Just about all of us have to work for a living. We try to find a job we enjoy, and one that can also give us the standard of living we want. We work, take home a salary, spend time with friends and family, and try to have a little left over for other things. In the scheme of things, most of us do pretty well. But at some point, we bump up against some limits, and we can’t help wondering whether we can afford a little more in our lives. Or if we’ve been really good, we have some extra money in the bank, and we start wondering what to do with the savings. At that point, we start to think about investing.
The thing about investing, it’s always best as early as possible in our lives, but it’s never too late. I definitely wish I had started earlier. And I had my reasons for not doing so – “ I didn’t make enough money, I had student loans, I didn’t have time for it. Eventually, I got the investing in gear, and to my surprise, I found that you can do a lot with just a little work. And now, investing is a significant part of, and makes a significant difference in, my life.
But that’s not the half of it. Sometime ago, I realized that that there was a slight problem with all the jobs I’ve had. Now, I’ve done a pretty wide range of things. I’ve been a banker, a venture capitalist, a consultant, an actor and a director (I’m sure you’re wondering why, but we’ll save that for another article). And believe it or not, I’ve loved all the jobs I had. But in each case, I had the same problem: I had to be awake to make any money.
You might think I’m kidding, but I’m serious, really. Let me explain. After college I worked at Goldman Sachs, the highly respected Wall Street investment bank. At the time, I had a fairly high salary relative to other people the same age. There was, however, a hitch: I had to work 80-100 hour weeks to earn that salary. And that wasn’t just as a junior person. If I stayed at Goldman and made a career of it, I would make a lot of money (consider this: in 2006, the 190 Goldman partners each had a minimum bonus of $4 million each), but I was going to have work lots of hours for many, many years, regardless.
I believe though, you’d be surprised by what you can do with the basic resources of the internet, a little bit of time, and some common sense. In this series of articles on finance, I’ll introduce you to the basics of investing, and show you what has worked for me.
Of course, I couldn’t resist asking, “Is there a better way?” I looked around, and I noticed something. The wealthiest people, or let’s say, the “most financially free”, had one major thing in common: they make money while they slept. Look at Bill Gates or Warren Buffett, the No. 1 and No. 2 on the Forbes 100 list. They make lots money every night while they’re snoozing. I’m sure someone has calculated it, but I won’t, because I’m afraid of the answer. They probably make more money in a night than I do in a… okay, let’s not go there.
The problem with jobs that you have to be awake for is that there’s a limit to how many hours you can be awake. If we want more, our only choice is to make more per hour, or work more hours. And we’re always fighting for more time. Some of us, like Brad Pitt or major CEO’s, make a lot per hour, but there are only so many stars and so many CEO positions. So the only way to go beyond this limit is to make money while we sleep.
Once we accept this premise, we’re in new, but fertile territory. There’s only two ways to make money while we sleep: first, have other people working for you (Bill Gates); or second, own cash-producing assets that work for you (Warren Buffett). The first of these, having other people working for you, means starting a business – “ a risky, and sometimes not very feasible option for many people. The second of these is none other than a long way of describing – “ yes, you guessed it – “ investing. And the beauty of investing is that it’s available to everyone, at any time.
I know what you’re thinking. You’re thinking, “Well, it ain’t easy to be Buffett.” And you’d be right. People try to imitate Buffett, try to dissect his stock picks, all the time. The world of Buffettology is alive, well and thriving. I believe though, you’d be surprised by what you can do with the basic resources of the internet, a little bit of time, and some common sense. In this series of articles on finance, I’ll introduce you to the basics of investing, and show you what has worked for me. In fact, I’ll also show you what hasn’t worked for me, because that’s where I’ve learned the most, I think.
I will always give you the logic of my investing choices or philosophy. So at the very least, you can look at the thinking, and make your own decisions based on whether you agree or disagree with the logic.
And you might still say, well, who is this Ming guy? Why should I listen to him? And you’d be perfectly right to ask these questions. I won’t claim to be a market guru, or the definitive word on investing, but I will promise this: I will always give you the logic of my investing choices or philosophy. So at the very least, you can look at the thinking, and make your own decisions based on whether you agree or disagree with the logic. But I have found that if the logic is good, and the variables are properly assessed, the odds in the stock market are in your favor.
A Sample Strategy: Buy the Cycle
So let’s jump right in and look at a case study. One of my favorite stock market strategies is what I call “buying the cycle.” What do I mean by that? Well, pretty much all established businesses have cycles. I say “established” because new businesses don’t really have cycles. New businesses kinda go up as they grow, and when they stabilize, then they have cycles.
