When people ask me what I do for a living, and I tell them I manage stock portfolios for private clients, their eyes usually glaze over. Sometimes, however, they want to know more, and they'll ask me what I do all day.
I wish I could make it sound exciting -- going to power breakfasts, meeting with big clients, hopping on the corporate jet for exclusive calls with the biggest names in business, and so on.
But in reality, I spend most of the day in my home office soaking up information -- financial and world news, specific stories about stocks I own, numerous posts on message boards relating to market sectors and individual stocks, and the endless drone of CNBC in the background. I read, listen, think, chat with friends and colleagues, update my client portfolio records, and generally decide what, if anything, I want to do in the markets that day.
Sometimes, the end result of all that deep thinking is that I do absolutely nothing.
What about all of the other things you would expect a money manager to do? I specifically avoid several of them. Here's why.
Discounted cash flows: skip 'em
A discounted cash flow (DCF) is a model in which you make assumptions about a company's revenues, expenses, and profits for the next several years. You decide exactly how much the company will make per share each year. Then you make assumptions about the economy and interest rates to decide what that company's future earnings should be worth today.
Some investors treat DCFs like a religion. For me, it's a large pile of assumptions, any of which could be drastically wrong. The price estimates you get from a DCF are often not worth the paper they're printed on. Since there's no guarantee that the rest of the market will believe in that particular DCF-derived target, I would rather lean on more traditional valuation ratios.
Analyst upgrades and downgrades
Background noise. Numerous academics have proved that following analyst calls does not help your portfolio. Trading on their actual buy, sell, and hold recommendations will underperform a simple index fund most of the time. I remember a Citigroup analyst who put a sell on Russian gas giant Gazprom (OTC BB: OGZPY.PK) at around $20. Today, it trades in the $40s, and there's still no reason to sell, based on the fundamentals. My cost basis is roughly $14.
So why do brokerage houses spend all of that money on analysts? It's mostly PR and marketing aimed at institutional clients, and a come-on for the retail crowd. Ditto their quarterly estimates; I use them as a guideline, but I never get upset if a company "misses" by a penny. I want to know the bigger story about sales growth, profit growth, balance-sheet management, and all of that boring long-term stuff.
However, analyst research is useful in one respect: The analysts do your homework for you. That's especially true with international stocks, in cases where the analyst knows the home country better than you do and can access local data sources that you would need hours to round up yourself. Take the background information they spend weeks putting together, and use it to your advantage. Just make up your own mind. If they say "sell" when you're convinced that the stock is a buy, follow your own advice.
Stay at home
I don't visit companies or speak with management. Many fund managers wouldn't dream of investing in companies until they meet the CEO face to face, check out their premises, talk to customers and competitors, and the like. I see the endless parade of corporate dog-and-pony shows as a sure way to run up your expense account, not your portfolio.
Reg FD, the SEC rule that says companies can't hand out information solely to analysts without making it public, makes most conversations with company officials pointless. I wouldn't trust a CEO who poured out his heart behind closed doors about the "real truth" on his company if he hasn't already put it in his SEC filings. And unless you invest in microcap stocks, company officials probably won't bother to meet with you, anyway. Would the CEO or CFO at Nordstrom take time to meet with one shopper? How about the head of Anadarko Petroleum? Should he meet with you because you own a few shares and buy gas made from the oil he finds?
Invest your energy in studying the company financials instead. If you do, you will profit many times more than listening to tin-plated rhetoric from a corporate mouthpiece. I would rather be connected to the universe I can explore on the Web, and I'd rather reflect on it in the quiet of my home office, not in an airport departure lounge.
I ignore most short-term technical analysis. It's important for swing traders, but it just isn't related to what I do, which is finding, buying, and holding cheap stocks until they aren't cheap anymore. Time your entries with technical analysis if you want a challenge; just don't sell a solid value play when the short-term technical analysis deteriorates. Picking the correct re-entry point is harder than it looks.
Decide whether you are a trader or an investor, and then focus your attention accordingly. I never play index-tracking stocks or options for short-term profits. I know there's a whole industry built around "E-Mini" SPX futures and trading the NASDAQ 100 Trust Shares
We all get tempted to stray from our strengths and play a new game now and then. One of the most successful hedge-fund managers in the U.K. made just 8% in 2004, when the FTSE was up by double digits. He admitted that he was so entranced by the predicted run-up in commodities that year that he bought high and sold lower too many times (stopping out of positions). He abandoned the value instincts that worked so well for him the year before, when he made 50%, and he paid the price.
When you are tempted to do what you shouldn't and take risks in sectors you really don't know, my advice is simple.
Don't do it. Stick to what you know best.
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Fool contributor Dale Baker, a private-client portfolio manager, agrees with Clint Eastwood that a man has to know his limitations. He owns shares of Gazprom for himself and his clients but holds none of the other stocks mentioned. He welcomes your questions and comments at firstname.lastname@example.org.