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Timely and actionable investment insights for executives, business owners, and family offices, with Louis Llanes, CFA CMT.

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November 29, 2024

Winning Strategy for Investors Who Want Rising Income | Ep 97

<center><iframe width="560" height="315" src=" " title="YouTube video player" frameborder="0" allow="accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture; web-share" referrerpolicy="strict-origin-when-cross-origin" allowfullscreen></iframe></center> In this episode of The Market Call Show, I discuss a practical strategy for investors seeking a rising income stream, particularly in the face of inflation and increasing retirement expenses. I outline a dividend growth approach that combines consistent income with long-term capital appreciation, making it a core strategy for retirement portfolios. I explain how to identify and select a "winning universe" of stocks, emphasizing the importance of companies with strong fundamentals, reliable earnings, and a history of steadily increasing dividends. The process includes filtering stocks based on criteria like liquidity, a 10-year track record, and consistent dividend growth. This narrows the focus to high-quality companies that can provide stable and growing returns. Portfolio construction is another key element. I share how to build and manage a diversified portfolio by limiting sector and industry concentrations, maintaining balanced position sizes, and setting guidelines for rebalancing. I also discuss how to evaluate stocks continuously, using both fundamental and quantitative rankings to guide investment decisions. This approach is designed for long-term investors aiming for reliability rather than speculative gains. I highlight the benefits of blending this core strategy with other satellite investments, such as bonds or private real estate, to enhance returns and reduce risks. Whether you're retired or planning for the future, this strategy can serve as a foundation for a resilient and income-generating portfolio. Listen in for actionable insights and tips to build your financial future.   SHOW HIGHLIGHTS <ul style="list-style-type: disc"> <li>I discuss the need for a rising income strategy in response to inflation and retirement expenses, emphasizing the importance of long-term capital appreciation alongside growing income.</li> <li>I explain the value of dividend growth investing, focusing on selecting companies with a consistent track record of increasing dividends and strong earnings.</li> <li>I outline criteria for selecting stocks, such as filtering for liquidity, excluding companies with less than 10 years of performance history, and prioritizing sustainable dividends.</li> <li>Portfolio construction is discussed, including limiting sector concentration, balancing position sizes, and maintaining diversification to reduce risk.</li> <li>Stock analysis involves both qualitative and quantitative methods, focusing on profitability, analyst coverage, and adaptability to ensure steady growth.</li> <li>I highlight the importance of ongoing portfolio management, including regular reconstitution and rebalancing to maintain alignment with investment goals.</li> <li>Criteria for selling stocks include dividend cuts, declining fundamentals, and insufficient liquidity, ensuring the portfolio remains strong.</li> <li>Strategies for blending dividend-focused portfolios with other investments, like bonds or real estate, are explored to enhance returns and mitigate risks.</li> <li>This approach is positioned as suitable for long-term investors, offering stability and income generation, particularly for retirees.</li> <li>The episode concludes with a discussion on integrating this strategy with faster-growing investments for a well-rounded portfolio.</li> </ul>   PLUS: Whenever you're ready... here are three ways I can help you prepare for retirement:  1.  Listen to the Market Call Show Podcast or Watch on Youtube One of my favorite things to do is to talk with smart people about investing, financial planning, and how to live a full life.  I share this on my podcast the Market Call Show.  To watch on Youtube  – <a href="https://youtu.be/7bM-geh0pyE">Click here </a>  2.  Read the Financial Freedom Blueprint:  7 Steps to Accelerate Your Path to Prosperity If you’re ready to accelerate your path to prosperity, the Financial Freedom Blueprint lays out a proven system for planning and investing to secure your financial independence. You can get a personalized signed hardcover copy – <a href="https://www.pathtorealwealth.com/the-book/p/financial-freedom-blueprint">Click here</a> 3.  Work with me one-on-one If you would like to talk with me about planning and investing for your future. – <a href="https://meetings.hubspot.com/louis-llanes?uuid=979d970e-5869-43f5-87f7-0c20ea991e6e">Click here</a>       <center> TRANSCRIPT (AI transcript provided as supporting material and may contain errors) </center> Louis:Okay, today we're going to be talking about a winning strategy for people who are looking for rising income. What spurred me to want to talk about this was that, frankly, there's a lot of people that are needing rising income. They need rising income because inflation continues to go up. And many people are retiring and they need an income stream that's going to keep up with inflation. So I wanted to talk about a strategy that is very effective, really as a core strategy for people who are needing rising income. Because