1. Just a few of the marvelous books that treat these in depth: Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds (New York: Wiley, 1995, first published in 1841); Niall Ferguson, The Ascent of Money (New York: Penguin Press, 2008); A. Gary Shilling, The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation (New York: Wiley, 2010).
2. Thornton O’glove, Quality of Earnings: The Investor’s Guide to How Much Money a Company Is Really Making (New York: The Free Press, 1987).
3. Charles W. Mulford and Eugene E. Comiskey, The Financial Numbers Game: Detecting Creative Accounting Practices (New York: Wiley, 2002); Charles W. Mulford and Eugene E. Comiskey, Creative Cash Flow Reporting (New York: Wiley, 2005).
1. Blackstar Funds, “The Capitalism Distribution: Observations of individual common stock returns, 1983–2007, http://www.theivy portfolio.com/wp-content/uploads/2008/12/thecapitalismdistri bution.pdf. (Accessed December 10, 2011.)
2. “Historical components of the Dow Jones Industrial Average,” http://en.wikipedia.org/wiki/Historical_components_of_the_Dow_Jones_ Industrial_Average. (Accessed December 10, 2011.)
3. Peter Lynch, One Up on Wall Street: How to Use What You Already Know to Make Money in the Stock Market , 2nd ed. (New York: Simon & Schuster, 2000), 56. “Ken Heebner at Loomis-Sayles Sticks His Neck Out Too, and His Results Have Been Remarkable.”
4. Bob Veres, “How to Lose Money in the Top Performing Fund,” reprinted in Financial Symmetry blog, http://financialsymmetry.com/blog/how-we-see-it/lose-money-topperforming-fund. (Accessed December 10, 2011.)
5. The table and figure are both from “S&P 500: Total and Inflation-Adjusted Historical Returns,” http://www.simplestockinvesting.com/SP500-historical-real-total-returns.htm. Table author notes: Figures for dividend distribution rates in Table 1.1 present high uncertainty, of about ±5 percent. Geometric averages were calculated for price changes, total returns, and inflation. Raw data for this work was obtained from the following sources: Standard & Poor’s S&P 500, U.S. Department of Labor, Yahoo Finance, and data collected by Robert Shiller, from Yale University, for his book Irrational Exuberance , second edition (New Haven: Yale University Press, 2000).
6. Idem. “Reinvesting all dividends from 1950 through 2009 returned 8 times the return of the average alone.” But that’s a pretty long time for compounding those dividends and it suffers from the same age, wage-earning levels, and behavioral concerns as dollar-cost averaging.
7. Graham, of course, is the founder of value investing and coauthor with David Dodd notably of Security Analysis , multiple editions (New York: McGraw-Hill, 1996 and others); he is also the author of The Intelligent Investor , revised ed. (New York: Collins Business, 2003) and The Memoirs of the Dean of Wall Street , (New York: McGraw-Hill, 1996). His most famous student was Warren Buffett, whom he taught at the Columbia Business School and reportedly awarded his only A+. As recently as the Berkshire Hathaway meeting in 2010, when asked his style of investing by The Motley Fool’s Lou Ann Lofton, Tom heard Buffett reply, “Benjamin Graham.”
8. Jason Zweig, “If You Think the Worst is Over, Take Benjamin Graham’s Advice,” Wall Street Journal , May 26, 2009, available at http://online.wsj.com/article/SB124302634866648217.html. (Accessed December 10, 2011.)
9. Jeremy Siegel, Stocks for the Long Run: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies , 4th ed. (New York: McGraw-Hill, 2007).
10. Jeremy Siegel, “Yes, Stock Data Do Go Back 200 Years,” undated, pdf available at http://www.jeremysiegel.com/index.cfm/fuseaction/Resources.ViewResource/type/article/resourceID/6950.cfm. (Accessed December 10, 2011). In our view, Zweig has the far better argument in the now-classic Zweig-Siegel debate, which Zweig began in “Does Stock Market Data Really Go Back 200 Years?” Wall Street Journal , July 11, 2009, http://online.wsj.com/article/SB124725925791924871.html. (Accessed December 10, 2001.)
