars in the US, and another 10.5 million cars around the world. The cars contain smart software that will detect an emissions test underway and fake the results, while spewing the poisonous greenhouse gas nitrous oxide and other pollutants in regular driving. VW lied to its customers, to its shareholders, all the world governments which regulate those pollutants, and likely to most of its employees and its board of directors. This is the very definition corporate malfeasance: fraud on an absolutely massive scale. 

11 million people spent a combined $275 billion to buy these cars around the world thinking they were conserving a natural resource and protecting the environment at the same time. They were duped.

VW plant, Wolfsburg, Germany
How bad could it get? Volkswagen has already halted selling of the affected cars in the U.S. and probably will be forced to do the same worldwide. They face fines in the billions of dollars for the U.S. EPA infractions alone. The company will likely have to retrofit millions of cars with appropriate software and hardware to contain the unlawful emissions, which in turn will reduce both the cars' mileage and performance figures. Impacted customers will sue for the inevitable drops in resale value, and are unlikely ever to buy another VW branded vehicle-- which includes not only VW and Audi but Skoda and Seat (Europe only), Porsche, Bentley, Lamborghini and Ducati. What's bad for Volkswagen is bad for Germany: the German state of Lower Saxony owns 20% of the voting stock in the huge organization, which has fallen in value by over 25% in less than a week since the story broke. There are 300,000 Volkswagen employees in Germany, far and away the biggest employer in Europe's most financially stable and generous nation. Another 300,000 employees across the globe will also be forced to reckon with flat-lined sales and reduced company resources. The future of this massive institution may even be in jeopardy. And the governments who were tricked-- all of them of prosperous, educated nations whose leaders should know better-- come out looking foolish and irresponsible to have let this happen in the first place. 

"My [VW diesel] is no longer a car, it's a comeuppance. I now have a car that has been harming, not helping, the environment. It does not provide the benefits for which I paid a premium. It will have a lower resale value when I want to get rid of it." --Sam Grobart, Bloomberg

The mess is now causing regulators from around the globe to reassess other auto manufacturers' claims, starting with German competitors BMW and Mercedes-Benz (1 out of every 7 jobs in Germany is related to auto manufacturing). Now everything must be exhaustively inspected, tested, graded. There is talk of VW having actually turned the entire planet off of diesel as a realistic vehicular fuel, despite its excellent efficiency, strong performance, and low production cost relative to gasoline. It could swing the entire renewable energy debate. This thing is gargantuan.

"Clean Diesel" intro. Sales soared.
My wife and I got off easy, in the short term. Our Audis are not among the affected cars, which according to a quick Craigslist search now show resale values down about 20% from a week ago (though that could be a hiccup). My resales are probably down slightly due to damage to the VW and Audi brands, but those might rebound over time. But I cannot imagine the dismay of, for instance, a young outdoorsy couple who scratched and scrimped to purchase their first VW Golf turbo-diesel, paying up to feel they did right by the planet.

I've been shouting 'Audi' from the rooftops for more than a decade, and I've converted several former BMW and Lexus owners. I've made a profit as a Volkswagen shareholder. I've got a favorite performance fleece with the Audi logo, a gift from a friend who works at my nearby dealership. I even have an Audi watch. The geek as evangelist. 

On this, I am lost. It's a first-world problem, I realize, but I don't know what to do. My current car is leased, and comes due in a few months. I had planned to replace it with another Audi. Yet don't I now have a moral responsibility to boycott Volkswagen products? That's what a concerned citizen does to fight colossal corporate corruption: vote with my wallet. What if I get a used Audi next time, a transaction from which the company sees no financial gain? Is that also now morally off-limits? And what about the other German automakers? Surely they cannot all have been pulling the wool over our eyes? Unless they were actually in collusion with one another all along ...? 

