Published May 10, 2013

Leveraging Research to Overcome Risk

Dear Reader,

Vedran Vuk here, filling in for David Galland. First, we'll have Dennis Miller discussing one of the best ways to reduce your risk – getting good investment research. Dennis and I have been talking about this topic a lot. In the financial media, you're practically bombarded with investment suggestions. However, there's a difference between investment research and investment ideas. There's only so much that you can learn about an investment from a two-minute TV pitch or a couple of paragraphs online. While those sorts of pitches might give you a good idea worth exploring further, it's really not research. Which one are you getting?

As an example of our research, a little while back we released a free pick for Miller's Money Weekly. The stock currently has an astounding 5.1% dividend yield. On top of our two dividend payments, the total holding period return so far is a nice 14%. For that pick, check out the free Miller's Money Weekly. For a subscription to Miller's Money Forever – a gateway to yet more great yields – click here.

Next, since it's graduation time for many college students and I always get a ton of reader responses on articles about education, I'll share some reflections on what many consider "useless college majors" –in particular the arts. Why do they have such a bad reputation? Don't these degrees sometimes produce value? But first, let's start with Dennis.

Reducing the Risky Part of Risk

Dennis Miller, Editor, Money Forever Portfolio

While investing in the market is a little like gambling in a casino, when we invest part of our hard-earned nest egg, we want to tilt the odds in our favor before placing any bets.

At one time in my life, I was a student of the game of craps. When I placed a bet on the pass line, I could tell you the exact statistical probability of winning or losing on each roll of the dice. Of course, the odds of every game in the casino favor the house – otherwise there wouldn't be a house. Gamblers consider themselves lucky when they can hold positions called "true odds" – which is basically 50/50 – and that happens very rarely.

Craps – like a stock portfolio – allows you to hold several positions at the same time and can quickly get complicated. Each shooter ends the game on a roll of the dice, with the casino potentially hauling in all the money on the table.

In the recent Downturn Millionaires webinar, Rick Rule of Sprott US Holdings said: "Volatility and risk are not the same." Certainly, when we invest in a good company, the volatility of the market may cause the share price to fluctuate; however, if we know the company is solid, then the daily closing prices are nothing more than background noise. I seriously doubt Warren Buffett feels a need to check the price of Coca-Cola several times a day.

At one point or another, I'm sure many of us have jumped into a stock hoping to catch a short-term trend going in the right direction. Though the rewards of this sort of investing can sometimes be very high, if you are a baby boomer nearing retirement or already retired, it's better to throttle your emotions and place small bets.

When the dice get hot and people around the craps table start screaming, normally rational people often get too caught up in the game. When the shooter finally sevens out, the casino takes in quite a haul. One of the most important lessons in craps is learning the discipline to keep from getting caught up in all the emotion.

Since joining Casey Research, I've been amazed at how Marin Katusa, editor of the Casey Energy Report, Louis James, editor of the Casey International Speculator, and Alex Daley, editor of Casey Extraordinary Technology, have all managed to have such phenomenal success in highly volatile sectors. How have they managed to take risks down to a manageable level and build such a tremendous track record?

As a quick example, in the October issue of Miller's Money Forever, I interviewed Louis James about the junior mining sector. At the end, I shared the track record of the Casey International Speculator with our subscribers:

"In the last ten years, it has recommended 359 positions; 280 have been closed, and the average gain is 107% over a time period of 24 months. What is interesting is that only 37% of its current recommendations are in positive territory, while the publication averages 60% winners. It gives great credence to the caution that, many times, after they make a recommendation, a stock will go down. In other words, despite a huge volatile market, where a good percentage of the investors lose all their money, Louis and his team have done a terrific job."

Is this what Rick Rule was trying to tell us?

Risk Reduction Through Real Research

After I read a stock write-up in a non-Casey publication, I often forward it Vedran for his input. I've been surprised by the number of times he's had to explain misinformation that somehow gets published. One recent example happened when I asked him about a company that specializes in animal pharmaceuticals. The author (who appears regularly on TV) went on and on about the company and their superior research and development. However, Vedran read its annual report, which basically stated that its R&D is less than innovative. Instead, the company simply takes products that have worked on one animal and try to tailor them to work on others.

