Mel's Unloved Mid-Caps for international too?

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Cuatro
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Mel's Unloved Mid-Caps for international too?

Post by Cuatro »

So I've recently taken Mel's Unloved Mid-Caps to heart for the domestic part of my portfolio, in which I hold Vanguard's VTI with a heavy tilt toward mid-caps using VO.

Is there any reason I shouldn't also follow this approach for the international part of my portfolio, in which I would hold Vanguard's VXUS with a heavy to moderate tilt toward mid-caps using VSS?
Costanza
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Re: Mel's Unloved Mid-Caps for international too?

Post by Costanza »

Sounds like a good plan. I do the same, holding 10% of my international allocation in VSS -- and I should probably increase this tilt. Economists Fama and French found the premium for small and mid cap stocks (as well as value stocks) to exist internationally as well as domestically. They did not, however, look at small caps relative to mid caps -- a lot of the academic research distinguishes only between large and small caps -- but VSS contains both small and mid, anyway.
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Re: Mel's Unloved Mid-Caps for international too?

Post by Call_Me_Op »

Cuatro wrote: Is there any reason I shouldn't also follow this approach for the international part of my portfolio, in which I would hold Vanguard's VXUS with a heavy to moderate tilt toward mid-caps using VSS?
Tilting toward smaller capitalization increases expected return and volatility, which the academics use as a measure of risk. So if you are OK taking more risk in the hope for greater return, by all means go ahead. I tend to prefer tilting for smaller equity allocations. I would be careful if I have most of my investments in equities - unless you are OK with a very wild ride.
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Re: Mel's Unloved Mid-Caps for international too?

Post by Random Musings »

Sounds like a good plan as long as you stay the course. Although tilting towards small-value has shown higher returns over long periods of time, there are still relatively long-cycles where large caps outperform, and then small caps outperform.

IMHO, the small-cap cycle has been running for almost 14 years, and the relative value compared to large caps isn't where it was in 2000.

Pays your money and takes your chances.

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nedsaid
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Re: Mel's Unloved Mid-Caps for international too?

Post by nedsaid »

I invested in an International "Small Cap" ETF only to find that a good portion of the "small-caps" were actually mid-caps. So I think you can get exposure in International Mid-Cap without too much effort. Mid-Caps are more liquid than the smaller stocks and are easier for fund managers to deal with. My ETF is based on an index.
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Re: Mel's Unloved Mid-Caps for international too?

Post by Scooter57 »

The unloved US mid caps are now severely overloved, i.e. overvalued, compared to large caps. So while they were wonderful investments a few years ago they are not in the aggregate now.

Without knowing how intl mid caps are currently valued there is no way to know how they are likely to fare. Focussing on a class based on past behavior and ignoring valuation coulkd be a very costly mistake.
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Dutch
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Re: Mel's Unloved Mid-Caps for international too?

Post by Dutch »

Scooter57 wrote:The unloved US mid caps are now severely overloved, i.e. overvalued, compared to large caps. So while they were wonderful investments a few years ago they are not in the aggregate now.
Is this the case? Would anybody be willing to post a chart comparing a US large cap index to a US midcap index?
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Re: Mel's Unloved Mid-Caps for international too?

Post by Kevin M »

Dutch wrote: Is this the case? Would anybody be willing to post a chart comparing a US large cap index to a US midcap index?
Image

Two points are obvious from this chart:
  • There is very little difference in the performance of the Vanguard small-cap and mid-cap funds in the last 10 years. You would have achieved about the same returns with the same volatility with either one.
  • Vanguard small-cap and mid-cap funds have outperformed large-cap in the last 10 years.
The last point says nothing about the future.

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nedsaid
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Re: Mel's Unloved Mid-Caps for international too?

Post by nedsaid »

Yes Scooter you have hit on an important point. "Unloved" investments can get too much love later on and no longer have the better value characteristics that we liked as investors. The "small" and "value" and now the "mid-cap" strategies are getting better known and one has to wonder if these asset classes will have a period of underperformance. And yes, valuations matter.