And what of Volkswagen shares, which in 6 months or so will be cheap, and which still reside on my watch list? Is it karmically wrong to own part of a company which so ruthlessly ignores the health of the planet and circumvents the laws that govern its people, in the name of profitability? Come to think of it, I've long refused to own cigarette manufacturers-- and haven't they always played the same game of Obscuring the Obscene? 

In the end, we're all the losers on this. Consumers were duped and feel betrayed by Big Corporate, again. Germany itself, rising postwar to become Europe's only financial superpower, has stumbled. Elected leaders in the U.S., already disliked and mistrusted, look even more inept. Monumental international brand reputations have been trashed. Hard-asset resale values are slashed. China's pollution problem is worsened. Global temperatures probably notched up .001%. 

Maybe I'll get myself a nice bike. With an oxygen tank.

Monday, September 21, 2015

Path of a Stock Purchase: from Discovery to Ownership

If you're a regular reader of this blog, you know I've written before about the process of stock buying-- Awareness, Identification, Study, Screening and so on. Each of these is necessary in the disciplined and measured business of choosing companies whose stock is more valuable than your hard-earned dollars. After all, we spend our incomes primarily on products and services which are consumable: food, tuition, cars, clothes, travel, entertainment, furniture and so on. We purchase a thing, we use the thing, and when it wears out or fashions change or enough time passes, we replace it. For most of these things the value decreases following purchase-- your car depreciates rapidly; that cheeseburger is worthless as soon as after dinner. Obviously.

Investments are different. They are to be bought and held, and their value should increase over time, or they're not good investments. So unlike a shirt or a couch, we want investments which will last, which will grow in value substantially over the years and help us one day to pay for something else, like your kids' education or your retirement or a great vacation.

So what we choose to buy is more important here than anywhere. We want certain kinds of
companies, involved in certain kinds of business and leveraging certain long-term trends.

Today I'll take you through my decision to buy Under Armour (UA) in February 2014.

Under Armour's original compression
"performance" shirt
I am a fitness enthusiast, for lack of a better term. I wear workout gear often and I'm tough on it, so it seems I'm always shopping for replacement shirts, shorts, shoes and all that. About 12 years ago I bought an Under Armour brand "wicking" compression shirt because looked sleek (on the mannequin), made bold performance promises, and was discounted to just over 1/2 the price of my then-favorite workout t-shirt, made by Nike.

I was immediately impressed as I wore the shirt. It kept me cooler exercising even in the summer in a health club without air-conditioning. It was comfortable and fairly flattering and even stayed pretty dry during a hard workout. Within a couple of months I had purchased two more. A few years later I found the company also made underwear and socks and shorts out of the same high-tech material. Nike's various products slowly got replaced in my dresser drawer.

I liked the gear so much that I started to research the company. I read the terrific Founder/CEO story of Kevin Plank and his days on the University of Maryland football team. I learned that the company's market cap was under $1 billion and that their products were often favored by pro athletes-- which I took to mean they were very high quality. Their gear was generally a little pricey and rarely went on sale, both of which usually means big profit margins. But they had little name recognition and even less shelf space at major sports retailers. It seemed Under Armour was a good business making great products, but was focused on a niche market so was not necessarily a great investment. Yet.

By 2013, however, things had changed. The company had begun sponsoring athletes I knew and liked: World Cup and Olympic skier Lindsey Vonn, rising Golden State basketball point guard Steph Curry, and superstar Superbowl quarterback Tom Brady. They had landed a deal to make competition suits for the US Olympic Speed Skating Team. They were advertising on TV. I was seeing a lot more of their logo in the gym. My kids wanted UA-branded sweatshirts for school. They were making shoes for soccer, running, and basketball. UA had gone mainstream and things were taking off for the company.

I started looking seriously at buying shares. The financials looked good: high profit margins, low debt, rapidly growing sales. The market cap had risen to over $15 billion in 2012 but the stock had taken a hit due to some analyst concerns regarding high inventories-- generally not a value-deterring issue-- and share prices were now discounted around 30%. Which started to look like a great value, given that its similar-sized competitors-- Adidas, Puma, Reebok, Lululemon-- were showing stalled growth, while Under Armour's revenues were climbing 25% or more per year. UA was shaping up to be the only company prepared to go toe-to-toe with sports apparel behemoth Nike. It was time to get in.

