Superinvestors of Graham and Doddsville: What We Learned


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“While they differ greatly in style, these investors are, mentally, always buying the business, not the stock. A few of them sometimes buy whole businesses, far more often they simply buy small pieces of the business.”  

        Warren Buffett, Superinvestors of Graham and Doddsville

In May 1984, Buffett laid out his thoughts on everything you need to know about his investing philosophy.

In a speech at Columbia Business School, which was later adapted into an essay. Buffett introduced what he termed “The Superinvestors of Graham and Doddsville.”

The “Superinvestors of Graham and Doddsville” is a name that Buffett gave to Benjamin Graham and a group of his proteges. The group of money managers once studied under or worked for Graham, Buffett or Munger, Buffett’s partner at Berkshire Hathaway. We will talk about each of them more in depth coming up.

The speech was given in honor of the 50th anniversary of “Security Analysis” which was written by Benjamin Graham and David Dodd. The book was published in 1934 and was the seminal book on analysis business using financial fundamentals that were outlined by Graham and Dodd.

Warren Buffett is arguably the world’s great investor, there have been many books, essays, and papers written on his greatness. I am not smart enough or eloquent enough to improve on them but I will touch on his beginnings for a moment.

Although Buffett’s father was a stock broker he didn’t have his a-ha moment until he read another very famous Graham book “The Intelligent Investor”. It caused Buffett to apply to the Columbia School of Business to study with Graham. To this day, Buffett credits that book with changing his professional life and Warren believes that most of what everybody needs to know about investing come from two chapters in the book.

The chapter on Mr. Market, which outlines behavioral finance concepts before the term even existed. And the chapter on Margin of Safety.

Breakdown of the speech

At the start of the speech he asks the question “is the Graham and Dodd look for values with a significant margin of safety relative to prices approach to security analysis out of date?”

He then touches on the theory of Efficient Market Hypothesis, which states that the market is efficient in how it prices each and every stock in the market. Meaning that the market is taking into account everything that is known about the company’s prospects and the state of the economy in the price of each stock.

The hypothesis states there are no undervalued stocks because there are smart security analysts who utilize all available information to ensure unfailingly accurate pricing.  

He thinks that this is bunk!

According to the theorists. Investors who are able to beat the market year after year are just lucky. Which would rule out anyone who follows the value investing philosophy of Benjamin Graham and his followers.

In his speech, he asks us to consider a group of investors who have beaten the S&P 500 consistently year in and year out. He wants us to consider their performance against the theory that the market is efficient.

To illustrate his point he starts out by using an example of coin flipping. The next comments are straight from his speech.

“I would like you to imagine a national coin-flipping contest. Let’s assume we get 225 million Americans up tomorrow morning and we ask them to all wager a dollar. They go out in the morning a call the flip of a coin. If they call correctly, they win a dollar from those that called incorrectly. Each day the losers drop out, and on the subsequent days, the stakes build as all previous winnings are put on the line. After ten flips on ten mornings, there will be approximately 220,000 people in the United States that have correctly called ten flips in a row. They have each won a little over $1,000.

Now this group will probably start getting a little puffed up about this, human nature being what it is. They may try to be modest, but at cocktail parties, they will occasionally admit to attractive members of the opposite sex what their technique is, and what marvelous insights they bring to the field of flipping.

Assuming the winners are getting the appropriate rewards from the losers, in another ten days we will have 215 people who have successfully called their coin flips twenty times in a row, and who by this exercise, each have turned one dollar into a little over $1 million.”

Of course, there would be some professor who would state that you could take the same experiment and conduct it with orangutans and get the same result. And to break it down further you possibly find that there was a concentration of winners from a particular geographical region, such as Minneapolis. Your natural inclination would be to go to this zoo and study the habits, food and other environmental stimuli that could lead to this concentration of orangutans that produced these winning flips.

The other conclusion you could come to would be that maybe instead of geographical, maybe it could be the intellectual origin. Buffett thinks that a “disproportionate number of successful coin-flippers in the investment world come from a very small intellectual village that could be called Graham-and-Doddsville. A concentration of winners that simply can’t be explained by chance can be traced to this intellectual village.”

In the group of investors that Buffett wants us to consider, there has been a common intellectual patriarch, Benjamin Graham. All of the investors from this village have followed different paths, picked different stocks, and yet they have had a combined record that just simply can’t be ignored or written off as simply chance.

The common theme of the investors of Graham-and-Doddsville is this, they search for differences value of the business and the price of small pieces of that business in the market.

Efficient Market Hypothesis vs Graham-and-Doddsville

Before we get on with the individual investors of Graham-and-Doddsville, we need to discuss Efficient Market Hypothesis and why Warren Buffett disagrees with it and how he dismantles it.

As we discussed earlier, with Efficient Market Hypothesis (EMH) it is not possible to “beat the market” because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information.

According to EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to purchase undervalued stocks or to sell stocks for inflated prices. This would indicate that it would be impossible to outperform the overall market through expert stock picking or market timing, The only way an investor could possibly get better returns would be to find riskier investments.

As you could imagine, this news was a great relief to the investing community because now they knew that they didn’t need to worry about market timing or stock picking skills. Since all the relevant information was already included in the stock price, one didn’t need to worry anymore about doing research on the companies, or the macroeconomic developments, or the regulatory environment.

The didn’t need to do anything. Zip. Nada. How liberating.

You could purchase anything you wanted at any price because all factors are already included which means that you just need to buy and all will be ok.

This hypothesis was partially developed by Eugene Fama in the 1960s. And part of this theory falls into Modern Portfolio Theory, that was developed by Harry Markowitz in 1952. This theory states that to achieve higher returns you must take on higher risk. Lower returns mean lower risk.

In 2013 Eugene was awarded the Nobel Prize for his work on this theory.

So what did Warren Buffett think of this hypothesis? Let’s take a look at his words directly. This is an excerpt from one of his shareholder letters for Berkshire Hathaway from 1988.

Amazingly, EMH was embraced not only by academics but by many investment professionals and corporate managers as well. Observing that the market was frequently efficient, they went on to conclude incorrectly that it was always efficient. The difference between these propositions is night and day.

In my opinion, the continuous 63-year arbitrage experience of Graham-Newman Corp, Buffett Partnership, and Berkshire illustrates just how foolish EMH is. (There’s plenty of other evidence, also) While at Graham-Newman, I made a study of its earnings from arbitrage during the entire 1926-1956 lifespan of the company. Unleveraged returns earned 20% per year. Starting in 1956, I applied Ben Graham’s arbitrage principles, first at Buffett Partnership and then Berkshire. Though I’ve not made an exact calculation, I have done enough work to know that the 1956-1988 returns averaged well over 20%. (Of course, I operated in an environment far more favorable than Ben’s, he had 1929-1932 to contend with.)

All of the conditions are present that are required for a fair test of portfolio performance: (1) the three organizations traded hundreds of different securities while building this 63-year record; (2) the results are not skewed by a few fortunate experiences; (3) we did not have to dig for obscure facts or develop keen insights about products or managements – we simply acted on highly-publicized events; and (4) our arbitrage positions were a clearly identified universe – they have not been selected by hindsight.

Over the 63 years, the general market delivered just under a 10% annual return, including dividends. That means $1000 would have grown to $405,000 if all income had been reinvested. A 20% rate of return, however, would have produced $97 million. That strikes us as a statistically significant differential might, conceivably, arouse one’s curiosity.

Yet proponents of the theory have never seemed interested in discordant evidence of this type. True, they don’t talk quite as much about their theory today as they used to. But no one, to my knowledge, has ever said he was wrong, no matter how many thousands of students he has sent forth misinstructed. EMT, moreover, continues to be an integral part of the investment curriculum at major business schools. Apparently, a reluctance to recant, and thereby to demystify the priesthood, is not limited to theologians.

Naturally, the disservice is done students and gullible investment professionals who have swallowed EMT has been an extraordinary service to us and other followers of Graham. In any other contest – financial, mental, and physical – it’s an enormous advantage to have opponents who have been taught that it’s useless to even try. From a selfish point of view, Grahamites would probably endow chairs to ensure the perpetual teaching of EMT.”

I would say that pretty much sums up what he thinks of EMH. I don’t think I could have said it any more eloquently.

Superinvestors of Graham and Doddsville

We have talked about EMH and what Buffett thinks of it, now let’s take a look at the investors that he discusses and their records.

First up is Walter Schloss. Over a 28 year period, he compiled a 21.3% rate compounded annually. Schloss never went to college, but took a night course from Benjamin Graham at the New York Institute of Finance. Afterward, he worked at Graham-Newman until 1955.

Schloss was different. He didn’t play by the rules of Wall Street. He ignored the news, bought cigar butts or really cheap, depressed stocks and held them forever. He looked for stocks that were trading for less than their book value. He also looked for companies with no debt, low price-to-book value, simple businesses that he could easily understand. He was a buy-and-hold investor who held onto his picks for many years. For more info on Walter, check out this great article from Old School Value here.

Next up is Tom Knapp, who with Tom Anderson formed Tweedy, Brown in 1968. Tom was a chemistry major at Princeton before WW2 and after the war spent some time at the beach. One day he learned that David Dodd was teaching an investing course at night at Columbia. He took it as a non-credit course and loved it so much that he ended up enrolling at Columbia Business school and received his MBA from there.

Tweedy, Brown Partners had a record over 16 years of 20% returns compounded annually. They have a wonderful manual called “What Has Worked in Investing.” I highly recommend you check it out. It’s Free!

Next up is the author himself. Warren Buffett. We have spent quite a bit of time talking about so I won’t go into much detail here. His returns at the time of this speech were 23.8% compounded annually. Not too shabby.

The fourth investor that Buffett used for comparison purposes was Bill Ruane who ran the Sequoia Fund. This fund is arguably one of the most famous funds out there. It has been closed to new investors for years. As a matter of fact, I just learned that Guy Spier, an amazing investor himself bought a share of Sequoia on eBay so that he could attend the annual meetings.

Bill Ruane was a graduate of Harvard Business School and afterward went to work on Wall Street. When Warren Buffett wound up his Buffett Partnership he asked Bill if he would handle all of his partners, and they to a person went with Bill to set up the Sequoia Fund to invest those funds. The Sequoia Fund was able to generate returns of 17.2% compounded annually over 14 years. Pretty outstanding.

One thing I should note. Of the investors that we have discussed, there has been very little overlap in the companies that they owned, which I find very interesting. This indicates that there are many ways to value companies that you are interested in buying and it is not always the same companies that will strike your fancy.

One of the great things about value investing is that you can take the teachings of Ben Graham as a foundation and then branch off from there. That is what every single investor that we have discussed so far have done and you can too.

The fifth investor on the list is none other than Charlie Munger, who has been Warren’s right-hand man through the last 56 years. Charlie graduated from Harvard Law and worked as a lawyer for many years. After a conversation with Warren about changing careers, he told Charlie that law was a fine hobby, but that he could do better.

He was right. Charlie was a very concentrated investor who only held a few stocks in his portfolios, which lead to some pretty crazy volatility but he was mentally prepared for that. He has become a brilliant teacher of mental models and some awesome talks and speeches that you should check out. My favorite is here.

Charlie’s returns during the 13 years shown here were 19.8% compounded annually. Pretty impressive.

Next up on the list is Rick Guerin, who was a math major at USC, where he met Charlie Munger. He worked at IBM after graduation and was a convert after Charlie was converted from Warren. He operated the Pacific Partners and his returns were an eye-popping 32.9% compounded annually. That is simply amazing and from probably the least know of the people mentioned in Warren’s speech. His returns were the best of any of the people mentioned. Little is known of him after 1984.

The seventh investor from the speech is Stan Perlmeter who was a liberal art major from the University of Michigan. He was a partner of an ad agency before making the switch to investing. Another investor that is little known and not much more after the speech. He was not trained in business but took to value investing quite naturally. He was only interested in what the business was worth. When the business was trading at a discount to what he thought it was worth, he would buy it. He was only interested in deep value. His returns of 23% compounded annually over 18 years are pretty impressive.

The last two investments that Buffett mentions are pension funds that he didn’t have direct involvement in but who he recommended that they install value-oriented managers to help improve the fund’s performances. Both funds have subsequently held a number one rating in their size class for funds.

A final note about all the investors that Buffett selected. These were people that he personally knew and was familiar with their backgrounds, teachings, and philosophies when it came to investing. They all had different takes on value investing and there was very little overlap in the portfolios but the results they achieved are nothing short of extraordinary.

Their philosophy was simple. Buy businesses, not stocks. Find a good business that is selling for less than it is worth. Do that and you will have a margin of safety in case you make a mistake. And you will make money over time. That is the key, patience and time.

Final Thoughts

The speech Warren Buffett gave was amazing. He laid out his thoughts on value investing and compared it to the latest theories on how stock markets worked. He pulled no punches when he stated that the EMH and modern portfolio theory are wrong.

His whole goal with the speech was to educate. He wanted to show everyone that his way of looking at businesses was a much easy and more practical way to do it. His results and the other investors that he mentions should lay to rest any doubt about what he is talking about. They speak for themselves.

A note about Eugene Fama, later on in life he came to change his opinion on value investing and as a matter of fact did studies that showed that small-cap stocks could outperform the market over a period of time. He felt like this was based on the higher risk premium of a small cap stock. They have more volatility to them because of their size.

So over time, he has come to agree that there are mispriced stocks in the market. Which is what Warren was preaching from the beginning.

Value investing is not easy and it takes a certain type of individual that has the right mental capacity to handle the ups and downs of the market. It has nothing to do with brain power. Only that you have the stomach for the roller-coaster ride that can be the stock market.

The principles of buying dollar bills for 40 cents is a pretty simple process to understand. In Warren’s opinion, it either takes to you immediately or it doesn’t take at all. Of course, there is more to it than we are discussing here, but the concept of buying at a discount is pretty simple and what we all strive to look for.

I will close this up with a quote from Warren, after all, he says it best.

