FORTY YEARS A SPECULATOR

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Tuesday, June 14, 2011

"My life As A Speculator-How I Make Money By Losing Money," Fred Carach

I have been at this game for a very long time. I made my first investment in the stock market in 1961 and I have never been out of the market since then, not even for a single day.

I don’t believe in sure things. What I do believe in is risk-reward ratios and that is the concept that I build my life around. I think that believing in certainty in the world of investing is an exercise in delusional thinking that will destroy you. The higher the tolerance for uncertainty, the greater the rewards.

At this point the “I refuse to lose my money crowd” will proudly point to the fact that they have never lost a dime in their investing because they only invest in sure things like government guaranteed savings accounts or treasury bonds.

I go nuts. The first thing I do when I hear this argument is to frantically search for a chair so that I can break it over their idiot skulls. How can anybody be stupid enough to believe that any government guaranteed investment earns you a positive rate of return after inflation is beyond me? At this point dufus proudly points to the official government statistics that prove that the rate of return on government treasuries is above the rate of inflation. The stupidity takes my breathe away.

There is however, one exception to this rule. From time to time governments will embark on a kill inflation now crusade. During these short crusades, it is indeed possible for the true rate of interest to exceed the rate of inflation.

Except for these short term crusades I do not know of a single nation on the face of the earth whose bonds will pay you a positive rate of return after inflation if accurate numbers are used. I regard government bonds as guaranteed certificates of confiscation. The longer the term of the bond the more certain the confiscation.

For the sake of argument, let us suppose that we have discovered that the ten-year bonds of Outer Mongolia will pay you a positive rate of return after inflation using true numbers. I am talking miracles here. When the bonds mature in ten years, you do indeed have a positive rate of return. Or do you? There is the little matter of converting the Mongolian currency into dollars. You have a positive rate of return only if the Mongolian currency is convertible into dollars at a rate that is equal to or higher than it was at the time you purchased the bonds. In other words you could not only have a loss but you could have a very large loss on what you presumed to be a guaranteed return and this problem exists with every currency on earth.

The point that I am trying to make is that your investment in Mongolian bonds is certain only if you know with certainty what the exchange rate is going to be ten years into the future.

Recently a 21-year-old kid questioned me about my investing. He wanted me to recommend an investment that he could not lose money on. When I told him that I have never in a lifetime of searching found such an investment a look of total scorn appeared on his face. He told me that only stupid people invest in things that they can lose money on. Smart people only invest in sure things. When I asked him what he regarded as a sure thing, he said a savings account and then real estate.

This belief in sure things is not rare; it is as common as dirt. Nothing is more common than the belief in a sure thing. People spend their whole lives looking for it and when they think they have found it, they bet the ranch. All too often, their sure thing turns out to be a mirage and they lose everything.

I am a great admirer of Warren Buffet who is beyond dispute one of the greatest investors of all time. Recently however, he said something that was so stupid that it blew my mind. He said that the first rule of investing was not to lose money. The only trouble with this is that to follow that rule we would all have to be psychic and be able to predict the future. Since the only true psychics are safely tucked away in mental institutions, which is where they belong. It therefore follows that we cannot invest in anything because we cannot be assured in advance that we will not lose money.

If you look at the cover my book, you will see a green felt table with dice on it. It is a true depiction of how I invest. In well over forty years as an investor, I have owned more than 750 positions and have been successful more than 60% of the time. Anyone who tells you that they are right more than 80% of the time in this business is a liar.

It is time to reveal the secrets. If there is a key to investment success it is above all else the willingness to lose and to put your money at risk. The willingness to take a loss overrides all other investment considerations in importance. Nothing else even comes close. It is hard to overestimate just how unwilling people are to even consider the possibility of taking a loss. Let alone taking a loss. There are vast numbers of people who doom themselves to a career of working at a fast food joint after they turn 65 because the miserable returns they have earned on their safe investments did not even keep them up with inflation. If we are being truthful these people actually lost money by investing in a sure thing but they would rather die than admit it. For reasons that I have never been able to understand these people are quite proud of the fact that they have never taken a risk. Having dispensed with these pathetic losers, we can now consider the next category of investors.

Investors who are emotionally capable of accepting the fact that if they don’t want to be working at a fast food joint after they turn 65 then there is no choice but to invest in investments that have risk but earn you a real return. The crisis that will determine their success or failure as investors rests largely with how they react when they have a “paper loss.” It is impossible to overestimate the importance of paper losses in the career of investors. A paper loss is a loss that would occur on an investment if you sold it at today’s price.