It wasn't the UA suits
In February 2014, following bad press regarding UA's speed skating suits and another small stock drop (the US team's poor showing in the Sochi Winter Olympics was later shown to be unrelated to the suits), I bought shares. My decision to finally pull the trigger was careful and methodical, but my timing was astonishingly lucky: in the 18 months since, those shares have doubled in value, a 67% annualized rate of appreciation. UA is already the largest stock position in my portfolio.

I can't expect my ownership stake in Under Armour to continue to grow at that rate, as it is almost certainly unsustainable for a company that size. But that's okay, I'm planning to hold the shares for a long, long time and Under Armour has lots of ramp ahead of it: so far they've only got a tiny piece of the multi-billion-dollar US basketball apparel market, and they're only beginning to catch on overseas. In the meantime, I make a point to buy Under Armour products whenever I can-- I can be my own brand ambassador, I like the products, and at least a few fractions of a penny of everything I buy goes back in my own pocket as dividends, because I own part of the company!

From time to time I will revisit the subject of stock selection, start to finish, using one of my own positions as an example. Until then ...

Please write me or tweet with questions or comments. I welcome the feedback as I work to make this blog a more helpful and easy-to-use resource. It is my goal to respond to you within 24 hours.

Drifting to Fifty | Random unrelated nugget of the week

Eat less. It's harder than it sounds of course, but it's just that simple: put less food on your plate and have fewer, smaller snacks. Make up the gap with a glass of water. In a few years, you (as well as your doctor) will be grateful you started this practice when you did, and you'll wish you had been stricter earlier.

Monday, September 14, 2015

The One Thing Most Impacting Your Investing Returns

Don't be fooled. The thing most impacting your returns 
is not what you think.

Befitting my line of work, I get asked about investing all the time. What would I recommend in energy stocks right now? What do I think the Federal Reserve's rate rise will do to the markets? Do I currently own anything in China? What would I suggest to get a college-age person's portfolio started?

All great questions, worthy of research and discussion. But the answers to none of these will substantially improve an investor's returns over time. Rather, each addresses a specific situation, and therefore impacts only a small percentage of any investor's wealth, or a mere moment relative to one's total investing life. Such narrowly focused questions are important but offer little help when most investors have overlooked the really big issue.

What's the really big issue? Is it diversification across industries and nations? Is it risk tolerance? Stocks versus bonds/commodities/real estate/gold?

No, the big issue is emotional management. Nothing will sap investment returns, destroy wealth, and lay ruin to one's financial future like a lack of emotional management.

Of course, when I try to explain this to folks who are looking for a great tech stock tip or the best online brokerage, they scoff. They just want to get their per-trade costs down so they can stop worrying about overpaying commissions. (That shouldn't be a concern anyway, as your trading ought to be infrequent ... no more than a few trades per month.) They laugh at the idea that getting a handle on their emotions-- something they've already proved by putting away the ice cream unfinished or not hurling a coffee mug at their boneheaded boss or offering a defensive driving example to their teenagers-- could possibly relate to their investment returns.

But it can, and it will. Managing one's emotions around investing is complex, surprisingly sneaky and astonishingly difficult. Often an investor will not even realize he or she is behaving out of emotion, and will insist the numbers bear out one action or another-- when in fact the numbers are really just a confirmation bias, lending data to argue that which she's already decided to do. (For more on biases and blindsides, click here.)

By way of example: let's say you've owned stock in a particular small-cap company for 6 months. You bought with the idea it would slowly grow over the years, and over the coming decades that stock would become a cornerstone of your portfolio and thus your retirement. But instead the stock rises over 50% in the first several months of your ownership. Pleased but surprised, you do a little research and determine that while nothing intrinsic to the company has changed, it's growth is so great and so fast that it's now totally overpriced. You decide to sell while it's high, before bad news knocks it back down.

