Category Archives: strategy

Snap Inc., Not an Investment.

Snap Inc, “the camera company” IPO’d on March 2, 2017. Snapchat is popular and useful to those who use it.  It is a prominent player in the currently expanding market in visual media on social media. Therefore, admirers of Snap products might be attracted to the Snap Inc IPO as an investment.

Does Snap meet criteria of an Amateur Investor investment?  Let’s go through them.  The first criterion of an Amateur Investor investment is the presence of a sustainable competitive advantage, such that the company sells a product that is indispensable to its users.  It is virtually certain that in 10 years the company will still be dominant in the market for its product.

Will Snap be dominant in its market in 10 years?  Let’s back up and ask a simpler question.  Will Snap exist in 10 years?  Hmm… Why not back up again and ask a different question.  Did Snap exist 10 years ago?  Of course, the answer is no.  How could we get an idea as to whether similar companies had sustainable competitive advantages?  Oops, I guess the word “had” kind of gives it away.  As chronicled in this lovely Wall Street Journal article (I recommend subscribing to and reading the Wall Street Journal, especially Business section, because its articles are simply narratives based on facts, unlike articles in some other high profile newspapers (I won’t mention the New York Times)), a number of social media wonder stocks have climbed to the height of stardom and then fizzled when least expected, not necessarily even going out with a bang.  For example, Twitter has over 319 million users, but its market value has fallen by more than half since its 2013 IPO.  Friendster back in the first decade of the 2000s had 75 million users before fading. Other somewhat less successful social networks are mentioned in the article. There is evidence that Snap does not dominate its market and is not indispensable, in that Instagram’s launch of Stories, a feature similar to snapchat, resulted in a significant slowing of Snapchat’s growth.

The second criterion for an Amateur Investor investment is that the company adapts by evolving its competitive advantage into evolving new markets.  Since Snap does not have a competitive advantage, it does not meet this criterion.

The third criterion addresses devotion to shareholders, for instance by making sure shareholders have voting power commensurate with their stock ownership, obtaining a good return on investment in acquisitions, avoiding stock dilution and so on.  In fact, the shares floated in the IPO on March 2nd do not have any voting power at all.  They are Class A shares, with no voting power.  After the IPO, close to 90% of the shareholder voting power is held by the two cofounders, Evan Spiegel and Robert Murphy. They hold all the Class C shares, which have 10 votes per share.  I didn’t even bother to look up who owns the Class B shares, which have 1 vote per share. Because Amateur investors would not be able to get ahold of those anyway.  Why does this matter?  Say in a few years (or months?) Snap decides to acquire another asset, say another company. In order to raise the necessary cash, it floats a large amount of Class A shares (only about 25% of these were sold in the IPO), thereby diluting the shares in the market and causing the price to fall.  Suppose many stock holders disagree with the wisdom of this acquisition.  What can they do? Can they vote against it as in a normal company? No, there is nothing they can do.  The founding company owners are already wealthy, they are not affected.

The fourth criterion for one of my investments is that the company must be at least 10 years old.  The fifth, that the investment is worthwhile based on the company’s past achievements, not just its hoped for future attainments.  The Sixth criterion addressed good return on investment, including low debt level, growing free cash flow, high gross margin, high ROI.  Snap has no earnings, in fact its losses of over half a $ billion exceeded its revenue of about $400 million.

In a nutshell, it is not possible to be sure whether Snap will still be going strong in 10 years.  It might, but then again, it might not.  It has no earnings.  Why take a chance speculating with your hard-earned money by buying this new company, when instead you could buy a company which you could be sure would grow and continue to be extremely strong and successful for the foreseeable future?

For inexperienced investors that feel they want to try buying something they like, I must agree that gaining some experience in the stock market, if it is with a very small amount of money that you can afford to lose, might be a way of stimulating and motivating the emotional learning process needed to learn about proper investing.  There are people who say you should not invest at all except with money that you can afford to lose.  But we Amateurs know that is nonsense.   Investment, as Benjamin Graham stated, is a purchase that upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative. There are various approaches to investing that could satisfy this definition, depending chiefly on what you, the individual investor, judge to be an “adequate”, satisfactory return.

