Download March 2015 - Warnke/Nichols Ltd.

PORTFOLIO NOTES
March 2015
To our Business Partners:
 RECENT RESULTS. The weakness in stocks experienced in January was more than offset by strong gains in February. Indexes
rallied 5-7% in February, led by the tech-heavy NASDAQ Composite, resulting in a year-to-date gain of 2-5%. Over the last 12
months, index gains range from 12-15% for large company composites to 5-9% for smaller company indexes. Our composite group of
portfolio stocks* continues to perform well versus the indexes in every time frame.
 VALUATION. The price to estimated value of our portfolio stocks stands at a still-high 93%. A dollar’s worth of our closely
followed and widely held stocks is still selling for nearly a dollar. We’d rather buy a dollar’s worth of value for 60-70 cents, and
continue to comb the stock universe for opportunities, which today are few and far between.
 MARCH MADNESS. All college basketball fans are familiar with the term “March Madness” as we enter the NCAA tournament this
month. With recent events, it occurred to us that the stock market has had its own versions of “March Madness” in recent years. The
NASDAQ Composite closing above 5000 on March 2nd brought to mind a couple other stock market versions of “March Madness.”
The March 2nd NASDAQ closing was the first time since March 10, 2000 that the composite closed above the 5000 mark, when it
reached its all-time high of 5048.62. The other “March Madness” date of significance in recent years was at the opposite end of the
spectrum – March 9, 2009 – when the market reached its lows following the 2007-2008 bear market. The Dow, S&P 500, and
NASDAQ hit intraday lows of 6440, 666, and 1265, respectively. The market has been on a tear ever since, with the S&P 500 (now at
2067) producing returns of over 17% annually in the ensuing 6 years. Such returns are usually only possible following significant
declines, which yield above-average returns.
This brings us back to the NASDAQ Composite of March 2nd of this year and the lessons it presents. A NASDAQ investor in March
of 2000 has experienced zero return over the last 15 years. And, adjusted for inflation, he’d still be about 25% below the 2000 highs.
This is what happens when markets get extremely overvalued. The year 2000 NASDAQ was being driven by a mania in technology
companies, in which many were going public with neither sales nor earnings! In 1999 alone, the stock prices of 11 newly public
companies climbed over 1,000% during the year. Mindless bullish investors and advisors pooh-poohed traditional valuation metrics in
favor of website mouse “clicks” and website-viewing “eyeballs” as they desperately sought to justify such lunacy. Overall, the
NASDAQ traded at a price-earnings ratio of 175 – one-half a penny in earnings per dollar of stock price. And that’s just on
companies that had actual earnings! Prices got so detached from reality that it’s taken the index 15 years just to get back to even. We
old timers have seen this craziness before, when a group of stocks of the late 1960s reigned, and earnings multiples reached 50-70
times for those anointed few “nifty-fifty” companies. Those stocks took a similar amount of time just to get back to prices that
prevailed prior to the 1973-74 bear market.
The fact that both of these events occurred in the month of March is just coincidental. The more important point is that markets often
reach extremes, both on the upside and the downside. Market participants strain to justify inflated prices as the madness sets in and
generates a life of its own for a period of time. This is what Ben Graham referred to as the manic-depressive “Mr. Market” (Chapter 8,
“The Investor and Market Fluctuations,” The Intelligent Investor). But, eventually, sanity prevails as the forces of financial reality and
valuation are brought to bear and the markets adjust to more sane levels.
While the current environment does not yet suggest the extremes described above, valuation measures do suggest that future returns
are likely to be below average. This should not be surprising after 6 full years of stock price advances and a decline in interest rates to
virtually zero. Careful attention to valuation and quality will become paramount going forward. As seen in the past, mistakes made
during periods of excess can be particularly difficult to recover from.
Steve Nichols, CFA
Bill Warnke, CFA
*The group of "portfolio stocks" -- our Equity Composite for the purpose of evaluating investment performance -- consists of 18 stocks that are held
in our clients' accounts. Portfolios might hold some or all of these stocks, depending on investment guidelines unique to each client, the timing of
purchases and sales, and start dates of accounts. The performance of this group of stocks is a good proxy for our equity performance but might vary
widely among accounts. Of course, past performance is not necessarily indicative of future results.
We hereby offer to deliver to you without charge a copy of our current Form ADV Part 2, in accordance with the U.S. Securities and Exchange
Commission’s "Brochure Rule." Please contact us if you would like us to send you a copy.