So this is why when I tilt that I don't do hugely exaggerated tilts. I am prepared for that I might be wrong atleast for a while. I think over longer periods of time that most investors would get bored with the tilting strategies talked about here and would rush back into the more popular large cap growth stocks. The popular large growth stocks get most of the ink in the financial press. But we all know that our best loved asset classes can underperform and for years at a time.

I use caution when I invest. Partly because I realize that my knowledge in limited. And partly because I realize that even the best investment strategies have their periods of underperformance. I also realize that my ability to predict the future is pretty limited.
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Dutch
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Re: Mel's Unloved Mid-Caps for international too?

Post by Dutch »

Thanks Kevin!
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Re: Mel's Unloved Mid-Caps for international too?

Post by Scooter57 »

The better improvement of the mid caps has a lot to do with the fact that their PEs have grown much faster than those of the large caps. According to the Vanguard web site, the Vanguard Mid Cap index's average PE is 24.7 with an average earnings growth rate of 11.9%. The Vanguard Large Cap index has a average 19.6 PE ratio with an average earnings growth rate of 11.4%.

These are crude measures of valuation.

I spent some time this week looking at the top 25 stocks in the mid cap index using valuation software that takes into account an individual stock's historical PE over various time frames, its historical growth rate and estimated growth rate (concensus of analysts and my own, which is usually significantly less than the consensus), and an estimate of what kind of return you might expect in the future given this information.

What I found was that for most of these stocks, the current price is considerably higher than its historical PE and that even those stocks that have been growing aggressively--with rates of growth well over 15% a year--are unlikely to deliver more than a modest return if all the growth and earnings estimates turn out to be accurate.

The S&P 500 is a lot better valued, especially after the recent pullback (after which I bought some more TSM for the first time in a few months.)

But while there are still a handful of individual Mid cap US stocks that look like reasonable investments, buying an index full of them right now looks like a great way to lock in mediocre returns for years to come.

The only international mid cap fund I could find on Vanguard's site was SPDR S&P International Mid Cap. It has a much lower PE ratio, 15.98 according to Morningstar, but 16.73 according to the fund's own web site ( https://www.spdrs.com/product/fund.seam?ticker=MDD) , but the sales, book value, and cash flow growth numbers for these stocks, according to Morningstar are all negative. The fund's web site says that the estimated 3-5 year growth is 14.42%.

So it is possible that these would be a better investment. OTOH, you have to deal with currency conversion issues and according to Morningstar, the top 25 stocks in this fund are dominated by Japanese companies.
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Re: Mel's Unloved Mid-Caps for international too?

Post by Visitor »

Scooter57,

Interesting analysis you've provided. However PE ratio for Mid Cap Value is 20.6 with earnings growth rate of 6.3 percent as opposed to Mid Cap Index being 24.7/11.9 as you've stated.

What do you make of those numbers? Does it appear Mid Cap Value isn't as "over valued" as Mid Cap Index?

Another interesting comparison is half of the top ten holdings in the Mid Cap Index are in Mid Cap Value.
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Re: Mel's Unloved Mid-Caps for international too?

Post by Scooter57 »

When I have looked at several other funds lately that are labeled "value" I have seen quite a few overvalued stocks, if you define overvalued with a combination of future growth expectations, current earnings, and historical PE for that same stock.

I'm not sure how often these indexes are reconfigured, but since so many small value stocks ballooned over the last 6 months of last year, it is possible that they were not removed from that index yet. When I looked at a few of the top stocks in the index it looks like several were in value at the beginning of the year but no longer are.

Beyond that, though, my understanding is that a PE of 15 is supposed to correlate with a 6 to 7% annual growth rate in earnings. So an average PE of 20.6 linked with a 6.3% growth rate looks far from "value" to me, since value is usually defined as meaning that the PE underestimates the growth potential of the stock and a 20.6 PE is assuming significanlty higher growth than the stocks currently are generating.

When I looked at a few of the stocks among those top 10, they looked fully valued to the software I use. In addition, because these are small cap stocks, you really have to look very closely at each one to see where the E part of the PE is coming from. United Rentals (URI), for example, which is one of the top stocks in the index, has a huge debt load, a large recent acquisition, and did a big share buy back. The last two items can artificially boost the earnings while growth is stagnant, and in fact, Morningstar rates their income growth as mediocre. So basically if everything goes exactly as expected, perhaps the stock can live up to expectations, but since they have a huge amount of what looks like junk debt to refinance this year, who knows?