The world of established businesses is pretty big. Oil, gas, commodities, food, banks, services, consumer goods, real estate, industrial products – “ pretty much, all cycles. You might say, well, “That’s obvious, what’s so interesting about that?” Yet you would be surprised how many people – “ and this includes investment-trained financial advisors – “ who say, “sure, everything’s a cycle,” and then, in the next breath, say, “real estate never really goes down.” Or how many people back in 2000 said, “This isn’t a tech bubble, this time it’s different”.
I believe this: established businesses move in cycles, the cycles are long, and the swings are significant. Humor me for a moment, and give me the benefit of the doubt as we proceed. If you accept this premise, then your stock strategy is very simple – “ buy at the bottom of the cycle, when the price is low, sell at just before the end of the cycle, when the end is anticipated.
Case Study: Boeing
The best way to demonstrate this concept is with a specific example, and in this case, we’ll look at Boeing. Boeing is a great example because everyone can relate to it, and everyone is at least somewhat familiar with it. But a bit of disclosure first: I own Boeing stock.
A bit of background for those not familiar with the airline industry. We’ve all flown various airlines. Most of us have flown several domestic US Airlines and at least one or two international airlines. Chances are, you were in either a Boeing or an Airbus, because there are only two major airplane makers in the world.
Back in the 2001-2002, the airline industry was also undergoing a major transformation. First, we had 9/11, which, besides the tragedy itself, also shut down airlines and cut demand for new airplanes. But other fundamental changes were also under way. Both Boeing, and its major competitor, Airbus, were planning to introduce their next generation of planes. Take a look at this statement in Boeing’s 2002 annual report:
“The line of demarcation between how Boeing and Airbus are investing for the future could not be clearer. While Airbus is investing in a gigantic super jumbo [this is a 550 seat plane, which would eventually be dubbed the Airbus A380], we are investing in developing the Boeing 7E7 [now known as the Dreamliner], a highly efficient 200-250 seat airplane that will provide non-stop service between more city pairs. We believe millions of busy people, given a choice, will prefer to fly directly to their destinations rather than endure lengthy stopovers at major hubs like Narita and Heathrow.”
Let’s look at this statement carefully. First, this transition means that Boeing would stop producing the old models, and only offer the new next generation family of planes, including the Dreamliner. So customers don’t really have a choice. They will eventually have to upgrade. Kinda like Microsoft releasing Windows Vista. In a few years, if you have a Windows XP computer, Microsoft will stop supporting XP. So if you have a problem with your XP computer, no one’s going to be around to help you fix it. In other words, at some point, you won’t have a choice, you’ll have to dump your XP computer and buy a new Windows Vista one. Now, you won’t really.
Second, let’s look at the strategic choice. Now if you ask me, I’ll always take a direct flight on a mid-size plane over a flight on a super jumbo that has to connect to another flight on a smaller plane at some hub. So, I have to agree with Boeing’s strategy. I think it’s the winning play.
Add one more twist to this scenario. Airbus also has a mid-size plane, but Boeing is using lighter materials in the Dreamliner, making it much more fuel-efficient than any of the existing Airbus models. Roll forward a year or two from 2002 to the time when gas prices are climbing, and now everyone wants the more fuel-efficient plane.
What happened to Boeing’s stock? Through 2002, Boeing’s stock drifted downward, hitting a low of $25 in early 2003. At that point, the stock turned as sales of its 7E7 kicked in and the replacement cycle started.
The stock has been on a run ever since. Take a look at the five-year chart:
Boeing trades today at about $91. Had you bought at the bottom, at $25, you would be up 264%. And you didn’t have to call the bottom to have made money on this stock. I bought shares on July 13, 2004, at $50.20. So I missed the bottom by a pretty wide margin, but I’m still up 81%. If you had bought 100 shares at the time that I did, your original investment of $5,020 would now be worth $9,084.
Earlier, I asked you to bear with me and give me the benefit of the doubt. I said that mature businesses are cycles. Boeing’s stock growth is being driven by the airplane replacement cycle. If you followed the stock, and just casually perused the news on Boeing, you would see major international carriers consistently ordering the Dreamliner over the last few years. Today, Boeing has over 500 orders, and the Dreamliner is the fastest selling plane in Boeing’s history.
To be fair, several factors helped. As mentioned, rising oil prices helped drive demand for the more fuel-efficient 7E7. And Airbus even chipped in. Last year, Airbus announced that its 550-seat Airbus A380 would be delayed, and some customers even canceled their orders for the A380. That pretty much left the field to Boeing.
