A Rise in Commonsense Investing

April 2010

A Rise in Commonsense Investing prudent leverage and d) a margin of safety. It is a long-term, contrarian approach to investing By William Parmenter, editor Small caps are often favored by value investors, due to their superior gains. Between Bill Nasgovitz, president and founder of the end of 1973 and the end of 2009 small caps Heartland Advisors, spoke on value investing at returned 14 percent average annual return, the April 17, meeting of the Los Angeles chapter compared to11 percent for large caps, according of AAII at the Skirball Center. to Merril Lynch research. The idea is that by Nasgovitz received a bachelor’s degree taking on additional risk return increases.. from the University of Wisconsin, at Madison, At Heartland the stock selection process then started at Dean Witter in 1968, and went on starts with focusing on the universe of 10,000 to found Heartland in 1983. Today Heartland small and micro-cap stocks. That universe is Advisors has about 50 employees, 10 partners, run through quantitative screens that meet value three value mutual funds and $3.5 billion under criteria. Those stocks are put on a watch list to management. be monitored and evaluated. ‘Why the value investing approach? It has Next, individual stocks are subject to won repute from Benjamin Graham, author of the extensive fundamental analysis on ten principles Intelligent Investor, a guide to value investing, of value investing. . Heartland analysts meet and fame from Graham’s star pupil Warren with more than 800 management teams each Buffett. year. At the end of the selection process is The value approach emphasizes Graham’s Heartland’s diversified portfolio with from 125 idea of a margin of safety. That idea is brought to 175 stocks that have upside potential and out in a quote from Graham’s book, “Confronted limited downside risk. with a like challenge to distill the secret of sound Heartland’s ten principles of value investment…we venture the motto, margin of investing, refered to above, include the safety.” following: Margin of safety is defined variously as: 1) A catalyst for recognition: something removing risk, as avoiding debt, as having cash, that would make the stock’s price as paying a low price for earnings, as buying rise, for example a new product. proven reserves and as buying assets selling at a 2) Low price in relation to earnings: discount. Value investing aims to buy stocks that meet the following criteria: a) priced at a fraction Table of Contents Commonsense Investing ……..Bill Nasgovitz………. p.1 of their intrinsic worth, b) low absolute and Future of Asia...... Lydia So……………..p.3 relative valuations, c) strong balance sheets/ Investor Education……….……Dr. Don Gimpel……..p.5

