![\"Value](\"https:\/\/businessecon.org\/wp-content\/uploads\/Investment-Fund.jpg\")
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“Courage taught me no matter how bad a crisis gets … any sound investment will eventually pay off.”<\/em>\u00a0\u2014 Carlos Slim Helu<\/strong><\/span><\/p>\n An investment fund is a collection of capital from one or more individuals and is used to purchase financial instruments of various companies or other funds. The most common types are brokerage funds that allow incremental purchases from members. These funds are often dedicated to a certain group or type of investment with similar attributes. Some funds are dedicated to stocks from only small-cap companies. Other funds focus on a sector or industry within the economy. For example, there are utility funds, real estate funds and retail based funds.<\/span><\/p>\n The primary goal of a fund is to restrict the purchases of financial instruments to a certain investment group or type believing that this group or type is dynamic enough to earn a good return for its members that contribute the capital to buy rights to companies.<\/span><\/p>\n There are two forms of investment funds. The first form is an open fund. This means that it continuously allows new investors into the fund and its capital basis can expand over time. Most brokerage funds are open as they are used with many retirement plans. The opposite of this is a closed fund. Here, a preset sum is invested and the fund grows off this limited capital investment. Ownership of the fund may change as a member has the right to sell their respective position in this fund.\u00a0<\/span><\/p>\n This site’s investment fund is a closed fund. It is owned by the site and does not allow others to join. Only the activity of the fund is documented and reported on this site to demonstrate how value investing works and how it continuously grows the investment. Furthermore, the fund’s respective information is available to club members<\/span><\/strong><\/a>. They have the right to use the information for their own investment fund.<\/span><\/p>\n When a value investor creates their fund, they utilize pools of similar investments in their fund to enhance the fund’s overall performance. It is encouraged to have at least three pools of investments in a fund and no more than six pools. A well designed fund uses the attributes of the respective pools to reduce risk, improve overall performance and minimize the holding of cash. The following three sections cover these three pooling benefits and how they achieve the overall goal of value investing.<\/span><\/p>\n The club’s Value Investment Fund<\/span><\/strong><\/a> consists of five pools of investments. Each pool is a set of companies in a similar industry. All potential investments belong to the top 2,000 companies traded in the market. The three pools and their corresponding members are:<\/span><\/p>\n Railways<\/strong><\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 Real Estate Investment Trusts (Residential Rentals)<\/span>\u00a0 \u00a0 \u00a0 \u00a0Banks<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 Fast-Food<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 Insurance (P&C)<\/span><\/span><\/strong><\/span><\/p>\n There are no less than 30 potential corporate investments. Each pool has its own dedicated set of resources, spreadsheets, formulas and supporting documentation in their respective section of the website. You must be a member<\/span><\/strong><\/a> of the club to gain access. It is encouraged for members to create their own pool and have that pool validated by the facilitator and in a forum of other members. Once completed, that pool may be posted to this site with the creator’s permission. If you desire to have your pool posted here, you will be considered the expert for that pool; any interactions with fellow club members related to that pool is controlled by you.\u00a0<\/span><\/p>\n As explained and illustrated in Lesson 14<\/span><\/strong><\/a>, pools of similar investments reduce risk primarily driven by a requirement to have comprehensive understanding of that industry. It is difficult for a single individual to have a comprehensive understanding of more than five industries due to the extensive time commitment required. When the investment fund has several pools in it, the overall risk factor can be further reduced just by the sheer volume of selection of potential investment options. In effect, intrinsic value<\/span><\/strong><\/a> for each company in each pool can be set one to three percent lower for all potential investments as there are often several potential investments at or near their intrinsic values at any given time. To illustrate, this table identifies at least five of the above 18 potential investments that are below, at or near their respective intrinsic values. Today is January 22, 2021 and the DOW Jones Industrial Average is at or near its all time high of 31,250. At closing, the DOW is at 30,998.