Air travel also became popular again. In the US, air travel dipped significantly following 9/11. By mid-2006, air travel was back to pre-9/11 levels. Add to that the growth of the BRIC economies (Brazil, Russia, India and China, sometimes extended to other rapidly developing countries as well), and you have a strong long-term trend.
Now, for those of you familiar with Boeing, you might be saying, it’s the defense portion of Boeing and the Iraq war that’s responsible for the stock moves. And I would challenge that. While defense has definitely helped Boeing’s top and bottom lines, by itself, defense has not seen exceptional growth. The real swing has been in commercial airplanes, and that’s the growth that investors care about. How to confirm this? If you watch Boeing news releases, and watch the stock, you’ll see that very little happens when defense contracts are announced. That’s because the defense side is consistently strong, but not enough to justify more than 2x growth in the stock price..
I also said that the cycles are long. So far this cycle has been about four years. And I think there’s still more to go (and so I’m holding on to my stock). Why? Because there are still buyers out there. And it’s obvious who – “ the American airlines, because they’re either in bankruptcy, or coming out of bankruptcy. And when they stabilize, they’ll have to buy new planes. So the cycle isn’t over yet.
I also said the swings are large. Well, one look at the chart will support that argument, I think. Heck, the stock has more than doubled in three years.
Now, if everything is a cycle, the party has to come to an end at some point. When will that happen? I’m waiting until the American airlines come out of bankruptcy and order their new planes. Then I’m going to see who else will still buy the plane. If I can’t find buyers, it may very well be time to sell.
Hopefully, I’ve convinced you to at least consider the “buy the cycle” approach. But a few observations and notes if you’re thinking about investing this way.
First, note the time horizon. I’ve held Boeing stock 2 ½ years, and will probably end up holding it 3-4 years. Obviously, I have a long-term approach to this. Now I know some people are day traders, some people want results by year-end (most of Wall Street). To use the “buy the cycle” approach, you have to be a long-term investor.
Second, the “buy the cycle” approach works best in industries that are monopolies or oligopolies. That means industries where there is one, or a handful of players that dominate the industry, and it’s very hard for a new entrant to enter the business. In consulting parlance, this is known as an industry with high barriers to entry.
Why is this important?
Compare the airplane makers with the airlines. It’s relatively easy to start an airline; there are new, low cost airlines entering the business all the time. And the ease of entry into that market makes the airline industry a deadly playing field. The industry is littered with bankruptcies. In contrast, there are only two major airplane makers in the world: Boeing and Airbus. And it’s really hard to build an airplane. Consider that Airbus is a consortium of several European companies that were heavily subsidized just to get the business off the ground. In other words, it took several countries and heavy subsidies to create a competitive airplane maker.
This is important because Boeing only had to worry about one competitor – “ Airbus, and when Airbus stumbled, Boeing stood to benefit. If Boeing had to worry about other competitors coming into the business, they’d be spending their time and energy fighting off the new kids on the block.
Third, notice how little information you needed to make this investment. I haven’t run any numbers, haven’t broken down any balance sheets. I haven’t even touched on net income and PE ratios. And I haven’t referred to any Wall Street reports. In fact, almost every fact I’ve mentioned in this article has appeared in your local paper or on CNN several times, or was easily available with a few clicks of a mouse. In other words, you could easily have come to the same conclusions about Boeing’s business.
Fourth, and finally, notice that you could have slept pretty well with this investment. All you had to do was buy the stock somewhere in the trough, and hold on to it. Then check to make sure that the stock was going astray. As long as purchases were announced, I held onto the stock. If I saw cost overruns, delays, order cancellations, or a significant market share going to Airbus, then I should worry. But I didn’t. And so I held on to the stock.
There are still a few issues to discuss when using the “buy the cycle” model, but we have to save something for next time (besides, this article is long enough, don’t you think?). In future articles, we’ll talk about business models (meaning, why some businesses are inherently better than others, and therefore are better investments), how to spot good management and valuation. We’ll also talk about special situations and other profit-making strategies, such as buying into spin-offs.
Until the next time, I urge you, if you haven’t already, to start looking at businesses on a regular basis. Try to understand where they might be in their cycles, and how that might relate to the price of the stock. So until the next time, good hunting, and sleep well.
Ming Lo is an actor, director and investor. He has an A.B. from Harvard College, Cum Laude, and an MBA and an MA Political Science from Stanford University. Prior to going into entertainment, Ming worked at Goldman, Sachs & Co. in New York and at McKinsey & Co. in Los Angeles. firstname.lastname@example.org.