So essentially, the company is just tweaking existing drugs for use on different species. That's an interesting strategy, but it's certainly not what the big TV personality was promoting. Vedran said to me:

"It happens all the time, and the guy touting the stock should know better. The devil is always in the details with these things. What many people don't understand is that the research behind even big names in the financial press is often very shallow. You can't comment on fifteen different stocks every day and expect to really know what's going on in each one. Unfortunately, a lot of people are investing based on this sloppy research."

Wham! It hit me. That's why pure research companies are so valuable to individual investors. Vedran and his team thoroughly research every single recommendation in the Money Forever portfolio. We want our subscribers to know as much about a company, its products, and its industry as we do. The same holds true for the other Casey editors I mentioned earlier.

So what is my point? The best way to reduce risk in a risky world is to lean on competent professionals who know what they're talking about. I think Vedran said it best:

"Dennis, we look at the company, its management, and hundreds of other variables. Most of the companies we investigate never come close to making the grade. Once a company is good enough to be a recommendation, both the researchers and editors (after a required waiting period) are likely investing in the stock along with our subscribers. Our odds of success have to be well tilted in our favor before we will recommend it."

Rick Rule was right. The best way to minimize risk is to do the hard, challenging research, and then invest only where the odds are well in your favor.

In addition, we have an extra accountability factor. If a TV pundit touts a stock and it goes south, that is one thing. Tomorrow he will tout the next one. But when we add a pick into our portfolio, our subscribers hold us accountable. Also, we are reminded regularly when we check our own portfolios how well our picks are doing.

While I read as much as I can, I pay a lot more attention to a recommendation that is going into the author's model portfolio as opposed to a cool, one-page article about a company that sounds like it was written by its marketing department.

In the same discussion with Vedran, he was quick to mention that picking a solid company is the first step toward reducing risk in a volatile market. What happens if we have a lot of money tied up in junior mining stocks or technology stocks and the volatile market turns in an ugly direction? Much like the craps player who has multiple bets on the table, we might take a beating if we are too heavily invested in one sector.

For our subscribers who are baby boomers saving for retirement, or for those already retired, we focus quite a bit on sector allocation. Retirees can't afford to get hammered when one sector takes a hit. Good companies with good products and top-quality management will follow the market, but have a history of recovering quicker than most. Meanwhile, spreading our capital among sectors and limiting our bets gives us an additional hedge against volatility.

So how can we reduce the risky part of risk? It's pretty simple. We either do the research ourselves or work with trusted research professionals who can guide us through the process. Let the TV characters create the hype and emotion; they are geared for entertainment. The true professional research newsletters are comfortable doing the heavy lifting. I will continue to rely on the latter to help me understand where to place my bets when the odds are well tilted in my favor.

What Gives “Useless Majors” a Bad Name?

When I was in my sophomore year of undergraduate studies, like many students, I was more interested in finding out what's happening this weekend than hitting the books. So it was no surprise that when I got to one of my first challenging courses, Business Statistics II, my carefree lifestyle had a head-on collision with reality. One of my best friends and I were both taking the class, and we both completely bombed the first test, failing miserably. Embarrassed, I withdrew from the class.

When I took the class the next time, I was determined to overcome it. I had failed once, and it wasn't going to happen again. I would study several hours before and after each class and afterward would visit the professor's office every week to glean further insights on the statistics course. When it was all said and done, I earned the highest grade in the whole class, 99 out of 100 points. Note that wasn't my final exam grade, but my final class grade – I pretty much got everything right on every homework, quiz, and test.

What did my friend do? He dropped out of the business school and began studying political science. He just didn't want to do the statistics class again – he said the math was too boring and hard for him. Hey, math isn't exactly fun, but he could have done it. He was essentially trying to take the easy way out. Unfortunately, few easy roads lead anywhere worthwhile.

I've noticed this same problem with many students in "useless majors," such as political science, history, art, philosophy, music, etc. Most of them are not particularly hard-working or ambitious. And in my opinion, the students themselves are what give these majors a bad name. Look, there's nothing wrong with art, music, and the liberal arts. The world would be a worse place today if Van Gogh, Mozart, and Monet had become accountants instead of artists. If you're talented at art and want to really push yourself in that field, please do become an artist.

