JB Hi-Fi Limited (ASX: JBH) shocked the market with a profit warning, its shares slumping 14 per cent. If investing was as simple as buying cheap stocks, we’d all be billionaires, writes The Motley Fool.
Regular readers may have spotted Take Stock has been away for a couple of weeks. We’re back into the swing again now.
Did we miss anything whilst we were away?
It doesn’t appear so. The S&P/ASX 200 index trades at just about the same level as it did at the beginning of December.
Yet uncertainly still rules. The European debt crisis remains unresolved, with seemingly no solution in the offing. The U.S. economy is recovering, albeit painfully slowly. And here in Australia, to many people, it almost feels like we’re in recession, even if the data suggests otherwise.
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As if to prove the point, this week former share market darling JB Hi-Fi Limited (ASX: JBH) issued a rather grim trading update, warning half year profits will be around 5 per cent down on last year. The market had been expecting profits to rise by 5 per cent.
Not only are these companies being whacked by the stalling economy, but they are fighting against an ongoing structural change, namely the internet.
The death of retail stocks
Our Investment Analyst Dean Morel warned of this structural change some months ago now in an article titled “Your retail stocks are dying“, where he said the death of David Jones and many other retailers may not be imminent, but will be inevitable.
We all love a bargain, and when it comes to investing, we’re no exception.
Many retail investors will be eyeing up the opportunity to buy shares in JB Hi-Fi and the like on the cheap.
Dean and I won’t be joining them…yet, anyway.
More to investing than valuation
In general, we think too many investors place too much emphasis on a company’s valuation. That may sound weird coming from two people who consider themselves value investors, but hear me out.
Warren Buffett is often referred to as a value investor. He’s not. He has one great skill, and one great advantage over mere mortals.
His great skill is to identify companies with a sustainable competitive advantage. Think Coca-Cola, American Express, Procter & Gamble, Washington Post, Burlington Northern Santa Fe and his most recent big purchase, IBM.
Buying this ‘very expensive’ stock made Buffett millions
With perhaps the exception of American Express, bought during the salad oil scandal, most of those companies, including IBM, weren’t valued cheaply when Buffett bought them.
In fact, one Wall Street analyst called Coca-Cola “very expensive” around the time Buffett started buying it. We know who had the last laugh.
Buffett’s other great advantage is time. His favourite holding period is forever.
Great companies, with sustainable competitive advantages, purchased at a fair price, will serve you very well, over time.
Why valuation models are flawed
As Dean says, valuation is simply one step in his investment process. Although valuation can be the main thrust of his recommendations, and is always important it’s not the be all and end all.
Every valuation model depends on the inputs used, including forecasts.
That’s one of the major flaws in valuation models and why Dean strongly believes their input into any investment decision should be minor.
Too many people concentrate too much on valuation outputs and in particular automating their valuation tools, when they would be better served by gaining a deeper understanding of the business and the industry it operates in.
Putting it bluntly, if investing were as easy as buying shares trading on a P/E of less than 10 and a dividend yield of more than 8 per cent, we’d all be billionaires like Warren Buffett.
As Dean so succinctly puts it…
“As share markets are reasonably efficient, the idea that alpha – outperformance – can be easily achieved by running screens and buying those stocks with a margin of safety greater than 50 per cent holds no water. There is no edge to be gained by individual investors in the share market from anything that can automated.”
Just say no to these struggling dinosaurs
Bringing it back to retail, and especially companies like Myer, David Jones and Harvey Norman, we see an industry in decline.
As an investor, you have two choices. You can try to get lucky, by buying shares at a low point, and hoping for a rebound. Or you can just say no, and focus your energies elsewhere, looking for growing companies in growing industries.
When it comes to investing our own cash, we prefer the latter. Call us boring if you like, but we just don’t see the attraction in relying on luck to power your portfolio.
All that said, there will be times when even we will see a bargain too good to refuse.
Two retailers on our radar
As if to prove that point, in our first issue of Motley Fool Share Advisor, Dean highlighted two retailing stocks that are worthy of further investigation – Billabong International (ASX: BBG) and Speciality Fashion Group (ASX: SFH).
These are most certainly not formal recommendations. And in any case, Dean labelled them as purely speculative opportunities. Still, they are on our radar.
We’ve covered both these companies previously…
A not so merry Christmas?
As to the markets, a relative degree of calmness has descended.
Volatility, as measured by the VIX index, is trending down. The U.S. economy is improving. Could we be in for a Santa Claus rally in the last few trading days of 2011?
Not if Christine Lagarde, the managing director of the International Monetary Fund has anything to do with it.
As reported on Bloomberg, this week she said “the world economic outlook ‘is quite gloomy’ with pervasive downside risk, downward revisions, slower growth than expected, higher deficits than predicted and public finances in shaky condition. ‘And that is pretty much true the world over.’
Merry Christmas to you too, Ms Lagarde.
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