It is dogma today in the trend chasing community that dominates the stock market that all paper losses of more than 10% are real losses and that the only real investors are those investors who have the courage to accept this fact and act on it. In this community selling your losers and thus turning your paper losses into real losses is regarded as proof that you have what it takes to be a real investor.

I have spent more than four decades proving that these people are wrong. I have made a career out of turning paper losses into profits. It isn’t hard. The only thing you have to do is to hold on to your investment until it returns to the profit column. These geniuses will tell you that this can never happen because all stocks that fall more than 10% are destined to go to zero. Nothing can shake them from this belief. Including the fact that many of them have a list of stocks that they have sold at a loss that is longer than their arm. Stocks that would be in the profit column today. If they only had the courage of their convictions and held on to them.

It gets far, far worse. My ultimate crime is that I routinely increase my position in stocks that I am holding at a loss. After all why shouldn’t I. I know what these stocks are worth. I have spent decades analyzing stocks. In other words, I make money by losing money. The biggest profits I make tend to be stocks that I have increased my position in after they went down. The trend chasers who dominate today’s markets are adamant in their belief that adding to a losing position is suicidal. Then again, if you mindlessly buy stocks about which you know nothing solely because they are going up. You face a crisis when they go down. Don’t you? This incidentally is the stock and trade of the trend chasing community. After all, they do not have an opinion that is worth a dam as to the true worth of the stocks that they are buying and selling.

John Wayne summed it up nicely:

“Life is tough but it is even tougher when you are stupid.”

Forty Years a Speculator

Fred Carach

Oakland Park, FL 33309

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Thursday, April 21, 2011

"Stupidity Unchained -The Curious Saga Of Today’s Stock Market," by Fred Carach

As I contemplate fifty years in the blood-splattered arena that we call a stock market I realize that the game has never been more in my favor. Charlatans and buffoons have rigged a once sane market. It is a market where stupidity has been unchained. It is a most curious saga. I saw it all. I was there at the creation. The prevailing stupidities of today’s stock market are as follows:

1) any stock that falls 10% must be sold immediately because it is going to zero.

2) all stocks are generic clones of each other and therefore will go up and down together.

3) a dangerous over reliance on vague, generalized data about the market and the economy rather than hard, specific data on individual companies.

4) the growing belief that stocks are empty boxes with no intrinsic value and that therefore stock analysis is worthless.

5) a dangerous over reliance on averages and indexes that distort the truth.

When I broke into the stock market in 1961, the stock market was a much different beast than it is today. In those days, the stock market was dominated by long-term conviction investors. People understood that they were buying a business and not a lottery ticket. It would have never occurred to these investors that they were supposed to follow their stocks on a daily basis. The notion that a drop of 5% or 10% in a stock that they believed in was a cause for panic selling would have been regarded by them as a nonsense proposition. Indeed, it is quite possible that they would not even be aware that their stock had fallen by 10% or even 15%. I doubt if most of them even looked at the stock price more than about once every six months. In those days, most newspapers did not even carry the stock tables and there certainly were not any financial channels on TV.

Historically great emphasis was spent upon analyzing and researching individual stocks because your success or failure depended on your ability to pick winning stocks. The prevailing notion then was that picking stocks with superior future prospects that were selling at bargain prices was the heart and soul of successful investing. Macro-economic factors such as guessing about the economy or guessing about whether the stock market was going up or down was regarded as a fool’s game.

I am a survivor with fifty years in the blood-splattered arena that they call a stock market. During that period, I have owned about 750 stocks. Guessing about what the market was going to do or what the economy was going to do or what was supposed to be happening in China or Europe has never made me any money. What has made me money was being right about individual stocks that I had researched, understood and believed in.

Consider CNBC, everyone’s default financial data source. For the most part, what you see is a bacchanalia of guessing. Guessing about the economy. Guessing about the stock market. Guessing about China and Europe. Over any sustained period, their guesses are no better than a coin toss. Except for the nifty-fifty, individual stocks are rarely mentioned and when they are mentioned, the only thing you hear is vague generalities. Rarely do you hear hard, factual data on individual stocks that a serious student of the game would regard as being important.

The implication is that all stocks are clones imbedded in a mass of concrete and therefore must rise and fall together. In 2010 the S&P 500, the benchmark for the stock market was up 12.8%. The top performing stock in the index was Cummings, which rose 105.8%. The worst performing stock in the index was Office Depot, which fell 23.4%. Is there anything more stupid than the now common belief that if the stock market is up 12.8% then that’s what all investors earned? What is more important being right about the stock market or being right about individual stocks?