My own studies over the past year suggest that it is when you get into subclasses like small cap value and various forms of growth that you are most likely to benefit from active management (with low fees, of course) since two stocks with the same numbers can have very different stories behind how they got those numbers and a competent fund manager should be able to distinguish between the two.
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Re: Mel's Unloved Mid-Caps for international too?

Post by Kevin M »

Scooter57 wrote: My own studies over the past year suggest that it is when you get into subclasses like small cap value and various forms of growth that you are most likely to benefit from active management (with low fees, of course) since two stocks with the same numbers can have very different stories behind how they got those numbers and a competent fund manager should be able to distinguish between the two.
But aren't market prices set by all the really smart institutional investors, even for small-cap value stocks? Are we really able to identify a "competent fund manager", in advance, who is more competent than all the other institutional investors he/she is competing with (after costs)? Most of what I've read, from authors such as Larry Swedroe, indicates that the answers to these questions are yes and no respectively. Well, that may be a white lie--I think Larry thinks that the DFA fund managers use strategies that give them an edge over other "passive" fund managers, but most of us don't have access to DFA funds, so that's a moot point for me.

I recently sold some of my small-cap and small-cap value funds, not because I determined that they were overvalued, but because they were above my allocation targets. Conversely, I will not be selling any Emerging Markets any time soon, since it is somewhat below my AA target.As Rick Ferri discusses in a recent article, EM goes through up and down cycles regularly, and the Boglehead approach is just to rebalance back to our target allocation. That's what I do with all of my asset classes.

There has been chatter about REITs being overvalued. My REIT fund is pretty much right at target, although I've made some tidy profits rebalancing into and out of it in the last couple of years. If it is "overvalued", the price will eventually come down enough to trigger a rebalancing band and I'll buy more.

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Cuatro
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Re: Mel's Unloved Mid-Caps for international too?

Post by Cuatro »

Thanks all for the great conversation in response to my question about tilting international funds toward mid-caps!

I realize that VSS is a small-cap fund in name. However, according to Morningstar's portfolio breakdown, it is actually tilted (quite heavily) toward mid-caps (64% mid; 30% small), which I know complicates things regarding valuation, volatility, risk and such as many of you have nicely laid out here. Nevertheless, I prefer to stick with Vanguard funds, particularly ETFs. Moreover, next to Schwab's international mid/small-cap ETF (SCHC; 0.20% ER; which, now that I look at it, has a bigger mid-cap tilt, 72%.. hmmm... something to think about I guess), Vanguard's VSS has the lowest ER (0.25%) that I know of.

Thanks again for all the great information!
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Cuatro
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Re: Mel's Unloved Mid-Caps for international too?

Post by Cuatro »

Cuatro wrote:...next to Schwab's international mid/small-cap ETF (SCHC; 0.20% ER; which, now that I look at it, has a bigger mid-cap tilt, 72%.. hmmm... something to think about I guess), Vanguard's VSS has the lowest ER (0.25%) that I know of.
...And as I look even more at Schwab's international mid/small-cap ETF, I see that it includes only developed markets, whereas Vanguard's VSS includes developed and emerging markets.
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Re: Mel's Unloved Mid-Caps for international too?

Post by DonCamillo »

Kevin M wrote: But aren't market prices set by all the really smart institutional investors, even for small-cap value stocks?

Kevin
The really smart institutional investors have more information than we do, and by definition, "really smart" implies that they might be smarter than we are.

There are two problems with that.

1) They might have a better idea of what a stock is worth today, but management decisions in the company in whose stock they invest will change the value of that stock tomorrow. No one knows what will happen in the future.

2) Lots of really smart investors go broke.
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Re: Mel's Unloved Mid-Caps for international too?

Post by Scooter57 »

It is a matter of religious faith, here, based on research conducted 20-30 years ago, that everything known is priced into current prices. But I am not convinced that is true for several reasons. And since I made much of the money I've made on my own by distrusting religiously-held theories based on academic research in another discipline, I am interested in checking these ideas out against current data to see how well they hold up.