In conclusion, some of the more commercially minded among you may wonder why I am writing this article. Adding many converts to value approach will perforce narrow the spreads between price and value. I can only tell you that the secret has been out for 50 years, ever since Benjamin Graham and David Dodd wrote Security Analysis, yet I have seen no trend toward value investing in the 35 years I’ve practiced it. There seems to be some perverse human characteristic that likes to make easy things difficult. The academic world, if anything, has actually backed away from the teaching of value investing over the last 30 years. It’s likely to continue that way. Ships will sail around the world but the Flat Earth Society will flourish. There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham & Dodd will continue to prosper.”

I will put the link to this amazing speech here.

As always, thank you for taking the time to read this post. I hope you have found it educational as well as entertaining. If you think anyone you know would benefit from this information please share it with them.

Take care,


403b: 9 Benefits that Can Help Your Retirement Savings Grow

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What is a 403b?

A 403b plan is a retirement plan for certain public school individuals, employees of tax-exempt organizations, and ministers. Individual 403b accounts are set up by employees and managed by eligible employees.

While not as prominent as the better-known 401k, the 403b retirement framework is often used by schools systems, churches, hospitals and may other types of organizations.

The structure of the 403b is as follows.

An individual account within the 403b typically takes the form of a Tax Sheltered Annuity. This is an annuity contract offered by an insurance company. In exchange for a premium, which can be paid in a lump sum or a series of payments. The insurance company agrees to make fixed or variable payments beginning at a future date. This can be either for a specific term or for the rest of your life.

Like a pension, your contributions and your contract’s earnings from investments can consider building up your retirement income stream.

A 403b can also be structured as a custodial account that can invest in mutual funds.

Some 403b plans which are specific to churches can take the form of an account that invests in either mutual funds or annuity contracts.

You can’t contribute directly to your 403b plan. What they do instead is per your salary-reduction agreement they withhold a predetermined amount from your paycheck. This is known as an “elective deferral”. These elective deferrals are exempt from income tax, although you are still responsible for Medicare and Social Security tax on these contributions.

Plan earnings are also exempt from income tax until the participant withdraws them. This is one of the big benefits of the 403b plan and the tax-deferred annuity structure.

One thing to keep in mind is that some plans don’t allow for after-tax elective deferrals. In these cases, the deferral amounts aren’t deductible on your tax returns. Of course.

On top of elective deferrals, your employer can contribute directly to your plan via “non-elective contributions”. Current regulations allow your account to be funded through a combination of elective deferrals and employer contributions.

So how much can I contribute to my 403b?

This is going to get a little technical so bear with me. It will make sense.

Contributions to a 403b depend on each participant’s annual “Maximum Amount Contributable” or MAC. The rules for calculating your MAC are a little complicated, but the IRS provides a worksheet to help you with the steps in its Publication 571: Tax-Sheltered Annuity Plans. The MAC will test you on two major limits.

  1. Limits on annual additions. This is the limit on all employee and employer contributions that can be made on your behalf, including any after-tax contributions. For 2016, the limit on annual additions is the lesser of $53,000, or 100% of eligible compensation for your most recent year of service.
  2. Limit on elective deferrals. This is the amount you are allowed to contribute to your 403b plan through a salary reduction agreement. For 2016, the limit on elective deferrals is $18,000. Keep in mind that if you contribute to any other retirement accounts, those amounts must be accounted for when calculating your contribution limit for your 403b plan.

So your MAC will depend on the types of contributions that you have made to your account during the year. According to the IRS guidelines, if you’ve only made elective deferrals, and haven’t received any employer contributions. Your MAC will be the lesser of the limit on annual additions, or the limit on elective deferrals.

Confused, I know I was. So let’s try this. If your employer isn’t contributing to your account, you can make elective deferrals to your total eligible compensation for the year, but this is capped at $18,000.

If you have only received non-elective contributions from your employer, or if you’ve made elective deferrals and also received non-elective contributions, then your MAC is the limit on the annual additions.

Benefits of the 403b

Contributions to a traditional 403b are tax-deductible. Your federal income tax is deductible in a traditional 403b. This means that your money placed in a 403b is free from any taxes. This tax deduction is valuable because it can lower your taxable income which in turn lowers your tax bill. For example, if your last $10,000 adjusted gross income was taxed in the 25% tax bracket. This would mean that you would save $2500 in tax savings.

Taxes are paid on distributions in retirement a time when many peoples are in a lower tax bracket. Like a Traditional IRA, when you make pretax contributions your deductions in retirement will be taxed at that time. The advantage would be that when you retire you would ideally be in a lower tax bracket. Most people fall into this category and if you don’t then we don’t really need to worry about this because you have done an outstanding job saving for retirement. So if during your working career you were in a high tax bracket when you retire you will most likely fall into a lower one, which means that those retirement dollars that have been working so hard for you will now pay you big dividends without having to give Uncle Sam so much money.

Some 403b plans have a Roth. Since 2006, employers have had the option to allow Roth contributions to 403b plans. Unlike the Traditional, Roth contributions are not eligible for tax deductions. But the flip side is that when you make distributions from the Roth you will not have to pay taxes. Caution however because not all 403b plans allow Roth accounts. The employer must elect to offer a Roth option to be able to offer this to their employees.

Side note to adding a Roth option to the 403b. Studies have shown that a Roth outperforms Traditional accounts over the long-term because of tax savings.

Savings grow tax-free. A huge advantage of the 403b plan is that you don’t have to pay taxes on dividends, interest, and capital gains on investments held in your 403b account. Now if you hold your investments in a standard taxable brokerage account, you will lose potential gains from the drag of taxes on your account.

With the 403b you don’t need to worry about tax effects on your investments. You are able to rebalance your account more often without losing anything but the trading fees. You also don’t have to worry about the tax efficiency of your mutual funds that you hold and can focus on high returns and low expenses. This allows you to choose more aggressive mutual funds or index funds to help maximize your retirement savings. Without the usual consideration of the effect, taxes can have on those funds.

Loans can be taken against a 403b plan. There are certain plans that allow this, however, most financial advisors do not advise using this option as it lessens the amount of money you have in your 403b for retirement.

In certain situations, this could be a viable option. For example, buying a home. If you choose to use this option it is vital that you understand all the conditions of the loan. The requirements for these loans are very exacting if you miss even one payment it could trigger a default on the loan which would allow the IRS to declare a default and penalize you an early withdrawal penalty.

Employers can offer contributions matches on a 403b. This is a huge benefit that you should be sure to take advantage of. Simply find out what the company will match and be sure to contribute that amount from your paycheck.

Let’s show and example so you can get an idea of how much this could benefit you.

Let’s say you make $40,000 a year and you are 30 years old. You start your 403b with $1000 and you retire when you reach 65. If you contribute 6% and your company matches that contribution you final retirement number would be $375,548. This would be with a 7% return for those 35 years.

Now if we follow the same scenario and your company doesn’t offer a match your retirement funds would be $354,895.

This is a difference of $20,653 or 5.5% of your funds. This is without any increase in your salary for those 35 years. If we throw in an additional 5% annual salary increase. Wouldn’t that be nice? The numbers increase to $691,735 with the match and $653,184 without. For a difference of $38,551 or 5.5%. The point of all this I am trying to make is that would you throw away $38,000? Of course, you wouldn’t. So just contribute to get the match, all right?

Some 403b custodians allow employees to invest in low-cost “institutional funds”, which otherwise have prohibitively high investment minimums. Sometimes 403b plans can get you better investment options than you can on your own. This is because financial institutions will gladly take on the management of a 403b plan because it means access to hundreds of millions of dollars of new assets. To help entice employers they will waive requirements to access institutional funds, that will typically have prohibitively high entrance fees. This will allow the employees to invest in these funds, that they would normally not have access to.

An example would be the Vanguard Institutional Index Fund Institutional Plus Shares (VIIIX) which has an expense ratio of 0.025% and normally requires a $200 million minimum investment to get into the fund. And with your 403b you have access to this fund. Awesome.

Contribution limits are higher than for an IRA. The more money you can save for retirement in a tax-sheltered account the better for you.

As of 2016 you are allowed for elective deferrals to contribute $18.000 and if you are over 50 you can add an additional $6,000 in catch-up funds. These limits are huge over the Traditional and Roth. As of 2016, you can contribute $5500 per account and $6500 if you are over 50.

So obviously the more you are allowed to contribute the more you have invested for your retirement. And as we have shown the power of compounding will work it’s magic for you.

15 Year Rule. Some employees may be eligible to make additional contributions based on this rule.

A unique benefit of 403b plans is that they allow additional contributions for those that have 15 years of service with the same employer and have not contributed in excess of the cutoff point in previous years. Employees must calculate a number of additional contributions they are able to make by applying a three-part rule found in the IRS Publication 571.

403b or a Roth?

Which do we invest in? That is the question. The first criteria that must be met for us to consider are whether your employer matches any portion of your contributions or not.

If they do, then the choice is easy. Contribute up to the match, because even though the investment choices may not be what you want you would be crazy to turn down free money. As we have shown in earlier comments there is a ton of money to be made by accepting this free money. After you contribute up to your employer’s match then you should open a Roth IRA and contribute to that to its limit.


This will give a little control over your investments and also help with your tax burden. With the Roth, you will be able to choose any type of investment that you desire and feel comfortable with.

So, if your employer doesn’t offer a match then the decision is a little more tricky. Your best bet would be to open a Roth IRA and contribute to that first as you have many more choices of investments and the ability to change as you see fit. Once you have met the limits on the Roth then you should start contributing to your employer’s plan.

The reason for going with the Roth first is that you have more choices and flexibility as well. In addition to the tax benefits of the Roth and not tying up all of your money in your employer’s plan.

Another consideration to take into account as well would be that any investment with a public pension plan is a very big risk in today’s environment. With the public funding facing so many challenges it is a risk to put your money in these plans.

Especially for teachers who are part of a pension plan through their school districts. As they know there is a constant pressure to find money for so many programs and it would be a shame to have all of your retirement in this one egg and see it go bad and lose all or your savings. I guess what I am saying is that it would be wise to hedge your bets. And have money in a Roth IRA and your employer’s plan.

Final Thoughts:

The 403b plan is more intricate than the more well-known 401k. It is little understood and not much talked about. Partly this is because the 403b plans are for public employees, teachers, and church members.

And because of this limited audience, it doesn’t get much love.

These plans are great retirement options for these employees, especially if the employer offers a match to their contributions. The plans offer many benefits, including tax benefits that help your investments grow through the years. Also, there is the benefit of much higher contribution limits than are found in either the Traditional IRA or Roth IRA. Another benefit is the access to institutional investments that others will never have access to. These investments have great potential and extremely low fees which helps the bottom line too.

Some of the limitations of the plans are they limited investment choices, such as mutual funds. And the fact that the money is tied up and there is little flexibility if you need the funds for other needs that may come up. And for teachers there is the risk of the local government that you work for may run into financial trouble which would put your investments at risk.

Overall these are good plans for the people that are able to take advantage of them. Particularly if your employer offers to match your contributions. Then the tax benefits, much higher contribution limits and the potential to invest in the institutional funds.

As always thank you for taking the time to read this post and if you think it would be of benefit to someone else, please share it with them.

Until next time.

Take care,


3 Different Types of Annuities and How They Can Be of Benefit


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Did you know that Charles Dickens refers to annuities in his novels often because they were the favored investment of the upper class in 18th century Europe?

Or did you know that Babe Ruth didn’t lose his money during the Great Depression because his money was safely invested in annuities?

One last one for you. Did you know that Wheel of Fortune often gives away annuities as prizes?

Annuities are a product that most of us have heard of, but what do we really know about them? What are they really? How do they work and when should I use them?

These are some of the questions we will answer as well as looking at the different types of annuities, and there are many.

What are Annuities?

Annuities were invented by Babylonian landlords in approximately 1700 BC. They used the income from a certain piece of farmland to provide lifetime rewards for soldiers loyal assistants.

In more recent times, annuities were first offered to the American public in 1912 by the Pennsylvania Company for Insurance on Lives and Granting Annuities.

According to Investopedia, an “annuity is a contractual financial product sold by financial institutions that are designed to accept and grow funds from an individual and then, upon annualization, pay out a stream of payments to the individual at a later point in time. The period of time when an annuity is being funded and before payments begin is referred to as the accumulation phase. Once payments begin, the contract is the annuitization phase.”

Annuities were designed to be a reliable source of steady cash flows for an individual in their retirement years. Or alleviate risk or the fear of outliving your money. A very real fear.

Annuities can also be created to turn a large lump sum of cash into a steady cash flow. This is great for winners of large sums of cash such as lottery winners or a winning a lawsuit.

Defined benefit pensions or Social Security are two examples of lifetime guaranteed annuities that pay retirees a steady cash flow until they pass.

You remember those J.G. Wentworth commercials? Well, those are the perfect example of a lifetime guaranteed annuity. You give them your lump sum of cash and they give you a lifetime cash flow for that exchange.

How do Annuities Work?

An annuity is a cross between an insurance product and an investment product. They come in many different shapes and sizes, but the basic theme is that you give your money to a financial institution, like an insurance company and they promise you a certain rate of return, usually for the rest of your life.

The annuity will make payments to you on either a future date or series of dates determined by you. The income you receive from an annuity can be paid out monthly, annually, or even a lump sum payment.

Typically the size of your payments is determined by the length of your payment period, among many other factors. You can either opt for a set number of payments for a set number of years or opt for payments for the rest of your life.

A big question asked often, are there tax benefits to an annuity?

In a word, yes. Money that is invested in an annuity grows tax-deferred. When you eventually start to take distributions that original investment is not a tax, but any gains will be taxed at the regular tax rate. This is very much like a Roth IRA in that respect.

Do you use annuities in an IRA? No, no, no, must I say it again! No.

Putting your money in an annuity is already tax-advantaged, which is one of the main benefits of any IRA, so that would be like trying to fly that airplane you are on by flapping your arms. Silly.

What are the different types of Annuities?

There are two different types of annuities: deferred and immediate.

1. Immediate Annuity-this is usually the easiest annuity for most people to understand. In its most basic form, it has very easy provisions. A typical fixed immediate annuity involves you making a lump-sum payment to an insurance company upfront. This is done with the understanding that you will receive payments on a regular basis from the insurer on an immediate basis. These would begin right away.

