(B)(N) Extreme Economics – The Battle Plan

Drama. Wall Street has favored us again with over twenty bespoke buys and also ten companies which are really cheap but that we should avoid or sell them because they might get cheaper, they say.

But those ten companies are trading at less than 1/5th of the aggregate price of the twenty and bringing home 1/4th of the income – that sounds promising – more income now even if the price of it is lower later; and those ten companies have a current dividend yield of 3.4% and a 45% payout rate but the twenty companies are good for only a 2% dividend yield and a payout rate of 39%; and those ten companies have a demonstrated annual price volatility of 26% and are trading at 20% off this year but the twenty companies have a demonstrated annual price volatility of only 15% and have already gained +20% this year – so where’s the upside coming from and who is going to buy these expensive stocks from us?

What shall we do? Sell or short the ten (and our income) and buy the twenty?

To parse this information, we need to appreciate that Wall Street is just like our doctor who tells us that smoking is not good for us – it’s risky – and then offers us one of his cigarettes – a special blend from Turkey or someplace – because that’s his retirement plan and “doctoring” is just what he has to do on the day-to-day to stay solvent and get there.

But there are hundreds of good stories for each and every quarter about companies with increasing revenues, good profit margins and cash flow, good returns on the shareholders equity, a plausible dividend and reasonable debt – it’s a beauty contest and the debutantes are arriving every day – and although these things might help a company to survive, they’re neither necessary nor sufficient for survival and they don’t necessarily help their stock prices to increase (and not go up in smoke) and bad companies sometimes do and don’t go up in smoke either even if they miss their quarterly earnings consensus now and then.

That’s confusing because neither “good” nor “bad” is necessarily so, but it’s not a contradiction (please see The Tao of Stock Prices) and it breeds us for the rat race and chain smoking and consumer investing and although there are many investors who thrive in that environment and prefer it, we’re not among them and we’ve burned those bridges and think only about what we need to do as investors to earn an income from our money because that’s our job and we need to do it ourselves; please see below for The Battle Plan. Prosit!

The Battle Plan – RiskWerk Always On/Never Off

The Battle Plan isn’t new – it’s been used for centuries by enterprising Romans, Vikings, and the Mongols and it’s the foundation for the economics of the 20th century – 100 years of warfare following on 100 years of warfare – and although we can still say that Wall Street conquers and pillages for their daily bread, that’s their job – they’re market makers and venture capitalists and don’t run anything but our money – whereas our interest is to defend what we have and earn an income from it – we want 100% capital safety and a hopeful but not necessarily guaranteed return above the rate of inflation – and Wall Street doesn’t talk about that or do anything about it because security is not what they’re selling – they’re selling risk and they’re good at it but we’re better at what we do.

For example, if we buy all twenty-one of the current bespoke offering (as above) then that’s our Army of the Occupation and it turns out (please see Exhibit 1 below) that all of these companies are in the (B)-class now and are currently trading at or above their stop/loss prices and although we can’t do any worse than that, we have to wonder about where the upside is coming from and why should a 2% dividend yield be attractive to us or to new buyers who should pay a higher price for it.

But it wasn’t always so; in order for us to understand this portfolio now, we pulled it back to 2012 and only ten of these companies were in the (B)-class at that time and the rest were in the trading range of investor uncertainty (the (N)-class which we can reasonably call the Navy) and we added the rest of them by the end of 2012 to form the Army of Occupation, so to speak, which we hold now and are not just buying yesterday or today at high prices.

And whereas buying them all in 2012 returned +140% by the market value (or +130% when price weighted) and doubled our money, the return on the equivalent (B)-class portfolio is +212% (at the stop/loss prices) with the same information and the same result and we have an interest in all of these companies that new investors might want to buy from us if Wall Street is successful in its endeavors (as above).

On the other hand, the ten companies that Wall Street has reservations about (as above) are all trading in the (N)-class now (the Navy) and the prices are so low that we could call them the submarines and for patient money, they are likely to be a better investment than in the Army, but that wasn’t so at all times either and we owned all ten of them in 2013 before shedding them at the stop/loss prices in 2014 and this year and that portfolio was good for +110% and doubled our money as a (B)-class portfolio, all of which we have now in cash and are wondering what to do with it; please see Exhibit 1 below for more details.

