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.

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.

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. 

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.

Stock Investing: What to buy NOW

[Investor Ralph Wagoner] likens the market to an excitable dog on a very long leash in New York City, darting randomly in every direction. The dog's owner is walking from Columbus Circle, through Central Park, to the Metropolitan Museum. At any one moment, there is no predicting which way the pooch will lurch. But in the long run, you know he's heading northeast at an average speed of three miles per hour. What is astonishing is that almost all of the market players, big and small, seem to have their eye on the dog, and not the owner.                          How stock markets work, as recalled by Bill Bernstein

This is an unusual post.

As my regular readers know, I generally shy away from specific stock recommendations in this blog as I feel strongly that most individual investors are best served betting their money on their own experience and expertise. I have unwaveringly advocated buying the stocks of companies in fields those individuals already know and understand-- or at the very least, of companies they know from their own experience as consumers. But today, in violation of my self-selected and self-policed restrictions, and at great risk to your future readership (if my predictions prove inaccurate), I will tell you what I think are great values right now.

At this moment, as the S&P 500 index is down precipitously from its May 2015 highs (though up again some today), value opportunities have presented themselves which are too good to ignore. To be fair: these are companies whose stocks were down by their own doing prior to a week ago when the correction began, and which have been dragged down further by the broader market rout. Yet these are businesses which I believe in and which should provide real gains in the coming years. Two are smaller, growth oriented businesses, and two are ultra large-cap blue-chip stalwarts. I present them here in no particular order.

    1. Twitter 

Twitter (TWTR) has had problems for some time now. The company recently reported stagnant user growth, largely due to an interface which many find difficult to use and a lack of top executive leadership: 5-year CEO Dick Costolo resigned early this summer amid a rash of concerns, not least among them investor frustration with the shrinking valuation of this once high-flying tech Silicon Valley darling. Twitter founder and ex-CEO Jack Dorsey immediately stepped in as interim CEO, and many are calling for his leadership to continue permanently (assuming he can find someone to replace his role atop his other startup, Square). 

But Twitter seems now to be hovering on the brink of resurgence. In June an angel investor in the company, Chris Sacca, published an 8,000-word screed entitled What Twitter Can Be. Though a tiresome read, the document presents what many believe will become a sort of blueprint for Twitter to follow over the next several years as it corrects its leadership issue, improves ease of use and begins to harness the massive power of over 1 billion registered users-- of whom only about 300 million are actively engaged on the platform exchanging breaking news, photos, opinions, and open dialogue in real time. As I write this, Twitter's revenue is rising even as its stock has fallen to about 5% below its IPO price of $26, presenting a singular opportunity. 

Always buy what you are comfortable with: your understanding of the businesses you own is paramount to your ability to accurately assess changes. 

  2. Apple

Apple retail store, Hangzhou, China

It is the largest company on Earth by market cap, more than 50% bigger than the closest competitor. Just about every investment portfolio contains at least a few shares of this over-exposed but widely-loved company. Nonetheless, Apple (AAPL) has shown itself to be increasingly a one-product business, as its iPhone is now responsible for over 60% of its total revenue. As such, shares are 20% discounted from their record highs a few months ago, not least due to concerns about the seeming collapse of the Chinese economy (China is now one of Apple's biggest customers). 

Apple has become a victim of its own success: Apple investors grew accustomed to one industry-altering mega-hit product after the next and the staggering market share and revenue growth that accompanied them. Beginning with the iPod and iTunes Store in 2003, the company first changed the way people bought and consumed music. Then with its original iPhone in 2007, Apple upended the mobile phone business, ending the dominance of Blackberry and Nokia and Sony with an exclamation point. Finally Apple made even its own laptops look old-fashioned as its 2010 iPad ran rampant over previous technologies and effectively darkened the only bright spot in the personal computer business. Now its just-released Apple Watch is winning some early adopters, though most believe it cannot and will not wallop the market like preceding products. 

But just because Apple will not continue to grow and change industries as in years past does not mean the company is cooked. Far from it: Apple has perhaps the most loyal customers in all technology, and they will both need to replace their myriad devices over time, and will continue to look to the iTunes Store for music (often subscription-based purchases likely), apps, and movie rentals in the future. Additionally the second version of the Apple watch will likely be a bigger hit than the first, and Apple is moving sharply into both the live television and the payments businesses over the next few years, not to mention rumors of an electric Apple car one day. At a price-to-earnings ratio of only 12 and a price-to-sales ratio under 3, with some of the best growth rates of any major global business, in spite of its size, Apple looks like a steal at today's prices.

