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Published by: Lyon Capital Management, LLC - A Registered Investment
Advisor
24B Grove Street * Pittsford, NY 14534 * Tel: 585-248-9821 *
www.lyoncapital.com
Sticking to Your Strategy
By Doug Lyon, CFA
In a past newsletter we quoted the old adage, "It is time, not timing, that builds
wealth." In the current market we have seen and heard of many investors becoming
impatient with their manager’s (or their own) investing style and shifting funds into
more well-known and talked about areas of the market. Is this smart? Maybe not. To shift
funds after a year or less of poor performance can be a serious mistake. It is,
essentially, selling low. When is it time to switch and when is it time to exercise
patience?
Picking a Strategy
To answer this question, your first step as an investor should be to choose an
investing strategy you believe in, feel comfortable with, and understand. Then stick to
the strategy for a reasonable period of time. When I became an investment manager I did so
only after carefully studying various investing styles and their records over a long
period of time. Being a value investor made sense. But, as with any style, it isn’t
always easy to ride the bumps of the style and the market.
A value investor, by definition, buys stocks that are out-of-favor with most investors.
Human nature is to like things that are pretty and tell a great story and to shun things
that are ugly and unexciting. It takes courage to buy what others don’t desire. (Your
friends don’t want to talk to you about a stock they have never heard of and
isn’t in vogue.) Investing is one of the few areas of life where the majority of
people would rather buy things that have gone up in price.
I would rather buy when a stock is "on sale" and at a discount to it’s
underlying value. Being a value investor is akin to buying name brand clothes at
Marshall’s for 50% of what you pay at Nordstrom’s, or trying to get a deal on a
great used car instead of walking into a showroom and demanding to pay a premium over the
sticker price.
The value investment style is a style that has produced superior returns for the level
of risk taken, over significant periods of time (see the chart below). We use the value
style because we believe it is in the best interest of our clients.
Value of $10,000 Invested since 1975
| This chart shows the value of $10,000 invested in the S&P BARRA
Growth Index and the S&P BARRA Value Index from January 1975 to April of 1999. We
chose this period because it is the longest period of time for which we have data. The
longer the measurement period, the more statistically significant the results. The
standard deviation of returns for these indices over the same period of time was: Growth: 16.10 Value: 12.99
A higher standard deviation indicates more volatility of returns and therefore more
risk. Clearly, historically, over this period of time, with these indices, value investing
has produced higher returns with lower volatility.
Data for this chart was obtained from Chase Global Data and Research. Index returns are
compounded and include reinvestment of dividends. Each index is based on approximately 50%
of the S&P 500 index stock divided according to their book-to-price ratios. Past
performance is not an indication of future results.
Tough Times
There have been tough times for some value managers lately. Even the mighty
Vanguard Group, a giant in the mutual fund market, has selected a new, additional manager
for it’s highly touted Windsor (value) Fund after performance for several years
lagged competitors. As trustees for their clients Vanguard decided it was time to
diversify managers.
Making a Change
Deciding to switch investment managers can be a harder decision than hiring a manager.
Here are some things we think should prompt an investor to change managers. If you can say
one or more of these things about your investment management situation, it may be time for
a change or time to diversify by adding a new manager:
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I receive a poor level of service. |
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My investment manager is not
implementing the strategy to which we agreed. |
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I don't understand the investment
manager's strategy. |
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The investment manager's strategy is
changing. |
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Performance has not been good for a
full investing cycle (3-5 years, depending on how often your manager turns over the
portfolio.) |
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My portfolio performance has not met
my original target-goals for a full investing cycle. |
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My fees are not competitive. |
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Standing Pat
But on the other hand, if you are able to say….
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I receive a high level of service
from my manager. |
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My investment manager is
implementing the strategy we agreed to. |
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I understand my manager's style. |
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My manager does a good job of
communicating with me on a regular basis (not just in good times). |
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My manager sticks to his/or her
style (in good times and bad). |
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Performance has met my long-term
goals. |
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Fees are competitive. |
…then stand pat and stick to your strategy.
