O Captain, My Captain!

Cover Story, by Mark Robertson, Managing Partner

Posted on April 1st, 2008

Using analyst consensus estimates in combination with historical trends during a stock study could be a powerful tool in portfolio design & management ... and lead to better long-term returns.

Robin Williams as John Keating: “O Captain, My Captain. Who knows where that comes from? Anybody? Not a clue? It’s from a poem by Walt Whitman about Mr. Abraham Lincoln. Now in this class you can either call me Mr. Keating, or if you’re slightly more daring, O Captain, My Captain.”

“No matter what anybody tells you, words and ideas can change the world.” — Robin Williams as the mercurial English teacher, John Keating, Dead Poet’s Society (1989)

This Oscar-winning screenplay is the foundation of another movie about an inspirational teacher. Robin Williams seizes the setting of a Vermont prep school to encourage independence and imagination. NAIC founder George Nicholson, Jr. CFA urged us to invest in the stock market back in 1941 and gave us a set of reliable tools to help chart the course. We believe he’d want us to continue to use the time-honored resources while seeking to capitalize on all available information.

[Start scene: Our teacher, Mr. Keating is standing on his desk.]

John Keating: Why do I stand up here?

Student Dalton: To feel taller!

Keating: No! [Dings a bell with his foot] Thank you for playing Mr. Dalton. I stand upon my desk to remind myself that we must constantly look at things in a different way.

Last month, our own Cy Lynch stood on the shoulders of muskrats to emphasize honoring tradition. His message was that it is possible to seek innovation and improvement using what may seem to be unusual (in some cases, uncomfortable) approaches or settings.

The scene — and the pained question — has repeated itself enough times during my work with individual investors and investment clubs that there’s simply no way that it can go unnoticed.

The most recent incident was during a visit with a successful investment club. The group of ladies had been together for several years and their performance since inception was quite good. The portfolio was strong with a number of blue chips with the level of quality rating that I often see when working with successful portfolios. The overall portfolio PAR was near the sweet spot and everything was pretty much in order.

But they wanted to talk about their “problem child.” You know the story. They had one stock in their portfolio that was driving them crazy. Since the ladies were adept at the traditional NAIC stock study process, they clearly understood the roles of growth, profitability and valuation and their Stock Selection Guides (SSGs) displayed strength all around with this one exception. The problem holding seemed to be pretty good, although challenged in the near term … but its stock price had plummeted precipitously over the last year.

The question was inevitable. Why isn’t the SSG working?

Beyond “By the Book”

Early during Dead Poet’s, Keating has the students rip out the introduction to a book of poetry.

[The class hesitates to rip out the introduction page] “Go ahead, rip it, it’s not the Bible, you won’t go to Hell for it.”

The ladies had faithfully prepared their SSG on the problem company and their forecasts and assumptions were current and accurate. They had completed their Guide using the lessons taught in class and the lessons learned over decades of investing. Their output resembled the SSG shown in the accompanying figure on the left.

Your Choice. Which (SSG) Visual Analysis Looks Better to You? The company on the left has experienced a recent challenge but the one on the right is totally unworthy of consideration by any NAIC-based investor. The problem is … the two SSGs were prepared on the same company … on the same day. The one on the right merely includes forward-looking consensus estimates for sales and earnings.

An emotionally-attached partner defended the situation and deftly explained how the company had fared well during a recent recession and that although recent annual results had fallen short of long-term trends, the company had recovered well during similar challenges in the past. The financial strength was “A” and the PAR was too-good-to-be-true.

The recent EPS results are less than the long-term trend and we know this is a major red flag … but the defense was compelling and our “by the book” expectations seemed to be fairly strong.

What was wrong?

More Windshield!

I swallowed hard. Your SSG isn’t wrong and it isn’t lying to you. It just needs a little bolstering.

First, let’s remind ourselves of Nicholson’s approach to a stock study. He wrote that he gathered (1) the Value Line report, if available; (2) the S&P tear sheet; and (3) the company’s annual report; as he launched into his analysis.

I believe it’s fairly clear that he believed that “all available information” was important. [Heads nodded.] I also believe that there are times when a hammer can be used as a screwdriver. Think about the last time you were on a ladder and needed to remove a screw and all you had was a hammer. It’s not ideal but it can be done. [I was losing them as my carpentry exploits were rapidly becoming suspect.]

Here’s the question. If George were here today, would he heed the analyst consensus estimates during his analysis of a company? [Heads nodded, again.]

The visual analysis on the right was prepared including a couple of years of estimates (2008 and 2009). As you can see, it’s far from a pretty picture. It gets better. If the StockWatcher for this company could have transcended emotion and performed this check, the “decay” or degradation of fundamentals (and expectations) started to become quite obvious as much as eighteen months ago. [Audible gasps]

I think it’s clear why the investing world is running from your “problem holding.” It doesn’t even matter if our beloved rhinos are right or wrong because what they think is a large part of what moves stock prices.

Innovation while remaining true to a time-honored heritage isn’t inconsistent. We preserve heritage by honoring the very principles and objectives that have always been part of George’s “Grand Experiment.” Achieving a little more relative return along the way never hurt a bit, either.

O Captain, My Captain!

[last lines] Keating: Thank you, boys. Thank you.

The NAIC Stock Selection Guide (SSG) is a tool used to perform fundamental stock analysis according to the principles of the National Association of Investors (NAIC) For more, see: http://www.betterinvesting.org.


Mark Robertson

Mark Robertson is founder and managing partner of Manifest Investing, a source for research and portfolio management focusing on strategic long term investors.

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