So far--and this is only a year in, and I am well aware that it usually takes me about 7 years to really understand something I study--I am thinking that a few developments may have changed conclusions drawn 20+ years ago.

1. High frequency traders and traders in general trade based on a range of factors ranging from chart derivatives (moving averages, MACD, RSI, etc) which or by "scraping" newsfeeds and applying artificial intelligence to them. So when earnings come out if certain words or phrases appear, the price responds immediately. So the price of a stock may drop 5% immediately after reporting earnings despite reporting it's best year in business ever. For a person who wants to own that stock because of it's long term history of growth and characteristics of its business, this provides an ideal way to get into the stock, with a nice margin of error. Over the next month, most of these stocks recover from the HFT-inflicted drops, or at least, they have done so in all the stocks I am following with good fundamentals and healthy businesses over the past several years.

2. Again, because of how much very short term trading is out there, certain speculative stocks that are very volatile will generate a great deal of trading though it is very clear that their business fate rests on specific things happening at a known time whose outcome is NOT knowable currently. Small pharmaceutical companies with products up for FDA review fall into this category. The traders who trade them know nothing more than their ticker and their daily chart pattern, but the people who study the stocks carefully should know when the FDA review is scheduled, what the potential market is for the drug, and what the rumors are about whether large companies are interested in buying the drug if approved. So it is possible for the investor interested in building up a position in one of these stocks to watch the price gyrating by as much as 20 or 30% during a period when there is NO news at all, and pick an entry point--if they have reason to believe the product has a good chance of approval and success.

3. There are some actively managed funds, several from Vanguard, that have been outperforming the market, and their category. For example, since 1999 the Vanguard Selected Value Fund has beaten Mid Cap Value consistently according to Morningstar, and this holds true no matter what start date you chose beginning in 1999 with the exception of the last few weeks where there is a very small gap that is closing. As many people here have pointed out Wellington has outperformed its benchmarks over that same period (since 1999) and has also outperformed many of the other portfolios Madsinger tracks over that same period.

Not so coincidentally, this is the period during which programmed trading and computerized day trading really kicked in. In fact, I think it is safe to say that the market before 1997--i.e. in the days when you invested by calling your broker and paying a hefty fee for each purchase--and after the family bought a PC, which gave the retail investor access to online trading platforms--are two entirely different markets.

Beyond that, I also think that the proliferation of ETFs that chain stocks together is also altering the behavior of stock classes in ways that make older academic research irrelevant. Index funds, as we all know, were rare beasts until very recently, but now there are almost as many ETF index funds as there are individual stocks for them to invest in. This makes it too easy for investors to buy into a class, which means that the actual prices of the underlying securities making up that class are affected by a decreasing number of active traders in the securities, which probably changes the way they behave, too. Exactly how this impacts on the long term behavior of these classes isn't clear to me, but it is something I am thinking about and observing. My guess right now is that it will mean there are some advantages to investing in stocks that are not widely held in ETFs and that the stocks that dominate cap weighted indexes will behave irrationally for a long time to come (in valuation terms).

4. Re relying on what Swedroe preaches. Swedroe, as far as I can tell from reading his posts over the last year, here and elsewhere, as well as reading several of his books (since mostly he answers any substantive question with "read by book") is a writer whose main thrust is a) unceasing self promotion and b) slavish adherence to whatever the latest fashionable academic research is that will convince customers that it is worth paying his fees to invest in "advisor only" funds.

I do not see any original thinking in his posts here or elsewhere, and I note that he seems unusually deaf to any reasoned argument any intelligent person makes in response to his posts, descending into personal attacks with a striking unpleasant tone when people don't accept whatever he says without argument. Often his responses to simple, clearly stated questions are couched in obfuscatory prose so opaque that they make no sense to someone not steeped in academic jargon. This may serve his purpose of making naive readers think he is much smarter than they are, but it has been my experience over many years of dealing in an academically colored discipline that the people who have something important to share with nonprofessionals are able to translate their findings into English and express them in ways that ordinary, intelligent, thoughtful people can understand. So I don't give much weight to his writings. There are other people writing about the same topics who do so in a much clearer, much less self-promoting way, and who respond to questions that are posed to them with more than scorn or "buy my book."