1 that is a low price/earnings ratio. on loans. Nasgovitz believes the economy will 3) Low price in relation to cash flow: soon recover. strong cash flows give a company China is ramping up consumption and greater financial flexibility. surpassing the U.S. in auto sales. China 4) Low price in relation to book value: anticipates about 13 million light vehicle sales these stocks offer investors potential in 2010, compared to 11 million in the U.S. downside risk protection. China’s car market has much further to 5) Financial soundness: companies that grow than that of the U.S. In China about 40 are not encumbered with long-term cars are owned per 1,000 population, compared debt. to 750 per 1,000 in the U.S. 6) Positive earnings dynamics: companies In LCD sales China is rivaling the U.S. In with improving earnings and upwardly China, 10.7 million LCDs were sold in the trending earning estimates. fourth quarter of 2009, compared to 11.5 million 7) Sound business strategy: analyzing in North America. business strategy includes meeting and Budget problems in the U.S. and some interviewing CEOs, financial officers European countries are making people think of and competitors. putting gold in their portfolio as a hedge. 8) Capable management and insider Among the mismanaged economies ownership: that includes implement- Greece had the highest budget deficit as a ing sound business strategies and percentage of GDP in 2009 at 12.7 percent, increasing stock ownership by company officers. 9) Value of the company: that involves Los Angeles County Meeting Schedule analyzing whether a stock is a compelling value relative to other in its Westside Computer Group – Don Gimpel, 310/276-9875 [email protected] Topic TBA, at Veterans of Foreign Wars industry. Memorial Bldg. Culver Blvd. & Overland Avenue, Culver City, at 10) Positive technical analysis: looking to 10:30 a.m. Saturday, June 5. At 9 a.m., June 5, “What’s New in UltraFS Version II , at the same place. see if the company has a “base,” and is trading in a narrow range, following a Pasadena Group – Ivan Wong. To meet from 7 to 9 p.m. on May 18. The group meets at Pasadena Main Public Library, 285 East bear market. Walnut St.,. On the third Tues. of the month, except for August The overall aim is to capture upside growth, and December. Topic and speaker to be announced. to limit downside risk, and buy businesses when Mutual Fund Group – Gunter Hagen 310/457-7404, they truly are on sale. [email protected]. Meeting time, date and speaker to be announced, at Fairview Library, 2101 Ocean Park Blvd., Santa Nasgovitz put up an analyst’s report on the Monica. The meeting is free to the public company Quintana Maritime Limited and showed Stock Selection Group —Norm Langhou IBD’s ‘Can Slim’ method and explained how the company had met seven of of investing 310/391-6430, [email protected]. Fourth the 10 principles of value investing. Among the Wednesday of the month at 7 p.m. Next meeting on May 26, at Fairview Library, 2101 Ocean Park Blvd., Santa Monica. Topic most important variables highlighted were: low Using IBD’s CAN SLIM method of investing. P/E ratio, low price/cash flow ratio, the Options Group—Robert Morgen [email protected] company’s financial soundness and its valuation. meeting at 9 a.m., May 29, Community Room A in the Westside Now is a good time to be hunting for Pavilion, 10800 Pico Blvd., Los Angeles, CA 90064 . bargains. Banks have excess reserves, Desert (Palm Springs area)—Patricia Gammino; Time date, topic approximately one trillion dollars, but will they and place TBA. [email protected]., ph. 760-485-6161. lend money? Los Angeles Chapter Skirball Center at 9 a.m, Sat. May 15, Ron Banks are paying near zero on their money Muhlenkamp, The Signposts of Change; and John Larson, Income Investing: Municipal Bonds market funds, but charging five to seven percent