You can structure an immediate annuity to pay for the rest of your life, for a fixed period of time, or for as long as you live and you designate someone as a beneficiary and they will continue to receive your benefits for as long as they live.

Payments for most immediate annuities are sensitive to interest rates, so when rates are low, like today, historically low if you weren’t aware. And when I say historically, I mean as in the history of mankind! This means that the amount of future income you can receive from an immediate annuity will be small.

Something else to keep in mind. If you purchase an immediate annuity based solely on your life and you pass away shortly after purchasing the annuity, the money spent on the premium can be lost if you don’t choose a specific insurance rider for your contract.

As a way to ensure a steady stream of income during your lifetime, an immediate annuity can be of some benefit.

2. Deferred Income Annuities-Unlike immediate annuities, deferred income annuities don’t start making payments right away.

They are very similar in many ways to the immediate annuity. You pay a lump sum upfront to your insurance provider and the agree to make payments in a predetermined amount to you at a later date determined by your contract.

Many people use deferred income annuities as a hedge against longevity risks, with payments that are scheduled to kick in when you are 80 to 85. These can provide supplemental income when you need it most.

Theses annuities are somewhat sensitive to interest rates as well. But the payments can be much higher than with immediate annuities because of the delay to receive payments and the chance that you will pass away without reaching the specified age.

The kicker with this type of annuity is that you could get nothing if you pass away before your specified age of your contract. This kind of annuity is often referred to as the longevity insurance. There are very few insurers that offer this type, those being New York Life, Symetra Financial, and Northwestern Mutual. These companies are willing to hedge against the possibility of you living a longer life.

One difference with this type of annuity from the immediate is that you don’t have to offer up as big of a lump sum in exchange for future payments per your contract.

Let’s say you are 55, you buy a $100,000 immediate annuity that will start paying you $5800 a year for the rest of your life, with the payments beginning right now. Or you could buy a deferred income annuity that will pay you $68,000 a year starting at 85 and continuing for the rest of your life.

This longevity insurance can reduce the risks of living a long life but it can be a risk that you won’t live that long and not be able to collect on that money.

3. Fixed Annuities-A fixed annuity is an annuity whose value increases based on the returns improving during the life of the contract. The money that is invested in the annuity is guaranteed to earn a fixed rate of return during the accumulation phase of the annuity. During the annuitization phase, the money less the payouts will continue to grow at the fixed rate.

Typically fixed annuities don’t have payments begin right away and can be considered deferred annuities. But the difference being that unlike a deferred annuity you get to pick and choose when your payments can begin during the contract.

Interest rates can be higher on fixed annuities than bank CDs and other popular income investments, and another bonus. They are tax-deferred.

You do have to be careful about how you access the money and the ease of getting it. There may be taxes and penalties involved in accessing the funds when you may need them. Surrender charges can make it extremely expensive to access the money in the first few years after you open an annuity. You will be able to find any specific provisions in your fixed annuity that will allow you to access the funds.

Among fixed annuities there are two main types:

  1. Life Annuities-there are several different kinds of life annuities, they differ by the insurance components they offer. Certain types of life annuities may alter the future payment structure of the annuitant in the case of something negative happening, such as illness or sudden death. The more insurance components that are added, the longer the payments may last over time and consequently, the more components the lower the payments will be over time. The also depend on the life expectancy of the annuitant, the shorter the expectancy the higher the payments and the longer the smaller the payments.

        In addition, the more insurance components added to the annuity

        The more expensive it will become. With life annuities, you can designate a beneficiary who will receive a lump sum payment upon the passing of the annuitant.

  • Straight Life Annuities-these are the simplest form of life annuities. The insurance component is based on nothing but providing income until death. Once the annuitization phase begins, the annuity will pay a set amount until death. Because of the simpleness of the insurance component, it is the lowest cost annuity. Also, straight life annuities do not offer any form of beneficiary payments after the annuitant’s death.
  • Substandard Health Annuity-it is a straight life annuity that may be purchased by someone with a serious health problem. These annuities are priced according to the chances annuitant’s chances of passing away in the near term. The lower the life expectancy, the more expensive the annuity because there is a reduced chance of the insurance company making a return on the money invested in the annuity. Because of this, the annuitant will receive a lower percentage of their original investment in the annuity. In addition, because the life expectancy is shorter the payments will be substantially larger.
  • Joint Life with Last Survivor Annuity-This annuity continues payments to the annuitant’s wife after their death. The payments continue no matter what, there is no term limit that must be passed. These annuities also allow additional beneficiaries to be added in the unforeseen early death of the significant other. In addition, the annuitant may designate lower payments for the beneficiaries. This type of annuity gives the spouse peace of mind of continued payments after the annuitant’s passing. And because the payments are individual payments, this eliminates a tax liability as they would have with a lump sum payment. One downside is the added insurance components which makes this annuity very costly.

2. Term Certain Annuities-these annuities are very different from the life annuities. Term certain annuities pay a given amount per period up to a specified date, no matter what happens to the annuitant during the term of the contract. One downside, if the annuitant dies before the end of the contract then the insurance company gets to keep the remainder of the annuity’s value. There are vastly fewer insurance components to this type of annuity which makes it substantially cheaper than other annuities. Another downside is that once the contract is fulfilled there are no more payments, so the income stream ends.

For all fixed annuities the growth of the money invested is tax-deferred. But annuities can be purchased with pre-tax funds and be tax-deferred. Or they can be purchased with after-tax funds. The type of income, pre-tax or post-tax, with which an annuity is purchased determines whether it can be qualified for tax-deferred status.

Qualifying annuities are purchased at retirement with funds that have been invested in a qualified retirement plan and have grown tax-free. Qualifying annuities can be purchased during your working life with monies that have not already been taxed.

Annuities that are purchased with funds that have already been taxed are not considered tax-deferred.

The advantage of a qualified annuity is the growth of the funds tax-free and then are only taxed upon disbursement. The advantage of a nonqualified annuity is tax-deferred growth on the income made from taxed money invested in the annuity.

One potentially big problem for these types of annuities beneficiaries are taxes. When the annuitant passes away the beneficiaries will have a very large tax burden on the investment income. It is very important to do your homework and consult with a tax accountant when setting up an estate plan that will include annuities. You don’t want to burden your loved ones with a big tax burden after you pass.

4. Variable Annuities

Variable annuities are often called “mutual funds with an insurance wrapper”. This all-in-one product that is sold by the insurance company combines the characteristics of a fixed annuity with the benefits of owning mutual funds. When you pay your premium, it goes towards the purchase of accumulation units of those mutual funds.

The Good

Variable annuities get a lot of bad press from misleading sales techniques and inadequate disclosure. But there are some annuity products out there that have some benefits for you.

  • Tax-deferral of investment gains-just like your IRA, your contributions and gains grow tax-deferred until you start to take distributions.
  • Ease of changing investments-because variable annuities have sub-accounts with numerous mutual funds to choose from, there is very little cost, if at all to the investor to make a change.
  • Income for Life-once you select payment from you account, you and your wife, if you should choose that option are guaranteed payments for the rest of your life.
  • Asset protection-in certain states, annuities are shelters from creditors.

The Bad

Although the idea of income for life sounds great, one little point that most annuity salesmen forget to mention is that once you decide to annuitize your contract. Then your contract is frozen, and your decision is final.

Let’s take an example to show you how this can be bad for you. Let’s say you pay an insurance company $264,000 at age 60 and accept the company’s offer to pay you $1000 a month for the rest of your life. You will have to live until 82 just to break even on the contract and if you die before then you will have surrendered the rest of money to the insurance company. If you live past 82 then they will have to continue to pay you. This is the bet you have to make, that you will live longer than the insurance company thinks that you will, that is their hedge. That you will die before you collect all of the money. Nice, huh.

Another downside is that once you sign the contract you cannot touch the funds until you are 59 ½ or you will pay a 10% penalty on the withdrawal. Additionally, when you start to take distributions you will be taxed on the investment gains at your ordinary income tax rate instead of the long-term capital gains rate. For some this could be higher than the capital gains rate.

So you think having your funds frozen once you decide to annuitize? Wrong!

The Ugly

  • Surrender charges-Most insurance companies charge you a surrender charge, usually a diminishing seven to eight-year scale. Starting around 8% the first year and decreasing 1% a year incrementally. So, a $100,000 investment could cost you $7000 in surrender fees if you decide to move your annuity into another company in the second year.
  • Front-end loaded annuities-to this day annuities are primarily commission based products. When your salesperson attempts to sell you the annuity, you must ask about the commission they will make from selling the annuity. In most cases they will make a 5% fee on the sale, your funds will be under a surrender penalty for at least 5 years. In addition to that, the mutual funds will charge your fees too. So check for front-load fees, 12b-1 fees, and others.
  • Annual fees and administrative and mortality and expense charges-This is where investors get burned. All of these charges are buried in the language of the annuity contract and take away from your annual profits. The average annuity will charge around 1.4% for these expenses, and some as high as 2.5%. Keep in mind that if your fund’s performance is less than that you will lose money! They will take the fees regardless of how poorly the mutual fund performs. That is the rip off of mutual funds.

Final Thoughts

Annuities have been around for thousands of years. They go so far back that a Roman named Domitius Ulpianus compiled the first recorded life table for the purpose of computing the estate value of annuities.

So these products are nothing new, but I would argue that they are very misunderstood and misrepresented.

We discussed what an annuity is and how they are set up. We also discussed at great length many of the different kinds of annuities that are out there. And to be honest we only scratched the surface of this product. There is so much information out there about annuities that it was a little overwhelming. I could probably write 10 more posts about annuities and still not cover everything.

My goal with this post was to illustrate how an annuity could be a benefit to you, with the right guidance from a trained professional that you trust.

There are some great annuities out there, you just need to look and ask questions.

Annuities have gotten a bad rap in recent years because of frankly a lot of greed and deception on the part of the agents that sell them. The fees involved in annuities can be extremely prohibitive to your returns and it is absolutely imperative that you ask lots of questions and if you aren’t sure, don’t pull the trigger.

On the good side, they can be a great way to guarantee income in your later years, and potentially at a great rate. They also can help you set up arrangements to make sure that your beneficiaries are taken care of. Which can be a great relief.

That should do it on annuities.

As always, thank you for taking the time to read this post, and if you find it of value and you think it could be of benefit to someone else. Please share it with them.

Take care,


Tools That I Use to Be a Better Investor


Photo courtesy of

This is a list of the different tools that I use to help me find the stocks that I investigate, track, and purchase. It is an ongoing list and I discover new tools all the time. Please check back from time to time to see what may have changed. I will update as I discover new things. This is the fun part as we discover more ways to learn about stocks and how to invest. It is never over, the learning. 

Stock Screeners:


This is hands down my favorite screener. It is super easy to use and has great information on all sorts of financial data. It is sortable by rows and you can edit out the data you don’t want. It does have a premium edition that enables you to export your picks into an excel spreadsheet.

One of the things I like about this particular screener is that you can sort by all the financial data I am looking for to weed out the stocks I won’t be interested in. For the value investing metrics that I look for it gives me great flexibility to edit those metrics out to help narrow down the choices.

It also has links to different news sources relating to the particular company you are investigating. Another perk of this site is that if you are looking for in-depth info on a company and need the data quickly it is easy to search for that data on their site.

One last perk, it is free!


This is another great screener that I will use to get additional ideas. I came across this website in general thru Preston & Stig from The Investors Podcast. They use this site for their stock screener. They send out a checklist for signing up for their newsletters that have some great ratios for you to screen for.

One of the things that I like about the Google screener is not only the ability to screen for stocks but also the ability to check on all the news in the financial world.

An additional plus is you can download the app as well so you can access all of these features from your smartphone as well.

Also free.



This is one of the best sites to gather financial data on any company that you are interested in. It has ten years of data, which can be difficult to find on many sites.

The site is mainly geared to mutual funds and has many resources, including ratings of funds to help you pick the best fund for you.

However, I use it mainly as a source of financial data on the individual companies that I am trying to evaluate. It allows you to gather information from financial statements, balance sheets, and cash flows. Extremely useful information and you can sort it as you need. In addition to this information,  they also have a tab that breaks all this down to ratios. Which is extremely valuable and time saving. Lastly, they also will include the analysts’ ratings and projections which come in very handy when you are working on discounted cash flows.

Overall, this is one of my favorite sites and I spend quite a bit of time here. All the information that I have referenced is free and they also have a paid subscription which has much more extensive information as well. Offers an app that allows you to see your watchlist and track industry news.


An extremely well laid out site. Gurufocus has some amazing information at your disposal. They have some great screeners that allow you to sort the data however you would like. With the site, you can create your own watch list that you can sort all of the data available to help you make your decisions. This site is probably setup a little more user-friendly than morningstar but unfortunately, some of the more advanced data is behind a paywall. 

Another useful tool is the ability to track what stocks some of the big name investors are buying or selling. You can choose any large investor and see exactly what they are doing. For example, you can search the portfolio of Warren Buffet. By law, he has to file a 13f, which details his activity within his portfolio. With this filing, you can see what is being bought and sold, how many shares are purchased, and at what date they are purchased. With this info, you can get some ideas based on what he is currently holding. This is a great tool to help you gather some ideas to investigate to possibly purchase in the future.

Another useful tool they offer is the ability to do a discounted cash flow analysis of any company. This can help you determine a margin of safety for that particular company and help you decided if it is overpriced at that particular moment. I use this a lot to help me.

Also offers an app that is very useful for tracking your watch list and some quick financial data to check up on certain companies.


Seeking alpha

One of my favorite sites. I spend a lot of time on this site because of the great articles are written by so many awesome writers. There is some great analysis of companies here. It is a treasure trove of information and gives you a great idea of how a particular company is doing. You will see both sides of the coin here, bear and bull on the same company.

One of my favorite aspects of the watch lists with seeking alpha is that you can create as many different watch lists as you like. You can also name them and sort them as well. In addition to the many lists, you can create you can also drill down into each company to find out more information about that company. Great site.


I already mentioned this site above so I won’t go into those aspects some more. The one thing I really like about this watch list is the ability to set a purchase price so you can see real-time results to give you a good idea of how you are doing picking stocks. This is super useful if you are trying to track companies that you aren’t sure enough to purchase but want to track their performance from a particular price point.


