Larry's Blog

This is the personal blog of Lawrence Sautter. You should consider hiring me. This blog is not investment advice. This is not a solicitation to invest. Follow me on Twitter: @sautterlas65, view my profile on Linkedin.





Are "quality stocks" a crowded trade?

As investors cluster around a handful of core names, you might have valuation risk


Not all large cap stocks are high quality, hence defensive investments. But a lot of index trackers and passive investors are crowding this segment, when the market gets worried. However, this does not mean that you cannot find value within the large cap stocks. You should not focus too much on your Benchmark and market cap weightings. Search for "quality" stocks within the whole market universe from small-, mid- to big cap stocks and globally with emerging market exposure. Concerning valuation risk, just stick to your own "quality" standards, when looking for a good company to invest for the long-term. You could look for the following characteristics:


1. High ROIC without accounting gimmicks or a lot of leverage.

2. Generating cash profits. (High profit margins)

3. Has predictable earnings and growing.

4. Not a natural target of regulation.

5. Owner-oriented management.

6. Understandable business model with a strong balance sheet.

7. Owns strong franchises, thus having the freedom to raise prices.

8. Low asset intensity with a lean expense structure.

9. High return on tangible assets.

10. Dominant and growing market shares in their principal products and/or service lines, long product cycles and excellent global market positioning. (strong product demand in a growing market)


Look for management with a record of doing what it says it's going to do and has a vision. Further management should spend on R&D and innovation.


Buy and stick to companies with the best global growth prospects.


Do your own diligent research before making any buy or sell decision.


Over time stocks are going to move with earnings growth.


You must calculate your "fair"-price you are prepared to pay for a good company and sometimes you have to wait for the price to come down first, before investing in a "quality" company. Never overpay, but do your fishing, when the weather is grey and terrible, when investors panic. This is called "bottom-fishing", when valuation risk is low and prices are attractive.

Price is what you pay. Value is what you get.

Warren Buffett






Is your bond portfolio vulnerable to rising rates?

Although current interest rates are at all-time lows, eventually they could rebound.

Because the value of existing bonds tends to decrease when interest rates increase, investment portfolios overweighted to fixed-income assets could see significant losses should rates rise.

Consider investing in equities

The chart below shows how rising rates on the 10-year Treasury bond would have affected different hypothetical portfolio allocations during the past 20 years, when rates increased seven times. In those years when interest rates rose, the 100% bond portfolio returned little more than 2% on average, while the pure stock portfolio returned an average of 17%.

Adding even a small portion of stocks to a bond portfolio can increase returns significantly.


Sources: Bloomberg, SPAR, FactSet Research Systems Inc. Hypotheticals assume quarterly rebalancing.






About chaos theory, fuzzy logic and emotions

Guesses made by securities analysts and investment advisors represent fuzzy estimates we aim to distill. This can be done through defuzzification. Taking an analogy from physics, what defuzzification essentially does is to establish boundary conditions. This is a subjective process but also very important because it permits us to better define the area within which we make our guesses. It is quite vital to underline that uncertainty (possibility) and randomness (probability) should not be confused. Whether in science or in the arcane arts of financial and economic analysis. The strength of fuzzy engineering lies in its ability to handle subjective judgments and emotions. The Monte Carlo Method is a very good tool to handle "noisy" data or better fuzzy data. And because the world is very uncertain and more chaotic than we think, we have to stress test our strategies more often, think in scenarios and do some Monte Carlo simulations which is a standard tool in portfolio construction, especially in a non-Gaussian world. Guesstimating the fair value of securities is indeed a fuzzy concept and the tail risks are mostly underestimated, because the bell curve is a myth and tomorrow's prices are not independent of past prices. By the way, our world would be very boring, if we had the algorithm to predict the future and without volatility you would not find any investment opportunities.

Market conditions, along with weather patterns, across most continents have been anything but stable over the past several years. Thats why we aim to produce consistent risk-adjusted returns over time by managing risk, volatility and enhancing diversification. So investors can remove emotion from the equation and stay invested to achieve long-term goals. Do not try to time the market, stick to your strategy and process to meet your financial goals. Traditional finance theory is bad at predicting what people really do. The mass oscillates between euphoria and panic. Are you a rational investor? What's your investment style, finance behaviour and market conviction?


We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.

Warren Buffett







Market valuation

Markets look a little stretched for the moment. They had a very good run. According to the Shiller P/E for S&P500 Index the valuation is at 23.5 times earnings vs the long-term avg. of 16.5x. Companies deleveraged a lot and are still doing so. They are buying a lot of stock back and the balance sheets are looking healthier. The bull market party is still going strong and could last for a while, as there is no real alternative investment opportunity than quality stocks at a fair price with a sustainable dividend policy as a future inflation hedge.

Your strategy: hold on to your global quality stocks and accumulate more at a cheaper price, if the valuation seems to be stretched.

Stick to companies with a good business model with pricing power and strong FCF, excellent innovation potential and a fair amount of R&D spend.

Your tactical move: buy more equities and stay/get overweight relative to bonds, when the broad markets start to correct. Government bonds are not attractive and interest rates are artificially low. You have a better inflation hedge with solid companies that can grow their dividends over time and that had a dividend policy of doing so in the past.