11. Jeremy Siegel, “Rough Going for Now, but Stocks Still a Good Bet,” Knowledge @ Wharton , September 8, 2008, http://knowledge.whar ton.upenn.edu/article.cfm?articleid=2052. (Accessed December 10, 2011.) “And, if you go back 200 years, has it been right to sell in the bear markets? The answer is no. You take the pain, you hold your position, and you will be rewarded in the future.”
12. Ross Kerber, “Average 401(k) balance near $75,000: Fidelity,” Reuters , May 11, 2011, http://www.reuters.com/article/2011/05/11/us-retirement-fidelity-idUSTRE74A0L720110511. (Accessed December 10, 2011.)
13. Idem. “Averages were higher for older workers and those who have added steadily to their 401(k)s. Among those active in a plan for 10 straight years, the average balance at March 31 was $191,000, up from $169,200 a year earlier; within that group, those 55 and older had saved $233,800 on average, up from $203,600 a year earlier.”
14. CNN Money Chart and others from “What Should Your Net Worth Be? Net Worth by Age and Income,” Fabulously Broke in the City , March 21, 2011, http://www.fabulouslybroke.com/2011/03/what-should-your-net-worth-be-net-worth-by-age-and-by-income/. (Accessed December 10, 2011.)
15. Barton Biggs, Wealth, War and Wisdom (New York: Wiley, 2008).
16. The Fama-French three-factor model (FF3) is detailed in “Small Cap Value Is Beautiful Again,” Financial Advisor Magazine , July 2009, http://www.fa-mag.com/component/content/article/1-features/4270-small-cap-value-is-beautiful-again.html. Its results were especially impressive over the full business cycle following the late 1990s publication of Fama and French’s research. The article discusses the economic logic for small-cap value outperformance, defining the stock category as “small companies trading at low multiples to book value and other fundamental measures [that] tend to be distressed firms, even in the best of times.” James O’Shaughnessy argues in What Works on Wall Street (New York: McGraw-Hill, 2011) that the historic outperformance relies heavily on stocks that are too illiquid, but these are apples and oranges. Fama and French’s data are for valuations and O’Shaughnessy’s for absolute market cap and associated liquidity.
17. Christopher Browne et al., “What Has Worked in Investing: Studies of Investment Approaches and Characteristics Associated with Exceptional Returns,” (Tweedy Browne paper, revised 2009), http://www.tweedy.com/resources/library_docs/papers/WhatHasWorkedInInvesting.pdf. (Accessed April 8, 2012.)
18. A sad denouement to a formerly stellar career: Sree Vidya Bhaktavasalam, “Legg Mason’s Bill Miller Will Exit Main Fund after It Falls Behind Peers,” Bloomberg , November 17, 2011, http://www.bloomberg.com/news/2011-11-17/legg-mason-s-bill-miller-to-exit-main-fund-after-falling-behind-its-peers.html. (Accessed December 10, 2011.)
19. Edwin Lefèvre’s, Reminiscences of a Stock Operator , annotated ed. (New York: Wiley, 2008).
20. This is a fascinating event in modern investing history because both the CEO and money manager, Whitney Tilson, were willing to put themselves on the line so publicly. These pieces capture this historic exchange, with the two interesting postscripts. Tilson went long in October 2011, quoted in Business Week as saying, “The core of our short thesis was always Netflix’s high valuation. In light of the stock’s collapse, we now think it’s cheap and today established a small long position. We hope it gets cheaper so we can add to it.” See http://www.businessweek.com/news/2011-10-25/t2-s-tilson-former-netflix-bear-buying-shares-after-plunge.html (accessed October 25, 2011), committing then two of the shorting sins identified in this chapter—overvaluation (in effect, momentum investing and market timing, see Chapter 6) and poor business model. This is also followed by one writer’s excellent post mortem—a writer/investor who endured the pain of being short from $125.00 to the $300.00 top, who then, in his words, ended up with the most successful investment of his lifetime. But everyone seems to ignore that the painful short or long could have been avoided by focusing on aggressive accounting—not the clairvoyance to know a fad, fraud, or business model failure, or exactly when a momentum stock will turn. Whitney Tilson, “Why We’re Short Netflix,” available at http://seekingalpha.com/article/242320-whitney-tilson-why-we-re-short-netflix (accessed December 16, 2010); Reed Hastings, “CEO Reed Hastings Responds to Whitney Tilson: Cover Your Short Now,” available at http://seekingalpha.com/article/242653-netflix-ceo-reed-hastings-responds-to-whitney-tilson-cover-your-short-position-now (accessed December 20, 2010); Whitney Tilson, “Why We Covered Our Netflix Short,” available at http://seekingalpha.com/article/252316-whitney-tilson-why-we-covered-our-netflix-short (accessed February 11, 2011); “Slim Shady,” “A Response to Whitney Tilson’s Netflix Flip-Flop,” http://seekingalpha.com/article/302726-a-response-to-whitney-tilson-s-netflix-flip-flop (accessed October 27, 2011).