As far as the value of the research of the academics whose findings he retails goes, Bogle himself seems to think little of Fama & French & Co. And when academics "discover" only this very past year that the stocks of profitable companies do better than those of others, I find myself scratching my head in wonderment that people pay these people a salary to come up with this kind of "finding". This is so basic to the theories of Graham etc. going back decades as to require no comment.

Beyond that, the Fama & French school of investing that Swedroe adheres to tells customers that they can't get ahead by stock picking on their own or by buying actively managed funds and then turns around and tells them to buy fake index funds that construct their own "indexes" using sophisticated computer-implemented screens to pick stocks on an ongoing basis. Somehow, since this is done using complex algorithms, they do not define this as stock picking. Again, if someone can explain to me in English (and without scorn) , why this is not what is going on with the DFA and other FF type funds, I would greatly appreciate it. But it seems to me that the way FF&Co add "factors" is not all that different from the way that Ptolemaic astronomers added epicycles in order to explain planetary motion without giving up their Earth-centric model.

All that said, the point of this post is NOT to say that everyone should use actively managed funds or robotized-actively-managed faux-indexes. My money is mostly invested in the big Vanguard index funds. But I am trying to point out that when you buy into any class of stocks via a fund what you are buying is a collection of individual stocks, weighted in some specific way, and the performance of each stock in that collection is going to have some kind of impact on the outcome of your investment. So the valuation of those stocks--the relationship of their price to the expectations of their future performance matters. If your fund holds large amounts of stock in companies that has been big up to prices that don't make sense in terms of how the companies are likely to perform over the next five years, you are going to eventually see disappointing investment results.

A person who had looked at the stocks that were pushing up the value of large blend funds like TSM in 1998 and seen all the ridiculous valuations that dominated that cap weighted index (and any other) would have sold, very wisely, and waited for valuations to come back to something reasonable, and would have not experienced a "lost decade." For that matter, someone who looked at valuations in 2009 after the crash and saw all the profitable businesses that were still booking reasonable amounts of revenue and profit and bought heavily would now be sitting on a big pile of money.

But if you don't look to see what is in your funds, and somehow treat abstract academic concepts like "small cap value" or "risk premium" as if they were independent of the individual stocks making up the concept, you are going to be no different than those who do the usual performance chasing and buy whatever fund did well last year.
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Re: Mel's Unloved Mid-Caps for international too?

Post by nedsaid »

Scooter57, you are thinking things through and I very much like your posts. You illustrate a couple points I have made over and over on this forum. First, valuations matter and they matter a lot. Second, investors can benefit from contrarian thinking. Don't just believe everything you are told.

I sometimes feel like the sinner in the confession booth on this forum as I confess the many non-Boglehead things that I have done. I have not followed all the conventional wisdom and actually have done pretty good.

I have owned individual stocks for many years and contrary to all the "reefer madness" warnings from certain advisors, I have done okay doing this. These represent maybe 15% of my retirement portfolio. I have followed a "value and dividend" strategy and this has worked out good for me. Despite all the "dividends are bunk" threads on this forum, I find that those dividend payments that hit my brokerage account sure come in handy. I have had my disasters and have had my successes. Over all, individual stocks have treated me pretty well.

I also own active funds. Mostly no load. I have load funds that I bought from an independent broker I have worked with for years.

But I get indexing and probably a bit over 1/4 of my portfolio is in index funds and ETFs based on indexes. I have worked the expense ratios of all the funds I own down over the years. My biggest holding is a US Total Stock Market Index Fund.

I want to stick up for Larry Swedroe. He spends a lot of time posting here and frankly I don't understand why he would do it other than wanting to help people. This forum is not going to generate much if any business for his firm. He has talked about the funds that he uses and has been pretty specific in his advice. I have learned a lot from him. But despite his posts, I have kept my individual stocks and I like dividends. He also has educated me on the use of commodities in a portfolio. (I don't use this strategy either). But I like what he says about the performance factors because it confirms what I have known or suspected for years.

I am a believer in the academic research. I realize that it is not perfect but again it confirms what I have known or suspected for a long time. So my portfolio has a value and mid-cap/small cap tilt. But I am not overdoing the tilts. If I am wrong, I won't be wrong by much.

