Something of Interest to Value Investors

There is a new book out entitled, "The Little Book That Beats The Market." The author is Joel Greenblatt, and the publisher is John Wiley & Sons.

This book offers a simple, "magic formula" approach to long-term, low-risk, market-beating performance.

And what we find especially interesting is a Web site that has been created in order to guide the reader in using this "magic formula" approach. And you can find this in our "Links" listing under "Magic Formula Investing."

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The Credit Report You Don't Know About

For many years, there were three national credit bureaus: Equifax, Experian and TransUnion. Add a fourth to the list: Innovis Data Solutions.

Unlike the Big Three credit bureaus, Innovis doesn't sell consumers' credit histories to lenders, insurers and potential employers. Innovis specializes in helping creditors compile mailing lists. Adverse information on your Innovis credit report, accurate or not, could prevent you from getting favorable credit offers in the mail. Whether you think that's a good thing or bad thing is up to you.

Innovis became a major player at the beginning of 2001, when mortgage financing titans Fannie Mae and Freddie Mac began requiring their mortgage servicers to report borrowers' payment history. Fannie Mae requires servicers to notify Innovis of delinquencies and foreclosures; Freddie Mac requires servicers to tell Innovis about every borrower's payment status, current or late.

The federal government reports to Innovis about individuals who are late with debt payments to the feds.

Innovis offers two products to creditors. FailSafe is a data base containing names of consumers who are late or who have been late on debt payments.

The other product, called New Movers, is a monthly list of people who have reported a change of address. If you received a torrent of unsolicited commercial mail after your most recent move, it is because of lists such as New Movers.

If you ask consumer advocates and privacy experts what they know about Innovis, they would tell you that they have heard of it and are curious about the company, but don't know much about it. Innovis is an affiliate of CBC Companies, a closely held business based in Columbus, Ohio, that operates a network of local credit bureaus, runs a nationwide collection agency, and screens employees for other businesses.

The Consumer Data Industry Association, the Washington-based lobbying arm for the credit bureau industry, refers to "four reporting systems" and "the four national repositories." But on the organization's Web page that tells consumers where to write to get their credit reports, it lists only Equifax, Experian and TransUnion. Innovis is absent.

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New Highs and New Lows

The New Highs Indicator is a three-day moving average of the number of individual stocks that closed at their highest price of the last 12-months.

The New Lows Indicator is a three-day moving average of the number of individual stocks that closed at their lowest price of the last 12-months.

The New Highs - New Lows Cumulative Index is a cumulative total of the number of new highs minus new lows.

If the market is reaching new high ground, then one would expect the New High Indicator to be at its peak. If the market is reaching new low ground, one would expect the New Low Indicator to be at its peak.

If the market makes successive new highs but the New High Indicator shows progressively lower peaks, then an investor needs to be cautious. This non-confirmation may indicate a deterioration in market leadership and an increase in market risk. And the same, in reverse, is true at market bottoms.

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The Cumulative Volume Index

The Cumulative Volume Index (CVI) measures the flow of money both into and out of the market. Since it takes increasing buying pressure to drive stock prices higher, an ascending CVI is important in sustaining a market advance.

Big money traders - including institutional investors - often use the cover of high prices to liquidate stocks to less knowledgeable investors. Thus, if the CVI does not confirm a new upward price movement after a period of rising prices, such a non-confirmation may indicate "distribution" by these professionals.

Professional investors seek to accumulate stock at low prices when the public is withdrawing from the market in discouragement. The CVI can provide a valuable indication of hidden market strength when it establishes or maintains upward momentum, while other market measures are neutral or lower.

The general rule here is: "price follows volume."

The CVI is a cumulative total of the difference between up-volume and down-volume. It is calculated by adding the volume of advancing stocks and subtracting the volume of declining stocks from a running total.

The formula for doing this is: CVI = (USV - DSV) + IND

Where:

USV = Upside Volume in millions of shares
DSV = Downside Volume in millions of shares
IND = The Value of the CVI yesterday

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A Titan of Investing

At our meeting in Naperville last night, someone raised an interesting question about Berkshire Hathaway, and when it was that Warren Buffett bought the company. So I did some research today, and found these interesting details.