However, many students go in to these fields with the exact opposite mindset. They don't study political science because it's a challenge, but because it's easier than statistics or chemistry classes. In fact, students are often encouraged to study things that they enjoy, rather than what's practical or realistic given their abilities.

Let me just put this out there on the topic of studying what one enjoys in that sense. If you don't like music or art and reading literature, history, and/or philosophy books, you probably don't have a pulse. I'm pretty sure that 99% of the world enjoys at least one of those things – it doesn't mean that 99% of the world has a calling in the arts or philosophy.

From my experience, what separate the liberal arts students from the business students is really a single factor: ambition and drive. I'll just say this flat-out about my own major: If you want to find the dumbest kids on any campus, head straight for the business school. Business education is pretty easy. Accounting is nothing more than addition and subtraction, plus learning a bunch of arbitrary rules. What else is there? Learning to create a PowerPoint and giving presentations in front of a group… come on, it's all easy stuff. I'm pretty sure you could teach a monkey to do it, and at some point, a wily business student will surely outsource all these tasks to well-trained chimps.

With that said about business students, what I've always found amazing is their ability to hustle and make something out of nothing. For example, business students are always trying to network, think of business ideas, and get internships. You almost never see the same behavior from other majors. I'll give you an example of a conversation that I've had literally a hundred times with art majors:

Vedran: "So, you're an art major; what kind of art do you like to do?"

Random Art Major: "Ummm, I don't know... ummm… like, different kinds of stuff."

Vedran: "Oh, OK. Well, what are you working on now?"

Random Art Major: "Uhh, I don't know. I'm kind of in between projects right now."

Vedran: "Do you have any pictures of your other stuff online? I'd love to see them."

Random Art Major: "No, I don't. You know, I'm trying to get that all organized and stuff, you know."

I kid you not; this is the typical conversation with an art student 95% of the time. They supposedly "love art" so much, yet they're almost never working on anything and never have their art organized for display, online or off. They're just waiting for some fairy to sprinkle them with magical pixie dust which will transform them from art-world nobodies to overnight successes. In a way, it's a bit ironic that artists necessarily require a more entrepreneurial spirit than business majors. The business student can always get some sort of job in an accounts receivable department, but the art student must always sell himself on the market.

There's nothing wrong with these majors at all. A good ambitious and entrepreneurial artist can make a much better living than many business students or even sciences students. The problem is that those liberal arts majors are more often than not dominated by a slacker mentality. Many make the choice of these majors not because they want to work hard, but rather because they don't. As a result, they give a bad name to the hard-working and dedicated students in those fields.

My example of the artist is true across these fields of study. I've met few history majors who literally read everything that they can get their hands on. I've met only a tiny proportion of philosophy students with anything interesting to discuss. We are graduating thousands of music majors every year – how many great songs are they producing for the world? Let me tell you, it's not in the thousands per year. There's a lot of mediocrity out there.

Furthermore, consider the unique opportunity of the arts. Artists don't need anyone to hire them. As someone with a finance background, I can't exactly start my own investment bank tomorrow. That's pretty tough, but no matter what, an artist can always create a painting or a song and use it down the road, if not immediately.

People make fun of "useless majors" a lot – as have I in the past – but there's really no such thing as a useless major. There's only a wrong way of approaching things. In these majors, one can't afford to be a slacker or unambitious – yet slackers and the unambitious are the people often attracted to them. One can be a mediocre accounting student and still get a job somewhere, but mediocrity is not an option in the arts. Given the lack of drive often found among these students, it's no surprise to me to find so many of them pouring coffee for a living. That outcome has less to do with their major than their reasons for choosing it in the first place. If one selected a major based on its ease, how do you expect the rest of their life to go? Taking the easy route leads nowhere in art, in science, in business, and in life.

Friday Funnies

And now for a collection of funny protest signs…

That's it for today. Thank you for reading and subscribing to the Casey Daily Dispatch.

Vedran Vuk
Casey Senior Analyst