    3. Zillow

When consumers want to know the price of the house up the street that just went on the market, or they're thinking of moving across town or they're weighing a job offer that requires moving to a new city, there is only one place they look today: Zillow (non-voting: Z, voting: ZG). Zillow's stock has taken a beating this year as the company spent heavily to acquire their only significant competitor, Trulia, then spent substantially more to merge the two companies' complex software systems. But there is absolutely nothing wrong with the underlying business as its revenues, largely from the advertising of real estate agents, keep climbing and its user base keeps growing. Zillow is expanding into new markets as well, including rental data, mortgages, and virtual 3-D online display of listed homes. Now, with already a profitable and well-known brand and without real competition, as soon as the merger is fully in the past this company is going to blow the doors off. You'll want to be on board. 

    4. Disney

The entertainment conglomerate has taken a pounding since it peaked in late July of this year, but unfairly so. When Disney (DIS) reported earnings August 4, it called out a drop in ESPN cable sports subscribers and since then has been playing defense against the Wall Streeters who are concerned that ESPN, which provides the bulk of Disney's cable segment revenue, will not be able to regain lost sales given the "cord-cutting" trend which has taken a toll on nearly all media companies and cable providers. But those fears will likely not be realized: it is more likely that even now Disney is working on a standalone ESPN app to allow those with internet but without cable TV in the future to continue to tune into their favorite teams, a strategy which has worked well for HBO, Showtime, and Amazon, not to mention Netflix. In any case, Disney has a multitude of very healthy businesses upon which to fall back. 

The cast of the new Star Wars movie. Kidding, I'm kidding.

For starters, there's the eponymous theme parks, which are doing extremely well and (in the U.S.) are expanding to accommodate new, substantial Star Wars-themed attractions. Everything else aside, the opportunity to immerse oneself in a Tatooine universe of characters and experiences, not to mention to experience personally piloting Han Solo's smuggler spaceship The Millennium Falcon, is all but a guarantee of strong theme park revenue in the years to come. Disney's multiple film-production business are crushing it as well, with Marvel superhero pictures continually ranking among the biggest hits worldwide year after year and its Pixar films scoring with audiences young and old each and every time out of the gate. Then there's the avalanche of merchandising for the hundreds of Disney cartoon and film characters, including video sales, toys, games, and clothing. And we haven't even touched the big one: Disney's release of a new Star Wars film, the first in a decade and the first of three to come, in late autumn. Even those who aren't fans of the films are expecting lines around the block for days in advance of the opening. 

Disney is the sort of company you want to buy stock in and leave to your children. It's a feel-good, crowd-pleasing, family-friendly media juggernaut currently experiencing a fire sale on its stock. Load up and forget about it for decades. 

There are several more great opportunities I could include here for your consideration: Starbucks (SBUX), Under Armour (UA), LinkedIn (LNKD), and GoPro (GPRO) among them. All well-priced and all with substantial growth ramps ahead. I'll let you to do your own research on those, just as you should on the ones I discuss in more detail above. Always buy what you are comfortable with: your familiarity and understanding of the businesses you own is paramount to your ability to accurately assess changes in their operations, management, financial structure, and the competitive field on which they play. 

As I wrap up this post, I note that (of course) a bit of the pricing value I discuss above has evaporated in a roaring market comeback today. Not to worry. The 4 companies I've detailed will see dark days again tomorrow or next week and many times over the coming years, which is how it goes for publicly traded companies which have wide consumer awareness and attention. Your job is to start walking, ignore your pooch and keep your eyes to the northeast.

Stock Investing: Bloody Hell! Now what?

Damn, it's ugly out there.

This is it, the big market drop we've been expecting ... I think. Of course it depends how long it goes on and how far it falls. But we've been told for months (years, if you actually listen to the perma-bears) that the crash was coming. Or, the correction. Or dip. This is what we think now. We don't know anything until afterwards. A lot of folks on TV and their blogger equivalents will tell you what they're reading in the tea leaves, or what the historical charts indicate about today, or what we can glean from historical data ... yada yada yada. They're blowing smoke, folks. Anyone who says they know what we're looking at right now, or exactly why, or what's going to happen next, is lying. It's always different this time, and only hindsight is 20/20.