It's nearly impossible to avoid hyperbole when discussing Warren Buffett's success as an investor. He bought his first share of stock at age 11. By age 14, he had saved his paper-route money and purchased 40 acres of Nebraska farmland. In college, he discovered the concept of "value investing" (which is a method of seeking-out overlooked companies whose stock was undervalued) which he then developed into a precise science. In 1957, Buffett started his first investment partnership, whose goal was to beat the Dow-Jones Industrial Average by an average of 10 percent a year. By 1969, Buffett's investments had returned a compounded rate of 29.5 percent a year, compared to 7.4 percent for the Dow.

Berkshire Hathaway, Inc., the company Buffett now heads, began as a 19th century textile mill in Bedford, Massachusetts. Buffett began buying shares of Berkshire stock in 1962, at less than $8 per share. As of this writing, a single share of Berkshire Hathaway Class A stock trades for $89,500. And this stock has never split.

Buffett owes his success to a combination of simple, homespun wisdom (eg. "Never invest in a business you cannot understand.") and savvy, decisionmaking. Before investing in a company, he pores over annual reports, tirelessly reading columns of numbers until he is sure he knows exactly where the company stands financially. He prefers buying companies outright to owning shares, and Berkshire's subsidiaries include GEICO Direct, Fruit of the Loom and Dairy Queen.

Buffett's annual letter to Berkshire shareholders is a much-anticipated event. Past letters have addressed individual companies' strengths and weaknesses; more recently he has directed criticism at corporate governance and the scandals within the mutual fund industry.

Whatever his topic, Buffett writes with absolute clarity. His avoidance of technical jargon is commendable, and he discusses his company's performance with blunt honesty, in both good times and bad. As the world's most successful investor, Warren Buffett should be an inspiration to us all!

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Investor, Beware!

Do you recall a man by the name of Wade Cook?...He wrote several books such as, Wall Street Money Machine and Wealth 101, as well as conducting investment seminars in the 1990s. Well, federal prosecutors have now charged him with eight counts of tax evasion.

Cook's investment advice was seemingly simple, though incredibly risky and ultimately fundamentally flawed. Cook claimed that by following his advice, investors could earn upwards of 20% to 40% annually.

His fundamental flaw was that it is impossible to consistently reap such incredible returns!... Even Warren Buffett has managed to achieve only a 25% annual return.

Offering bogus financial and investment information wasn't what led to Cook being indicted; instead, it was his concealmemt of nearly $9 million in seminar fees and book royalties.

But amazingly, this also reveals how gullible investors willingly forked over thousands of dollars in order to attend Cook's various seminars - which were nothing more than infomercials for penny stock and options trading, and using your credit card to pay for it all.

If convicted, Wade Cook faces prison terms of three to 15 years on each of the eight counts, as well as fines ranging from $100,000 to $1 million.

This certainly proves that P. T. Barnum had it right when he stated, "There is a fool born every minute!"

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How To Construct The Advance/Decline Line

The A/D Line = (ADI - DCI) + IND

Where:

ADI = The number of Advancing Issues
DCI = The number of Declining Issues
IND = The value of the indicator yesterday

The A/D Line is calculated by subtracting the number of stocks which declined in price for the day, from the number of stocks that advanced, and then adding this value to a cumulative total.

For example: If on day #1 there were 700 stocks that advanced, while 300 declined, the value of the A/D Line would be +400. If the next day 400 stocks advanced while 600 declined (net change of 200), the new value of the A/D Line would be +200 (+400 previous value, plus net change of -200 = +200).

You can begin an A/D Line using any starting number (even zero). The numeric
value of the A/D Line is of little importance. What is important is both the slope and pattern of the A/D Line.

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The Advance/Decline Line

The Advance/Decline Line measures market breadth. It is an indicator that is used to confirm the major trend of the market.

If the market trend is up (as measured by major market indexes like the S&P 500 Index) we would expect that most individual stocks are trending higher in price. The Advance/Decline Line should then be zig-zagging upward.

