Why I bought Canon (again)

I very nearly caught up on all the investment decisions I've made thus far, and I managed to not mention limit orders. All of my stock purchase and sales have been executed as limit orders, which means that I pick a price and my broker tries to get it for me. In contrast market orders are executed at whatever price the broker can find on the open market. Since I have a pretty good idea what I want to pay (or receive) for a stock, and since I live on the West Coast and don't get up early for the opening bell, limit orders work well for me. A further twist to limit orders is the Good-Until-Canceled order which let's me leave the order open for 30 day, until I cancel it, or the order is executed at my price. That way I can set a price, forget about my account for a month, and not miss opportunities.

The danger, of course, is missing out on a great stock because it never quite falls low enough or selling too late if the price never quite reaches my "reserve". In fact, I had money to spend almost all year, tried to buy Select Comfort, Pixar and Canon at various times, but couldn't because my limit orders never got executed. Finally, I ran against the deadline of making at least one trade a year, yet again. Canon seems way undervalued according to the intrinsic value calculations I've done. I guess it trades at something like a 30 to 50% discount. Considering Canon's impressive growth and ~1% dividend, I jumped at the chance to buy at $50.

Actually I started at $49, but when that price wasn't reached after a week or so, I tried $50. On November 30, Canon's day low was $50.01 so my order was not executed. I was tempted to try a market order the next day, but I resisted. Since Canon trades primarily on the Tokyo Stock Exchange, it's relatively easy to guess the next day's price in New York -- just convert the closing price in Tokyo from yen to dollars. On December 1, I found out that my broker had executed my order at $49.66, which was that day's low. Since the market price was less than my limit price, my patience paid off in a small way.

Glad I didn't short PeopleSoft!

I suggested back in September that shorting PeopleSoft would be a pretty good risk. I was horribly wrong. Anyone who tried it would have lost about $7.15 a share. That would be an annualized loss of about 7% (depending on commissions). In short, it was a terrible investment idea.

According to Larry Ellison some of PeopleSoft's ongoing revenue was better than Oracle had estimated. I sure hope so, because it's difficult to see how this deal makes sense otherwise. I've had 18 months to ponder this and it seems to me that the only way this deal works in Oracle's favor is if they can retain PeopleSoft's revenue and cut the fat. Using Quicken's intrinsic value calculator:

Revenue (TTM)            = $2.67 (billion)
Assumed operating margin = 20%
Assumed operating income = $0.534(billion)
Assumed growth rate      = 5%
Discount rate            = 11%
Intrinsic value          = ~$25

It appears Oracle is overpaying about $1.50 a share.

I've had to make a ton of assumptions, which presumably Oracle management didn't have to do. For instance, maybe there are more costs that can be cut or perhaps there are deals in PeopleSoft's pipeline that we don't know about. But the possibility exists that Oracle was over-eager to get the deal done. It's troubling that the final price is just 50¢ more than the previous high bid, because it seems like a face-saving device for the PeopleSoft board, rather than a robustly calculated number. Also, Ellison pointed out that he didn't really see anything that surprised him in the PeopleSoft numbers, just that he didn't have to be so conservative in his estimates. We have a strong tendency to see the things we want to see.

Surname Distribution in the U.S.

It is now possible to see the influence of Ericsons spread from 1920 to 1990. It's also easy to figure out why so many people think there's a "k" in my name.

Why I buy the Excelsior Value & Restructuring fund

Starting next year, I won't be forced into buying Raytheon stock every two weeks. And since I'm way over-exposed to Raytheon and I don't think it's a particularly good buy, I won't. That means I need to find other things to invest. Also, I still want to diversify away from the S&P 500. My screen didn't show enough funds, so I started playing around with relaxed criteria. As it turns out, when I eliminated the manager tenure requirement I found this fund:

 					Non-Load Adjusted Returns
Investment Name                         1 Yr	3 Yr	5 Yr	10 Yr	LOF
---------------                         ------  ------  ------  ------  ------
Excelsior Value & Restructuring		19.56%	11.48%	8.83%	15.89%	17.22%

Fidelity doesn't know that David J. Williams, the fund's manager, has been either manager or co-manager since the fund started in 1992. I decided that this is good enough to meet my requirements even if Fidelity doesn't agree.

When looking at companies, there is normally too much information. I don't think I could ever bring myself to buy McDonald's no matter how great an investment it might be, because I don't like their product. The opposite is true of Oracle -- I'll probably hang on too long because I like their database. It's irrational and puts me at a disadvantage.

Mutual funds have nearly the opposite problem. The only thing it produces are investment returns and all you know about how a fund gets them is reading some generic phrases in the prospectus. Just about everything can (and often is) manipulated by the fund management. For instance, the top holdings are sometimes changed at the last minute to give the appearance that the manager picked hot stocks (like Taser this year). (There's even a term for this: "window dressing".)