In addition to all the great features that I spoke of above, one of my favorite aspects of this site is the ability to set as many different watch lists as you like. And you can determine a purchase price and a brokerage cost which allows you to see how profitable your picks have been. It is a great way to track your purchases as well as your potential purchases. With this tool, you can see how well your watch list is doing. For example, I just recently read a great book by Joel Greenblatt in which he discusses his “Magic Formula” for picking stocks. After reading about this I decided to test it out myself and set a watch list based on his formula so I can see for myself how it performs. And so far it has done pretty well considering the market has been a little sideways for most of the year.


Value Investors Club

This is a site run by Joel Greenblatt that features the detailed analysis of different companies. The site has a free version that allows you to see data that is 45 days old. There is a paid version that allows you to see everything real time. To enroll you need to present one detailed original idea for a company to invest in.

The one thing that makes this site so useful is that you can see some great stock picks with amazing detailed analysis. This information can help you decide if that particular company is worth doing some more digging into. Plus it can also open your eyes to some companies you might have never thought of or given any thought to before. Very useful site and I highly recommend you check it out.

This list is by no means complete and will continue to grow as I grow and learn. None of the tools or sites mentioned here should be a sole means of making a decision to purchase a company. They are meant to be a starting point of analysis on the road to making that decision. Never just find one stock you like and decide their balance sheet is great I am going to buy, or that their stock price falls to the price you were looking for. Without understanding the whole picture you are asking for trouble and this can lead to some big losses that you might not be able to recover from. 

If you have any favorites or tools that you like to use, by all means, please let me know. I am always looking for different sites or tools that I can use to help me find and make better decisions. 

401k vs Roth: Which is best for you?

photo courtesy of girls just wanna have funds


“Hang in there, retirement is only 30 years away!” Workplace graffiti
401k is one of the most common words used when discussing retirement. But what do we really know about them? Most employers offer them to their employees as a means of providing a benefit to their employees. It is also a means of retirement for many workers.

Let’s lay out some stats for you so you get a framework of the influence a 401k has on our retirement.

Total value of assets held in a 401k   $4.5 Trillion

  • Percentage of assets held in a 401k    18%
  • Total number of participants in a 401k    52,500,000
  • Percent of works that participate   81%
  • Average percent of salary contributed   6.8%
  • Percent of assets held in a mutual fund   64%

The average match of company contributions to 401k plans is 2.7%.

Let’s spend a little time to layout what a 401k is and how it works. Then we will spend some time comparing it to a Roth IRA.


What is a 401k?


A 401(k) is a retirement savings plan sponsored by an employer. It lets workers save and invest a piece of their paycheck before taxes are taken out. Taxes aren’t paid until the money is withdrawn from the account.”   Wall Street Journal

The 401k was established in 1978 and has grown to become the most popular type of employer-sponsored retirement plan out there.

Millions of workers rely on their 401k for their retirement plans. It also a vehicle for companies to distribute stock options to their employees.

By definition, a 401k plan is an arrangement that allows the employee to defer a percentage of their salary to the 401k. The amount is usually not taxable until the employee until it is withdrawn or distributed from the plan.

Some plans allow the contributions to their 401k to be made on an after-tax basis. This is known as a Roth 401k plan and these amounts are tax-free on withdrawal.

The 401k is considered a defined-contribution plan. This means that the accounts balance is defined by the contributions to the plan as well as the performance of the investments.

The employer is not required to make a contribution, but most employers wisely choose to match a percentage of their employee’s contributions. This is based on a percentage of their gross pay.

This is free money and it is a sin to pass this up. Regardless of the amount that your company offers, TAKE IT!!! My employers offer a 6% match, which is awesome. I am saddened on a daily basis when I hear that people are not taking advantage of this option.

Contribution limits for the 401k for 2016. Will be the same in 2017


  • Maximum that can be contributed is $18,000 annually
  • If you are 50 or older you can make catch-up contributions of $6000 annually
  • The maximum allowable for joint employee/employer contributions is $53,000 or $54,000 (2017). This includes employer match, nonelective contributions, and profit-sharing contributions.

Let’s talk a little bit about distribution rules. The rules for distribution differ from those of an IRA. The money inside an IRA and 401k grow tax-deferred. But a difference arises where with an IRA you can access the money at any time. With a 401k a triggering event must occur for a distribution to be made from the 401k plan. The assets within the 401k can only be distributed in these circumstances.


  • Upon the employee’s death, retirement, disability or separation of service from the employer.
  • Upon the employee’s attainment of age 59 ½
  • When the employee experiences a hardship as defined under the plan, provided the plan allows for hardships


Required minimum distributions are required to begin at 70 ½ unless the employee is still employed and the plan allows rmds to be put off until retirement. Distributions will be considered ordinary income and assessed a 10% penalty for early distribution if done before the age of 59 ½ unless an exception applies. Exceptions include the following:


  • The distributions occur after the death or disability of the employee
  • The distributions occur after the employee separates from service, providing the separation occurs during or after the calendar year that the employee attains age 55.
  • The distribution is made to an alternate payee under a qualified domestic relations order
  • The employee has deductible medical expenses exceeding 10% of adjusted gross income
  • The distributions are taken as a series of substantially equal periodic payments over the participant’s life or the joint lives of the participant and beneficiary.
  • The distribution represents a timely correction of excess contributions or deferrals.
  • The distribution is the result of an IRS levy on the employee’s account.
  • The distribution is not taxable


The exceptions for higher-education and first time home buyer are only for an IRA. Sorry.

Another option for access to your funds would be a plan loan. This is an option that is available to those that their plans allow. It is a loan that you are able to borrow up to 50% of your vested balance and can’t exceed $50,000. There is typically a 5 year payback period.

The interest rate must be comparable to most loans from financial institutions. Any unpaid balance at the end of the term will be considered a distribution and will be taxed and potentially penalized accordingly.

Please explore all other options before considering this as a way to access funds. In addition to the possible fees and penalties you also have that money not earning interest for you during that time. This could be extremely expensive for you in the long run. With the power of compounding, that money could increase exponentially and when you take it out of the 401k as a loan it is now not working for you.

401ks have income limitations to them. If you are a high-income earner, meaning over $200,000 a year. Let’s say you earn $550,000 a year. You are only able to consider the first $265,000 for contributions towards the 401k. This will rise to $270,000 for 2017.  Employers can offer nonqualified plans, like a deferred compensation or an executive bonus plan to provide other options for additional retirement savings.

401k plans will continue to be the backbone of retirement plans here in the US for many years to come. This has been a brief overlay of the plans. Every employer that offers them will have specific details on their plans available to their employees. If you have any questions you can discuss them with your plan provider or reach out to me.


What is a Roth?

A Roth is a retirement plan that is after-tax money. Meaning that when you make a contribution from your paycheck it is coming after the taxes have already been deducted.

The advantage to this is that you will never have to pay taxes on those contributions ever. This means that when you start withdrawing the money during your retirement you will not have to pay Uncle Sam for that money because he’s already gotten his share.

You will be responsible for taxes on any gains during its time in the Roth and of course, any capital gains made as well. Another advantage to the Roth is no mandatory distributions when you reach 70 ½ or any age. You can start distributions any time you want after age 59 ½.

These are the main points of a Roth IRA. We discussed this account in great detail here. Please refer to that post if you want more information.


401k vs Roth

First, let’s talk about how a 401k is set up. You have the option when you start contributing to your 401k of what type of account you would like to have. You can use either the Traditional or Roth or the combination of both.

When your contributions are made they will be taken from your paycheck accordingly, based on the instructions you decide upon. The money will be withheld from your paycheck either before tax or after tax, depending on which type of IRA you choose.

The money will then be invested in whichever investment vehicle you choose.

For those who are eligible for employer matches in their 401k. Take it, for sure. Don’t make me get ugly. Next thing to consider is that most employer matches come in the form of company stock, which can be great. Especially if you company performs well.

This investment is considered as a before tax contribution or a Traditional. Later on, this will be something to consider when you are making decisions about rollovers, as well as distributions when you are retired.

Any dividends you receive in your 401k are eligible for reinvestment at no charge. This is an awesome way to grow your savings and I would highly, highly encourage you to take advantage of this option. Remember through all of this compounding is our friend.

Let’s talk about investment choices within a 401k. These ideas apply to either the Traditional or Roth designation.

Within your 401k plan, your employer is going to provide investing options for you. They are going to be a mixture of mutual funds, ETFs, index funds, bonds and target date funds.

So you can choose any mixture of those investments that you want. And you can mix them however you wish. Let’s take a look at them each briefly.


  • Mutual funds will be the most common option for you. Within this category, you will typically have choices between large cap, small cap, international, emerging markets and so on. One thing to keep in mind with mutual funds is the fees involved. Typically there are more expensive than ETFs or index funds. This can substantially erode your money.
  • ETFs are similar to mutual funds with one huge difference. The fees are drastically reduced which is great for you. You have the same assets available to invest in but at a lesser cost.
  • Index funds are the lowest fees in the fund class. These funds track a particular index such as the S&P 500. Again you have the same choices of assets to invest in.
  • Bonds are probably the narrowest choices you will have. Typically you will have a bond index fund and maybe an emerging market bond fund or international bond fund. This part of your portfolio should be the thinnest.
  • Target date funds. These are funds that have a target date picked out for you based on when you are scheduled to retire. Each fund then has an allocation strategy picked out for you. As you are younger the allocation will be more aggressive and as you age the fund will shift to more conservative allocations to help protect your investments as you get closer to retirement. This is the best option to start with if you have absolutely no idea what to invest in and want to get started.

A typical asset allocation for your portfolio in a 401k would look something like this.


  • Age: Less than 40 — 100% equities. Of this, invest 40% in a large cap growth fund, 25% small cap growth funds, 25% large cap value funds, and 10% International.
  • Age: 40-50 — 80% equities and 20% fixed income. Of the equity portion, invest 40% large cap growth fund, 25% small cap growth funds, 25% large cap value funds, and 10% International. The fixed income would be in bond funds.
  • Age: 51-55 — 70% equities and 30% fixed income. Same allocation as above for equity portion and 30% in bond funds for the fixed income segment.
  • Age: 56-60 — 50 % equities and 50% fixed income. Same allocation as above.
  • Age: 60-65 — Reduce equities 5% each year and increase fixed income 5% each year, so that at retirement you 25% equities and 75% fixed assets.


Ok, so we have talked about what a 401k is and how they work. We have also talked about different investments available and asset allocation strategies to help maximize your account.

Some stark differences between the two accounts are first. With a 401k your investment choices are pretty limited. And in some cases limited to expensive mutual funds which are going to drive down your investment gains with all the fees you will be responsible for.

The 401k allows you the option to switch in and out of different investment options, however, you will be charged a fee for these transactions. This can get very expensive very quickly so it is a better idea to at least talk through ideas before implementing them. As you get closer to retirement, saving every penny becomes important. And the choices you make for your retirement account will have a big impact on your ability to make enough money to retire with.

The investment choices with a Roth are limitless. You can literally buy your company’s stock if you want, at any time. This gives you tremendous freedom to design your own retirement portfolio as you wish. You can have stocks, bonds, warrants, muni’s, T-bills, and the list will go on and on. Also remember that this is all done with after tax money so you are not on the hook for any taxes at this point. You also don’t have that pesky RMD that you have to do every year

So why would you choose one over the other? One reason could be because your company doesn’t offer a match at all. In that case, what would be the opportunity to invest in the 401k when you have other, possibly cheaper options that you get to choose for yourself.

So let’s say your company doesn’t offer a match, then what do you do? My suggestion is to max out your Roth IRA first, for the tax benefits. And then you look at putting money into the company’s 401k for the tax benefits. Remember that the contribution limits for a Roth are $5500 for single filers and $6500 for older signers. Once you reach this limitation of the Roth then you can start investing in the 401k  again.

So we have spent some time talking about the 401k and your investment options. Now we are going to take a moment and talk about the Roth.

First, I want to remind you that a Roth is an after-tax retirement account. Meaning that any money you contribute will be after the taxes are deducted from your paycheck. The advantage of this for you is that you are not going to have to pay any taxes on those contributions when you start doing distributions during your retirement.

This can save you thousands of dollars in your retirement. And let’s be honest who doesn’t want to save money on their taxes.

As for your investment options. The door is wide open to anything you want. You can buy individual stocks, bonds, mutual funds, ETFs, index funds, real estate and precious metals. These are all available in a Roth.

The advantage for you if you go down this road is that it gives you so much more flexibility and control over your own finances. If you are of the type where that matters to you, then this is the way to go.

Keep in mind this should be after you determine that you are not going to have any matching funds in your 401k from your employer. If you do have matching funds then you must take advantage of that and then start contributing to the Roth.

Another advantage to the Roth is the ability to keep your fees for your investments down. As we discussed in my post on mutual funds, the fees on those types of investments are a killer. They can cost you thousands over the course of your investment lifetime.

With the flexibility that you have to choose so many more options, you have the ability to keep those fees down even more on other investments as well. For example, instead of two or three different index funds to choose from you would have hundreds. And you could search for the ones that have the lowest fee structure and still fit your investment criteria. A win, win for you.


Final Thoughts


Investing for your retirement offers some really big challenges. Which account do I choose? Which investments do I choose? How much money do I need to invest?

If your employer offers any type of retirement accounts you should learn as much about them as you can before making your choices. Most employers offer at least a 401k for their employees. This is in their best interests because if they offer a benefit for your retirement it can help promote better employees.

If your employer offers matching funds for your contributions you must absolutely take advantage of that. I mean that is free money, and who likes to give away free money? Nobody.

The best thing for you to do is to contribute as much as your employer matches, to take advantage of that benefit. Then, if you are able, you should open a Roth IRA and contribute as much as you can to that to give yourself some options.

One thing I will mention about investing in your 401k. Each plan offers prospectuses on each investment. This is a document that outlines what each mutual fund offers in regards to investment styles and a listing of the top stocks in their portfolio. They will also list their fees for that particular fund.

This allows you to research all of your potential investments to see which would be the best fit for your allocation strategy, risk profile, and fee structure.