21. David Shook, “Artistic Allusion—Or Delusions—at Human Genome Sciences?” Bloomberg Business Week , July 2011, http://www.businessweek.com/bwdaily/dnflash/jul2001/nf20010712_430.htm. (Accessed April 8, 2012.)
22. Consolidated Class Action Complaint, In Re Ambac Securities Financial Group, Inc. Securities Litigation, count 37, p. 16, http://securities.stanford.edu/1039/ABK_01/2008825_r01c_0800411.pdf. (Accessed April 8, 2012.)
23. Case Study: The Collapse of Lehman Brothers, Investopedia , April 2, 2009, http://www.investopedia.com/articles/economics/09/lehman-brothers-collapse.asp#axzz1ZHdnjptAm. (Accessed on December 10, 2011.)
24. See note 21.
25. Reed Hastings, October 24, 2011 Shareholder Letter, Netflix , http://files.shareholder.com/downloads/NFLX/1536753156x0x511277/8 5b155bc-69e8-4cb8-a2a3-22465e076d77/Investor%20Letter%20Q3%202011.pdf, p. 9. (Accessed December 10, 2011.)
26. Credit must go to the Motley Fool Pro and Options advisor and portfolio manager Jeff Fischer, a friend, colleague, and former business partner, for writing in an early issue of the no-longer-published magazine, The Motley Fool Monthly , that it would be a good idea to sell AOL at the time of the merger.
1. Financial Accounting Standards Board, Statement of Financial Accounting Concept 5: Recognition and Measurement of Statements of Business Enterprises (December 1984) at 30, http://www.fasb.org/pdf/con5.pdf. (Accessed December 12, 2011.) This is the source of the definitions of “realized,” “realizable,” and “earned.”
2. We realize that some use the actual days in the quarter and average the beginning and end numbers of accounts receivable. That’s fine. This simpler formula does the job, so long as it is consistently applied, making comparisons like for like.
3. “EResearch Has Replacement for Esposito,” Philadelphia Business Journal , June, 12, 2006, http://www.bizjournals.com/philadelphia/stories/2006/06/12/daily8.html. (Accessed December 12, 2011.)
4. The following is from Note 11 of Quest’s 10–Q filing on August 9, 2005:
“On March 17, 2004, we acquired Aelita. See Note 3. Certain venture capital funds associated with Insight Venture Partners (the ‘Insight Funds’) previously holding shares of Aelita’s preferred stock became entitled to receive (subject to claims against an indemnity escrow fund) approximately $47.6 million in cash in respect of those shares of preferred stock as a result of this acquisition.
“On May 20, 2005, we acquired Imceda. See Note 3. Insight Funds previously holding shares of Imceda’s preferred stock became entitled to receive cash and (subject to claims against an indemnity escrow fund) shares of Quest common stock representing an aggregate value of approximately $48.0 million in respect of those shares of preferred stock as a result of this acquisition.
“Jerry Murdock, a director of Quest Software, is a Managing Director and the cofounder of Insight Venture Partners and an investor in the Insight Funds. Vincent Smith, Quest’s Chairman of the Board and CEO, and Raymond Lane and Paul Sallaberry, directors of Quest Software, are passive limited partners in Insight Funds and, as a result, have interests in the Aelita transaction and the Imceda transaction which are considered to be not material. One analyst’s ‘not material’ related-party transaction can be an earnings quality analyst’s red flag.”