If your strategy is value, give us a call at Lyon Capital Management. Or, visit our web
site (www.lyoncapital.com) to read more about our investment philosophy. $$
Lyon Capital Management Celebrates 5-year Anniversary
In March of 1999, we celebrated our 5-year anniversary of service excellence. Started
as a sole proprietorship in 1994, Lyon Capital Management has grown from 2 to 40 clients
and from $2 to $11 million in assets managed.
In 1996 we made a move from a small (one room) office in the basement of an industrial
building in Henrietta to a modest office suite in the Village of Pittsford. In 1997 Doug
Lyon earned the CFA (Chartered Financial Analyst) designation. In 1998 we made the
Rochester Business Journal’s list of "Local Money Mangers" for the first
time and launched our web site.
Who do we owe it all to? Our clients! They have given us the opportunity to prove that
bigger isn’t necessarily better, that personal service matters, and that value
investing is smart investing. Our thanks to them and others who have provided support
along the way! $$
What is a Preferred Stock?
By Doug Lyon, CFA
A preferred stock is a security that is between a bond and a common stock in the
corporate financial hierarchy. A preferred stock’s dividend is paid after all
interest on the company’s bonds is paid, but before dividends on common stock are
paid. In a liquidation, bond holders get paid first, then preferred stock holders. Common
stock holders get what is leftover. The common stock holder is an owner of the company.
Bond holders and preferred stock holders are not. They are lenders to the company.
Preferred stock is more like a bond than a stock. The dividend payment (like a bond
interest payment) is usually fixed for the life of the security. Common stock dividends
usually go up or down with the fortunes of the company.
The price of a preferred stock is more heavily influenced by the same factors that
affect a company’s bonds. Preferred stocks and bonds are primarily affected by the
level of interest rates and the issuing company’s credit worthiness and less so by
the company’s long term growth prospects. Conversely, the price of common stock is
affected primarily by the company’s long term growth prospects and less by interest
rates and company credit worthiness.
Preferred stocks can be callable. This means certain issues of preferred stock may be
repurchased by the issuer. The repurchase usually takes place at, or slightly above, the
par value of the preferred. (Par value is the price the issuer will pay the investor at
maturity. The par value is established up-front, prior to the issue and is in the
prospectus.) The option to repurchase is held by the issuer, not the investor. When a
preferred stock is issued, whether or not the preferred is callable and the terms of the
call are disclosed in the prospectus. Callability, timing and price are important facts
for any investor to gather before deciding whether to buy a preferred stock
There are two reasons why investors use preferred stocks. First, because they are
neither bonds nor common stock, preferreds often fall between the cracks in the investment
world. This creates pricing inefficiencies and therefore opportunity. Patient investors
can often buy preferred stocks that have attractive risk reward profiles. Second, as with
dividends on common stocks, preferred stock dividends are often partially excluded from US
corporate income tax. U.S. corporations can thus generate attractive after tax returns by
investing in a portfolio of preferred stocks. Currently corporations may exclude 70% of
qualified dividend income from taxable income. Assuming a 35% tax rate, a preferred stock
yielding 8% would return an after tax yield of 7.2%. This is better than Treasury Bills or
a money market account. That is why we recommend them for well-diversified, fixed income
portfolios.
If you would like to capitalize on the opportunities that preferred stocks offer,
contact Lyon Capital Management at 585-248-9821. $$
Are you an Index Watcher?
Special On-Line-Subscriber's-Only Article
By Doug Lyon, CFA
Recent years have been exciting ones in the U.S. stock markets. One way many
people know this is because they have heard about market indices moving ever upward.
The DJIA (Dow Jones Industrial Average) and the S&P 500 (Standard and Poors 500) have
been "up" over the last few years. But, these indices can be poor
benchmarks for portfolio performance comparison purposes. In fact, if you don't own
the top 5 to 20 companies in a given index, the index may be an irrelevant
benchmark. Why? Read on...