The whole art of stock investing used to concern itself with discovering what the intrinsic value of a stock was. This process was called “price discovery” and was regarded as the primary function of the stock and commodity markets. By analyzing the stocks that investors as a group bought and sold, the market “discovered” the intrinsic value of stocks. Until about twenty years ago, nobody doubted that stocks had intrinsic value. The issue was discovering what that intrinsic value was.

Today growing armies of alleged investors believe that stocks are empty boxes with no intrinsic value. If stocks have no intrinsic value then stock analysis is worthless. It therefore follows that what is of supreme importance is not analyzing stocks but analyzing the actions of buyers and sellers who are now regarded as “price dictators” and not “price discoverers.” In other words stampeding with the herd is the supreme virtue.

If you gave a skid row bum today who knows nothing about the market $50,000 and turned the TV on to CNBC and told him to start trading he would be operating on a level that is equal to that of most investors today. After all what does he have to know? The short answer is nothing. The only thing he has to do is become a trend chaser and stampede with the herd. Mindlessly buying whatever is going up and mindlessly selling whatever is going down and he will do this instinctively. There is no need for training.

The astute reader has already figured out the consequences. An ever-greater deviation between intrinsic value and stock prices as fewer and fewer investors made any attempt at all to analyze the intrinsic value of stocks.

At no time in the history of the stock market has there been such a dangerous over reliance on averages and indexes to guide investment decisions. Very few investors have a clue as to just how convoluted and dubious the formulation of these averages is. I have commented about the S&P 500 index that was up 12.8% in 2010. A year in which the top stock in the index was up 105.8% and the bottom performer was down 23.4%.

Or take a gander at the famous NASDAQ 100. In 2010 this 100 stock capitalization weighted index ranked Apple as number one with a weighting of 19.7%. Google at number two has a weighting of 4.7%. The top two stocks account for 24.4% of the index. The bottom fifty stocks account for virtually nothing. The only reason they are in the index is to deceive the ignorant.

Averages are liars. Once the investor realizes this, he has a powerful weapon in the unending battle for superior performance.

In such a world the elite core of investors who still analyze and invest in individual stocks are living in a golden age. It is only necessary to hide in the weeds with our high-powered investor rifles and blow away the big game animals as they stampede past us in one of their mindless cattle stampedes.

Forty Years a Speculator

Fred Carach

Oakland Park, FL 33309

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Wednesday, March 16, 2011

“How The Small Investor Can Afford To Buy Commercial Real Estate,” by Fred Carach

What is truly astonishing is that after all these years this fantastic investment tool is almost unknown to the general public in spite of its impressive performance.
The benchmark against which stock market performance is measured is the Standard & Poor’s 500, which is the index of the 500 largest and bluest stocks in America. It is universally referred to as the S&P 500.
Since 1972, the REIT index has blown away the S&P 500 but almost no one is aware of this fact. Since that year, the REIT sector has delivered compound average annual returns of 11.9% a year. Compared to only 9.8% for the benchmark S&P 500 index. It is interesting to note that 60% of that return has been in dividends. It is not hard to figure out why this is the case. REITs are a privileged investment asset. As long as they pay out 90% of their earnings in dividends, they are not required to pay corporate income taxes.
As a result, REITs pay unusually high dividends. Six percent and higher are not unusual.
I have been cashing in on REITs high dividends for many years and they are the core of my income portfolio. In my own investing with rare exceptions, I insist on a dividend yield of at least six percent. The current period is one of the rare exceptions. Since the March 2009 stock market bottom, REITs have had a spectacular rally and I have had to lower my sights to about five percent. However, I think you will find my REIT portfolio to be of some interest. Dividend yields are as of March 7, 2011.
The small investor has always longed to buy into commercial real estate but it has always been a bridge too far. Simply put it has always been beyond his resources. And yet the investment tool that could enable him to buy not just commercial real estate but multimillion-dollar blue chip commercial real estate has been readily available to him since 1972 when the first Real Estate Investment Trusts or REITs as they are called arrived on the scene.