Completely rational, logical assumptions, thoughtful strategic planning. Well done. But emotionally driven and absolutely wrong.

This happened to me. The company was Starbucks, which I bought the day it went public in June 1992. By New Year's 1993 the price had nearly doubled. It was early in my investing career and I wasn't expecting that kind of ride, so I sold-- thrilled and proud of my astonishing foresight and speedy returns (which I promptly converted into a motorcycle. Ah, youth.) I then missed the next decade of Starbucks' massive growth.

There was nothing intrinsically different about the company I owned, or the competitive environment surrounding it. So why did I sell? Fear. Worry. Knee-jerk reaction to discomfort that the price moved so fast. But it was to be foundational to my (ultimate) retirement, and the company was doing fine. And even if my guess was correct and it was suddenly overpriced, that price would have drop some ... and all else equal, the stock would have started slowly climbing again, as I originally planned. There was far more value in the stock, and much higher demand for it in the market, than I had realized. I need not tell you how much I didn't profit.

Here's another example: you've owned a stock for a long time and have done well with it. It's again your intent to hold for a long term (which, of course, should always be your intent). But one day you read that leadership at your company has made a big move, altering the business plan by spinning off what you believe is an important contributor to the business, and they've rearranging prices so customers pay more. To you, the shareholder, it seems like an irrational and unnecessary change. Up to now you've been impressed by the company's executive team and you don't understand why they would now act so rashly. You realize you've lost faith in the managers of your business, so you decide to sell and reinvest your gains elsewhere.

Once again you've acted with thoughtful deliberation and considered decision-making. You're keeping tabs on the business you partly own and making your call based on detailed research and sound reasoning. But again, you're making the emotional decision.

Bad Idea Hall of Fame
This also is a true story, one I've mentioned here before. In the summer of 2011 Netflix CEO Reed Hastings announced they were splitting the company: Netflix for on-demand video streaming and Qwikster for DVDs-by-mail. Pricing would be broken out and raised-- at a time when many customers were effectively getting both services for the price of one. Analysts balked. Customers quit. The stock tanked.

But even the most brilliant leaders screw up, and I should have waited it out. I ought to have trusted the people I had previously admired to sort it out, instead of panicking and leaping to sell my shares. Once again I focused on the short term-- even though I had originally purchased Netflix with an idea that it would someday supplant Blockbuster (contrarian at the time!) as the default movie-rental service. By 2011 I had 20 years of stock investing under my belt ... and still I let my emotions in the moment control my actions.
When you read something unpleasant about a company you own, the right thing to do is usually nothing. 
Within a month, of course, Netflix backtracked and killed the Qwikster plan. Hastings issued a painful public mea culpa, appealing to both customers and shareholders to return. The stock stabilized. A few months after that, the company released its first in-house episodic drama series, House of Cards. And the stock has been on a tear upwards since, another staggering accumulation of wealth that I've missed out on.

Who will be the new CEO?
As I write this, Twitter stock has been battered to a price less than a dollar above the company's IPO start of $26, which is $19 less than where trading ended on IPO day-- a one-day gain of 42%. They've got 50% more active users today than at their IPO and revenues are rising. They're about to install a new CEO (possibly a founder) and tackle a bunch of usability issues which have been holding them back. Are you a buyer or a seller? By the same measure, GoPro's high-resolution action cameras have a market share 3x that of the nearest competitor and they are soon going to release their own camera drone to capitalize on the explosion in drone photography used for sports, real estate, forestry and wildlife research and so on. But GoPro stock has slid 30% recently due to investor concerns about rising competition and whether its tiny are a fad product. Buyer or seller?
GoPro's latest: the Hero 4 Session

Don't be fooled by the news, and don't trick yourself into ignoring the impact your emotions are having on your returns. Develop an ability to resist quick reactions. Learn to look further out into the future. Obviously, no one has a crystal ball. But you're reading this because you believe in choosing the right companies and holding them for a long, long time. Trust your research, ignore your impulse. The stock markets overall have been rising for nearly 230 years (for my favorite-ever chart, click here). The right thing to do when you read something awful about a company you own is usually nothing. Manage your emotions and you will do a helluva job managing your portfolio, even if you do still keep one eye on the Fed's rates. 

