Greetings from Solana Beach,
The spring clouds of coastal fog in the north county are slowly losing their grip on our weather pattern, bringing a smile to our friends visiting from Arizona and the local dermatologists. The long summer days without the routine of school being in session lend themselves to recreational pursuits which we hope you are enjoying.
Our work at DLK continues its normal course and in this edition of the Quality Investment Report we look at what makes a quality investment vs a company that makes a quality product or service. We also share some fun had by our USS Midway Raffle winners at the Top Gun Maverick Movie showing in May.
What is Quality?
Do the following companies make quality products and services?
Tesla
Facebook
Silicon Valley Bank
First Republic Bank
IBM
General Electric
Kodak
Does that make them a quality investment?
It depends on your risk tolerance and the time you have to allow an investment that drops in value to recover. However, in the case of Silicon Valley and First Republic Bank, within the first six months of 2023 the common stock holders were wiped out, losing all of their value forever. While hard for an investor, think about the employees of these companies. Here is an article about how their investments vanished!
How long can it take for an investment to recover?
General Electric (GE) has been making quality products and services that have been integral to our country’s success and well-being for a century. Yet for the last 25 years, an investor who allocated $50,000 of their retirement savings to GE common stock has been waiting for it to get back to $50,000. And, that includes the dividends!
What about buying the index of an entire country?
The country of Japan is known for making the most precise and highest quality products the world over. The Japanese stock market, the Nikkei, had a tremendous run up in value in the 1980’s. As of this writing, it still hasn’t returned to its highs. That is almost 40 years. The person who retired at 65 in 1989 and allocated $50,000 to Japan and thought they were diversified by buying the index of Japanese stocks is now 99 years old and probably had to sell shares to pay for living or medical expenses.
A quality investment is partly tied to the quality of the products and services that the company makes, but it is also tied to the health of the companies’ financials and importantly, the growth of the key metrics within those financials.
A quality investment process focuses on how the companies are doing in their pursuit of growing key business metrics. There are a series of goals for the Quality Investment Process. One of the goals is to avoid companies that may appear to be making a hot or quality product but that are not returning enough of that value to its shareholders. Another goal is to avoid holding an investment that is losing its financial strength even though its products may still be of high quality. The process involves selection, review and removal in a careful and pragmatic manner.
The outcome of this process can be a smoother ride for the investor who, needs an equity return to outpace inflation and needs enough funds for the last stages of their lives, but doesn’t have the time to wait for the Nikkei or GE to recover.
The Quality Investment Process is not going to own some of the more high growth stocks which many investors know. This will prevent it from matching the testosterone laden Market Cap weighted S&P 500 Index or its equally juiced cousin NASDAQ. The S&P is a financial marketers dream, which always buys more of the popular stocks and pushes them higher, and sells the losers which pushes them lower. Stock prices are often driven by sentiment and money flows, and not fundamentals. Thus the index, while holding 500 names, ends up having four to ten companies comprising up to 80% of the index’s weighting.
This creates an index that delivers returns at an amplitude that requires the investors to have the stomach of a top gun pilot, as the values can swing up and down by 30% in less than a one year period. Most retired investors looking for an equity return of 7% to 8% can achieve this return without the emotional stress of watching their account value drop by hundreds of thousands of dollars all in the name of eking out that stock return.
Macrotrends S&P 500 Index – 90 Year Historical Chart – By Year
What makes a quality investment?
A quality investment is one that seeks to consistently return profits to its shareholders, and consistently attempts to increase that profit. This is the type of airplane where you can take your seatbelt off and relax.
Top Gun Maverick on the USS Midway
On May 26 several members of the DLK client family attended the showing of Top Gun Maverick aboard the USS Midway! It was wonderful to see this blending of our non-profit and individual client family. Hopefully we can continue the trend in the future. Some pictures of the fun are below.