But you do raise excellent points about factor investing. I made the point with Larry Swedroe that as one adds more factors to the computer screens that stocks stay in the "sweet spot" for shorter and shorter periods of time. You wind up with narrower and narrower "indexes" and at some point the fine line between indexing and active management gets crossed. This 'passive" method of investing has more and more turnover as you add more and more factors. It gets to be active management with lower fees and more stocks.

The trouble is that the academic research is not written in secret code. Anyone can read this stuff. The active managers are not idiots and they are aware of these performance factors. They read the research too. My thinking is that these factors work because of human nature and human behavior. They can be arbitraged away for a while but then humans will revert to chasing the loved, the popular, and what has performed well recently. I do think these factors are persistent.

Scooter, you have made excellent points about how the markets have changed. The proliferation of index funds and ETFs.
The rise of discount brokerages. The availability of information to the small investor that used to be pretty much owned by the big investment houses. I agree that the markets have changed a lot since I started investing in the early 1980's. One has to wonder how much reliance we can put on historical data since the markets have changed so much.

There are problems with the value based investing philosophies that we share. I remember that money magazine published an article that said pretty much that the stock market tends to go up when P/E's are low, and tends to go up when P/E's are high. Markets can be in an "overvalued" state for a long time. What I believe is that valuations cannot predict the direction of the market but can give you a good idea of future returns. The higher the valuations, the lower the future expected return. The lower the valuations, the higher the expected return.

Another issue is that accounting standards have changed over the years. Earnings 40 years ago are defined somewhat differently than they are today. So this makes historical comparisons a bit tricky.

I like what you are doing with looking under the hood of the indexes and getting a good idea of what is really going on. Trying to figure out if what is there is good value or not. Your methodologies are good. But in the investing world, nothing is perfect. Our tools, even the best of them, have their flaws.

Keep thinking, keep posting. You are raising good points.
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Re: Mel's Unloved Mid-Caps for international too?

Post by Scooter57 »

nedsaid,

Thanks for your long and thoughtful reply.

Your statements about valuation as a predictor pretty much agree with what I am thinking, though I think that defining valuation strictly in terms of PE is a mistake. I think you really do have to dig in and look at what a company is selling, it's "moat", it's financials, etc, to get a feel for what the PE is reflecting. But even then, if you don't really understand the business, you can be fooled. So one thing I learned this past year is that most stocks with lower PEs have lower PEs for a reason--and that reason is usually something that doesn't show up simply by analyzing numbers.

For example, IBM has an attractively low PE, but when you start looking past its numbers, you see declining revenue and EPS propped up by relentless share buybacks and a lot of debt. So to really understand whether IBM is a real value stock whose price eventually will rise based on rising revenue, or the next Kodak postponing its eventual demise through financial manipulation, you would have to have a much deeper understanding of their business model and its prospects than you can get from reading their reports. It's way beyond my abilities to evaluate it, so I leave that to the fund managers with the good track records who I would hope have been studying IBM and its business activities for years. My actively managed value fund does not currently hold it. Warren Buffett does. I'm content to hold a tiny bit via TSM. But I would not want to own it via a "Value" index fund that would buy it entirely based on its current 12-something PE.
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Re: Mel's Unloved Mid-Caps for international too?

Post by nedsaid »

There is a lot to putting value to a stock or to the stock market. Price/Earnings is a good measurement but there is a lot more to valuation than that. One wants to look at the balance sheet, particularly the amount of equity and debt. The amount of cash on the books is another thing to look at. Price to book value is supposed to be the best indicator of value. A lot of folks look at Price to Sales too.

You also want to look at the health of the industry and the health of a company within the industry. For example, Eastman Kodak showed up on the value screens of a lot of people. I owned the stock. The film business was a slowly dying business in a slowly dying industry and Eastman Kodak had no edge in the digital cameras market. Kodak eventually had to go through bankruptcy and re-emerge.

It is putting a price on a business and deciding if the business is worth buying.

Back to the discussion at hand. The S&P 400 Mid-Cap Index ETF has a P/E of 19 on Yahoo finance based on forward earnings. Trailing earnings is probably in the low 20's. Not bargain prices. Looks expensive to me. I would expect the International Mid-Caps to trade at lower P/E's than the US Mid-Caps.