What is an Index?
First, a definition: an index is used to compare the value of a group of
variables (stocks in this case) at one point in time to the same group of variables at
another point in time. The Dow Jones Industrial Average is an index made up of 30 of
the largest U.S. based companies such as IBM, General Motors, Coca Cola, and Phillip
Morris. As each of these 30 stocks' prices change, so does the value of the index.
The Price Weighted Index
The DJIA is a so-called "price weighted index." This means the index is
calculated by adding up the price of each of the 30 stocks that comprise the index and
dividing that sum by a divisor. The divisor is a number that has been developed over
the years to compensate for such events as stock splits and spin-offs.
High priced stocks in a price weighted index like the DJIA have a larger affect on the
level of the index than lower priced members. IBM is, at this writing (5/25/99),
selling for about $221 per share and so is weighted heavily in the DJIA. Wal-Mart,
newer to the index, sells for about $42 per share and is not as heavily weighted.
If IBM's price changes by 10%, the index is changed significantly. If Wal-Mart's
stock price changes by the same 10%, the index is changed much less significantly.
The Capitalization Weighted Indices
The S&P 500 and the NASDAQ are different indices that measure the change in value
of a group of stocks. The S&P 500 includes the 30 DJIA stocks plus 470 stocks of
large companies. The NASDAQ (National Association of Securities Dealers Automated
Quotation System) is made up of all domestic stocks traded over-the-counter, stocks not on
the New York Stock Exchange (NYSE) or the American Stock Exchange (ASE). The NASDAQ
contains over 5700 issues. Many of the largest NASDAQ stocks also appear in
the S&P 500 index. These two indices (the S&P 500 and the NASDAQ) are not
price weighted like the DJIA. Instead they are "capitalization weighted,"
or weighted according to the market value of each of the stocks in the index.
The market value or market capitalization of a company's stock is determined by
multiplying the shares of stock outstanding by the price per share. So, a
capitalization weighted index, like the NASDAQ or S&P 500, is dominated by the largest
companies in terms of market value. The 20 largest companies in the S&P 500
comprise over 25% of the value of the index.
So, if these 20 stocks that represent only 4% of all S&P500 stocks, change by 10%
in price, the index changes in value by 2.8% even though the market value of the other 480
companies may not have changed.
So if you're an index watcher keep this in mind. If you don't own "top 20
companies" these indices may have little comparative value to your portfolio.
Be sure to compare apples to apples, i.e. select indices that are comparable to the
investing style used in your portfolio, and be sure your money manager is doing the
same.$$
Lyon Capital Management Bulletin Board
Did you see our article in the May 7th issue of the Rochester Business Journal about "The Secret Bear Market?" If not, click on the article
title above.
In 1990 Warren Buffett made a bet on depressed west coast real estate by buying a big
stake in California based Wells Fargo Bank. His bet, with patience, paid off handsomely.
Buffet recently spent $50 million on shares of four REITs (Real Estate Investment
Trusts). Is this undervalued, under-performing sector of the market ready to make a turn?
We think so. For more on REIT investing visit our web site and click on
"Articles".
Market Capitalizations |
| Company |
Market
Capitalization |
Price to
Earnings |
Price to
Sales |
Price as of
05/14/99 |
| EBAY |
$24B |
809 |
287 |
186 |
| AOL |
$144B |
357 |
38 |
125 |
| Microsoft |
$399B |
57 |
25 |
77 |
| GE |
$357B |
33 |
3.6 |
106 |
| Kodak |
$25B |
16 |
1.9 |
78 |
| Phelps Dodge |
$3.7B |
224 |
1.3 |
65 |
| Fleetwood Ent. |
$1B |
9 |
.3 |
25 |
| Applied Materials |
$22B |
54 |
6.4 |
61 |
| Deerre & Co. |
$10B |
22 |
.7 |
42 |
| Lubrizol |
$1.7B |
17 |
1.0 |
30 |
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