Hello Value Focused Investors,
I've added another position in a speculative retail stock. That gives me a great opportunity to discuss a question that investors often face. What is the difference between investing and gambling?
Well, it depends who you ask. When I first began the site, I had listed as one of the Principles of Christian Investing something along the line of, "We should avoid strategies that are akin to gambling." I still believe that's true. The reason it's no longer there, is that I've never come up with a clear definition of what constitutes gambling. The other thing is, when I first began, I was very focused on prudence and conservatism. I think those things are important, but specific to the individual and their financial situation. No matter who we are, or what our situation, I think that we should never let greed cloud our judgment. I think that we have to work hard and spend much time in prayer to make sure we are doing the right things for the right reasons.
However, at some point along the way, God began to lead me to take more risk. As he did that, and as I continued to study the Bible, I became acutely aware that God never leads his people to completely and totally "play it safe" in life (in fact, the opposite is often true). It would follow that we can't play it completely safe in business pursuits as well. The free report available on this site, What Every Christian Investor Needs to Know, was written when I was in a place called The Foundry. I didn't even have my own place to live at that time, much less any investments to manage. But, even then, God had led me to study what his word has to say that is relevant to the topic of investing. Even then, he was shaping Wisdom's Reward according to his plan. I did realize during the initial study that God would not have us act (or fail to act) out of fear any more than he would have us to act out of greed. So I knew that risk taking was inevitable. It is clearly a part of investing and a part of life.
But, while my definition of risk has changed significantly since I began the site, I can say that I certainly didn't have any idea how much "risk" God would lead me to take. When I began this site, I only wanted to invest, and write about, taking relatively small positions in rock solid dividend paying stocks. I had no idea that I'd end up taking concentrated positions in more "risky" stocks. I certainly never dreamed I'd have any positions in stocks that I considered speculative. So, for the Christian, I think these decisions should be made with much prayer. I think we have to go where God's spirit leads us.
At the same time, I think God has led me to build certain disciplines into my process. For example, I put no more than 1/7th of the portfolio in a single place. No matter how much I believe God has led me to a certain stock, and no matter how much it makes sense to me, I simply don't know what disaster may occur. Only God knows the future. Even if I believe God is leading me down his path, do I know what the specific outcome will be? No, I don't. So, I have to build in some disciplines. Of course, those should be decided upon with prayer, Bible study, and perhaps the counsel of the wise.
For me, the relevant discipline that comes into play today is having no more than 10% of the portfolio in speculative stocks. That discipline comes from the teachings of Benjamin Graham. In The Intelligent Investor, Graham writes of the usefulness of speculation:
"Two paragraphs should be added about stock speculation per se, as distinguished from the speculative component now inherent in most representative common stocks. Outright speculation is neither illegal, immoral, nor (for most people) fattening to the pocketbook. More than that, some speculation is necessary and unavoidable, for in many common stock situations there are substantial possibilities of both profit and loss, and the risks therein must be assumed by someone. There is intelligent speculation as there is intelligent investing. But there are many ways in which speculation may be unintelligent. Of these the foremost are: (1) speculating when you think you are investing; (2) speculating seriously instead of as a pastime, when you lack proper knowledge and skill for it; and (3) risking more money in speculation than you can afford to lose."
Indeed, without people making speculative investments, no one would ever start a new business. No experimental technology would ever be developed and brought to market. No struggling business would ever be turned around, and so on. The question for each individual is how much of their funds they can allocate toward speculative ventures. In the commentary to that chapter (available for free in the updated edition linked above), Jason Zweig writes, "For most of us, 10% of our overall wealth is the maximum permissible amount to put at speculative risk."
Once you decide on a limit, you then have to figure out what you mean by "speculative". For me, companies that are incredibly overvalued are the first things that pop into my mind. To me, buying an overvalued company is much riskier than buying a series of struggling companies with depressed valuations. The reason is that struggling companies with depressed valuations give you a clear picture of the upside potential in light of the risk you are taking. If you execute the strategy properly, the gains from the winners should always significantly outweigh any losses from the losers (and if you're very blessed, maybe you can avoid having losers altogether).
