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Charles Rotblut is a vice president with the American Association of Individual Investors (AAII). He is the editor of the AAII Journal and helps to manage the Stock Superstars portfolio. Charles is a CFA charter holder and recently authored a book titled Better Good than Lucky: How Savvy Investors Create Fortune with the Risk-Reward Ratio. Charles was kind enough to answer some of my questions.

Thanks so much for your time Charles. I am curious if you can start off with telling us a little bit about your background?

Sure. I started out analyzing privately-held companies and partnerships in the mid-1990s. This involved a lot of onsite visits and careful scrutiny of the financial statements. It was a good way to learn how to be an analyst because there weren’t good comparative valuations and we had to consider what an outside investor would actually be willing to pay. From there, I went to work at INVESTools – a for-profit investment education company, Curian Capital – a money management firm, and Zacks Investment Research – a research firm.

How did you end up at the AAII and make your way up the corporate ladder?

The former editor of the AAII Journal held the position for 26 years. When she announced her decision to retire, I received a call from an old friend who worked at AAII to come in and apply for the position. Though I was happy working as a market strategist for Zacks, this was a rare opportunity at a great organization.

What got you interested into value investing?

Soon after the Internet bubble of the late 1990’s popped, I read Security Analysis by Benjamin Graham and David Dodd; all 700+ pages of it. The book really stood out, primarily because the lessons learned from the 1929 crash were very relevant as the new millennium started.

Though the Chartered Financial Analyst program and my work analyzing private companies emphasized the importance of valuation, it is important to remember that value investing was very much out of favor during the late 1990s. This turned out to be a short-lived event, as it always is. High expectations always come with a very large potential for disappointment. This is why it is so important to manage risk when investing.

Who came up with the AAII survey and can you tell us about the methodology used?

The AAII Sentiment Survey was started in 1987. The survey question has not change since inception and asks whether stocks will be up (bullish), flat (neutral) or down (bearish) over the next six months. AAII members take the survey by visiting our website.

Over its history, extremely high bullish and bearish readings have been correlated with market reversals. For example, on March 5, 2009, bearish sentiment hit 70.3%, right as the bear market was bottoming. Though the results are interesting, investors should look at a variety of indicators before making a forecast about market direction.

Do you have any information on the average of weekly respondents?

We do not conduct a random sampling of our members, the way Gallup poll does with their polls. What we have observed over time is that increases or decreases in the number of respondents do not significantly impact the results.

Also do you have demographic info on respondents, are they mostly retired?

Investors who are AAII members are typically affluent and college educated. The median age is 65, which seems to surprise people when I mention it. Yet, this is very typical of the subscriber base for many investment websites and newsletters.

There was a Wall street Journal article last month which discussed the AAII survey and quoted you several times. The article seemed to paint a neutral picture regarding how the AAII survey is conducted. Do you have any follow up statements you would like to mention?

The reporter interviewed me when he wrote the story. I thought it was a fair and balanced story. Our survey has been correlated with market reversals, but, to reiterate, investors should look at other indicators before making a market forecast.

Does long term historic data indicate when investors are bullish now being an example market returns are usually poor and vice-versa?

We’re presently seeing the second-longest streak of above-average bullish readings since the first half of 2004. Bullish sentiment is also high compared to its historical averages. Based on current readings, a case could be made for market performance to be disappointing over the next six months.

The big caveat is that we saw a 43-week streak of above average bullish sentiment in 2004 and that was followed by another 19-week streak of above average bullish readings. So the question is whether we are seeing what could become another repeat of 2004? Just keep in mind that history never perfectly repeats.

Why do you think investors are always so wrong, do you think investors get caught up with the herd mentality?

It’s human nature to want to be a part of something, particularly something that is going well. Add in greed and you have the right mix to bid up assets. Manias have always occurred, whether it is shares of Facebook now, stocks in the 1920s, railroads in the 19th century or tulips in the 17th century.  More manias will occur again; it’s not a question of if, it’s a question of when.

What inspired you to write your new book Better Good than Lucky?

There is a gap between the ideas expressed in much of the great investment literature that has been written over the years and many individual’s personal strategies. I saw an opportunity to bridge this gap by writing a book that explains those key concepts in easy-to-understand language.

If you had to sum up your book in a few paragraphs what would be your main points?

The key to any successful investment is to maximize the potential for reward and minimize the potential for downside risk. In terms of stocks, this means seeking out companies with good business models, strong financials and attractive valuations. It also means buying companies that add to your portfolio’s diversification, not subtracting from it.

It is also important to keep a journal of all investing decisions. Write down both the reasons you are attracted to a stock and what could cause you to sell it, before you buy a stock. The reason is that you have no emotional attachment to the stock before you buy it.

In sum, investors will really benefit if they take the time to truly assess a company’s potential rewards, its risks and a have a plan for selling.

In your book you discuss how to evaluate stocks, how much emphasis do you put on the qualitative versus the quantitative?

I give readers a 10-point scoring system for evaluating stocks in the last chapter. Eight of the criteria are quantitative, while just two are qualitative – business model and diversification. As important as it is to have an attractive valuation and good financials, the numbers cannot tell you everything. For example, nothing in Apple’s numbers tells you that Steve Jobs just took medical leave. I think it is also useful to look at the chart, if for no other reason, than to be

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