No one knows what the market is going to do, or even what to call what it's doing now. No one. Those questions simply cannot be answered in good conscience, even when one is well paid to answer them. So stop listening.

The only question we truly can answer is, What do I do about it?

Easy: Don't do anything. Yet.

I know you want to panic, sell it all, put the cash in your mattress and keep it safe from harm. But here's the thing: if you do, in many cases you'll be selling below your cost, which means means you will have bought high and sold low, which is an somewhat undesirable outcome. You will lose actual dollars-- different from theoretical dollars represented on a brokerage statement. Why? To "protect" your money.

Understand that in most cases there is nothing wrong with the companies you bought. Sure your holdings-- your share of ownership-- are in the red. But the businesses and their operations are fine: they are churning out quality products which are selling well and they're making their debt payments and taking care of both their employees and their customers-- which takes care of their owners. Nothing wrong. Their stocks dropped because all the other stocks dropped, and all the other stocks dropped because most investors panicked and sold.

Don't be part of the problem. If you sell you might prevent further losses. But markets are cyclical, they go up and then down and then up again. When will you get back in? You'll be looking for a signal that the rout is over, that we've hit bottom and it's safe to buy. But there is no signal. You will absolutely, with 100% certainty, miss the bottom. And likely you will miss the first good chunk of gains from the bottom as well because you won't be convinced that the turn is real and the worst is past. You'll want to see several days of strong market gains-- and that will be your signal. But those gains will now be behind you, and you're still holding the losses you took on when you sold due to panic. The whole selling-on-a-downturn thing is a trap. Don't fall for it.

Instead, hold on tight and get ready. Hold on because it could be a long and nasty ride down, with heartache and headaches and maybe an ulcer or two, given your investing time horizon. Get ready because soon it will be time to buy more of the companies you believe in. Because like I said, there's nothing wrong with them.

Next post, I'll break protocol, and provide you some specific suggestions. Stay tuned.

Drifting to Fifty | Random unrelated nugget of the week
Learn a sport you can play even as you age: golf, skiing, tennis, swimming, biking, hiking, even billiards or table tennis. Then learn another. The goal is to find something you love that will keep you on your feet and active the rest of your life. Your spouse will thank you.

Stock Investing: Financials, Part II

When I left off discussing the numbers of a company you’re interested in adding to your portfolio, almost a month ago (sorry), I told you about some broad checks I do to ensure the company is in good shape, like Return on Equity, PEG Ratio, Total Debt, and 52-week Price Change. Now let’s drill a little deeper. Like in my previous Financials post, this information is all available and free for the taking, in Yahoo Finance.

First let’s look at the Current Share Price. This is not meaningful in and of itself--- a share can cost $10 or $200 or, in the case or Berkshire Hathaway A shares, over $215,000 apiece. Share price is not an indicator of value, though obviously there are few among us who have the cash to pay for a Berkshire A share. The only thing we care about the price of a stock is whether it’s not too inexpensive; we want to avoid “penny” stocks, which naturally are those under $1 per share, and anything too close to that level.

Penny stocks often are that price for a very good reason. And while there are those who like to dabble in stocks with tiny prices (5,000 shares for under $1500!? What a deal!) the truth is usually that something terrible has happened to the company and it is in danger of not only bankruptcy, if it’s not there already, but of being dropped, —delisted— from the major trading houses. Which means it becomes very hard to sell, even if the prices rises some. And more often than not, the prices stays down and even becomes worthless. Have you heard of Pets.com or Toys.com?

I like to find companies whose shares trade above about $7, which is most of the companies we’re talking about anyway. Less than that is just too close to the line for me and in those cases I frequently cannot get enough reliable information about the company, so I can’t make an accurate assessment of its market chances.

Market cap

Next up is Market Cap, or Market Capitalization. This is simply the total value of all currently outstanding shares in the company. Unless you know a founder or you’re in some other way personally very familiar with a particular company, I would urge you to keep your investments in companies with a market cap of at least $2 billion. Again, like share price, it is merely an indicator that the company has been around long enough, and available in the public markets long enough, that you—like any analyst or journalist or curious customer—can easily locate solid information.