CBL & Associates (CBL) pays 4.83%

Innvest REIT (IVRVF) pays 7.34%

Commonwealth REIT (CWH) pays 7.47%

Hospitality Properties Trust (HPT) pays 7.96%

Medical Properties Trust (MPW) pays 6.94%

National Retail Properties (NNN) pays 5.93%

Sun Communities (SUI) pays 7.38%

Riocan REIT (RIOCF) pays 5.84%

CBL & Associates- ordinarily I would have kicked out any REIT from my portfolio that was paying such a low dividend but CBL is a champion. In 2007, this stock sold for $50 a share and paid a dividend of $2.00 a share. In 2009 at the bottom of the crash, it had cut its dividend to 80 cents a share and it was selling for an unbelievable $1.92 a share. What were these lunatics thinking of? Today the price has recovered to $17.54 and it has just announced a 5% dividend increase. A return to the region of a $2.00 dividend and its old high of $50 a share in the next two years is not unthinkable because it asset base is largely unimpaired. Its assets are not inconsiderable. They own a controlling interest in 75 malls located throughout the country with a total GLA (gross leasable area) of 71,264,850 square feet.
Innvest REIT- this is a Canadian outfit. It is the largest hotel REIT in Canada with 148 hotel properties and 19,381 guest rooms which are located in every province in Canada. This stock peaked in 2007 at $13.39 a share and its crash low was $1.90 a share. Almost identical to CBL’s crash low. It has now recovered to $7.00 a share and as the economy recovers, it could return to its old $13 a share range.
Commonwealth REIT- this REIT invests in office and industrial properties. It owns a mix of 518 office and industrial properties with a total size of 66.8 million square feet. This is another case of the investment follies. At its 2007 high, it sold at $54.68 a share. During the crash, it was knocked down to $6.28 a share. It is now selling at $27.00. Those who stick around will be rewarded.
Hospitality Properties Trust- this is another recovering hotel REIT. It owns 289 hotels with a total of 42,880 rooms. Its 2007 high was $51.46. During the crash, it fell to $6.88. It is now selling at $22 a share. Do you see a pattern here?
Medical Properties Trust- this hospital REIT owns 51 hospitals in 21 states. It has $1.3 billion in total assets. The 2007 high of this stock was $16.70. During the crash, the buffoons took it down to $2.76. It is now selling at $11.50. You are being well paid to wait for the return to its old high and more.
National Retail Properties- this retail REIT has increased its dividend every year for the last 20 years. It specializes in stand-alone single tenant, long term, and net-leased properties of national importance. It has 1,015 properties with a total GLA of 11.4 million square feet. The long-term net leases that they utilize are typically for 15-20 years. This is an unusual strategy for REITs. A net lease strategy shifts all property operating costs such as maintenance, taxes insurance, etc. from the owner to the tenant. This results in a far more stable cash flow. Their typical clients are national outfits like Best Buy, Barnes & Noble and Denny’s. As a result of its unique strengths it withstood the crash well. Its low of $10.03 a share has been exceeded and it now sells at $25 a share.
Sun Communities- specializes in 136 high-class mobile home/recreational home communities with 47,385 rental sites. Its 2007 high was $35.54. During the crash it shares fell to $6.76 and have since rallied back to $34 a share.
Riocan REIT- is Canada’s largest REIT. It has a portfolio of 246 shopping centers with 54.5 million square feet of GLA. Its 2007 high was $27.34 a share and its crash low was $11.23 a share. It has since rallied to $25 a share. It is a powerhouse that has shopping centers in every province in Canada and has started to acquire properties in the United States.
There is one more unique characteristic of REITs that must be discussed. The first thing that the wise investor does when he is researching a high dividend paying stock is to check out its EPS or earnings per share to insure that the dividend is safely covered. In other words, the EPS per share must comfortably exceed the dividend per share or the dividend is at risk.
It is more than common for alleged stock market professionals to discover to their horror that the dividend being paid by REITs exceeds their EPS. Our alleged professional then flees in terror from what he regards as an unwise investment.
It is a unique characteristic of REITs that the metric that determines their ability to pay dividends is not EPS but FFO or Funds From Operations. REITs by virtue of their enormous commercial real estate holdings generate massive amounts of depreciation every year. According to GAAP (generally accepted accounting principals) to calculate EPS you are required to first subtract depreciation from the EPS figure.
Let’s pull a figure out of the air to see how this works. Your REIT earns $100 million this year. This amount is cash on hand, money in the till that is available to pay dividends or other discretionary purposes. In REITs, this figure is referred to as FFO. Your depreciation for the year is $25 million. According to GAAP, you are required to subtract this $25 million from your FFO to arrive at EPS. Thus according to GAAP your REIT earned not $100 million this year but only $75 million. The $25 million that you were required to deduct is a fictional accounting expense. The reality is that you have in the till not $75 million but $100 million in cold hard cash.
Now let’s take a look at why I am so keen on CBL. In 2010, its EPS was 21 cents a share and yet it paid out 84 cents a share in dividends. How does this work? It works because its FFO was $2.03 a share. Theoretically, it could have paid out $2.03 a share because that was what was in the till. It would not surprise me to see CBL raise it divided perhaps as often as every quarter for the next year or two.
Fred Carach

Forty Years a Speculator

Fred Carach

Oakland Park, FL 33309

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