The Battle Plan

But we’re not going to make that choice for either the Army or the Submarines as above – thanks but no thanks, guys – because our ambition is to repeat the process that created that choice and make a landing (the marines) and plant our army in the sixty-seven or so S&P 500 Industrial companies – a much bigger portfolio and the future of America absent the banks, financials, and the high fliers (the bombers and jets, so to speak, routinely produced on Wall Street) – of which only 26 qualified for the landing in 2012, rising to 54 in 2014 thanks to the marines, and then dropping to only 26 now – and we need to figure-out what to do with our +205% in profits and an aggregate dividend yield of 19% over four years and over three times as much money as we had in 2012 and we can reasonably expect three times again by 2018 no matter what the market does if we just take care of our business and not theirs; please see Exhibit 2 below (and click on it and again to make it larger as required).

Exhibit 1: (B)(N) The Daily Bread on Wall Street and the Submarines

Figure 1.1: (B)(N) The Battle Plan on Wall Street

Exhibit 2: (B)(N) Extra! Extra! The Marines Have Landed in the S&P 500 Industrials

Figure 2.1: (B)(N) S&P 500 Industrial Companies – The Army, Navy, and the Marines

For more information and examples of the Free Market Yield and the terms that we have used above, please see our Posts “(P&I) The Dismal Equation (Ecclesiastes 9:1)” and “(B)(N) S&P 100 Volatility Risk and The Full Moon” and “(B)(N) NASDAQ 100 Volatility and The Stone Bunnies“ and for an introduction to The Barometer “(B)(N) What’s A Girl To Do” or “(P&I) The Swiss Franc Debacle“.

And for more information on real “risk management” in modern times and additional references to the theory and how to read the charts and tables, please see our Post, The RiskWerk Company Glossary and “(P&I) Dividend Risk and Dividend Yield“, and our recent Posts “(P&I) The Profit Box” and “(P&I) The Process – In The Beginning“; and we’ve also profiled hundreds of companies in these Posts and the Search Box (upper right) might help you to find what you’re looking for, such as “(B)(N) TLM Talisman Energy Incorporated” or “(B)(N) ATHN AthenaHealth Incorporated” or “(B)(N) PETM PetSmart Incorporated“, to name just a few.

And for more applications of these concepts please see our Posts which rely on the Theory of the Firm developed by the author (Goetze 2006) which calibrates The Process to the units of the balance sheet and demonstrates the price of risk as the solution to a Nash Equilibrium between “risk-seeking” and “risk-averse” investors within the demonstrated societal norms of risk aversion and bargaining practice. And for more on The Process, please see our Posts The Food Chain and The Process End-Of-Process.

And for more on what risk averse investing has done for us this year, please see our recent Posts on “(P&I) The Easy (EC) Theory of the Capital Markets” or “(B)(N) The Easy (EC) Theory of the S&P 500“, and the past, The S&P TSX “Hangdog” Market or The Wall Street Put or specialty markets such as The Dow Transports & Utilities or (B)(N) The Woods Are Burning, or for the real class action, La Dolce Vita – Let’s Do Prada! and It’s For You, Dear on the smartphone business.

And for more stocks at high prices, The World’s Most Talked About Stocks or Earnings Don’t Matter – NASDAQ 100. And for more on what’s Working in America, Big Oil, Shopping in America or Banking in America, to name just a few.

Postscript

We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of investment lore. We have just one product

The Perpetual Bond™
Alpha-smart with 100% Capital Safety and 100% Liquidity
Guaranteed
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For more information on RiskWerk, please follow the Tags or Categories attached to this Letter or simply enter Search for additional references to any term that we have used. Related data may be obtained from us for free in a machine readable format by request to RiskWerk@gmail.com.

Disclaimer

Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”). The Canada Pension Bond®™, The Medina Bond®™, The Barometer®™, the Free Market Yield®™ and Extreme Economics®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.