Insider Holdings is a very useful metric, available of the Yahoo Finance Major Holders page. It tells you what percentage of the outstanding stock is held by founders or executives of the company. The higher this number the better. We want to invest in businesses whose leaders ride in the same boat we do and so are generally motivated by the things that we are. In most cases an executive with ownership of 1% or more will be incentivized more by his or her share ownership than a pay package when making key decisions which affect that business. Not to mention someone who owns that much of a big, publicly traded company likely has a passion for that business and will work extremely hard to see it succeed. Precisely what a passive shareholder wants to see.

Revenue Growth and Earnings Growth:

(For these you will, unfortunately, need to start calculating. This is where that Excel spreadsheet comes in handy. I just copy-paste a company's Balance Sheet, Income Statement, and Cash Flow Statements right off the web and onto a worksheet, then I can build formulas to track my metrics.)

What we want to know here is how quickly Revenue and Earnings— profits— are growing on an annualized basis. And I weight my figures so that last year and this year are getting more say in the rate calculation than 2 years ago. Here’s the formula for Revenue Growth:

      This Year Revenues                          This Year Revenues

      ------------------------------  x .65      +     -------------------------------   x .35   - 1

      Last Year Revenues                          2-years ago Revenues

and for Earnings Growth:

       This Year Earnings                           This Year Earnings

       -------------------------  x .65      +        ----------------------------   x .35     - 1

       Last Year Earnings                           2-years ago Earnings

Ideally, we want a business where revenues are rising at least 10%/year, and earnings are growing even faster than that, preferably more than 20%/year. Of course, there are some outstanding exceptions: Amazon, for example, has astounding revenue growth and virtually no earnings at all most of the time, as nearly everything is reinvested into the business to maintain massive growth… it’s a choice which, as a growth stock investor, I’m totally happy with. 

Relative Strength is a measure of how much the stock’s share price has risen in the last 6 or 12 months relative to a given set of other stocks—in other words, how much faster a particular stock is rising compared to others. The idea is that this is an indication of management skill or profit margins or manufacturer efficiency. The reality is that while it could indicate any of those things, likely as not it’s more a measure of what we now call “trending,” or the level of investor interest in a given company. A business that is hot in the market lately will likely have seen a greater price increase relative to its peers than another business. In any of these cases, we like fast price appreciation and we look for it.

It is an impossible number to calculate, as you need to determine the price increase rates of a whole pile of other stocks and then compare to the one you’re researching. Best bet: search for it online. Use the ticker symbol (AAPL for Apple, NKE for Nike, etc.) and then look for Relative strength. Often you can find some analyst’s take on the first try.

Finally, Cash Relative to Total Debt is just what it sounds like: how much cash and other liquid assets the company has on hand compared to all their debt. We want cash on hand to be the larger number—preferably 1.5 times bigger. To be fair, this pretty much rules out a lot of manufacturers and other capital-intensive businesses, such as airlines and shippers and so on. But you want to know regardless: can the company pay off debt anytime should a need arise?

Of course, there are many more ratios and calculations you can perform to help you determine your company’s strength, cash flow habits, financial priorities, growth rates and profitability. I urge you to play around on a couple of websites in addition to Yahoo Finance that are great for this sort of exploration:

The Motley Fool offers a wealth of information just by typing in a company ticker to the top-right corner search field of their home page, including common ratios (most of those listed on my blog), charts and graphs, and some comparison tools as well.

Nasdaq provides data about just about any stock traded in the U.S., both in and out of the Nasdaq trading exchange. Their home page has a search bar to enter any ticker you want and get, on the left margin, a page called Guru Analysis which will rate a particular investment opportunity filtered through the philosophy of a number of renowned investors, such as Benjamin Graham and Peter Lynch. And you’ll find a quick and easy visual guide to their own analysts’ take under Analyst Report.

Drifting to Fifty | Random unrelated nugget of the week
Short-term thinking— a need for instant gratification— is the source of a great number of our problems. If instead one approaches a consequential decision from the perspective of how her or she will feel about that choice a year from now, or 10 years from now, one will likely find greater satisfaction.