In the Amateur Investor approach to investing, you must simply learn several important realities about businesses, the most important having to do with competitive advantage, of a durable nature.  You are looking for the company of which in 10 years it will be said “in 10 years this company will still be growing and dominating its market, and evolving and adapting to continue extending this dominance into the changing market.”

A sensible policy for cashing and saving dividends to invest in volatile high growth stocks at infrequently occurring low prices

1/18/2017 16:56

In the market volatility in September 2015 and January 2016, the S&P fell 10% from its peak of 2126 on July 17 2015 to 1921 on September 4, 2015, before climbing again to a peak of 2099 in November 6, then falling 12%  to 1864 on February 12, 2016.  I did not have a source of cash with which to take advantage of some really attractive bottom prices in stocks, specifically ADBE.  I resolved to find a way to take advantage of the low prices which appear in market dips, as purchases made in teeth of market terror are key to producing the most outstanding returns.

The purchase additional stocks for the portfolio must be funded either from the sale of current holdings or from cash kept for the purpose (I do not consider the use of debt to be a sound option).

There are various arguments against the sale of current holdings to simultaneously fund new purchases.  The decision to buy is driven by the identification of a prospective purchase that is currently found at an attractive, low price, or where business prospects for the company appear to be more promising in the immediate future.  Meanwhile, to optimize return, the company that is sold to fund the purchase would be judged to have less promising prospects and hence likely to fall in price, either because it is currently judged to be overvalued,  or because business prospects appear uncertain in the near future.  But there is no particular reason that the advent of an attractively low price in the target purchase would coincide in time with an attractively high selling price in another holding.  Rather, one may be faced with the prospect of selling a stock at a merely reasonable price to enable the purchase of a stock which is found to be hopefully at a nadir.  Unfortunately, the decision can potentially be wrong on both sides, that is, the price of the target purchase may subsequently fall even more, while the sold stock may subsequently continue to rise.

A variation of this strategy is to sell a stock that seems overvalued, or is expected to fall in stock price, in order to build up a cash reserve to fund purchases of a stock in the future, rather than simultaneously.  The problem with this strategy is that it  based as it is on prediction of the future, a sketchy enterprise at best. 

Indeed, the problem with any approach based on predicting the future of stock prices is that stock prices do not necessarily reflect current business events in the company in question at all.  They may rather reflect the market’s shifting reaction to those events, in turn driven by entirely distinct and distantly related social or economic forces.  Because of this, a stock that seems overvalued, and thus a likely candidate for harvest, may continue to rise into regions of continued overvaluation if social or economic sentiment looks favorably upon it, against conventional rational business expectations.  In this case, the sale price would be regretfully too low, too soon. Or in fact one may decide the stock should after all have been held for the long term.  Conversely, the tide of market sentiment may tumble a stock even though the company is prosperous, producing regret that one did not harvest at the previous peak.

One characteristic of my investing approach is the attempt to recognize and understand the emotional currents underlying  investing decisions.  By doing so, one can steer a course that is free of emotional hazards to sound investing decisions.  In the present case, awareness (perhaps not fully conscious) of the shakiness of one’s predictions about future prices is likely to cause anxiety which interferes with rational trading decisions.

One cannot change a future outcome that one does not control, either before it happens, or after it has happened.  But since no one else can either, failure to do so does not impair one’s performance relative to other investors, that is, relative to the market.  What one can do is first, avoid the chances of making an error, while maximizing the chances of better results, and second, minimize the emotional influences which interfere with sound investing decisions. 