5. M. Edgar Barrett and Jonathan N. Brown, Case Study: Stirling Homex (Boston: Harvard Business School, 1973), http://hbr.org/product/stirling-homex-a/an/173193-PDF-ENG. (Accessed April 8, 2012.) Eleanor Dienstag, the wife of the Stirling Homex executive who blew the whistle, produced a well-written narrative of the personalities and company’s rise and fall in Whither Thou Goest: The Story of an Uprooted Wife (New York: Dutton, 1976).
6. Michael J. de la Merced, New York Times , November 3, 2006, http://www.nytimes.com/ref/business/03computercnd.html. (Accessed April 8, 2012.)
7. U.S. Securities and Exchange Commission, SEC Staff Accounting Bulletin (SAB) No. 101 – Revenue Recognition in Financial Statements (December 3, 1999), http://www.sec.gov/interps/account/sab101.htm. (Accessed December 12, 2011.)
8. We thank The Motley Fool for permission to reprint John’s Juniper example, © 2011 The Motley Fool:
“We adopted Accounting Standards Update (ASU) No. 2009 -13, Topic 605-Multiple- Deliverable Revenue Arrangements (ASU 2009-13) and ASU No. 2009- 14, Topic 985-Certain Revenue Arrangements That Include Software Elements (ASU 2009-14) on a prospective basis, as of the beginning of fiscal 2010, for new and materially modified arrangements originating after December 31, 2009. Under the new standards, we allocate the total arrangement consideration to each separable element of an arrangement, based on the relative selling price of each element. Arrangement consideration allocated to undelivered elements is deferred until delivery.
“For fiscal 2010 and future periods, pursuant to the guidance of ASU 2009-13, when a sales arrangement contains multiple elements, and software and non-software components that function together to deliver the tangible products’ essential functionality, we allocate revenue to each element, based on a selling price hierarchy. The selling price for a deliverable is based on our vendor-specific objective evidence (VSOE) if available, third-party evidence (TPE) if VSOE is not available, or estimated selling price (ESP) if neither VSOE nor TPE is available. We then recognize revenue on each deliverable in accordance with our policies for product and service revenue recognition.
“VSOE is based on the price charged when the element is sold separately. In determining VSOE, we require that a substantial majority of the selling prices fall within a reasonable range, based on historical discounting trends for specific products and services. TPE of selling price is established by evaluating largely interchangeable competitor products or services in standalone sales to similarly situated customers. However, as our products contain a significant element of proprietary technology and our solutions offer substantially different features and functionality, the comparable pricing of products with similar functionality typically cannot be obtained. Additionally, as we are unable to reliably determine what competitors’ products’ selling prices are on a standalone basis, we are not typically able to determine TPE. When determining the best estimate of selling price, we apply management judgment by considering multiple factors including, but not limited to, pricing practices in different geographies and through different sales channels, gross margin objectives, internal costs, competitor pricing strategies, and industry technology lifecycles.
“For transactions initiated prior to January 1, 2010, revenue for arrangements with multiple elements, such as sales of products that include services, is allocated to each element using the residual method based on the VSOE of fair value of the undelivered items pursuant to ASC Topic 985-605.”
1. Thornton O’glove, Quality of Earnings: The Investor’s Guide to How Much Money a Company Is Really Making (New York: The Free Press, 1987).
2. O’glove, 1987, p. 109.
3. The Lipman quarters conformed to the calendar (March, June, September, and December), while VeriFone’s ended in January, April, July, and October.
4. From Assay Research , March 2008, reprinted by permission.
1. “Behind Salesforce’s San Francisco Campus Debacle,” SocketSite, May 14, 2012, http://www.socketsite.com/archives/2012/05/salesforces_san_francisco_campus_debacle_insight_and_su.html, accessed June 5, 2012; Jim Finkle and Noel Randewich, “Salesforce’s Canceled HQ Project Puzzles Investors,” Reuters, http://www.reuters.com/article/2012/02/29/us-salesforce-idUSTRE81S03I20120229, Feb. 28, 2012, accessed June 5, 2012.