Thursday, September 3, 2015

Market Swings are Making Me Nauseous

When I was young, the nearest amusement park was called Nantasket Beach, on the far side of Boston harbor. It was the kind of place that looked magical to those under 10, like a perfect afternoon for mischief for teens, but dirty and sketchy to the adults. Nantasket Beach had two roller coasters-- the newer, sturdy kiddie coaster and the old big one, a fading white-washed wooden behemoth visible for miles like a billboard. In my family we had to earn our way up to the big one, a rite of passage. It was deafening and full of steep banked turns and whoop-de-dos and one last great hill, so tall the ride would slow almost to a halt as it clanked and rattled its way up the long rise. Then suddenly it would drop, leaving your stomach behind and plummeting to your certain death. Then whip around one last tight turn ... and it was over. Miraculously you had survived, green and a little off balance passing through the turnstile on the way out.

Recent stock market movements have me recalling my old haunt, though the market hills keep getting bigger-- and the ride doesn't seem to end.

Naturally, the reasons for all this volatility depend upon the talking head of the moment and who's paying him to pontificate:

  • China
  • The Fed will likely raise interest rates
  • Tech bubble
  • Greece
  • Startup bubble
  • The Fed may not raise interest rates
  • Vladimir Putin
  • High-frequency trading
  • Oil glut
  • Global "jitters"
  • Droughts and wildfires
  • ETFs

I could go on. The gist of the list: no one knows what the hell is happening.

But here's the really fun part: It doesn't matter. It doesn't matter why, doesn't matter that it's happening. Because over time the market clearly rises:

Stock Prices 1789- present 
So you have to ask yourself a couple of questions: Is it play money or your kids' college fund that we're talking about? Are you speculative or committed? Are you a trader or an investor?

An investor develops the experience and the wisdom, through months like this, to know that the market goes crazy sometimes. It's driven by emotion, or computer trading algorithms or a bubble or world events-- but it occurs every few years and then it settles down and things get back to normal. And the only way to profit in the long run, absolutely for sure without question, is to leave your money in there.

Remember you own a stock-- a share of a market-leading, well-run business-- that varies greatly in value until sold. It goes up, it goes down, and it makes no difference to your pocketbook until you sell it. When you sell, you have to report your gains or losses to the taxman-- and now it's real. So if you give in to the panic of a really horrible down day, if you believe that the business you bought is suddenly worth a whole lot less today than it was yesterday (usually through no fault of the business) you'll be locking in losses. And by the time you've worked up the nerve to buy back in, the market will have rebounded and you'll have missed the best days. You will have bought high and sold low, which is the exact opposite of your intended path. Don't do it.

Instead, go for a run. Get a massage. Play some hoops with a friend, have a drink, watch a movie. Distract yourself any way you can. Tomorrow-- or the day after that, or the day after that-- things will look better. Your stock, which you chose carefully following diligent research, will rise again. You'll be made whole in time. Take another look at that chart above: as my friends at The Motley Fool have said, “The stock market has a 100% success rate at erasing corrections and bear markets.” Full stop.

No one said stock investing was easy, or that it was for everyone. It's an art and a skill, and yes, all the drama and hand-wringing and lurching about can be a challenge even for the seasoned. Some people just hate roller coasters. But that's why they have Dramamine.

(For more Foolish wisdom, click here)

Drifting to Fifty | Random unrelated nugget of the week

Money is a renewable resource and for most people it will come and go. Time, once spent, is gone forever. If there's something you need to say, someone you want to be with, or something you really want to do, find a way to do it.