One of the things I like about the Value & Restructuring fund is the handful of presentations and essays found on it's website. Value investing is interesting to me since I buy individual stocks. The "restructuring" aspect of the fund should also be fun to watch. For instance, the fund bought Black & Decker during a restructuring in 2002. The tool maker needed to reduce costs by shifting production to places like Mexico and the Czech Republic. It also needed to control inventories -- especially of seasonal products. In Peter Lynch's parlance, it's been a two-bagger since then.

The fund commentary also talks about disappointments, such as AOL Time Warner. I don't know if the fund will do better than it's benchmarks over the next few years, but I appreciate the honesty. It feels less like throwing darts and more like investing.

"That ship has sailed"

A while ago I used the phrase "that ship has sailed" in anger, but I wasn't sure why. I mean, I hadn't thought to use it before and I wasn't even sure I had used it correctly. It was like slipping into a foreign language in the middle of a conversation.

Since then, I've noticed lots of other people who use the phrase -- sitcom actors, columnists, bloggers, and so on. I can't decide whether I started noticing because of my (embarrassingly inept) use of the phrase or if I'm part of broad attempt at popularizing it. One way to gather information about this might be to use Google's newsgroup archive. The phrase was first used in 1990 (at least in groups archived by Google). Roughly 3/4 of the references are after 2000. In the last year it's been used about 200 out of 829 times. Of course the volume of posts have increased as well.

One way to work around the problem would be to find a "control phrase" which has not changed frequency over the same period. Maybe, "sounds good to me" or "I don't think so". Even better, use a group of phrases. Then compare the change in frequency to the control. Best would be if Google published volume statistics by year.

Why I buy the T. Rowe Price Small Cap Stock fund

Most of my retirement savings are tied up in my 401(k) plan, which from the beginning I've invested in a S&P 500 Index fund and Raytheon stock. I don't (currently) have much choice is the Raytheon investment, but my plan offers many options besides the index fund. I didn't spend much time looking at other options, mostly because I didn't know how to evaluate them. Who cares if a fund beat the market last year -- I want to know if it will beat the market for the next 30 years.

Last spring, the Motley Fool hired Shannon Zimmerman from Morningstar to cover Mutual funds. I've read the Fool as far back as when my family used AOL in the early 90s, and this was the first time I'd considered the idea that actively-managed mutual funds could consistently out-perform the market as a whole. Based on his first few months of articles, I came up with a screen to find the best candidates my 401(k) plan offered.

Stock Investments

At some point I should diversify to bonds for a percentage of my portfolio, but I'm young, interest rates are still going up, and stocks should continue to outperform bonds over the long-haul. I may need to re-evaluate this criteria in time.

Expense Ratio <= 1.00%

I wish I could get a fund that charged less than 0.5%, but actively managed funds don't usually come that cheap. Expenses for investors are like friction to bicyclists -- a drag. You can bet that Lance Armstrong has the smoothest ride possible because a poorly lubricated part could shave seconds off his time. We could trade bikes and he would still beat me, but he'd probably be dead last if he used my bike in the Tour de France. So the lower fee, the better, when it comes to mutual funds.

Equity Turnover Ratio <= 50%

Besides being another form of drag (trading expenses are reflected in the NAV, not the expense ratio), excessive trading is a sign of a manager who is chasing performance rather than evaluating companies from the bottom up. I'm looking for a manager who knows how to pick stocks that will beat the market over the long-term, not managers who get lucky trading over the short-term. 50% churn translates to an average holding period of 2 years.

Manager Tenure >= 10 years

I'm going to compare 10 year annualized returns, so it makes sense that I compare funds that have been under the same management for that period. The actual experience of a particular manager might be a lot more than his tenure on a particular fund, so if I were interested in a particular manager I wouldn't care too much if he were with a fund for only a short time. But so far I don't know any managers who fit that description.

Here is the result of that screen (as of today):

 					Non-Load Adjusted Returns
Investment Name                         1 Yr	3 Yr	5 Yr	10 Yr	LOF
---------------                         ------  ------  ------  ------  ------
Fidelity Equity-Income Fund		11.98%	6.52%	2.69%	10.72%	13.03%
T. Rowe Price Small Cap Stock SHS	15.17%	11.76%	11.80%	13.13%	13.57%
Vanguard PRIMECAP Fund Admiral Class	14.53%	--	--	--	7.39%

S&P 500 INDEX FUND			13.77% 	4.16% 	-1.15% 	11.12% 	13.07%
Vanguard PRIMECAP Fund 			17.86%	7.07%	3.38%	15.48%	--

Historical returns

I had to add the S&P 500 Index fund, since the screen didn't know the expense ratio (something less than 0.1%), turnover (about 2%) or management tenure (effectively forever). I also added the Vanguard PRIMECAP fund information from Morningstar, since the "Admiral Class" doesn't have a very long history. (I think the difference is in fee structure or something.) The Life Of Fund (LOF) number is fairly meaningless since a fund started in 1982 will look better than one started in 1999.

The T. Rowe Price fund seemed the best investment last spring because it beat the market in good times and bad, and I didn't have any exposure to small companies. In general, carefully picked small companies should do better than larger companies because there is more room to grow. People didn't become millionaires by investing in Microsoft in 1999, but in 1989 when it was relatively small and unknown.