So as much as I would hate to say it, the best values seem to be in the large caps in the US Market. Small-caps and mid-caps look to be pretty richly priced. Again, I would expect better values overseas.
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Re: Mel's Unloved Mid-Caps for international too?

Post by Kevin M »

Most of everything in the last few posts may be true, but I know that I am not smart enough or interested enough to take advantage of any of it. I have no confidence in my ability to determine whether an asset class is over-valued or under-valued, much less an individual stock. So I do my best to understand the concepts related to asset allocation, decide on an allocation, and stick to it within specified rebalancing bands.

On the other hand, sometimes there are clear opportunities available to small investors that even I can appreciate. The availability of a Federally insured 5-year CD that earns 2% (or recently 3%) clearly offers a better return than a 5-year treasury earning 1.5%, and has essentially the same credit risk and less interest-rate risk. This is easy for me to understand; valuing stocks and risky asset classes, not so much.

Kevin
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nedsaid
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Re: Mel's Unloved Mid-Caps for international too?

Post by nedsaid »

Kevin, I have opined that small-caps and mid-caps look richly valued at this time. in my investing life, however, I have done nothing about it. I have kept everything the same. Large Caps appear to be a better value than mid-caps/small-caps at this time but the gap isn't large enough to move me. I am not seeing extreme differences in valuation.

Small/Mid-Caps have forward P/E's of maybe 19 and the S&P 500 has a forward P/E of about 15. What that suggests to me is this is not the time to go piling into small/mid-caps. I would not make an all-in bet here. Maybe a rebalancing opportunity here but beyond that I would do nothing. So I am urging caution and prudence.
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Re: Mel's Unloved Mid-Caps for international too?

Post by pastafarian »

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Re: Mel's Unloved Mid-Caps for international too?

Post by Scooter57 »

Valuation on fundamentals is entirely different from technical analysis. And yes, if you don't want to study and learn, a simple index strategy makes sense.

But if you are going to "slice and dice" as many Bogleheads do, you owe it to yourself to learn some of these basic concepts and to understand the components of the slices you are investing in. Fail to do that and you end up like people who went all in in tech in 1999 or bought gold the last few years. And it may take 15 years to see your investment get back to where it was when you bought it.

The basic rule "never invest in anything you don't understand" does not get repealed even for investors in low cost index funds.
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Re: Mel's Unloved Mid-Caps for international too?

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Re: Mel's Unloved Mid-Caps for international too?

Post by Kevin M »

Scooter57 wrote:And yes, if you don't want to study and learn, a simple index strategy makes sense.
I think many on this forum would take exception to this comment. Many of us have spent hundreds if not thousands of hours studying and learning, and many if not most have concluded that a "simple index strategy" is indeed what makes the most sense for them. What we also have concluded is that fundamental analysis of individual stocks or sectors is unlikely to improve our returns, so that's not where we choose to spend our time studying and learning.

I doubt anyone would characterize John Bogle, after whom this forum is named, as not wanting to study and learn. Yet he promotes "owning your fair share of the market" through indexing as the best strategy for most people. He doesn't promote "slicing and dicing", but other Boglehead authors who have spent much time studying and learning do. You have criticized the motives of Larry Swedroe, but there are many other authors who also suggest indexing as the best strategy, and some of them think slicing/dicing/tilting may provide higher expected returns. Are they all just shysters?
Scooter57 wrote:But if you are going to "slice and dice" as many Bogleheads do, you owe it to yourself to learn some of these basic concepts and to understand the components of the slices you are investing in. Fail to do that and you end up like people who went all in in tech in 1999 or bought gold the last few years. And it may take 15 years to see your investment get back to where it was when you bought it.
Slicing and dicing, or tilting to small or value, is in no way comparable to going all in with a particular sector. I wouldn't go all in with small-cap value or REITs, but I'm comfortable tilting somewhat to them. I also understand that this can result in tracking error with respect to the total market for many years.