2 followed by Ireland at 11.1 percent. The U.S. and change in the years to come. U.S. citizens figure is close behind at 10.4 percent. By contrast have been living beyond their means for many in the well-managed economies, the 2009 figure years. Expect interest rates to go up, perhaps to was much lower. For instance, the budget deficit around 4.5 percent by the end of the year. as a percentage of GDP in Australia was 2.1 Nasgovitz concluded that value investing percent, in China 3.1 percent and in Brazil 3.3 is a common sense approach for today’s volatile percent. times. Value investing is easy to understand, Nasgovitz suggested gold could deserve a transparent, a time-tested discipline and has place in your portfolio due to world demand. given proven investment results. Value Gold could be the preferred choice over Treasury investing is not market timing. It is practiced by bills. It was recommended in December, 2009 a minority of investors. that China increase its gold reserves from 1,054 In the question and answer session, tons to 6,000 tons within the next three to five Nasgovitz said there is rampant inflation in years, said Ji Xiaonen, of China’s Assets China. Supervision and Administration Commission. Heartland looks for investment ideas in One argument for gold is that it has a very the new-low list, at insider buys and at low correlation with any other asset class except companies buying back stock. for commodities. Gold’s correlation with Individuals have been deleveraging, Treasury Bills, REITs, credit, the Wilshire 500, paying down morgages and credit card debt. the S&P 500 and the DJ Industrial average are all That will be a long process. There may be a slightly negative. double dip to the recession. Another argument is that gold production Heartland Advisors can be contacted at is declining and there is a lack of new gold www.heartlandadvisors.com. The president is discoveries. In 2009, the price of gold reached Bill Nasgovitz, at phone (414) 977-8744, with over $1,200 per ounce, yet worldwide mine fax of (414) 347-0937. Heartland has private production is still far below its 1999 levels. accounts as well as three mutual funds: Select In terms of investment strategy, now is the Value Fund (HRSVX), designed to be an time to be buying equity mutual funds. During investors core value holding; Value Plus Fund the bear market, up to November, 2009 people (HRVIX), small company value stocks; and were selling stocks and buying bonds. That trend Value Fund (HRTVX), small and very small changed in December, 2009 when people started value stocks. buying stocks, and fixed income sales declined. In January, 2010 S&P 500 stock purchases Investing in the Future of Asia were about $17 billion, and fixed income purchases were about $22 billion. By William Parmenter, editor Nasgovitz used his Value Fund to make the case for active management. From its Lydia So spoke on investing in the inception in December, 1984 to now, the future of Asia at the April 17 meeting of the Los Heartland Value Fund (investor class) for $10,000 Angeles chapter of AAII at the Skirball Center. invested returned $215,695 or 12.93 percent. So is the lead portfolio manager of That compares to the Russell 2000 Value indexes Matthews Asia Small Companies Fund and co- return of $152,252, or 11.35 percent. Heartland’s manager of the Matthews Asian Technology fund has a gross expense ratio of 1.20 percent. Fund. Raised in Hong Kong, she is fluent in Commenting on the current economy, Cantonese and received her bachelor’s degree in Nasgovitz asked how are the deficits going to be economics from the University of California, reconciled? Is there a tax revolt in the making in Davis. the U.S.? Investors can expect a lot of volatility 3 If the future of economic growth is in During that time per capita annual GDP has Asia, then you would be curious as to which more than tripled from about $900 to around countries and which sectors to invest in. $3,300. So addressed these topics, in a broad Driving domestic consumption in China sense, in a talk that covered a variety of topics, are rising household incomes, urbanization, including: Asia in a global context, urbanization higher education levels, aspiration and in Asia, entrepreneurship and access to capital, confidence. China’s consumption, and small companies— Since 1985 China’s middle class has addressing domestic demand. been growing. In 1985 the country was closed Historically speaking Asia, has dominated to the outside world and almost the whole the global economy. From 100 AD to 1820 population was poor. By 2005 10 percent of the Asia’s share of the global GDP was 60 percent or population had risen to lower middle class and more. Asia’s share of global GDP shrank to about another 10 percent had risen to upper middle 18 percent in 1950, and since then has expanded class. It is projected that by 2025 some 60 to around 36 percent, and it is still growing. percent of the population will have risen to By 2013 it is forecast that the shares of upper middle class. global GDP will be: Americas, 30 percent, Chinese consumption still has room to Europe, 30 percent, Asia, 36 percent and Africa, 4 grow for its 1.3 billion population. Chinese percent. consumption as a percentage of GDP is about 40 That compares with the breakdown of percent, compared to 60 percent in the U.K and global population in 2008, as follows: Americas, 70 percent in the U.S. 13 percent, Europe 11 percent, Asia, Pacific and Household debt as a percentage of GDP Mid-East, 62 percent; and Africa, 14 percent. is about 10 percent in China, and 9 percent in Looking at urbanization in Asia, some India, compared to around 95 percent in the countries are much more urbanized than others, U.S. with Sri Lanka at the bottom with 16 percent, and So gave some examples of China’s Australia at the top with 86 percent. Urbanization consumption power. By 2006 the appliances in other Asian countries include: India at 27 per 100 urban household had risen to: 90 percent, China at 44 percent and Japan at 65 refrigerators, 138 TVs, 90 air-conditioners and percent. 