Timothy P. Vick

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Timothy Vick is the senior investment analyst for Arbor Capital Management, and a partner and co-portfolio manager of The Power Fund, a partnership that invests in emerging companies in the alternative power industry. He writes about economic trends, business strategy and valuation, corporate performance, and portfolio management.

Books

How to Pick Stocks Like Warren Buffett , McGraw-Hill, 2000

Wall Street on Sale , McGraw-Hill, 1999

Finding value in the market

Picture yourself as the owner.

When I see a stock priced at $50, my first instinct is to multiply the price by the shares outstanding - let's say 10 million - and ask myself whether the whole company is worth $500 million. My second question evolves from the first: If I had $500 million to invest in the company and could be the sole owner, would I buy it? Starting from this premise , your mind naturally will focus on basic business issues such as payback (how fast can the company generate $500 million in profits to return your investment), cash flow, debt levels, taxes, sales prospects, capital expenditure needs, and profit margins. Price fluctuations, moving averages, and chart patterns have no place in this exercise.

Generally, the longer it takes a company to return my investment, the more I am inclined to walk away, whether I'm looking at public or private entities. If I wouldn't want to own the entire company, I won't buy even 100 shares of it.
You win in investing by not losing.

Investing is, by virtue of its competitive nature, a 'Loser's Game' - winners are those who make the fewest mistakes. The most revered investors in history, those sitting atop the largest pile of assets, did not make a killing on one or two stocks, but sat tight with their money, deployed it slowly and prudently, and exploited opportunities that negated their chances of losses. Experience has taught me that if you minimize your chances of losing money each time you buy a stock your overall returns will greatly exceed the average investor's. In contrast, short-term traders and institutional money managers are naturally prone to mistakes and underperformance. By doggedly chasing short- term returns to beat their peers and to keep pace with market indexes, they unwittingly force themselves to make dozens of poor investing decisions each year, which tends to limit and commoditize their returns.
Keep your eyes off the market - but be prepared to exploit it.

Confident investors don't look at stock quotes once a day, once a week, or even once a month. If you purchase an investment at a good price and are sure of the company, pricing will take care of itself. Daily fluctuations become just noise. I am always amazed by investors who claim to buy a stock for the 'long-term' yet continually monitor every price change, press release, and earnings revision. Eventually, their penchant to absorb useless news evolves into a psychological obsession to act - more often than not they will buy or sell prematurely for the wrong reason. Financial markets exist solely to execute your buy and sell orders: nothing more. Focus first on the performance of companies and use the market solely as a reference point to see if other investors are pricing the company properly. When you see a wide discrepancy between price and value, be ready to exploit the situation.
If you cannot understand it, don't buy it.

One of the chief ways I minimize mistakes is to invest only within my circle of competence. That should be an easy rule to apply, but humans have a tendency to beat their chests and feign unlimited knowledge when money is at stake. Every company or industry possesses, at most, two or three 'critical factors' that you need to analyze to determine your chances of making money. If you can understand the critical factors that make an airline, a hotel chain, a bank, or a maker of programmable logic chips, profitable, you will invest more confidently. If you cannot identify these factors, avoid the investment altogether. Likewise, if you cannot understand the company's earnings releases or its annual report, take your money elsewhere.
Rely on yourself, not on the opinions of others.

Ten days before the 1929 market crash, The Wall Street Journal jokingly questioned why "any ignoramus" can get away with talking about investments. Indeed, a man with an opinion is as common in finance as mosquitoes in summer - and is just as much of a nuisance. Because investing is as much an art as science, it invites anyone to pass judgment with little fear of reprisal. Great investors rely on facts (never on opinions) and their own ability to decipher facts. They rarely get good ideas talking to others and will never buy and sell solely on others' counsel. Think back to your worst investments over the years - likely they were bought on the recommendation of someone else. That's because every investor has unique risk and reward profiles - what's good for your neighbor, physician , golf partner, or brother-in-law will rarely work for you too.
Forecasts are useless, especially those about the future.

Aristotle once said that man has an innate desire to know the future, and that no desire is exploited more by his fellow man. The entire financial industry exists to sell product. If you don't understand this basic maxim , you'll be misled time after time.

The brokerage industry figured out long ago how to play to your hopes and fantasies, to conjure up forecasts and spurious mathematical reasons why an investment will sell for more in the future than it does today. Yet, in all my years of studying in business school, observing the conduct of managers, and practicing portfolio management, I've never come across anyone who has consistently been able to predict the direction of the market, the economy, interest rates, or a company's sales and earnings. As long as markets are emotional and fickle, and as long as business managers and investors are prone to react irrationally to fickleness, this poor track record will continue unabated. Invest in what is ; not what could be.
Time is your natural friend.

In finance, time corrects all short-term anomalies. It exposes poor businesses masquerading as great entities, and gives truly great entities sufficient chance to maximize the reward to investors. Choosing good companies at fair prices seldom has produced losses for patient investors.

A company that increases earnings by 12% a year over 20 years will experience a roughly 12% yearly increase in stock price. However, if you bought and held the stock for just one of those 20 years, any return is possible. Great investors always stay mindful of their opportunity costs. Every poor investment has two costs - the near-term loss you generated and the long-term money you gave up by choosing poorly. A $10,000 loss early in your investing career costs you more than $2 million at retirement if you could have compounded the money at 20% annual rates. An investment sold too early can have the same effect. Most investments you sell today will one day trade for much higher than the price at which you sold. Think about that before you sell.
Don't diversify - it breeds sloth and mediocrity .

If you want to be simply 'average', behave like the averages. Nothing breeds middling returns more than collecting stocks as if they were postage stamps or vases. Pension and mutual fund managers have to diversify portfolios to protect their jobs and to counter the effects of huge money inflows. You don't. Having to watch 40 or more companies poses the same burden on an investor as owning 40 apartment buildings , or 40 restaurant franchises. Why diversify, if you're not up to the task? At some point, your portfolio of assets becomes impossible to monitor and you're left hoping that nothing extraordinary happens to any of the 40. Worse, you guarantee yourself middle-of-the-road returns - that has been proven mathematically. The great money is made holding a small collection of assets that you understand intimately.
Know the difference between 'investing' and 'gambling'.

If you buy any asset without first valuing it, you should admit to gambling. Indeed, any stock-picking method that isn't premised on a sober appraisal of intrinsic worth is useless, and ultimately degenerates into trial-and-error forecasting. If you cannot reasonably calculate what the asset is worth before you buy it (or what it could be worth) you cannot determine whether you will make money. More often than not, you will have to gamble on the actions of others to make a profit. True investing entails reducing the probabilities of error, which is accomplished only through objective analysis. When gambling, you lose all control over the outcome. Before you buy a stock, ask yourself what you really are relying on to make money - is it the growth in the value of the company, or are you simply hoping for a magical increase in price after you buy it?
Calculate what you can take out of the company.

Since most investors fail to appraise a company before buying it, they usually have no preconceived idea of what they can earn over time. That's a fatal mistake. You should be able to estimate the annualized rate-of-return you expect from every investment and be able to quantify how you derived that figure. If your criteria for investing are nebulous, you're more likely to make back-end mistakes about selling. Are you looking for a 50% price increase in one year? If so, what factors can cause that to occur, and how likely are those factors to occur? Are you looking for 15% a year for 10 years? If so, calculate what the stock must trade for in 10 years and determine the earnings that will be needed to support the price. Then ask yourself whether those earnings can be attained. In this business, price and return are inextricably linked. The lower the price you pay, the greater your potential return. It's that simple.