Stock Investing: Surrounded by Bears

I hate financial television. I loathe it, can't stand it, utterly refuse to watch. Because turn on any business news channel-- Fox Business, CNBC, CNN Money, you name it-- and there's a guy in a pricey suit telling the camera that the stock market is too high, he's never seen such lofty valuations, the bull market is over, get-out-while-you-can-'cause-it's-all-coming-down.

Perma-bears everywhere

These market bears are everywhere, all around us, at all hours. They write newspaper columns and well-publicized blog posts and they turn up on talk shows and on radio. They speak with total conviction. They come with fancy Wall Street credentials and years of experience and seemingly accurate past predictions. And they know, they just absolutely know that the S&P 500 will fall any day now. The war in Syria/debt default in Greece/stock market rout in China/nuclear talks in Iran/election uncertainty in the US will cause a massive market selloff. You'll lose your life savings.

And they are totally, completely, utterly full of it. All of them, completely 100% nonsense. They know nothing. It is your job-- it is your duty to ignore them.

Dire warnings: Michael Sincere

First of all, no one knows what the market will do. A crash is a random and irrational event. It's a public hysteria confined to the equities market. Saying there will be a big drop is like saying a bee will fly up your sleeve. Of course it could happen, but there are no precedents, no warning signs, no patterns and no typicality, therefore it is totally unforeseeable. it never happens like it did before, and anyone who says they know different is lying, to you or to themselves. If later it turns out they were right, they got lucky.

Secondly, those guys in suits are paid to raise the alarm. No one wants to watch a guy who tells us 'the markets are strong, stocks are rising, your money is safe' (or absorbs the advertising bookending his statements). That makes for lousy TV. Worry is what gets viewers to pay attention. Have you seen the local evening news in the last 20 years? It's all shootings and car wrecks and fires and kidnappings. Any statistician will tell you our society hasn't gotten more violent or more unsafe over the years. But the news sure has. And financial news is no different.

Third, it doesn't matter anyway because the stock market always rises more than it falls. Even if you fall prey to the fear and even if your whole portfolio takes a big hit-- 50% has in fact happened-- if you ride it out you will be fine.

"The stock market is a device for transferring money from the impatient to the patient." --Warren Buffett

I cannot emphasize this enough: doing nothing in the face of widespread market panic is the hardest thing in investing. It is far more difficult than successfully picking growth companies, more difficult than the discipline to keep socking away the money to buy with. Sitting on your hands-- or tougher still, buying-- is flat out viciously and miserably hard.

It is also the key-- in fact, it is critical to long-term wealth. You cannot get there from here unless you refuse to sell when things turn ugly. Have confidence in your companies, have patience in the market.

Stock Investing: FAQ (cont'd)

Answers to more questions I get asked routinely:

1. Should I just go ahead and buy the stock I want, or should I wait for a price drop? What if it's really expensive? 

Stillborn Qwikster: Even the name was a terrible idea

I've told the story before of my Netflix gaffe: owned it in 2009 and 2010 and saw my investment increase over 300% in that time. Then in September 2011 Netflix announced it was splitting off DVD rentals from on-demand, such that existing customers would effectively pay double current prices for to keep their existing arrangement. It was such a bone-headed, greedy, out-of-sync-with-the-customers move that I lost all respect for CEO Reed Hastings and his previously brilliant management team, and I sold my shares immediately. A month later Netflix reversed course, apologized to its customers, and started building back the trust. I should have bought it back but I was skeptical ... Now the stock is up another 400% since my sale and I'm still waiting for that buying opportunity. Worse, Netflix is not the only company I've made that mistake on.

Some people have to feel they got a bargain. But for me, I generally don't worry about timing my purchase to a price dip. I'm buying companies I intend to hold for a very long time-- 3 years or more, on average. Longer if possible. Warren Buffet says, “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” In my current portfolio, the stocks I've held more than 6 months average a 34% annualized gain. If there's a company I've been watching and understand, which makes amazing things, and crushes their competition, and carries little debt, their stock on the rise, then I have little interest in timing the purchase just so.

2. I've heard people say "Sell in May and go away." Is there a time of year when things usually drop, so I shouldn't invest?

