Investing is not for the simple minded

By DAVID MOON, Moon Capital Management, LLC
November 25, 2012

An investing temptation is to focus on the thing that we understand, or the thing that is obvious, and then extrapolate an investment decision from there. It is as if investors focus on one variable at a time – and often the variable that catches their attention only does so because of superficial factors.

It is interesting that Wall Street became focused on the tax increases and spending cuts scheduled for January – but only immediately after the Presidential election. Those issues have been looming for over a year. Had Mitt Romney been elected they would still be sitting facing a Republican House and a Democratic Senate.

Now that investors have quit looking for daily polling numbers that confirm their preferred election outcome they’ve decided to focus on something else.

Increasing the tax on dividends is, admittedly, a terrible idea. Creating a discrepancy between the tax on capital gains and dividends displays a lack of even an elementary understanding of corporate accounting and capital allocation.

How will an increased dividend tax affect the number of car batteries Advanced Auto Parts sells?

It may sound obvious, but many people miss it: investing involves many more variables than simply the one or two that happen to be in the business section of USA Today this week. It’s complex and not always straightforward.

For example, on August 5, 2011 the US federal government lost its AAA debt rating. A year later the S&P 500 was 16 percent higher.

From 2002 to 2011 the earnings of Wal-Mart and Family Dollar Stores each increased about 180 percent. Wal-Mart’s stock price was flat, while Family Dollar’s almost doubled.

In the ten years following the first round of Bush tax cuts the stock market increased a whopping 0.70 percent annually.

The US has experienced 14 recessions since 1926. The stock market declined during only 7 of them.

In each of those simple, yet apparently contradictory examples, there was a reason for the discrepancy. Usually it was the beginning point for each measurement period. Wal-Mart sold at a much higher PE than Family Dollar. All of the fear about a possible debt downgrade had already scared investors so that the actual announcement was an almost non-event.

The tax and federal spending changes scheduled to automatically take effect in January are obvious factors hanging over investors’ psyche. But investing isn’t as simple as selling in the face of tax increases and buying when rates decline.

There are multiple variables that impact stock prices, not just the obvious or simple ones. And even the obvious factors don’t always have the obvious impact.

Even professional investors and advisors fall prey to this simplistic thinking.

Some real influences are macro. Things like interest rates and economic growth affect the environment in which all companies operate. Some are very business specific and almost completely unrelated to the overall economy.

Investors want simple answers. We want decisions to have either/or answers. Like much of life, investing is not a linear exercise. Sound investing is about degrees and nuance.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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