If the market trend is down, we would expect that most stocks are trending lower in price. The Advance/Decline Line should then be zig-zagging lower.

The direction of the Advance/Decline Line generally parallels the direction of the major market indexes. When there is a divergence between this indicator and the market averages (where one is going up while the other is going down) it often indicates that caution is warranted. An alert investor will watch for other signs that may point to a change in the market's trend.

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Looking To Make Better Investment Decisions?

Going a little psycho might help, suggests a new study. When researchers from the Stanford Graduate School of Business, Carnegie Mellon University and the University of Iowa compared investment decisions made by people with a diminished capacity for emotion to those of normal participants, they found that "functional psychopaths" make better investment decisions.

"To gauge the impact of emotions on investment decision making, we tested patients whose emotional circuitry had been impaired due to an accident or a stroke," explains Baba Shiv, an associate professor of marketing at the Stanford Graduate School of Business and co-author of the study.

The study's participants were each given $20 and told that they would be making a series of investment decisions. In each of 20 rounds, they had the option to invest $1 on the outcome of a coin flip -- heads meant losing the dollar, and tails meant recouping $2.50.

"The idea was to simulate the market reality in the sense that making an investment seems risky, but overall you will be better off investing in every round," explains Shiv, who notes that investing in every round of the coin toss yields only a 13 percent risk of ending up with less than $20. "That correlates to the stock market in the sense that historical evidence suggests investors are better off investing in the stock market long term. Yet people have a tendency to pull money out and put it in low-interest investments as soon as they lose money."

Of the 41 participants, the 15 with impaired emotional capacity took the most logical approach to the game, investing in 84 percent of the rounds and ending up with $25.70 on average. Normal participants invested in just 58 percent of the rounds and ended up with an average of $22.80. "People generally started off making the right decision and then either lost once or twice and got scared, or won and wanted to protect those winnings," explains Shiv. "The participants with damaged emotional circuitry made rational decisions because they were not caught up in the outcome of the previous round."

The take-away for investors? "Some people are naturally less emotional or more able to suppress their emotions," says Shiv, who suggests that those who tend to be emotional may want to leave the management of their investment decisions to a trusted third party. "Participating in an investing group and adopting a long-term mind-set toward investments can help minimize the risk of an emotional reaction," he says. "You can also shield yourself against being affected by outcomes by monitoring investment performance on a less-than-daily basis."

Note: This article appears in the February, 2006 edition of Entrepreneur magazine.

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NEXT MEETING: Thursday - January 19, 2006

We have several items of interest this month. First of all, our topic will center around Benjamin Graham's approach to Value Investing. We'll lay the groundwork this time and then next month we'll talk about applying Graham's approach to your own portfolio.

If you attended our meeting this past December, you heard about a very interesting idea put forth by member David Stanczak about a method for taking what we learn at our monthly meetings and then applying it to the creation of a "ghost portfolio" which we can then monitor to see just how well it will perform. And we will get into this at greater lengths at this month's meeting.

And finally, for those of you who attended the presentation on Covered Calls last November, Jim Bittman did send the additional literature that he promised and I will have it for those of you who attended that November meeting.
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We meet monthly on the third Thursday, at DePaul University in Naperville, Illinois which is located at 150 West Warrenville Road. Our meetings begin at 7:00 PM and end at 9:00 PM. The room number for each meeting is posted on the easel standing near the reception desk in the main lobby.