No, there is no such time of year. That's an old legend, once sort-of true, when the world moved slower and news was once or twice a day and traders spent half their summer at the beach club on Long Island. Those days are gone. Now things move fast and they change constantly. It never slows, not really. Get in as soon as you can, because the power of compounding will increase your invested savings exponentially over your lifetime. The sooner you get into the market, the wealthier you'll be when it's time to retire.

3. Do you have any tips? What's hot right now?

Disney never disappoints

This is one of those useless questions that everyone asks, because their investing philosophy is different from mine-- or more likely-- they do not yet have one. The answer is dependent on things only they know: what they do for a living; the industry or industries they understand and follow; the companies they already do business with; their savings and investing timeline; their patience with volatility, or their "risk profile." What I (seasoned and tolerant of risk) might recommend would likely make them seasick with wild price swings. What they (new to the stock market and accustomed to having a managed IRA) might find interesting would make me sleepy with the boring steadfastness of a dividend-based, low-growth return.

Generally I duck the question entirely by pushing them to a familiar name which grows pretty consistently despite a steady, blue-chip status: Starbucks, Disney, Berkshire-Hathaway (Buffet's conglomerate). A little something for everyone.

4. A lot of stuff I read says I should diversify across industries, like a little bit each of energy, biotech, banks, manufacturing... What do you think?

Short answer is Yes, you should diversify across industries, as well as across nations, growth stages, market caps, even asset classes (bonds, real estate, etc). But the reality is most of us know some areas a whole lot better than others. I've mentioned before that I know nothing, repeat nothing, about commodities. Or insurance. Or medical/health care. So while I should own stocks in those areas, I do not. Because at the end of the day, the single most important rule for me is Buy what I know. That's it. How can I possibly do a deep analysis-- either prior to purchase or later, when I'm keeping track-- if I don't genuinely understand the product they make, or the process by which they make money?

So I have industries I feel I get. Auto manufacturing, online retail, social networking, finance, entertainment, and so on. Limited, but within my wheelhouse.

5. If you only had enough money for one investment, would it be real estate, stocks, bonds, gold... ?

Stocks. Hands down. Nowhere else can I average over 20% per year on my capital. Even in a bad year I eke out 10% overall. The only thing which comes close to that would be private lending, which is very risky and a totally different kind of investment.

Looks great but it's not for everyone

Gold, it should be noted, has historically been a safe haven for cash in an unsafe or unstable financial world. Lately gold prices have dropped hard. But if you look back 100 years or 5,000 years, gold has been a great place to put your money. On the other hand, gold earns nothing. It just sits there. You have to have total faith that it will appreciate over time. Unlike a stock, there is no management team working their asses off to earn shareholders a return on that gold. So while there's virtually no risk that you'll lose your entire investment, there is also no promise that your asset will appreciate.

Real estate is generally a good investment, but again, it's a specialty requiring different skills and different expertise. Buying shares in a REIT (Real estate investment trust: many are traded over the counter as an exchange-traded fund) is not a bad idea if you are looking for broader diversification.

6. Choosing stocks and managing a portfolio looks confusing and difficult. Why can't I just put it into an index fund or a mutual fund and forget it?

You can do that, of course. Choosing stocks and buying for a long term hold is not for everyone. Direct stock ownership requires diligent research at the front end followed by years of tremendous patience and often a strong stomach after that. I do it because I make far better returns choosing my own stocks and managing my own portfolio than I would any other way. I also enjoy the process. But if you're the sort of person who is terribly busy, or easily distracted, or who would forget to look in on their stock holdings, or who hates that particular brand of responsibility-- yes, there are other ways to be in the market which require less from you. You will have to determine your own priorities and your own temperament and go from there.

7. How do I know when it's time to sell a stock?

There are only 4 reasons to ever sell:

• Your original investing thesis has changed or was incorrect;
• One of your holdings has grown too big and your portfolio needs to be rebalanced
• You found a better place for the money 
• You have a need for a tax loss to cancel some other substantial gain

I go into more detail regarding each of these reasons in a previous post, which you can find here.

Stock Investing: Fun with Financials

Let’s say you’ve been doing your qualitative research and have found several companies whose stock looks very interesting to you. These are businesses you understand at a basic level. They make a high quality product or service—and hopefully you’ve experienced that firsthand as a customer. You’ve decided that these companies have a wide moat, or a sustainable advantage, against their competitors. You’ve read up on their executive management and find them to be smart, capable, and relatively transparent leaders whose moves and choices make sense to you even as an outsider. Finally, you can see that these companies are growing both in size and popularity, or at least you see no obvious red flags pertaining to their potential.