Also, slicing and dicing is not the same as tilting, although slicing and dicing is likely to result in some tilt. I may choose to hold fixed percentages of developed markets and emerging markets instead of total international. At times that portion of my portfolio may be very close to total international, and at others it almost certainly will tilt toward DM or EM. I would not be intentionally tilting toward one or the other. Similarly, Rick Ferri chooses to hold separate allocations to Europe and Asia Pacific, without intentionally tilting to either one.

Having said all of that, you're in good company here challenging the Fama/French model. One of the longest ongoing debates here is whether it makes more sense to tilt to small and value or just to own the total market. The founders of this forum, certainly Taylor, recommend the latter, but many other smart forum members who have spent lots of time studying and learning suggest the former.

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Re: Mel's Unloved Mid-Caps for international too?

Post by Scooter57 »

Kevin M wrote:
Scooter57 wrote:And yes, if you don't want to study and learn, a simple index strategy makes sense.
I think many on this forum would take exception to this comment. Many of us have spent hundreds if not thousands of hours studying and learning, and many if not most have concluded that a "simple index strategy" is indeed what makes the most sense for them. What we also have concluded is that fundamental analysis of individual stocks or sectors is unlikely to improve our returns, so that's not where we choose to spend our time studying and learning.
I think you misunderstood the tone and meaning of what I meant by that post. I didn't mean suggest that a simple indexing strategy was only suitable for people who don't want to study investing and that everyone who invested that way was ignorant. All I meant was that if someone didn't want to study and was ignorant about investing, they would be much safer sticking with a very simple 3 fund type portfolio, rather than overweighting some subset of stocks because some pundit said they should.

The updates that Madsinger posts here each month make it pretty clear that quite a few different approaches that aren't the 3 fund approach outperform over long periods of time, by substantial amounts. However, since we are looking at past results here, it would always be a good idea to ask what it was about these approaches that made them work in that past.

If the particular portfolio outperformed because it invested heavily in midcaps back at a time when they were, as a class, undervalued relative to the rest of the market then one could understand that fine record, but also realize that until mid caps catch up with the heady expectations currently baked into their prices, it would be a mistake to expect them to keep outperforming. By the same token, if a strategy did poorly because cap weighing made the funds it invested in be full of internet crap back in 1999 that had huge market caps based on price and no profits(as TSM was back then) then that strategy might perform better going into the future.

With the 3 fund approach you can figure that over 30 or 40 years those fluctuations will all even out. For those of us who aren't likely to be around in 30 or 40 years and need to do what we can to have the best performance for the next 10-25 years, that might be cold comfort. So I do like to know what is in the funds I am buying. Which if it is the mid cap indexes right now, is a lot of stocks whose prices are assuming that the companies that issued the stock will grow at 15% a year for the next 5-7 years.
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Re: Mel's Unloved Mid-Caps for international too?

Post by Kevin M »

^Thanks for clarifying. I still don't understand how you think you or I can be better at establishing valuations on stocks or asset classes than "the market". Your arguments are a bit abstract for me, but I admit I haven't spent a lot of time studying them.

I agree that something like the 3-fund portfolio is the best starting point for most investors. It also probably is the best ending point unless someone wants to invest quite a bit of time to learn about other alternatives, and even then, accept that our confidence in those other alternatives perhaps should not be very high.

I think that once we have settled on an asset allocation, we're probably best sticking with it for a long time, unless we learn something that really convinces us that we can improve it. For now, I'll be maintaining my tilts to small and value, but won't be adding tilts to momentum and profitability any time soon--if ever.

Kevin
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Re: Mel's Unloved Mid-Caps for international too?

Post by nedsaid »

I want to restate that I have no argument with the pure indexers, those who go with the 3-4 fund portfolios. That is a very solid approach.

Though I "slice and dice", I have posted many times about what I perceive to the weaknesses of this approach. Mainly that if the pizza gets sliced into too many pieces that any one little slice isn't going to make a meaningful difference in the performance of the portfolio. It also gets harder to manage. But if I can get an extra 1/2 percent to 1 percent excess performance a year over many years, it is worth it to me. Who knows if I will actually achieve this? So far, so good.

It is a matter of investing philosophy and frankly taste.
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Re: Mel's Unloved Mid-Caps for international too?

Post by Cuatro »

Very interesting discussions, thanks all! :happy
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