Value Investors Should Keep It “100; “Orphan Annie” stocks

Value Investors Should Keep It “100; “Orphan Annie” stocks
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Like The Wu Tang Clan, Value Investors Should Keep It 100 by Sara Grillo, CFA, President at Grillo Investment Management

Let’s keep it real like the Wu Tang Clan.  Most portfolio managers fail to outperform the market – and those that do, rarely do so consistently. The way analysts currently pick stocks destroys long term value for investors.  This approach has been created by Wall Street so they can justify their six figure existence.

You don’t need an MBA to pick winning stocks; you don’t need to be a CFA® charterholder or a master of Excel modeling.  You need street smarts like the Wu Tang, and an understanding of what drives consumer buying decisions.  But instead, analysts base decisions on Excel models and minute details, relying on data that is biased, self-serving, and intended to expand the analytical process to levels that justify the sustenance of their high paying jobs!  They also pay too much attention to stocks that they hear about in the news flow, leading them to buying companies that are priced above their intrinsic value. Few of them make the effort to understand how a company truly makes money.  Few use alternative research such as first hand experience of the company’s products or services or interviewing industry experts.  This is why they basically all make the same decisions – they’re using the same data! Look at all the analysts who said “buy” on Lehman Brothers, Enron, and Citigroup, and look what happened to those stocks!

Value investors, you gotta get real and keep it 100 like the Wu Tang Clan.

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Tell it to the woman who hands out the morning paper when I get on the subway in the morning.[1] “Hey Professa Grillo, I gotcha paper.” She’s got mad street cred going on. She’s an extremely down to earth, practical, and real person (just not a bookish, theoretical, stuffy, highly technical person).  She wouldn’t buy my rap if I said to buy a stock based on my Excel model. If I can’t explain to her for real reasons how a company makes a profit and convince her that they’ll be able to make it fifty years from now, I wouldn’t buy the stock.

The value stocks that are worthy buying are what I call “Orphan Annie” stocks: neglected, unloved, misunderstood, and shunned, an out-of-favor name that is fundamentally mispriced (in other words, trading in the market for a stock price that is less than what it should.) These are firms with a business model that I completely understand, that will not change that much over the next 50 years. This method seems simple.  But in practice, it takes a lot of discipline to invest this way.  It takes a great deal of fortitude to hold a stock when it’s down 20% from where you bought it.

Empirical evidence shows that simply buying and holding certain stocks and compounding the dividend income is a highly effective way to accumulate wealth long term.  It’s simpler, easier, and better to invest in steady, more predictable growth of capital over long periods of time, choosing classic companies that will be in business fifty years from now, making money as effectively then as they are now.

Picking a stock should be like getting married; find a good one, think about it for a long time, and then don’t go back on it.  When you try to predict the market on a daily, monthly, or quarterly basis, you’re gambling.  When you use models to bet on mergers or acquisitions, management takeovers, stock buybacks, or flashy products in the pipeline, you are rolling the dice – no matter what the company management says on the earnings call.  Wall Street, failing to realize that a CEO’s major role is to market his/her firm, takes everything the company says as gospel.

Wu Tang wisdom all the way.

“Professa, you gotta buy cell phone stocks.  Everybody comin’ out the train be lovin’ them iPhones.”

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