2. Charles W. Mulford and Eugene E. Comiskey, The Financial Numbers Game: Detecting Creative Accounting Practices (New York: Wiley, 2002), 231.
3. Mulford and Comiskey, 2002, pp. 211–213.
4. Mulford and Comiskey, 2002, p. 204.
5. This chapter frequently refers to salesforce.com, where, as with every company, the negative catalyst of aggressive accounting may not—as is true on the long side with positive catalysts—result in the desired stock price result. There is a risk at salesforce.com. CEO Marc Benioff held management positions at Oracle Corp. under CEO Larry Ellison from 1986 to 1999. Oracle, a serial acquirer, has bought software companies started by former execs before. In 2006, it closed the purchase of Siebel Systems, whose founder and CEO Thomas Siebel held a management position at Oracle from 1984 to 1990. Oracle and Ellison might someday moot the negative catalyst for salesforce.com stock by paying a higher valuation to acquire it; we have no evidence that Ellison is a value investor. Ellison has shown that energetic public criticism from competitors is no barrier to acquisition. Benioff is among his most vocal critics.
6. Floyd Norris, “AOL Pays a Fine to Settle a Charge That It Inflated Profits,” New York Times , May 16, 2000, http://www.nytimes.com/2000/05/16/business/aol-pays-a-fine-to-settle-a-charge-that-it-inflated-profits.html. (Accessed December 11, 2011.)
7. ASU 2009-13, “Multiple Delivery Revenue Arrangements,” October 2009, Revenue Recognition, (Topic 605), issued by the Financial Accounting Standards Board (FASB), http://www.fasb.org/cs/Blob Server?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blob where=1175819938544&blobheader=application%2Fpdf. (Accessed December 11, 2011.)
8. There is no better analysis of the credit cycle than Charles Kindleberger’s Manias, Panics and Crashes: A History of Financial Crises (New York: Wiley, 1978), or of the duration of, damage by, and recovery from credit crashes than Reinhart and Rogoff’s exhaustive academic study This Time Is Different: Eight Centuries of Financial Folly (Princeton: Princeton University Press, 2009).
9. Rob Bluey, “U.S. Rivals Japan for World’s Highest Corporate Tax Rate,” The Foundry , September 25, 2011, http://blog.heritage.org/2011/09/25/chart-of-the-week-u-s-rivals-japan-for-worlds-highest-corporate-tax-rate/. (Accessed December 12, 2011.)
1. Financial Accounting Standards Board, “FASB Issues Final Statement on Accounting for Share-Based Payment,” December 16, 2004, http://www.fasb.org/news/nr121604_ebc.shtml. (Accessed December 12, 2011.)
2. Michael Rapoport, “Options Rule Also Hits Operating Cash Flow,” DowJones Newswires , May 15, 2006, Cash Flow Analytics , http://www.cashflowanalytics.com/news.php?articleID=114 (accessed December 12, 2011); BDO Seidman, March 2006, http://www.bdo.com/publications/assurance/finrptnl/fr_april_06/cashflows.asp. (Accessed December 12, 2011.)
3. Reprinted by permission of The Motley Fool. © 2011 The Motley Fool, Inc.
4. James Montier, KPMG, “Value Investing, KPMG survey of global M&A,” report, October 15, 2008, p. 269.
1. Christopher Browne et al., “What Has Worked in Investing: Studies of Investment Approaches and Characteristics Associated with Exceptional Returns” (Tweedy Browne paper, revised 2009), http://www.tweedy.com/resources/library_docs/papers/WhatHasWorkedInInvesting.pdf. (Accessed April 8, 2012) at ii–iii (“Tweedy Browne study”).
2. http://www.incademy.com/courses/Ten-great-investors/John-Neff/9/1040/10002.
3. Warren E. Buffett, “The Superinvestors of Graham-and-Doddsville,” Columbia Business School, 1984. Available at http://www4.gsb.columbia.edu/null?&exclusive=filemgr.download&file_id=522, p. 15.