<\/span><\/p>\n .<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0Values\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0<\/span><\/span><\/span><\/strong> Real Estate Investment Trusts (Residential Rentals)<\/span><\/strong><\/span><\/p>\n \u00a0Banks<\/span><\/span><\/strong><\/span><\/p>\n Of the 18 potential investments, five are currently trading on the market at less than intrinsic value. With such a wide array of potential investments and so many at less than intrinsic value, a value investor can easily adjust the buy point two to three percent less than intrinsic value and still have plenty of potential investments available to select for purchase. This further reduces risk as risk aversion is strongly correlated with intrinsic value. Any difference between intrinsic value and market price below intrinsic value is considered additional margin of safety.<\/span><\/p>\n Of the three industries, two are having difficulties right now and are frowned upon in the market. Banks are out of favor due to the impact of the pandemic and some historical misleading of the public. The pandemic also affects the REITs industry, specifically the apartment complex holdings which the above pool holds. With several different pools in the portfolio, there is always opportunity to buy a good investment and at the same time, one or two investments are doing well with their market price. For example, this site’s investment fund purchased Norfolk Southern back in October when the intrinsic and market value at that time was $204 per share and sold them 13 days later at $231 per share. Right now, railways are performing well and all of the potential investments in that pool are at their all-time highs. Thus, it will be several months before this industry sees any significant decrease with their respective market values approaching intrinsic value. This\u00a0 industry wide ‘UP’ is offset by the two other industries in the ‘Fund’. Thus, opportunities exist at all times. The best part is that opportunities always exist at or near intrinsic value which greatly reduces risk for the entire fund.<\/span><\/p>\n Enhancing overall performance of an investment fund is essential to improve the cumulative return. Improving overall performance starts with selecting highly defined pools for investments. To augment performance, ensure that the respective pool’s economic cycles are different. Some industries experience market fluctuations that are extended; others have quick frequencies of highs and lows. Having a mix of market price cycles allows a value investor adequate opportunities to buy low and sell high with less volume of potential investments.<\/span><\/p>\n It is important to note certain drawbacks to this concept. Awareness of these drawbacks forces the value investor to pay attention to market conditions and utilize preset computer orders to ensure proper timing and return. To assist in understanding, the following three subsections explain the drawbacks of extended, desired and shorter market cycles. In the next section, this lesson covers how to maximize return utilizing pools and how their respective market and economic cycles impact value investing.\u00a0<\/span><\/p>\n When a stock’s market fluctuation cycle exceeds one year, this is considered an extended cycle. In effect, the most recent low and high exceed one year and in some industries can approach three years in duration. The most common industries that exemplify this cycle period are high fixed asset based companies with long lives that earn revenue on a consistent basis. Examples include real estate based operations, shipyards, and publicly traded toll road operators. Companies like this are highly focused and rely on large initial capital outlays to purchase the necessary long-lived assets and associated intangibles (worker skills, logistics, market position). In return, they receive a consistent and reliable source of income. Their profitability is tied to their ability to efficiently produce their product or provide the service.<\/span><\/p>\n For illustration, here is Huntington Ingalls<\/span><\/strong><\/a> Shipyard’s stock price over the last five years. Notice the distinct extended low price of stock and the cycle time between these lows.<\/span><\/p>\n Furthermore, large companies like this earn consistently improving revenues over their respective lives. The next exhibit illustrates how Huntington Ingalls has a pattern with continuously improving revenue over time.