Wednesday, May 18, 2005

High Prices, Unhappy Returns

My favorite financial writers are:

James O'Shaugnessy
Harry Dent
Jeremy Siegel
John Rothchild
Ken Fisher, and
David Dreman.

These guys look deeply into the financial world and make sense out of it. They approach the same topic from various angles and reach the same central conclusions.

The central theme of these writers is the principle of perception versus reality. If most investors perceive that the best group to buy is X and not Y then the value of X is automatically over-valued and Y is the group that should be bought. O'Shaugnessy likes to remind readers of Oakum's Razor or the KISS principle. This to me is the key to successful investing. Once should keep ones approach as simple as possible.

Investors forget that the stock market is an auction sale. At an any auction sale, the most popular item is going to draw the biggest crowd and probably the highest price. The best deal is likely to be the one when you know the value, make the opening bid well below value and then have no competition. At first your heart sinks when you make such a buy. If you lake confidence, you are afraid you have made a big mistake. Good stocks can cause the same feelings. It is hard to like stocks when your peers think you have lost your common sense. My most recent example has been airline stocks. CAL had a price to sales ratio of .05 a couple of months ago. The stock has been a great performer and I have confidence in it; time will tell.

In the linked article, Siegel argues that the fastest growing companies are not the best to buy. He offers several reasons but the big one is that if everyone knows the company is growing very fast, then the price is pushed up too high. The expectation of fast growth in the industry brings in more competition. It is good to own a company that quietly makes a lot of money year after year after year.

In recent weeks, public opinion polls, sentiment surveys, put-call ratios, mutual fund cash flows and other indicators have shown that the public has low expectations for the market. Short sale ratios have grown to high proportions; these borrowed shares need to be repurchased. Cash levels are very high. The market is ready for a big move. Buy stocks!

The shorts are covering; chasing the market up.