So as you can see this is not about a 401k versus a Roth, but more about how they can work together to give you the best option for your retirement savings. If your employer doesn’t offer the match start with the Roth.

I wanted to mention one final thing about the Roth IRA. There are some opinions that you should only invest a Roth or Traditional, depending on your viewpoint. To me, this is silliness. They both offer some great advantages and you can mix and match them to your advantage.

What do I mean by this? If you are younger, chances you will be making less money at the start of your career. At this stage, it makes absolute sense to contribute to a Roth for the tax advantages. As you age and move up in your career you will, hopefully, be making more money. At this stage, it would make more sense to move to a Traditional to take advantage of those tax benefits.

As you can see there are so many ways that you can arrange things to take advantage of all the different accounts. It’s just a matter of deciding what your plan is going to be and executing on it.

As always, thank you for taking the time to read this and if you found something you think someone would find useful. Please share it with them.

Until next time, take care


Microsoft, Would I buy it again?


Microsoft, one of the largest, best-known tech companies out there. They are an interesting mix of trendy and hip. Or old-school tech with their previous reliance on arguably out-dated tech, laptop computers and Windows operating systems. With the advent of cloud computing and data storage, they have recently soared back into our collective conscience with their success in this field.

This company was the first stock I ever purchased so it has a soft spot in my heart. And always will. I have never sold that original purchase and have made additional ones since. I would like to take some time to look at why I bought this stock back then and what I think of the purchase now based on my evaluation of today’s company. Would I have bought it back then knowing what I know now?

Let’s take a look and see.

Business Overview

Microsoft was founded in 1975, and they operate in 190 countries around the world. Microsoft(MSFT) is a technology company “whose mission is to empower every person and every organization on the planet to achieve more. Our strategy is to build best-in-class platforms and productivity services for a mobile-first, cloud-first world.”

Their products include operating systems: server applications, business solution applications, software development tools, video games, and training and certification of computer system integrators and developers. They also design, build and service PCs, tablets, gaming consoles, and of course. Phones.

This is by no means and exhaustive list but a sampling of some of the more well-known products they offer. Of course, the two best known being Windows and Xbox.

For the year ending 2016, Microsoft reported revenues of $85,320 billion which resulted in net income of $16,798 billion. This was a decrease of 9% in revenue from 2015 and an increase of 11% in net income from 2015. The earnings per share increase from $1.48 in 2015 to $2.10 which was an increase of 42%.

Some explanations from MSFT for these changes were in 2016 there was a deferral of net revenue from Windows 10 of $6.6 billion(9%) and an unfavorable foreign currency impact of about $3.8 billion or 4%.

Additionally, the changes in EPS from 2015 to 2016 were due to the negative impact of the Windows 10 net revenue deferral and impairment, integration, and restructuring expenses. This drove down the EPS $0.69 to $2.10. This was an increase over 2015 but not as much as it could have been, obviously.

Some key changes in expenses were:

  • The cost of revenue decreased $258 million or 1%, mainly due to a reduction in phone sales, which was a result of the change in strategy regarding the phone business.
  • Impairment, integration, and restructuring expenses decrease $8.9 billion, due to prior year goodwill and asset impairment charges related to the phone business and restructuring charges associated with changes in the phone business.
  • Sales and marketing expenses decreased $1 billion or  6%, driven by a reduction in the phone business and a favorable foreign currency impact of about 2%.

Some highlights for 2016 were:

  • Commercial cloud annualized run rate exceeded $12.1 billion
  • Office 365 consumer subscribers increased to 23.1 million
  • Microsoft Dynamics CRM Online seat additions more than doubled year-over-year
  • Microsoft Azure revenue grew 113%, with the usage of Azure compute and Azure SQL database more than doubling year-over-year. Enterprise Mobility customers nearly doubled year-over-year to over 33,000.
  • Windows 10 is now active on more than 350 million devices around the world
  • Xbox Live monthly active users grew 33% year-over-year to 49 million.

In June 2016, the big announcement occurred that MSFT was going to buy LinkedIn. The agreement was for $196 per share in an all-cash transaction valued at $26.2 billion.

In other news from MSFT, in May 2016 the announcement of the sale of the entry-level feature phone business for $350 million. The sale is expected to close towards the end of 2016 but no announcement has come yet.

The hope is to streamline MSFT into one Windows experience and continue to focus it’s energies on the cloud experience as the driver of future incomes.

Source Microsoft 10-k 2016

Productivity and Business Processes

The focus of this part of the business is helping people be more productive by bringing intelligence to familiar office apps that they use every day. MSFT recently introduced cloud power intelligence to Word, Excel, Powerpoint, and Outlook. The company is also building intelligence into their apps to provide advanced security for its customers.

Monthly users of Office 365 commercial are now over 85 million, which is up more than 40% year-over-year. Office 365 seats were also up 40% year-over-year and revenue up 54%. Office is available on other devices as well which now has over 45 million users on ios and android, which is an increase of 70% year-over-year.

Productivity and Business Processes revenue increase slightly, due primarily to and in an increase in Office and Dynamics revenue. This revenue included a loss due to foreign currency exchange of 6%. Office commercial revenue saw an increase of $135 million or 1%, which was driven by increases in Office 365 commercial revenue. This was mainly due to an increase in subscribers. This was offset by lower license volume as MSFT has seen a shift in business PC market to Office 365. Office consumer revenue decreased $69 million or 2%, which was driven by the decline in the consumer PC market. This was offset by an increase in Office 365 revenue, mainly due to subscribers. Lastly Dynamics revenue increased 4%, this was mainly because of higher revenue for Dynamics CRM Online. This was driven by seat growth.

Operating Income and gross margin decreased for Productivity and Business Processes for 2016 primarily due to lower gross margin and higher cost of revenue, respectively. Each was down 7% and 4% or $898 million and $970 million. The Gross margin included the unfavorable impact from foreign currency which was 6%.

The cost of revenue increase $1 billion or 26%, this was due primarily to an increased mix of cloud offerings. Lower marketing expenses helped reduce the operating income by $72 million or 1%. The sales and marketing expenses were driven lower by the reduction in headcount-related expenses. This decrease was $82 million or 2%.

Intelligent Cloud

The Intelligent Cloud segment consists of public, private and hybrid server products and services. These services include Windows Server, SQL Server, and Azure. There is also an Enterprise component as well. These are all designed to help the IT professionals be more productive and efficient.

Azure is the main driver of cloud services for Microsoft. It is a scalable cloud platform with computing, networking, storage, database, and management. It is very flexible and allows customers to manage many different aspects of their business and devote more time to the business instead of the management systems.

Revenue from this segment increased $1.3 billion or 6% in 2016. This was primarily due to higher server products and cloud services revenue. This, of course, included a negative foreign currency impact of about 5%.

Server products and cloud services grew revenue $686 million or 4%, driven primarily by growth from Azure of 113%. There was a slight decline in on-premise server products which offset this growth.

Enterprise services revenue grew by $536 million or 11%, this was driven by growth in the Premier Support Services.

Intelligent Cloud operating income was down $513 million or 5% in 2016. The main culprit was higher operating expenses. Operating expenses increased $989 million or 12%, which was due to higher research and development expenses and S&M expenses. The increase in R&D of $567 million or 12% and S&M of $347 million or 9% was due to increase strategic investments and acquisitions to drive cloud sales capacity and innovation.

Gross margin increased $476 million or 3%, which was offset by a higher cost of revenue. This drove a growth in revenue. The costs of revenue increased $851 million or 15%, which was driven by an increased mix of cloud services.

More Personal Computing

This segment is all about everything Windows. It is meant to connect all users from developers, IT professionals, and end users. It includes Windows licensing, devices that include phones, Surface, and PC accessories. Also included in this segment is Xbox revenues and Bing advertising revenues.

Windows 10 has been a transformative event for the company as the software moves away from just an operating system on a PC to a service that can power a full array of devices.

The devices consisted primarily of phones and Surface. With the changes in the phone business, this segment of the business has been hit the hardest with revenue drops. In May 2016 Microsoft announced that they were selling the entry-level phone business.

Next up is the gaming business. Xbox with its multiple streams of revenue has been a big winner for Microsoft. With the launch of Xbox live and it’s ability allow people to connect live and share online experience. The purchase of Minecraft in 2014 has helped enhance the gaming portfolio across many different platforms.

Lastly are Bing and the advertising that it brings to the table.

In 2016 revenue declined for the More Personal Computing segment by $2.7 billion or 6%. This was mainly due to the lower revenue from Devices and Windows. This was offset by the higher revenues from Search advertising and Gaming

Devices revenue decreased $3.7 billion or 32%, which was mainly due to lower revenue from phones. This was driven by a change in strategy in phones. But there was an increase in Surface revenue. The decrease in phone revenue was $4.2 billion or 56% while the increase in revenues from Surface was $486 million or 13%. This was driven by the release of Surface Pro 4 and Surface Book.

Windows revenue decreased $871 million or 5%, primarily from lower revenue from patent licensing. This was driven by a decline in the PC market as less computer sold, the fewer licenses sold per unit.

There was an increase in Bing advertising revenues of $1.7 billion or 46%. This was primarily because of a growth in Bing, due to higher revenue per search and search volume.

More Personal Computing saw an increase in operating income of $1.5 billion or 32%, which was due to a decrease in operating expenses, which did see a decrease of $2 billion or 13%. This was all due lower sales and expenses in marketing and R&D. Sales and marketing expenses decreased $1.3 billion or 19% and R&D decreased $676 million or 10%. All of this was driven by a reduction in phone expenses. Gross margins dropped $564 million or 3%, due to lower revenue and despite a reduction in the cost of revenue. The cost of revenue dropped $2.1 billion or 9%, driven primarily by a decrease in phone sales.


The risks that MSFT face are twofold. First would be competition in the technology field, which is incredibly fierce. There is a constant battle of who can stay cutting edge and relevant in each field that they compete in. Windows is always going to be in a battle with Mac about which is the better operating system.

There is always someone out there trying to develop something better. MSFT has to devote tremendous time and resources to development to remain competitive. Some of the competitors that exist for a market share of operating systems would be Adobe Systems, Apple, Cisco, Facebook, Apple, Google, among others. Some very big hitters indeed.

In the internet surfing world, which is dominated by Google, MSFT competes with Bing. In the cloud, they face competition from Oracle, SAP, IBM. And finally, in the world of online gaming, they face off against Sony and Nintendo. With the lifecycle of a gaming station being 5 to 10 years there is fierce competition to see who will come up with the next best thing.

Another big risk is the failure of a new product or system. There is incredible time and resources put into the development of any new product or system. This investment is incredibly speculative because if it fails it can really set a company back, both monetarily as well with their reputation. It can take several years to become profitable on any new release which can affect the revenues of the company.


My process for evaluating companies has grown over the years, like everyone else’s. Today I have a set of criteria that I initially look for before I will look into the company more deeply. If I come across a company that peaks my interest I will do a quick evaluation with the following ratios. If those ratios don’t meet the standards then I move on to the next idea. The cool thing about value investing is that you don’t need to swing at every pitch. If you don’t like something, don’t swing.

The ratios are as follows:

  1. Equity Growth Rate
  2. Return on Invested Capital
  3. Revenue Sales Growth
  4. Earnings Per Share Growth
  5. Free Cash Flow Growth

The two most important to me are the Equity Growth and ROIC. For all of these, I look for at least 10% of each category. In addition, I will also look for trends, whether it is declining steadily or rising steadily. If there are sharp drops or rises in the growth rates. Basically looking for patterns.

The time periods I use are:

  • 10 Year
  • 5 Year
  • 3 Year
  • 1 Year

This gives me a snapshot of how the company has been doing and what their track record is. It also helps weed out a newer company that you may need to apply different standards for.

Chart courtesy of IRA for Beginners

First up is Equity Growth Rate. As you can see the numbers had been on a steady decline over the last ten years. I attribute this to MSFT being a more mature company that was struggling to stay relevant in the tech world.

Notice that there was a big jump in the last year. I think this is an indication of the new focus of the company and the switch away from its previous plan. With the switch away from personal computers and phones and towards the cloud based technologies they have found a new voice to help them grow as a company, once again.

A longer time period is needed to assess this trend to see if it continues. Based on this ratio I would pass at this time.

Chart courtesy of IRA for Beginners

Next up is ROIC Growth rate. Based on the first look at these numbers you can see they have done a pretty good job of being capital allocators. Ten years ago they were awesome and the last 5 years have seen a gradual decline. None of the numbers are necessarily bad but the decline is a little troublesome.

Another indicator of their allocation of capital is the payment of dividends. On this score, MSFT has been outstanding. They have increased their dividend payments from $.39 to $1.39 a share in 2016. That is a 72% increase!

ROIC is also another indicator of a moat for a company. With the decline in ROIC in the last ten years, you could argue that maybe they have lost some of their moats but I would argue that with the change in direction of the company I think this will be something to watch going forward.

You have to applaud management for seeing the writing on the wall and shifting directions. It is not an easy thing to do but necessary in today’s business world to succeed.

Based on the numbers here this would be a buy, with caution.

Chart courtesy of IRA for Beginners

Third in our list of ratios to look at is EPS Growth Rate. As you can see here it has seen pretty even over the last ten years with a huge spike in the last year. The spike can be attributed to a loss in revenue and EPS, that was reported in the 4th quarter of 2015. When compared to 2016 this comparison drove up the growth rate substantially. This was due to the impact of a $7.5 billion non-cash impairment charge related to assets associated with the acquisition of Nokia Devices, in addition to a restructuring charge of $780 million. These numbers are all GAAP reported.

If you look at the Non-GAAP reporting the EPS and revenue normalize to historical levels. This would show a very slight rise in growth for EPS in 2016. The increase would have been incremental of .47%. Pretty negligible.

Based on the trend of growth for the last ten years, this indicated to me that it is a mature company that right now is looking for an avenue for growth. As we have discussed time will tell on the cloud emphasis.

The current level of these ratios would have me pass.