4. For excellent summaries of these two theories, their proponents, and the ascent of their critics, see Wikipedia, “Efficient-Market Hypothesis” at http://en.wikipedia.org/wiki/Efficient-market_ hypothesis. See also “Modern Portfolio Theory,” accessed June 5, 2012.
5. Justin Fox’s The Myth of the Rational Markets (New York: HarperBusiness, 2009). A great listen on Audible, too.
6. Among others, see Deborah Brewster and David Swenson on “The Campus Endowment Legend Likes to Keep It Simple,” http://www.ft.com/intl/cms/s/0/a8d3be62-1c34-11de-977c-00144feabdc0.html#axzz1wvEf2lDF. (Accessed June 5, 2012.)
7. See, e.g., Bens, Wrong, and Skinner, “What Drive Companies to Repurchase Their Stock? The Relationship Between Employee Stock Options and Stock Repurchases,” paper (Chicago: University of Chicago Booth School of Business), Fall 2003, http://www.chicagobooth.edu/capideas/fall03/stockrepurchases.html, accessed June 1, 2012; Zahn Bozanic, “Managerial Motivation and Timing of Open Market Share Repurchases,” Review of Quantitative Finance and Accounting , May 1, 2010, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1979781, accessed June 1, 2012. (“Firms attempt to manage earnings upward through the use of repurchases,” and other conclusions other than that the repurchase represents better allocation of capital according to value principles.)
8. David Ikenberry, Josef Lakonishok, and Theo Vermaelen reported in their 1995 study that “the highest returns [from stock buy backs] were from the “value stocks” (those with the highest book value relative to the share price of firms that had repurchased shares). “Market Underreaction to Open Market Share Repurchases,” Journal of Financial Economics (October 1995), http://www.nber.org/papers/w4965. (Accessed June 1, 2012.) Apparently value-oriented management knows value at its own company when it sees it.
9. Berkshire Hathaway 1984 Annual Report, available at http://www.berkshirehathaway.com/letters/1984.html. (Accessed June 1, 2012; no page numbers provided.)
10. Tweedy Browne, 2009, pp. 39–40.
11. Nassim Nicholas Taleb, The Black Swan (New York: Random House, 2007).
12. Benoit Mandelbrot and Richard L. Hudson, The Misbehavior of Markets: A Fractal View of Financial Turbulence (New York: Basic Books, 2006).
13. Carmen Reinhart and Kenneth Rogoff, This Time It’s Different: Eight Centuries of Financial Folly (Princeton: Princeton University Press, 2009).
14. Robert F. Bruner and Sean D. Carr, The Panic of 1907: Lessons Learned from the Market’s Perfect Storm (New York: Wiley, 2007). Carr is the reader on the excellent Audible version.
15. A. Gary Shilling, The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation (New York: Wiley, 2010), p. 23 (“deepest recession”) and p. 29 (“S&P 500 Index rose 4 percent, but in real terms plummeted 64 percent”).
1. Relative strength, up/down volume, accumulation/distribution, and more of the metrics in this chapter are available from William O’Neil + Co., their daily newspaper, Investor’s Business Daily , and other sources at www.williamoneil.com.
2. Reprinted by permission of The Motley Fool. © 2011 The Motley Fool.
1. Thanks to The Motley Fool for permission to reprint. Copyright © 2011 The Motley Fool, Inc.
2. Kenneth Fisher, Super Stocks (New York: McGraw-Hill, 2007).
3. James O’Shaughnessy, What Works on Wall Street , third edition (New York: McGraw-Hill, 2005).
4. Everyone disagrees about whether it’s 85 percent over five years or more, or percent, or whatever, but we’ve been unable to find any source that contradicts this statement.
5. For more information, visit our site, www.deljacobs.com.
6. Justin Fox, The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street (New York: HarperBusiness, 2009).
7. This is deliberately provocative, because 2008 is hotly debated. See in particular James J. Green’s “The Failure of Asset Allocation” in the December 2008 issue of Investment Advisor , http://advisorone.com/2008/12/01/the-failure-of-asset-allocation. (Accessed December 13, 2011.)