On a recent visit to Raeford’s, a local barber shop and a Davidson, NC institution, I had a few minutes of reflection while waiting my turn. I listened to the customer ahead of me ramble on about Auburn University Football. I meant to ask him whether he felt Auburn vs. Alabama was the greatest college football rivalry in the country. I never did get the chance but it would have made for interesting debate. Raeford’s, like barber shops across the country, are great places for informal discussion. There is no competitive intent or reward for winning these casual debates, but they are enjoyable nonetheless.
When it was finally my turn I sat in a chair facing a large rack full of popular magazines. Staring back at me were front page articles about the battle for the Supreme Court, the drug epidemic in the U.S., the top 25 retirement communities, technology against the destructive powers of nature, not to mention an article in Golf about how to lower your score by five strokes. With my limited hair resources I only had about five minutes of reading time.
Were any of these articles important enough to read for five minutes? I decided none were. In today’s increasingly complex, globally-connected world this question comes up often. There is never a shortage of issues to discuss, but the key is to determine which are worth exploring. Most, like those at the magazine rack, are not.
A Barber Shop Market… A reporter for Wall-Street Journal radio recently asked me to describe this year’s stock market environment. Struggling a bit, I used terms like roller coaster, directionless, and trading-range-bound. But what I was really searching for came to me at Raeford’s. What we really have is a “Barber Shop Market”, with endless issues to debate, most of which are unlikely to be resolved in the immediate future. Moreover, it is difficult to quantify the impact of all the potential outcomes. This is the major reason the stock market has gone sideways for much of this year. In the seventh edition of Willingdon Views, June 1, 2004, I outlined five such issues, namely: high oil prices, the quagmire in Iraq, election uncertainty, higher interest rates, and the threat of a terrorist attack in the U.S. Most of these issues remain in the forefront of debate today and may for the foreseeable future.
But I fear that time spent debating these issues will have little impact on portfolio performance. Perhaps this point can best be illustrated by a few real world examples. First, let’s take a look at the two largest beverage companies in the world, PepsiCo and Coca Cola.
Since outlining the five aforementioned geopolitical and economic issues in June of 2004, the stock price of PepsiCo (PEP) has appreciated approximately 2%. Over the same time period Coca Cola’s stock (KO) has fallen 14%. This significant performance gap is unrelated to any of today’s popular debatable topics. PEP has outperformed KO due to its ability to develop and market new products, better continuity of top management, and its industry-leading portfolio that includes Lays, Gatorade, Quaker, Tostitos, and Lipton. Yet it is unlikely that you’ll see an article about PepsiCo’s new products on the cover of Time Magazine.
A second example is Staples(SPLS) and Office Max(OMX). Staples has invested heavily in building a strong corporate culture by instilling a sense of ownership among employees, while developing the best supply chain systems in the industry. Staples has relied upon these strategic advantages to dominate the office supplies market and to open 200 new stores between 2002 and 2004. In contrast, Office Max’s weak supply chain and information technology systems coupled with management turnover limited store growth to 15 new stores over the same period. Since June 1, 2004 SPLS is up 13%, while OMX is down 23%.
A Market of Stocks… The point of all this is that the stock market is really a market of stocks. The important thing is to own the right ones. Debating Bush’s foreign policy will not help you pick the right stocks. Analyzing market share trends, new product innovation, margins, revenue growth, and cash flow are infinitely more important to understand when it comes to stock selection. The relevant debate for a portfolio manager is not President Bush vs. Cindy Sheehan, but Bank of America vs. Citigroup or Lowe’s vs. Home Depot, or the examples mentioned above. Get the latter right and leave the former debate to your next visit to the barber shop.
And if you happen to be in the chair next to me at Raeford’s, the best rivalry in college football is Ohio State – Michigan and the best way to lower your golf score, as my dad often told me, is to skip the last hole.
One final note… I am very excited to announce that Tom Searson passed the final CFA exam. Earning the Chartered Financial Analyst (CFA) designation is a tremendous accomplishment. The CFA charter is the most prestigious designation in the investment management industry and demonstrates a personal commitment to excellence. We are very proud of Tom and the hard work he put into the CFA program.