Chart courtesy of IRA for Beginners

The next ratio we will look at is revenue growth rate. As you can see from the chart above it has been in a steady decline of the past ten years with a sharp drop in the last year. Digging into this further I found out that MSFT deferred $6.6 billion due to the deferral of revenue from Windows 10. The revenue from Windows 10 is realized at the time of billing and is assigned to the More Personal Computing segment. The deferral has been assigned to the Corporate and Other segment, where it is reported.

If you add that revenue back into the current numbers you will still see a decline but it is far less dramatic. And the decline can be attributed partially to a loss of currency exchange of $3.8 billion. The difference with the deferral added back in would be a loss of 1.7%, which given the currency exchange loss helps explain the difference.

Of course, you never like to see a decline in revenue but as we have discussed the company is changing direction and turning a company the size of Microsoft is like turning the Titanic before the iceberg. Slow and laborious but eventually it will move. Maybe not the best analogy, given the circumstances but the illustration fits.

The results of this ratio would be a pass.

Chart courtesy of IRA for Beginners

The last item up for bid today is the Free Cash Flow Growth rate. As you can see, pretty good ten years ago but the last five years or so pretty mundane.

Free cash is the lifeblood of any company and with the lackluster growth in this area, there is a reason for concern. With the decline in revenue over the last ten years and ROIC flattening out as well, you can see why the need for a change in direction.

Microsoft has such a strong balance sheet with so much cash on it. Currently, that number sits at $139 billion. This gives them a tremendous amount of flexibility. So the lack of FCF is not incredibly limiting for them like it might be for other companies.

The results from this ration would cause me to pass as well.

Final Thoughts

Microsoft is one of the world’s most recognizable companies with amazing products and services that are utilized by millions of people around the world every day. They have come a long way from the early days and have become one of the industry leaders in the tech world.

As I stated, in the beginning, MSFT was the first stock I ever purchased so it will always have a place in my heart. We all have our firsts and it is interesting to go back and look at why we bought it in the first place. My rationale honestly was that I was new to this and it was a company that I was familiar with and I read a few articles about them so it seemed like a wise investment.

I have never lost money on the buys that I have made, but I have not made as much as I could have buying other companies.

As my investment knowledge has grown and will continue to grow. Because I will never know it all, that’s what makes it so much fun. My views have changed over the years and I have come to embrace the value investing philosophy. And as I have embraced this set of ideas my valuations of the companies that I buy or look at has changed.

This has been an incredibly fun exercise to work through the numbers and the story of Microsoft. And I have to say I have learned so much about the company. It is a fascinating company with tons of opportunities and I am excited to see where it is going to go.

Having said all that I would have to say that based on what I see currently I would have to pass on buying the company currently. The ratios that we discussed are just not where I would want to see them. I am looking for at least 10% growth in each ratio and ideally to see them growing over the years.

In addition to the ratios, if you look at a quick intrinsic valuation using the graham formula you come up with a value of $17.20. Quite a bit below the current price today, which leads to me feel like the company is currently overpriced and wouldn’t fit into a category where I would feel comfortable buying it.

Microsoft has a lot going for it and I think the switch to the cloud-based platforms that they are developing will lead to growth. Also, another avenue that we didn’t discuss was their recent purchase of LinkedIn. There are many opinions both for and against, and I won’t weigh into those for now. But I know that Microsoft will continue to look for opportunities to grow internally or externally by adding companies that will create more growth for them.

As always thanks for taking the time to read the post. If you found it informative please take a moment to let other know.

Take care,


Trinity Industries (TRN): Are they still running down the track?



Trinity Industries (TRN) is a leading company that specializes in industrial products and services. They offer railcars, railcar parts, and leasing, management and maintenance products. They also offer additional services such as barges, storage and distribution containers as well as highway products and wind towers.

The company which is based in Dallas, Texas was founded in 1933 and employs 22,030 people and has annual sales of $6,392.7 billion as of 2015. Sales have tripled in the last five years from $1.9 billion to the current $6.4 billion.

In the last five years, TRN stock has seen a 74% increase in the current price of $23.49.

The last decade has seen a steady increase in earnings growth as well as dividend increases as well. TRN has paid dividends for the last 209 quarters and counting. While not in the same class as a Dividend Aristocrat, the fact that they have paid a dividend since 1964 lets me know that their shareholders are important to them.

TRN is not the highest-yielding stock. Its dividend currently is a pretty paltry 1.86% right now. But what it lacks in yield, it makes up for with consistency.

Business Overview

Trinity Industries breaks up their business into five different groups. We will discuss them in turn.

Rail Group

The Rail Group which is responsible for 45% of the revenue generated by TRN is a leading manufacturer of railcars, railcar axles, and railcar coupling devices.

They also produce autorack cars, boxcars, covered hopper cars, and tank cars among others. Currently, they compete against five other major railcar manufacturers in North America.

In 2015 TRN shipped 34,295 railcars which were 41% of all railcars shipped in North America.

In addition to the railcars, the Rail Group also manufactures railcar parts and components used in manufacturing or repairing railcars including couplers, axles, and other equipment. They also have repair services available at multiple facilities in the US.

They have set up the manufacturing to be able to change to demands of the business and be able to provide any type of railcar that is needed.

Railcar Leasing and Management Services Group

This group is a leading provider of leases for tank and freight railcars. Through TrinityRail they coordinate sales and marketing for this group, which provide a single point of contact for railroads and shippers seeking railcars and services.

Railcar Leasing was the second biggest driver of revenue and profit for TRN in 2016 with 20% and 35% respectively.

In addition, the Railcar Leasing Group also administers and manages a newer initiative for them. It is known as RIV Rail Holdings(RIV). TrinityRail was the first in the industry to create a platform of RIVs for institutional investors. Since 2006, TRN has placed $5.1 billion to RIVs.

RIV or Railcar Investment Vehicles are customized portfolios of leased railcars for institutional investors. All which are managed by TrinityRail.

Construction Products Group

Construction Products Group or CPG is a leading full-line manufacturer of highway guardrail and crash cushions in the US. In addition, TRN is a leading producer and distributor of lightweight and natural aggregates for concrete producers.

The Construction Products Group contributes 10% of the revenue and 5% of the profits for Trinity Industrials.

Energy Equipment Group

The Energy Equipment Group is a leading manufacturer of structural wind towers used in the wind energy market. The towers are produced in the US and Mexico and assembled by the customers. Most of the customers are wind turbine producers.

In addition to the wind towers, they also produce utility structures for electrical transmission and distribution, storage and distribution containers, cryogenic tanks and tank heads for pressure and non-pressure vessels.

The utility structures for electrical transmissions are used by primarily municipalities and other local and state governments. They are produced in US and Mexico and assembled by the customer. TRN is a leading manufacturer of these products.

This group contributes 15% of the revenues and 13% of the profits.

Inland Barge Group

This Group is a leading manufacturer of inland barges and fiberglass barge covers here in the US. TRN manufacturers a wide range of dry cargo barges, such as deck barges and open and covered barges that transport items such as grain, coal, and aggregates. The Inland Barge Group also manufacturers tank barges that are used to transport liquids such as chemicals and petroleum products. The fiberglass segment is used for grain barges.

The Inland Barge Group was responsible for 10% of the revenue and 7% of the profit.

All in all, this is quite a diverse lineup of products and services that are provided by Trinity Industrials. The two largest departments, Railcar Group and Railcar Leasing make up 65% of the revenues and 75% of the profits of the company.

Growth Prospects

Frankly, the growth prospects for Trinity Industrials in the short term are bleak. The company is very much a cyclical company and they are dependent on the whims of the economic cycle. With the current economic environment, they have seen a slowdown in orders for railcars from the industrial sector. In the second quarter of 2016, they received orders for 2910 railcars.

These orders reflect the economic environment and the replacement of the aging North American car fleet. Currently, TRN has a backlog of 40,205 railcars that are valued at $4.3 billion. With the orders they have received for the second quarter, the entire production of 2016 of 27,000 railcars has been sold and are currently working on getting orders for 2017.

There is weak industrial end-user markets, large American railcars, and excess railcar industry manufacturing continue to negatively impact new railcar orders and put pressure on lease fleet utilization and rates.

There are small pockets of industry that are seeing some light at the end of the tunnel. One of those industries being the frac sand producers. The sand producers are optimistic following the uptick in oil prices in the last quarter. They are indicating as the uptick in oil continues that there will be a strengthening demand for sand usage. This is being closely monitored by TRN and they have the ability to adapt their production to deliver smaller cube covered hoppers when the demand increases.

During the second quarter 2016, Rail Group delivered 6500 railcars, a 15% decline from the first quarter. This directly impacted the operating and financial performance for the quarter.

Another area that has been pressured by the downturn in industrial demand has been the lease fleet. The utilization of the lease fleet was down to 96.4% for the second quarter. The overhang of existing railcars in the marketplace and weak industrial demand is reducing renewals and causing declines in lease rents.

One area of promise is the RIV platform, which is currently guiding between $300 million to $400 million for the year, with a sales range between $130 million to $230 million for the second half of 2016. In the second quarter of 2016, the Leasing Group was able to complete sales of $149 million which resulted in a $43 million profit.

The RIV platform currently helps the Trinity Rail Group drive 25% profit to the bottom line of Trinity Industries. As the economy continues to muddle along, institutional investors are going to continue looking for hard assets to invest in. RIV offers them a hard asset that will continue to grow in value, has 30-40 years of life, and provide access to the continuing shift from shippers and railroads to third party lessors like TrinityRail.  The RIV platform provides Trinity Industries with a fantastic way to help utilize their current manufacturing abilities while not having to change who they are fundamentally. It also gives them another source of income and help insulates them from the vagaries of economic conditions.


Trinity Industries faces three main risks as they continue down the path.

  • Cyclical business: Trinity Industries is a manufacturing business that is dependent on the ups and downs of the economic conditions. As the economy improves there will be more demand for delivery of goods and services. As railcars are critical components of North America’s transportation infrastructure. Trinity Industries stands to ride that wave as things improve, calling for more orders of railcars to fill the customer’s needs. And conversely, as things wane the demand will lesson.
  • Steel Industry: The principal material used in TRN’s production is steel. During 2015, the supply of steel was enough to support the manufacturing needs. The market for steel is extremely volatile and ended 2015 lower than 2014. TRN utilizes many different strategies to help mitigate the volatility in steel and currently have enough in the supply industry to meet its demand.

The price of steel dropped early in 2016 and had a late rally around April. It is expected to fall again this fall as the glut of steel on the market drives orders down which will drive down demand and the price. Also to factor in is the upcoming election and the uncertainty that will bring. China, who is the largest producer of steel in the world has agreed to cut production but has failed to do so as of October 2016. This has had a drag on the market because they are also one of the biggest exporters of steel because of the government subsidies that drive down the price. US steel companies have been struggling to keep up.

Falling prices are good for Trinity Industries as it provides more profit margin on their production of rail cars. Steel is the number one commodity that they buy and the weakness in the industry has driven the price of steel down such that it has had a benefit for TRN.

Price of steel right now 10-25-2016  $300 per ton   

  • Litigation: Currently TRN is middle of a contentious lawsuit regarding ET-Plus, a guardrail system that they created and installed. Trying to predict the outcome of the trial is impossible but there is a $663 million settlement pending the result of the trial. The settlement is currently under appeal but it is anyone’s guess how that will go.

The unit in question that sold the guardrails is the Construction Products Group, which has been a small but stable source of operating profits for Trinity Industries. Right now, Trinity holds about $614 in cash on their balance sheet. The reality is that this lawsuit is unlikely to bring Trinity down or affect the operating units of TRN that much. It could affect the valuation of the stock in the short term but the strength of the company will continue to lead it forward.


The current P/E ratio for TRN is 5.73 for TTM, while the S&P 500 ended September with a 24.15 P/E and a 2.76 for P/B. While Trinity is sitting at a 0.89 for P/B. For a comparison, the industry average is a 15.56 P/E and the P/B is 1.17.

Currently, the stock is trading at a price-earnings ratio below its historical average of 11.31. So, it’s about half its historical valuation at current prices. This bodes well for the continued growth of the company, despite the short-term headwinds it is currently experiencing in the slowdown of railcar orders and the litigation that is still out there.

The EPS for TRN has seen steady growth the last ten years, despite the short drop during the economic downturn of 2007. EPS has grown from $2.88 in 2006 to finish 2015 at $5.08. That is an increase of 43% including a negative EPS in 2009. The company has shown the ability to weather many different types of fluctuation in the economy and cyclical nature of its business. With the many different types of revenue it has created they have become more than just a railcar company. Even with the downturn in the RailCar Group, which they guided too. They have been able to remain profitable, albeit not as profitable as just a year ago.

Credit ratings:

  • Current ratio    3.51
  • Debt/equity      0.89
  • Cash($ Millions)    $664
  • Last Year Free Cash Flow   $-90 Million
  • Last Year Net Income       $826 Million
  • Last Year Dividends Paid    $63.84, Million

The Current Ratio is at the highest level seen for the last ten years. And it is higher than 91% of all companies in the train industry. The backlog that TRN is currently sitting on is driving this number up. Right now TRN is sitting on $4.3 billion in railcar assets, with $535 million of that being produced in the last 6 months. The ratio is a little higher than we would like to see and is a minor concern with it being the highest seen for the last ten years. Overall this is not a concern as they are expecting to deliver 27,000 railcars in 2016 which will reduce the current inventory, which is one factor driving up the current ratio.

I am quite comfortable with the debt ratio as it stands. With the company’s current backlog of railcars and their ability to turn those into cash.  Either utilizing a sale or with the lease program, those railcars will provide enough cash to help liquidate those debts.

For the last ten years, TRN has been able to generate free cash flow, even during the Great Recession. Management has done a great job working through the tough challenges they have faced and have built a business that is able to withstand economic headwinds by having flexibility in their manufacturing and diversifying their product base.

TRN has been a consistent dividend payer since their inception. This is an indication of their commitment to their shareholders. Currently, the yield is 1.9%, which is less than stellar but they are consistent and it is a bonus in addition to the growth they have shown. In the first two quarters, they have repurchased shares amounting to $35 million.

Final Thoughts

Trinity Industries is undervalued at the current time given that they’re currently at a P/E of 6 and their historical median is 11.31. This is a discount of 53%. Undoubtedly the company is going thru a headwind with the downturn in the RailGroup and the Leasing portion of their business. However, management has done a great job of developing other streams of income to help lessen this blow.