Fantastic. You’re ready for some basic arithmetic. You may have been putting this off, or you may have been looking forward to some hard numbers. Different strokes. So let’s have a look at the companies’ financials to see how they’re doing on their ultimate purpose: making money for their shareholders.

First up, visit Yahoo Finance, enter the name or stock ticker of a company you want to look at and pull up their summary page. Down the left column is a list of 3 types of financial reports the company puts out quarterly: the Income Statement, the Balance Sheet, and the Cash Flow Statement. I find it easiest to copy these into an Excel spreadsheet to simplify and speed my analysis.

First let’s have a look at Return on Assets, which is simply the Net Income figure on the Income Statement divided by the Total Assets figure on the Balance Sheet. It represents the efficiency of the company in utilizing its assets to make a profit. You’d like to see upwards of 10%.

Return on Equity, another marker of efficiency, this time the company’s ability to use the combined equity of all current shareholders to make money, is Net Income divided by Total Shareholder Equity, another Balance Sheet item. Again, you’re looking for something above 10%.

Debt is a measure of all substantial borrowed money held by the company (to buy equipment or raw materials, to finance hiring or marketing or research) should equal less than 25% of Total Revenue. If a company is ringing up sales 3 or 4 times its total debt, that’s a good sign (though some capital-intensive industries, like heavy manufacturing or airlines, require more borrowed money). Ideally, Debt should be close to zero.

Debt-to-Equity Ratio, which is Long Term Debt divided by Retained Earnings and Total Shareholder Equity added together, measures the same debt against ownership equity in the company. For obvious reasons, this number should be as low as possible, but let’s be on the lookout for companies with a Debt-to-Equity ratio of 40% or less.

The Current Ratio is a simple one—it’s the measure of a company’s ability to pay off its most immediately-due debt with cash on hand. Using the Income Statement, just divide Cash and Equivalents (usually stocks or bonds or other asset which are effectively liquid) by Total Current Liabilities. You should see something higher than 2, or more than twice as much cash as current debt. This is important if those current lenders (many of whom may be vendors selling materials or labor to the company on payment terms) call the debt: in other words, if those lenders need the money immediately, can your company just pay them or is it going to mean trouble? A good indicator of the quality of financial management.

Next up is Accounts Receivables Growth: Is the amount owed the company by its customers—credit extended by the company—rising over time? On the Income Statement, locate the Accounts Receivables line and check to makes sure each successive year is higher than the previous. On Yahoo Finance you can click around to locate the quarterly reports from the company as well as the annual ones, and make sure the number rises quarter by quarter as well.

Next we’ll visit an area in Yahoo Finance’s company coverage called Key Statistics, a link on the left of the company summary page. Here you can find other very interesting data, some of which you could calculate but is easier just to look up.

52- week Price Change is in a block on the right margin. It’s simply an indicator of how far the stock price has moved up (or down) in the past year. You’d like to see the stock price rising over that time, of course, even if you’re considering buying on what you expect is a temporary price drop.

Also on the Key Statistics page you’ll find the PEG Ratio, in the middle-top section. This is an indicator of the Price-to-Earnings Ratio divided by a company’s expected growth rate.  The P/E Ratio (Price per share divided by earnings or profits per share) is a common old-school measure of a company’s profitability, a less useful marker now in the tech and information economy than it was in the days of manufacturing, but it’s still a good benchmark. The PEG ratio looks at that figure in light of the company’s growth rate. In general, the lower the number the better, as it indicates that the company is possibly undervalued by the market.

In my next post, I’ll detail some additional metrics I’ve found useful in choosing companies with the potential to completely upend the marketplace they operate in, changing the rules  of their industries or even inventing entirely new ways of doing business, and leaving others in their wake.

Drifting to Fifty | Random unrelated nugget of the week

The single most useful tool in your kitchen is a good, generally expensive, 9-inch chef's knife. If you never drag the blade edge sideways on a cutting board and you hone it briefly after every use it will stay sharp 4 times as long.