However, with companies that are growing rapidly, or for which there is much irrational exuberance, you can be tricked into thinking you've done something intelligent with your money, even when you overpay by a wide margin. Then, when the bubble bursts, you realize that there really never was much intrinsic upside to be had at the price you paid, but there was plenty of downside. Next on my list would be companies with experimental technologies and/or unproven business models. Short positions of various kinds are speculative in my view, though it depends on the exact situation. Obviously, taking unhedged option positions or trading on margin are both highly speculative activities that require professional level risk analysis and management skills.
The one type of speculation I'm comfortable with doing in the Value Focus portfolio, at least so far, is in the buying of companies for which TTM Cash From Operations has gone negative. But, it is still speculative nonetheless and should be limited. The definition I'm using for speculative, in this case, is not a hard line definition. In other words, there might be exceptions. For example, say a company has a large cash position, little or no debt, and a long history of solid operating results. But, this company, for reasons that are nearly certain to be temporary, experienced a net cash outflow from operations over the prior 12 months. In such a case, I would not define taking a position as a speculative activity, especially if the valuation were attractive. An attractive valuation would make such a situation the opposite, or as near to opposite as one can get, of speculation. That is, it would be a value investment.
Anyway, if you've made it this far with me on this particular post, I commend you. I also will reward you by getting to the point. The Value Focus portfolio already had 3 speculative stocks (ACI, ANR, and BEBE). The cost of those positions totals $8,582. As of this morning, 10% of the portfolio would be represented by $10,847, leaving me with roughly $2,300 to add in speculative positions. I used that today to buy 300 shares of stock in JC Penney Inc (JCP).
Pretty much all U.S. investors and consumers have some familiarity with this company. They have struggled the last several years. However, the numbers (ttm Revenues, Gross Margins, CFO) are all moving in the right direction. Further, a qualitative assessment of the company reveals a very pointed effort to turn things around. Whereas similar retailers such as Sears (SHLD) appear to be throwing in the towel, JCP is fighting hard not only to survive, but to reinvent itself and to thrive. Current assets for the company, as of the most recent quarter, are $4.44 billion versus current liabilities of $2.51 billion. This would indicate the company has sufficient liquidity to continue operating for some time, especially considering that Cash From Operations over the last 12 months was only negative $71 million. The roughly $1.9 billion liquidity cushion could buy the company a whole lot more time at that rate of loss.
As well, I would note that the company has just secured itself a new permanent CEO with a lot of promise. I would also note that the JC Penney stores, product assortment, and prices look great to me as a consumer. While many malls are suffering right now, I'm not sure that this is a permanent trend. Some of the worst malls will undoubtedly close. But, many malls and department stores could find new ways to reinvent themselves. This will be necessary for long run success. While all retailers may enjoy some nice tailwinds this holiday season, and perhaps into the next one if low oil prices and strong job creation continue, Target, Walmart, Academy Sports, Home Depot, Lowe's and trendier new outdoor malls are formidable competitors. Companies such as JC Penney will need to reinvent themselves on some level in order to win back market share. If they are successful, those who take positions today stand to reap very sizable rewards.
In other news, I continue to watch the oil market with some interest. I think there are some interesting opportunities in that space, but they haven't quite gotten to my level of comfort, as far as taking the plunge into some oil related stocks. I just think that a price war is inevitable in the near term. There are too many high cost producers operating in the oil space that could be put out of business by the lower cost producers, i.e. OPEC. It behooves the low cost producers to open up the spigot and choke the high cost producers out of the market. It behooves them to do this sooner rather than later. While there is no way to be sure of what OPEC will do, I am very confident that is what makes the most sense for them to do at this point. The bottom line is, while the price of oil can bounce around from day to day or week to week, I believe it has a good bit further to fall before we hit the bottom of the commodity cycle in oil. If I'm right about that, obviously it will continue to be good news for the U.S. consumer.
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