There is great opportunity with the RIV platform, especially as a means to lessen the downturn in their manufacturing orders. The company has managed to show a profit even during this headwind, which is encouraging. There have also been several developments with the large purchase by ValueWalk, and the possible good outcome of the pending litigation.

Even though there has been a decrease in earnings and profit proportionally, there is still value here and room to grow. With a solid management team in place and a nice sum of $814 million in cash and cash equivalents that they ended the second quarter with. They are in a good position to go many different ways to increase the value of the company. Either through an acquisition or share repurchases.

I currently long TRN and will continue to look for opportunities to buy more on the dips.

Disclosure: I/we am long TRN

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Podcasts That I Listen Too and So Should You

This list is by no means comprehensive but they are the most influential to me and I think bring great value to anyone that is looking to learn more about investing. They are in no particular order.

THE INVESTORS PODCAST        The Investing Podcast

Easily one of my favorite podcasts from the very beginning. This is run by Preston Pysh and Stig Brodersen. They both have great insights into investing and they come at it from a value perspective, which I really enjoy.

The format is structured around book reviews. Every week they will review a book that has been written by or about a millionaire. The thesis is that they study billionaires and how they accumulated their wealth. Not all of the books are related specifically to investing per se.

They also throw in some interviews with some great authors, hedge fund managers, and investing professionals. The also include their mastermind sessions with other very smart people in which they will discuss all kinds of subjects ranging from technical aspects to macroeconomics and everything in between.

Needless to say, each interview is very well done with some fantastic questions asked. I also really enjoy their discussions about macroeconomics and how it affects the market.

Their investing idols would be Warren Buffet, Charlie Munger, and Ray Dalio. All three of these gentleman are from the value investing world but with different slants to how they think. Preston and Stig do a great job of breaking down some of the different aspects of their philosophies and make it very understandable to even me.

Probably my favorite thing about his podcast is the energy and passion that they both have about value investing. And how much they want to help educate the public and encourage everyone to learn more about how to grow their wealth. They present all of their material in a way that can be easily understood, even to someone who would be new to this.

They post one episode a week on Sundays and they typically range to about an hour an episode. They also have a great website with some additional materials on it. In particular would be the forum that they run and some awesome educational videos they created. The videos are a series explaining the basics of investing to some very advanced topics. Top notch stuff that I aspire to be as good as.

THE MEB FABER SHOW        Meb Faber Research – Stock Market and Investing Blog

Another highly anticipated podcast for me every week is the Meb Faber show. Meb is a hedge fund manager for Cambria and he is a very educated and spoken host. I really enjoy his show for the education that he presents.

He has two shows a week and each is about an hour long. He has links to all the items that he discusses on his website. He has links to some awesome material from different white papers he has written to books of his as well as some other great investors.

One of the things that I enjoy most about Meb’s podcast is that he comes from the quant point of view which means that he has a mathematical bent. Frankly, some of what he discusses is above me right now but I enjoy that because that is how I learn best. By being pushed by people smarter than me. It also helps to learn the language of investing by continually surrounding yourself with it. It is a different language and the only real way to learn it is to submerse yourself into it.

He definitely has more to him than just the math. He is a big fan of Warren Buffet and the value investing arena. He wrote a great book about one of the more popular investing strategies which is to copy investors portfolios of people who you admire. Each fund manager has to report his positions every quarter and Meb has written a great book about emulating these investors and how to incorporate this strategy into your investing menu options.

INVESTED: THE RULE #1 PODCAST    Rule 1 InvestingRule 1 Investing

The invested podcast is a favorite because of the team, which is Phil Town and his daughter Danielle talk about all the different ways that the uninitiated can go about learning how to invest. They take the time to break down many different concepts and put them in words that the everyday person can understand.

They too are rooted in the value investing camp. Phil Town is a very big disciple of Warren Buffet and Charlie Munger. He bases a lot of his ideas and philosophies on ideas that he cultivated from that pair. His podcast is named after a famous Warren Buffet quote that goes like this.  “Rule number one of investing is to never lose money. Rule number two is to never forget rule number one.”

Phil spends a lot of time talking about rule number one and bases his whole investing approach on not losing money. In mind, that is a great view to take! The podcast is structured around the interplay of father and daughter. Phil is a hedge fund manager and his daughter is new to investing. So the interactions of the two are very entertaining. Phil is trying to simultaneously teach and encourage his daughter to learn more about investing while taking us along for the ride.

The podcast does a great job of breaking down the processes first established by Warren and Charlie and making it more manageable. They outline each step along the way of identifying businesses to invest in as well as giving us guidance on ways to avoid making mistakes. Phil does a great job of breaking down each step and explaining it thoroughly.

The Invested podcast also has some great links to their website which has great calculators that you can use to help with some of the analysis that they discuss on the podcast. Phil as also written two outstanding books that outline these processes that he discusses in the podcast.


   Money Tree Podcast | Investing | Wealth | Stocks | Personal Finance

The Money Tree podcast is a little different from the others that I listen to as it doesn’t  feature value investing as its core principal. This podcast is set up to have a one interview per week and then a roundtable discussion of that topic between the four cast members.

They cover a wide range of topics from mortgages to Robo-advisors and such. It is always interesting and very on topic. Again this is my attempt to surround myself with this language so that it becomes more natural for me. The guests are not always aspects that I would normally want to learn more about but it is great to try to widen my horizons and they do it in an easy and natural way.

The podcast features four very different hosts that come from very different backgrounds.

  1. The first being Joe Saul-Sehy who was a financial advisor in a former life. He brings a lot of humor to the podcast and is very insightful in is thoughts and comments. He also has his own show that he hosts, which is very good as well. It is callStacking Benjamins and they cover all ranges of topics from financial planning to money management.
  2. Miranda Marquit-She is a freelance journalist and professional blogger specializing in personal finance, small business and investing topics. I like her view on money managing and she has a great blog which talks about her rental properties business. She is a self-professed indexer, which means she invests in pretty much only index funds. Not sure I agree with her on this point but it works for her and that is the bottom line.
  3. Paula Jones-She is the founder of the Be Wealth & Smart VIP Experience, the first online mentored, investing and wealth building community. Linda became a multi-millionaire at age 39 by investing in stocks. She is definitely in the investing with stocks camp.
  1. Doug Goldstein-Doug’s been a financial advisor for over 20 years, specializing in helping people outside the US with brokerage and IRA accounts. His newest book is Rich as a King. How the wisdom of Chess Can Make you a Grandmaster of Investing. Very smart guy with some great insights into individual investing with stocks.

The podcast comes out once a week, on Fridays and is usually around an hour. Because of the nature of the roundtable forums, you get some very different viewpoints which are very helpful and informative.

THE MANUAL OF IDEAS          The Manual of Ideas

This podcast is hosted by John Mihalevic, who is a CFA and also the author of The Manual of Ideas. Which is a best-selling book about value investing. I have read the book and it was awesome.

The podcast features different fund managers, investment advisors or individual investors. He does an interview of each subject once a month. The typically run for about an hour and feature some pretty big hitters such as Guy Spier, Monish Pabrai, Howard Marks and so on.

They can get into some pretty in-depth discussions about investing and can get very technical. John has some very good insights into investing which he shares as well as some great insights from the guests as well. Very well thought out questions that elicit great responses from the guests. I particularly enjoy his views on value investing and the margin of safety.

So that is the list of podcasts that I listen to on a regular basis. This is a smaller list than some other that I listen to but I find these the most educational to me and the ones that I look forward to the most. I guarantee if you give these a listen you will be hooked just like me.

Blogs I Follow

Here is a list of the most influential blogs that I read. They are a great mix of investing insights and practical tips that you can apply easily.

Teaching yourself about finance and investing is like learning a new language. The only way to learn it is to immerse yourself in it. This list of blogs has been the most influential for me. I learn so much from them that I can apply on a daily basis. I hope you enjoy them as much as I do.

Investing for Beginners 101        Investing for Beginners 101

One of my favorite blogs. This is written by Andrew Sather. He is a self-taught investor that started just recently but he has a great way of explaining things so you can easily understand what he is trying to convey.

Andrew is from the value investing school and is a great admirer of Warren Buffet, Benjamin Graham among others. Andrew has written some really great articles and he has an awesome free ebook about how to buy your first stock and how to evaluate stocks. It is a very easy book to read and he has some great examples to show you how to do it.

The Value Trap is another book he has written in this he discusses some of the biggest bankruptcies and what lead to their demise. It gives a great look at what financial indicators were present that directly lead to the companies going bankrupt. The book has great charts and lays out the indicators to look for when you are valuing a company so you can avoid these value traps in your own investing. Definitely worth every penny

He was also one of the co-founders of one of my favorite podcasts, The Money Tree Podcast. Andrew was the value investor representative on the show and I really enjoyed his insights.

I really enjoy reading Andrew’s blogs every week and he is one the one that gave me the idea to start my own blog. I took inspiration from his story and I could relate to where he was coming from. I like his views on investing and I agree with with the way that he presents his material.

I hope you enjoy his work as much as I do.

Old School Value

Another favorite that is run by Jae Jun. Like Andrew, he is a self-taught investor as well. Jae also is from the value investing camp. His website has so many great tools, articles and a terrific screening tool that he created.

Jae comes at things from a much more technical aspect than some of the blogs that I read but I really enjoy his breakdown of how he uses these tools to value a company. He has a great way of explaining some of the more technical math problems and making them easier to understand. He has some great spreadsheets that you can utilize to follow the examples he writes about.

When you join his mailing list, and I highly recommend you do. You will get tons of free stuff including spreadsheets, lists, and ebooks that will give you tools to do your own evaluations of companies based on the information you will learn from Jae.

The website and blog also include a great forum that has some great conversations that can be of great value as well. There are some really smart people on there talking about all aspects of investing and can be very educational.

All in all, this is a great website and blog. I really enjoy his thoughts and views and I think you will too.

Base Hit Investing         bhilogofull

Another favorite written by John Huber. He also belongs to the value investing camp. John is a professional financial advisor and runs his own firm, Saber Capital Management. He has been in the investing world for years and has some great insights.

His blog is a no-nonsense look at investing from the value investing viewpoint. He is a big fan of making things simple and logical. He likes to break down his concepts in ways that you can easily understand. He presents common sense ideas that you can easily replicate and use in your everyday investing processes.

The blog presents ideas on concepts and strategy, which he likes to refer to as his own personal journal. He also covers investors and their strategies as well as value investing strategies. Additionally, he covers specific investing ideas that he is researching, giving you an insight into his ideas and processes. This is incredibly insightful and helpful. It is also very relatable.

Safal Niveshak

Another great blog that falls into the value investing camp, detecting a trend yet? This blog is written by Vishal and he has a great take on investing. His focus is on the philosophical side of investing. He as a great way of thinking of things and presents items in a way to give it way more thought. He is a big fan of Charlie Munger and his Latticework of Mental Models. He doesn’t spend a lot of time talking about the technical aspect of investing, it is more about the mental side of it.

He writes several blogs a week but my favorite is the Mental Models. This presents a different mental model every week. And he focuses on several ways you can incorporate this into your daily life as well as your investing. Vishal also has a stream of news, links, and ideas that he puts out as well.

One of my favorite links on his blog is his book recommendations. There are tons of awesome books with great reviews. His blog focuses on the Indian market, which is where he is from. Even though he talks about stocks in his market the ideas and thoughts are still the same and you can learn something about an unfamiliar market, at least to me.

When you subscribe to his newsletter you get tons of great info including lists of books, courses on how to invest in the stock market and ebooks.

Simple Safe Dividends         Simply Safe Dividends

Great blog written by Brian Bollinger, he was an equity research analyst for a multi-billion dollar investment fund in a former life. He is a straight shooter when it comes to his analysis of the stocks that he recommends. His blog is focused almost entirely on stocks that pay a dividend. This is an area of investing that I whole-heartedly agree with.

His analysis is very detailed and he takes great care to look into each company very closely. He reads all the annual reports, conference call transcripts, look at competitors among other things. Even though his level of detail is very defined it is still very readable and understandable even if you are not trained in finance.

His stock focus is on older, more established businesses. You will not see the analysis of the latest and greatest fad on his blog. He has a rating system that he employs and uses it rank all of the stocks by the safety of dividend payments plus the growth of dividends in the future.

The way that he writes inspires me to look more closely at the financials of a company and see where he is getting his opinions from. Brian also has a premium newsletter that he includes additional information of his analysis the companies he is looking at. Included in this subscription is a link to four different dividend portfolios that you can use a guide for own investments.

I would say he definitely is in the value investing camp and he is a very conservative investor.

If you are looking for some great analysis and are interested in dividends, this is a great place to look for ideas.

Sure Dividend

This outstanding blog is written by Ben Reynolds who was a trained financial advisor. He left that field to go into creating his own website and blog. His goal was and continues to be to offer investors a way to invest using dividends to increase their wealth.

Once again he falls into the value investing camp and he has a great long view on all of his stock ideas. One of the things I enjoy about his writing is that he makes it all so very easy to read and understand. He will definitely incorporate many different ratios and analysis’ of finance of a company.

His website is pretty straight forward and he offers a free newsletter that he sends out regularly, he also has a paid newsletter that has some great insights and additional information as well. Ben uses an eight-point value system to grade every stock that he discusses. Using the system he will look at all the financials and rate them for you giving you a good idea of the strength of the company and it’s continuing ability to pay a dividend.

One of my favorite aspects of his work is his yearly update on the Dividend Aristocrats and Kings. He sends out an email once a year with spreadsheets outlining all the important financial information in regards to the Aristocrats or Kings. He also does ongoing studies of the Aristocrats and Kings as the year goes by.

Great stuff and you will learn a ton by reading his newsletter. Very, very much recommend his work.

That concludes my list of blogs that I currently read on a weekly basis. There are other amazing blogs/newsletters out there that I read as well but they are either too new to me or don’t have the same impact on me as the ones listed above.

I hope you have enjoyed our little sneak peek into some of these great investors and their works. I guarantee if you take the time to read these you will  learn so much, which is always the goal. Remember that Knowledge is Power.