A different strategy is to build up cash reserves to fund stock purchase.  In the absence of new cash, the only possible source of these is stock dividends credited to cash instead of reinvested.   These have a few advantages as a source of cash.  First, the cash is contributed regularly, at a range of different stock prices, so that no bet is made that a particular price would have been the optimal selling price.   Thus, one avoids the chance of making a large error in choosing a sale price which may turn out later to have been the wrong one.  no specific decision must be made to sell a treasured holding, with the accompanying distress.  This will minimize the emotional turmoil which leads to hasty, ill thought out decisions.

There are thoughts pro and con this strategy.  Crediting dividends to cash means they will not participate in the hopefully continued rise in the stocks they were contributed from.  In order to make this strategy worthwhile, one needs to buy new investments at a low enough price, or to achieve a high enough return on investment, so that this will compensate for the time of missed returns before the cash was invested.

Purchasing at a discount from the long term stock growth rate is crucial to maximize the chance of a good outcome.  If the stock fits criteria for the portfolio, none of which depend on short term market action, then its long term growth rate should approximate that of the portfolio.  The cash that is held pending the new stock purchase has a return of 0%.  Let us assume that the stock to be purchased would have a certain price at the time of purchase, if the stock was adhering continually to the long term portfolio growth rate ( R ), and call this P (r).  Let us assume that at the time of purchase, the stock has fallen so that it is discounted in price P (r).   In order for the cash invested in the new purchase to attain the portfolio ( R ), then the discount from P (r) at which the new stock must be purchased must equal the time the cash was held, in years, t (cash), multiplied by ( R ).  The illustration below shows this for a stock bought with cash that has been held for one year.


For cash held for less than a year, then the discount from P (r) would need to be relatively less, while still enabling the stock to attain the same portfolio ( R ).  One source of error in purchasing stocks, especially volatile high growth stocks, is failing to patiently wait for an adequately low price.  In my proposed strategy of using accumulating cashed dividends to fund new stock purchases, the fact that the cash balance builds up slowly as dividends are contributed, is an incentive to wait for an adequately low price so as to generate returns at least equal to ( R ).  This is because frequently making small investments which use up the accumulating cash, if made at a discount to P (r) which is less than t (cash) times ( R ), will result in subpar long term returns.

There remains one question: if the stated goal of a rational policy of accumulating cashed dividends and reinvesting them, is to merely match the long term growth rate of the portfolio that would be attained if the dividends had been automatically reinvested in their respective stocks in the first place, then what is the point of hoarding the dividend cash in the first place?

The reason is as follows:  some stocks seem to have a higher expected growth rate because of the strength of their business and market expansion.  However once this is well recognized by the market, the stock in question becomes chronically highly priced, and is rarely available at an attractive price.  However, these stocks can yield great returns if they can indeed be found cheaply.  And, inevitably they sooner or later do fall in price.  In fact, when a company from which the market has high expectations (ADBE), meets a setback, it is generally swiftly punished and its stock falls more than would be the case for a company with a solid business but from whom the market has more conventional expectations (Philip Morris International).  This type of company might be termed a Volatile High Growth Stock. The above strategy of accumulating cashed dividends to take advantage of these infrequent opportunities can then in fact lead to overall increased returns.

Again the promise of higher returns by a high growth stock is only likely to be fulfilled if the purchase price is low enough.  On this inarguable basis,  a sound strategy might be to buy the target stock with half of the available cash when it reaches a % discount from the previous 52 week peak, that is equal to the 10 year growth rate for the portfolio ( R ).  Should the target stock fall to 2 x ( R ) from the same previous peak price, then the remainder of available cash will be invested in it.

This strategy may not be perfect, for example it may result in only half of the available cash being invested in the target stock at an attractive price. On the other hand, it preserves the chance for purchase of at least some of the target stock at the truly great price of a 30% discount to previous peak. This approach should at least preserve the average portfolio growth rate from damage caused by ill-advised purchases.  Meanwhile, If the target stock is one with growth rate relatively higher than the average for the portfolio, this should raise the portfolio performance.