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Stick to Your Strategy |
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5-year Anniversary |
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Preferred Stocks |
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Bulletin Board |
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Index Watching |
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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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