Value Investing Advice from the Dhando Investor

51gn-ygw5ol-_sx330_bo1204203200_The Dhando Investor, the low-risk value method to high returns is a wonderful book written by hedge fund manager Monish Pabrai. In it, he gives a comprehensive value investing framework for the individual investor.

The book is written in a straightforward style that is easy to read and comprehend. The Dhando Investor lays out the amazingly powerful value investing framework. Written with the intelligent individual investor in mind.

The Dhando method expands on the value investing principles expounded by Benjamin Graham, Warren Buffett, and Charlie Munger. In this book, we will come across phrases like “Heads I Win! Tails, I don’t lose much”, “Few bets, Big bets, Infrequent bet.”

Other concepts discussed are Abhimanyu’s dilemma, a detailed breakdown of the Kelly formula to invest in undervalued stocks.

So who is Monish Pabrai? I can hear you asking who is this guy and why are we talking about his book?

Let’s dig in a little and learn more about Monish.

Monish was born in 1964 in Mumbai, India and he moved to the US in 1983 to study at Clemson University. After graduation, he worked in the tech world until branching out on his own.

He started his own tech company with $30,000 from his 401k and $70,000 in credit card debt. In 2000 he sold the company for $20 million.

In 1999 he started Pabrai Investment Funds, that he still runs today. Since the fund’s inception, he has generated net returns of 517% versus the 43% return of the S&P 500 for the same time period. We are talking 16 years that he has made these returns.

His focus is long-only equities that are deeply distressed. He looks for two to three ideas a year, which he feels is enough. His portfolio is highly concentrated in that he generally only holds 10-20 stocks at one time. Currently, he has seven positions.

Buying and holding are only part of his strategy, he also looks very closely at his mistakes as well. Investing is a field where mistakes can be very costly and they must be looked into. He is unusual in that he doesn’t gloss over mistakes but rather spends time breaking down what happened so he can learn from the mistake. So he doesn’t repeat it in the future.

He uses a checklist of what not to do in the markets. He built this list by analyzing investors that he admires and deconstructing their mistakes. He ended up with hundreds of checkboxes on his investing checklist. This is not his exact checklist but rather an outline of his checklist and how he things about constructing his. He feels that each individual investor should come up with their own checklist as they learn more about investing.

Monish Pabrai’s primary source of investment ideas come from the 13F SEC filings from other value investment managers that he admires. 13F SEC filings are a quarterly filing required of all institutional investment managers with over $100 million in assets. In this filing, they will list all the current holdings for each fund. It will also list the prices purchased or sold as well.

This is a great source of investing ideas and is a whole investment strategy in and of itself. We will dig into this topic in a future post.

To illustrate how simple his holds are. He currently has these seven stocks in his portfolio.

  1. AerCap Holdings NV (AER)
  2. Fiat Crysler Automobiles NV (FCAU)
  3. General Motors (GM)
  4. Alphabet (GOOG)
  5. Berkshire Hathaway (BRK.B)
  6. Seritage Growth Properties (SRG)
  7. Ferrari NV (RACE)

Of these, Fiat, GM, and RACE hold 63% of his portfolio. So three automakers hold that much of his portfolio. Pretty simple stuff.

Ok, we have established that Monish knows his stuff and has some great results in his portfolio.

Let’s talk about the book.

Dhando Investor

Pabrai starts the book by discussing the term “dhandho” (pronounced “dhun-doe”), which is a Gujerati word meaning “endevours that create wealth” or “business”. Gujerat is a coastal province in India that has served as a hotbed for trade with Asia and Africa.

Most people think that risk and return are intertwined. Investors are told if you want high returns you must take on high risk. However, value investors like Warren Buffett, Benjamin Graham, and Joel Greenblatt have shown that it is possible to achieve incredibly high returns with very low risk.

Monish Pabrai shows that his Dhando investing framework is low risk with high returns. His framework contains nine principles.

Principle #1. Focus on Buying an Existing Business

Pabrai states that the path to wealth is investing in existing businesses through the stock market. His view is to find a few great bets that you can buy and hold, at least for 2 to 3 years.

There are few reasons to do this. First, there is little to no heaving lifting required. Secondly, you can find a multiple of bargain basement stocks to invest in. And finally, you don’t need a lot of money to start investing in the stock market. With the ultra-low transaction costs, there are very low friction costs.

As we have said before stay away from IPOs. They are extremely risky and they make money for one person and one person only. The owner of the business, not YOU!

Principle #2. Invest in Simple Businesses

Simplicity is an extremely powerful idea. After all, Einstein stated that simplicity was the highest level of intellect. Pretty smart guy.

The Dhando framework is simplicity itself. This is the power of this style of investing. Only after we buy a stock does the battle with our brain begin. This is when the yin and yang of self-doubt starts to creep into our decision-making basis.

To help fight this psychological battle with ourselves. We need to buy painfully simple businesses with painfully simple ideas. This will help you make a decent profit and reduce the need to create complicated spreadsheets to track all the data about the stock.

The framework is simple. Find a company you can understand. Buy it for a discounted price. Hold on to it until it is no longer a reasonable price or the story changes about the company. Rinse and repeat.

Principle #3. Invest in Distressed Businesses

Stock prices do not always reflect the fundamentals of the underlying business. In other words, price does not equal value of the company.

Pabrai states that the human psychology affects the buy and selling of stocks much more than the buying and selling of entire businesses. Bad news can lead to extreme fear, stock dumping, and a very low valuation as a result. Sell the news, is a phrase that is used in the market.

In other words, the stock you are looking at will rise and fall based on a piece of good/bad news.

You should look for simple businesses that are under duress. So you can buy them at incredibly low prices. If you see bad news about a company you are interested in this could be great news for you. If the underlying businesses fundamentals have not changed but the bad news has driven the price down out of fear. Then step up to the counter and buy all you can at the huge discount.

This is the secret of value investing. Finding wonderful businesses on sale and buying into them when everyone else is fearful.

A couple of recent examples of distressed companies that are selling at a discount right now but their fundamentals haven’t really changed much.

  • Volkswagen-with the emissions tests fraud
  • Wells Fargo-fraudulent account openings
  • Chipotle-food poisonings

All three of these companies are outstanding businesses that are going some rough times right now. You could argue that they are selling at a discount to their value and would possibly be great investments. The trick is to know what they are worth and buy it at a discount to that price.

Principle #4. Invest in Business with Durable Moats

Only a business with a durable moat or a company with a sustainable competitive advantage is able to show above average returns on their invested capital. These are the companies that are able to earn more money for their investors than companies without a durable moat.

What is a moat? It is a durable competitive advantage that makes the company sustainable for many, many years.

An example of a moat would be Walmart. Love them or hate them, they are a great example of a company that has built a wide moat. Their buying power and infrastructure have created a wide and sustainable moat. Retailers trying to go head-to-head with Walmart on a price basis have not fared well.

Another example of a moat would be the brand power of Coke, McDonald’s, and Nike. The strong brand name gives them the ability to charge a premium for their services compared to competitor’s prices. Which helps boost their profits.

One thing to keep in mind with moats. Nothing lasts forever, just remember that of the top 50 businesses from 1911 only one is still in business. General Electric. You should take this into account when you are considering investing in any business.

Principle #5. Few bets, big bets, and infrequent bets

Warren Buffett once said that diversification is a protection against ignorance. In the end, investing is just like gambling. Especially, if you are speculating.

According to Pabrai, “looking out for mispriced betting opportunities and betting heavily when the odds are overwhelmingly in your favor is the ticket to wealth.”

This particular style of value investing is a big part of the success of investors like Warren Buffett, Seth Klarman, and of course Monish. Because of the patience, they exhibit during the process that when they do find opportunities they go in big to take advantage of that opportunity. This is a chance to really hit it big when you do guess right.

Warren Buffet often talks about investing opportunities are like pitches in baseball. The only advantage you have is that unlike in baseball you don’t have to swing at every pitch. You just need to pick the one you can hit and then swing with all of your might.

Principle #6. Fixate on Arbitrage.

Always look for arbitrage opportunities with spreads as wide and long as possible. Arbitrage opportunities help you to earn a high return on invested capital with low levels of risk.

Arbitrage strategies can lower volatility and smooth out returns. They can also provide a cushion in down markets.

For the readers who aren’t familiar with this topic, risk arbitrage (workouts) is a term that usually refers to a situation where an investor buys stock in a company that is getting acquired by another company. Usually when a merger is announced, the stock of the company getting acquired will jump (sometimes significantly) to a level that is close to the buyout price. But there is always a small spread between the current price and the buyout price. For example, let’s say Company A is trading at $30 per share. Company B thinks Company A is undervalued, and decides to buy the whole company for $45 per share. The stock in Company A will immediately jump to a level close to that $45… let’s say in this example $43. The difference has to do with many variables including the likelihood of the deal closing, terms of the deal, interest rates, and many other variables. But that $2 spread eventually closes if the deal works, and that is how arbitrageurs profit. 

John Huber, Base Hit Investing

Principle #7. Margin of Safety – Always

Having a margin of safety is critical to your investing success. This goes hand in hand with finding distressed companies or companies that are trading at a discount to their intrinsic value.

The bigger the discount to intrinsic value the lower the risk. The bigger the discount to intrinsic value, the higher the return. Most of the time companies trade at their intrinsic value or above. This is when you need to let those pitches go by and wait for your pitch. When the company starts to fall below its intrinsic value is when you start to pay attention for that moment when you will be able to take advantage.

The term Margin of Safety was first introduced by Benjamin Graham and is of course adhered to by his most famous pupil. Warren Buffett.

Buffett is known as a staunch believer in a margin of safety and has been known to insist on a 50% rate before he will buy.

Why is this important? An example to illustrate. For example, if you were to determine that the intrinsic value of ABC’s stock is $162, which is well below its share price of $192, you might apply a discount of 20%, for a target purchase price of $130. In this example, you may feel that ABC has a fair value at $192 but wouldn’t consider buying it above its intrinsic value of $162. In order to absolutely limit your downside risk, you set your purchase price at $130.

Using this model, you might not be able to purchase ABC stock anytime in the foreseeable future. However, if the price does decline to $130 for reasons other than a collapse of ABC’s stock earnings outlook, you could buy with confidence.

This is a big deal because let’s say you lose 50% on a company, it will take a 100% increase to break even.

Principle #8. Invest in low-risk, high-uncertainty businesses

Think safe, boring incredibly successful business.

“we see change as the enemy of investments…so we look for the absence of change. We don’t like to lose money. Capitalism is pretty brutal. We look for mundane products that everyone needs.”
Warren Buffett

Some examples of companies that have proven to be low-risk, high uncertainty businesses would be Coke, McDonalds, Disney, American Express, Colgate

Why buy $1 for $.50? That is the Dhando way. You are looking for those discounted bets that you can really buy into. Let’s use an example to illustrate.

An AWESOME company is worth $1 but the uncertainty in the market has dropped the price to $.50. People are afraid and are dumping the company sending it down to $.50, even though the underlying fundamentals have stayed the same. There is the possibility that our friend, Mr. Market could get sick and drive down the price to $.30. So now people are selling $1 for $.3o. Some intelligent investors start loading up on the $1 for $.50. When they see the price drop they load up even more for the $.30.

Now days, months, years go by and little to nothing happens with the stock. Eventually, Mr. Market gets out of the hospital and starts to feel better and more optimistic. People start to notice and buyback the depressed stock. They push the price above the $1, which is higher than it is worth. Through all of this, the fundamentals have never changed.

The intelligent investor now unloads everything and makes a HUGE PROFIT!

Principle #9. Invest in the copycats rather than the innovators

According to Pabrai investing is a crapshoot but cloning is a slam dunk. Look for good businesses that have reliable earnings, that is the safe way to invest. Looking for the cutting edge companies that are trying to blaze a trail is a sure way to a lot of heartache.

A company that immediately springs to mind is the stock market darling, Tesla. Elon Musk, the companies founder is a dynamic, energetic, brilliant man that has had success with everything that he has touched. His vision of the world is a wonderous thing.

BUT, his electric car company has been a struggle to the least. It is a wonderful idea and dream and may very well be the way of the future. His company has struggled with production, design, delivery and just plain not selling very well. The cars are extremely expensive and the infrastructure is just not there yet.

Musk has great vision and is extremely creative but several factors are against him. First, the Big Boys of the car world have started to catch up to him in the electric car world. They have more money, better production facilities, and better distribution networks. His company is bleeding cash in a big, bad way and hasn’t even made a profit yet. Tesla is living off the reputation of its CEO right now. Investing in this type of company is a huge risk, it could pay off huge but I doubt it.

Monish certainly admires Musk, but would never invest in this type of company. Way too much risk for him. Remember his motto is “Heads I win, Tails I don’t lose much.”

Final Thoughts

I hope you have enjoyed our discussion of this awesome book. It is truly an enlightening book that is extremely easy to read. I couldn’t put it down and read it in a few days.

The principles of Dhando that he lays out are a terrific framework for value investing. Monish is a wonderful investor that has had great success by following the very principles that he lays out for you. Always remember his motto “Heads I win, Tails I don’t lose much.”

One of my favorite discussions in the book is his talks about a margin of safety. This is a principle that rings very dear to me. I will give you a personal example of not following this principle.

Very early in my investing journey, I was reading and learning. I came across this website that had a great following and had what I thought was great advice and guidance about buying stocks. I liked some of the recommendations but I was still new to this and naive. The website had a paid subscription that would give you all kinds of buy recommendations for stocks. The analysis was very thin but dressed up to look good with fancy layouts and such. Anyway, I purchased 3 stocks from these suggestions. And at first they did great but then the bottom dropped out. 2 of the stocks fell precipitously. One went from $42 a share to now trading at $13 a share. The other went from $12 a share to $1.55 a share. Those are just huge losses. I will never be able to recoup that money that was lost.

This was before I understood margin of safety and how to properly value a company. It is still a learning process and I will never know everything but that is the fun of the journey.

Thank you for taking the time to read this book review. I do appreciate it. If you think this would be of value to someone else, please share it with them.

Until next time,

Take care,