<\/span><\/p>\n <\/p>\n <\/p>\n <\/p>\n <\/p>\n <\/p>\n <\/p>\n <\/p>\n <\/p>\n As a value investor, this type of pattern is greatly beneficial. The key is to understand how to take advantage of this pattern and earn excellent returns. Since it is impossible to accurately time the respective deep highs and lows, an alternative method must be utilized. Assuming the investor has done their due diligence with calculating intrinsic value and the corresponding reasonable market recover price, what can a value investor expect as a return on their investment. Let’s walk through this.<\/span><\/p>\n Assuming a reasonable intrinsic value of $190 per share and a market recovery price of $230 per share, what would be the respective return on the investment over the first two cycles?<\/span><\/p>\n Looking at the share price line, the price dips to $190 in about April of 2017. The buy is then made. In November of the same year, the stock peaks suddenly to $240 passing the sell point of $230 within a couple of weeks. Thus, the transaction earns $40 (sold at $230\/share less basis<\/span><\/strong><\/a> of $190\/share) over an eight month period. In effect, the return on the investment equals about 30% on an annual method. In November of 2018, the price drops past the $190 buy point and the stock is purchased again. It looks like the price rises past $230 a share in November of 2019. Thus, the next cycle earns $40 per share over a full 12 months. The annual return on the investment approximates 21% due to the longer recovery period.<\/span><\/p>\n Two key important points of interest here. First, although the full economic or market cycle is extended, the actual buy\/sell period is significantly shorter. Value investors are not holding the stock from one low point to the next. At some point, the stock price recovers before it dips back to another low. Thus, a long extended cycle does not mean a long holding period for the value investor. It just means that the opportunities for investment exist in a long cycle, the actual full transaction is completed within this cycle. Secondly, the shorter time period between buy and sell points dramatically improves the annual average return on the investment. This is explained in Lesson 3<\/span><\/strong><\/a> of this series. This important principle is elaborated more in Phase Two of this program (development series).\u00a0<\/span><\/p>\n Extended cycles are riskier for investors due to the possible long extended market recovery period from a low purchase price. If this cycle extends into two and three years, the return on the investment drops below 10% annually. Therefore, it is important to pay attention to these cycles and how they can impact the performance of the investment portfolio. The ideal pool would have shorter cycles and greater differentials between high and low stock prices.\u00a0<\/span><\/p>\n\n
Investment Fund – Risk Reduction<\/span><\/strong><\/h2>\n
\nRailways<\/strong><\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 Intrinsic<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0Market<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0<\/strong><\/span><\/p>\n\n
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\n<\/span><\/span><\/li>\nInvestment Fund – Improves Overall Performance<\/span><\/strong><\/h2>\n
Extended Market Fluctuations<\/strong><\/span><\/h3>\n
![\"Value](\"https:\/\/businessecon.org\/wp-content\/uploads\/Huntington-Ingalls-Stock-Price-5-YR-Lesson-15.png\")
The deep lows occur every 15 to 18 months. The unique high stock prices also occur in between the distinct low points. Naturally, this isn’t a permanent pattern but it does illustrate how this company has an extended cycle time for distinct highs and lows related to stock market price.<\/span><\/p>\n![\"Value](\"https:\/\/businessecon.org\/wp-content\/uploads\/Huntington-Ingalls-Sales-by-Year-Lesson-15.png\")
<\/a><\/span><\/p>\nDesired Market Fluctuations<\/span><\/strong><\/span><\/h3>\n
![\"Value](\"https:\/\/businessecon.org\/wp-content\/uploads\/Perfect-Pattern-Lesson-15.png\")
Thus, $94 is invested for 90 days each twice a year, Mid-March to Mid-June and Mid-September to Mid-December. Again, there is a 20% market price change four times a year, two declines and two recovery periods. This allows two full opportunities to buy low and sell high. With market price fluctuations of 20%, an investor can expect about a 40% return on their investment. If the market price fluctuations are less than 20%, and the cycle is similar, an investor cannot reap the rewards given the risk factors involved.<\/span><\/p>\n![\"Value](\"https:\/\/businessecon.org\/wp-content\/uploads\/Lennar-Corporation-Lesson-15.png\")
In this case, the value investor is waiting for the price to drop to $75 after it peaks at $81 per share. It peaks to $81 at the end of September 2020; peaks just past $84 in Mid-October 2020. Then drops to $75 per share on 10\/26\/2020 (see gold cross-hair). The buy is made on this date. The price recovers to the sell point of $81 on January 20, 2021(see gold cross-hair).<\/span><\/p>\n