These meetings are open to anyone who shares our interest in learning about investing. We do have an annual membership fee of $15.00 per year (for 12 meetings) and non-members may attend any meeting for a donation of $5.00 per meeting.
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This Week in Barron's

The January 9th, 2006 edition of Barron's carries a very interesting article (on page 25) suggesting that drug stocks are on the mend, and the prognosis is excellent for the large pharmaceuticals like Pfizer and even Merck. Although we have heard the same sort of rhetoric in the not-so-distant past, evidence shows that the situation may be for real this time!
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This is also the edition of Barron's that contains the quarterly Barrons/Lipper guide to mutual funds. This is probably the most comprehensive listing of nearly 10,000 mutual funds that is available anywhere.
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Gauging Market Momentum

Many professional investors use the Standard & Poor's 500 Stock Index to measure the overall market trend. Portfolio managers are often ranked by their ability to "out-perform" the S&P. The S&P 500 is the average price of 500 stocks (400 industrials, 40 utilities, 20 transportation companies and 40 financial institutions) traded over the New York Stock Exchange. The index is adjusted on a value-weighted basis (for the number of shares outstanding) so that a smaller company does not affect the movement of the index to the extent of a larger company such as IBM for instance.

Market momentum measurements seek to highlight the intensity of trend movements. They are used by analysts as a means for forecasting market turning points. They do that by constructing a momentum chart.

A momentum chart is calculated by subtracting the value of the market x-days ago from today's value, in order to find the number of points that the index has changed. That change is then divided by the value of the market x-days ago, to calculate the percentage that the index has changed in the last x-days.

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Following The Dow-Jones Averages

The Dow-Jones Industrial Average is a measure of price change based on 30 leading industrial stocks. In Dow Theory, this average is important because it represents companies that produce goods and services.

The Dow-Jones Transportation Average is a measure of price change based on 20 leading transportation stocks. In Dow Theory, this average is important because it represents companies that move goods and services.

A healthy economy (and stock market) requires that both producers and movers of goods are prospering. When these averages trend in the same direction, then the market trend is said to be confirmed. And when these averages diverge, then a change in market trend may be developing.

The Dow-Jones Utility Average is a measure of price change based on 15 leading utility stocks. Because utility stocks tend to pay high dividends, they are the first to react to changes in the interest rate environment. Note: The market is unlikely to sustain an advance if that advance is not supported by strength in the Dow-Jones Utility Average.

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The Helpful Index

I spotted this in the current (January 9, 2006) edition of BusinessWeek magazine.

The next time you're stuck on infinite hold waiting for a customer service rep, think about whether you'd want to invest in that company. A new study shows that companies with high customer satisfaction ratings beat the market handily.

A portfolio of some 20 companies with the best marks delivered a return of 40% (excluding dividends and transaction costs), compared with 13% for the Standard & Poor's 500-stock index for the five-year period ended May, 2003, according to research from the University of Michigan's Ross School of Business. The portfolio also had less volatility than the index. "Customers know something about stock prices before investors do," says Claes Fornell, the study's lead researcher and director of the University's National Quality Research Center.

Topping the list of 200 companies (rated from 1 to 100) are Apple, Yahoo!, VF Corp., and Toyota. You can find the complete list at www.theacsi.org. "If you're scouting for investments, make sure you compare companies with their peers," says Fornell. "And take a pass on any company with a rating below 50."

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Use The Rule of 72 to Double Your Money

If you want to know how much growth you need to expect from your stock portfolio in order for it to double in "X" number of years, the easy method for calculating this is to use the Rule of 72.

The calculation is quite simple. You merely take the number 72 and divide it by the percentage growth rate of your portfolio during any year. And while the result may not be precise, it is close enough to count. And what's more, it is a fast and easy way of estimating.

Anyone who uses the Rule of 72 will find that it's a good idea to recalculate the doubling time annually, based on the return for the previous year. The process of recalculating will help an investor to stay on target with his/her original goal.

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Invest In What You Know Best

Investing in an industry or a company where you have been employed can be as profitable as diversification in a portfolio. Anyone who has worked in the business would undoubtedly have special insight into how the company works. This understanding could be worth more than spending numerous hours analyzing the company's balance sheet.

There is a problem with this strategy, however, and it lies in the investor's vulnerability to public relations. Because investors are unfamiliar with what is real and what is mere "window dressing," it is more difficult for an investor to discern which information is most significant.

The learning curve regarding investing is steep, and mistakes can be costly. But by investing in companies or businesses an investor knows and understands, this can significantly reduce the amount of information to learn. And this can also lead to quick understanding and faster decisions when it comes time to buy or sell the stock.

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