98 washing machines. Businesses surfacing in Asian capital By 2007 mortgage loans had risen to markets, excluding Japan, between 2005 and 2009 $360 billion, and the number of credit cards to were considered. Of the $168 billion raised, 63 95 billion. percent of it was by China and Hong Kong, India By 2008 the number of mobile phone 16 percent and Singapore and Korea each raised 5 subscribers had risen to 630 billion, and the percent. number of internet users to 320 million. The number of small companies, Residential floor space sold peaked at 700 excluding Japan, were 3,557 in Asia and 2,450 in million square meters in 2007, and then declined the U.S.A, as of February, 2010. The number of to 560 million square meters in 2008. small company IPOs in Asia, excluding Japan, China’s middle class is supplied goods from 2005 to 2009 was 1,872 for Asia and 579 for and services by local private companies, state- the U.S.A. The amount of capital raised was $168 owned enterprises and multi-national billion for Asia and $126 billion for U.S.A. companies. Small companies in China raised Since 1999 and 2009 China’s rate of GDP $105 billion in the last five years. The top three growth has ranged from 6 percent to 11 percent, categories were industrials, 20 percent, and grown over 8 percent in eight of those years. consumer 18.8 percent, and financials 18.5 percent. 4 Small companies have significantly For information on Matthews Asian evolved in China. Before 1978, in the pre-reform funds go to: www.matthewsasia.com. period, small companies were characterized by: basic manufacturing, competing on cost, low- Education Nuggets quality products, and lack of innovation. Since 1978, post-reform, the economy has By William Parmenter, editor opened to the world and now small companies are much more sophisticated. They compete on Dr. Don Gimpel’s started his five branding, differentiate on quality, evolve with the minutes on investor education with the question, needs of the customer and add value to products ‘How do you get your information on the and services. market?” Growth from consumption is promising in Many investors get their market China, but comes with challenges. The one child information from financial gurus. policy puts a brake on consumption, in that one How do the gurus perform? Who tracks child may have to support two aged parents and them? four grandparents. The site www.cxoadvisory.com. tracks Some of the challenges to consumption 53 gurus, of which 39 are active and 14 are growth China faces include the lack of a social dormant.. Click on guru grades. safety net, so people are savers, putting money The top three gurus for accuracy were: aside for medical bills, unemployment and old Jack Schannep via MarketWatch.com at 65 age. percent; Ken Fisher via Forbes.com at 61 The development of the middle class takes percent, and tied for third were Dan Sullivan via time. There are unseasoned management teams zachs.com, and Jason Kelly at jasonkelly.com, and businesses. And, intellectual property rights tied at 59 percent. Worst performer was Steve are weak in China. Saville via SafeHaven at 22 percent. In the question and answer period So made The range was from 65 percent to 22 a number of points. Her company, Matthews percent accuracy, with a median score of 48 finds companies to invest in by doing bottom-up percent. At 48 percent you could do better by analysis and talking to the company management. flipping a coin. She manages the Asian Small Companies Fund. Gimpel recommended the website of Matthews has 11 Asian mutual funds. CXO Advisory Group as having much useful People with a five-year timeline will be information. happy with their Chinese investments, she said. He also mentioned that the Money Show The Chinese bias is to save money for is coming up on May 10 through 13 at Caesar’s rainy days. People need savings as a buffer. Palace in Las Vegas. The audience at the show Monetary independence is China’s current consists of about 10,000 mostly retirees. Often policy goal. The country does not want to be the presentations consist of scare talk, followed wedded to U.S. policy-makers goals. by offers to guide the investor for a fee. One advantage of China’s authoritarianism Gimpel also mentioned that the L.A. is that things happen quicker. For example a Traders’ Expo is coming up on June 9 through bridge can be built without two years of debate. 12 at the Pasadena Civic Center. The U.S. will not be the growth driver of .Questions can be directed to Don the future. Investors need to expect that the Gimpel at [email protected]. emerging markets will be the growth drivers of the future. However, emerging markets and corruption go hand in hand. Orange County AAII Announcements

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Pro Forma

Pro Forma Editor William Parmenter Pro Forma Editor, Emeritus Orvis Adams

SIG GROUP CHAIRMEN

IBD Meet-up/ AAII CANSLIM Norman Langhout Mutual Fund Group Gunter Hagen Options Group Robert Morgan Pasadena Group Ivan Wong Palm Springs Group Patti Gammino San Fernando Valley Group Evan Press Westside Computer Group Don Gimpel

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