one of the most common challenges that investors face Is that over the long term, especially, you know, when you're trying to fight inflation, your expenses continually rise and you need a combination of long term capital appreciation and a growing income. So a dividend growth approach is one of the best strategies to achieve dividend growth. Now, I want to share today a method to accomplish this goal, and I'm going to be very specific because I find that people really feel more comfortable when they understand what's behind the curtain in generating a portfolio that you can really rely on, especially when you're dealing with your core strategies.So, this method can give you some ideas to form a core strategy, and Within a retirement income plan, and it's designed to be, really the bedrock of the portfolio, but it's also a good idea to have satellite strategies to enhance the returns over time for the portfolio. But let's just start off with the first thing that you need to do in order to have a good, rising income approach with stocks. The first is you need to choose winning a winning group of stocks. You need to choose a winning group of stocks that have a successful dividends track record. So you got to get that universe, right? And that's crucial. So what I like to do is I like to start off with the S&P1500. The S&P1500 includes large companies, mid cap companies, as well as small cap companies, and they're all in the United States. And I like to filter out from that group companies that have excessively high yields because companies that have really high yields, it's generally unsustainable. I want to make sure that the dividends that are there are well supported by earnings as well as the company fundamentals and that they have the ability to provide a competitive advantage. So the numbers are basically showing us that these companies have a strong business and a competitive advantage. So I want to explain a little bit more about, like, establishing the universe, if you will.the other thing I like to look at is, I want to look at the daily dollar volume and eliminate those stocks that are really illiquid. So the dollar, daily dollar volume just says, Okay, what is the average volume of the stock in the market? And multiply that times its price, and that gives you kind of the dollar value that is traded in a given day. So typically, So I rank order those companies and I want to make sure that they have a that they're generally usually in the top 90%. So like the bottom 10 percent of illiquid stocks I generally want to ignore them. And then I also have a cutoff, a dollar cutoff to say it needs to be at least x. And that number does change depending on the purpose. So basically get rid of those stocks that are too illiquid. You don't want to have them in your. In your strategy, because you're really looking for those solid companies. So I also want companies that have a long term track record. So I exclude stocks that have a track record that is less than 10 years. Now, some people say, well, wow, there's a lot of great companies that you're missing out on. Well, that is true, but I like to look at those younger companies for different types of strategies. For this strategy, this is a strategy that's designed for steady growing income stream. And, long term capital appreciation. So we're not really trying to hit the cover off the ball. We're trying to get steady growth of rising income and also getting rising capital appreciation. So we want to get rid of those companies that have a 10 year, less than a 10 year record. And now it's for the best part of the universe selection.I want to exclude stocks that are not raising their dividends. So I'm looking for companies that are raising their dividends every year and they haven't cut their dividend in the most recent four quarters. So in the last year, they haven't cut their dividend. They may have kept them the same, not necessarily raised them. But we're looking for annually, successively, higher dividends. And then we're looking at the quarters and saying, you're not cutting the dividend. This really narrows the universe down. And like, for example, as of right now, that universe is 341 companies. That I just outlined. So you want to start off with those winning stocks. So now we've got this group, this universe of companies that, you know, you've really shut off a lot of dead weight. You're only including those companies that have a long term track record of rising income, and they have the characteristics that can get you headed in the right direction. But you don't want to leave right there. You also want to actually move from there and actually look at these companies fundamentally. So, you know, you want to demand from these companies that they have steady rising dividends and strong earnings. So, a critical aspect of this strategy is to focus on companies that have adequate analyst coverage. So, analyst coverage would be, Is good to have. You want to make sure that you don't want to make it too stringent because there are some smaller companies that you want to have investment in and they may have less analysts following them. So I have found in today's marketplace that the sweet spots right around five analysts. So five analysts are covering it. You still have a big universe of companies that are in a smaller market caps. As well as the mid cap and the large cap. So why do you care about whether or not Wall Street is looking at these companies? Well, the first thing is there's a lot of value in actually assessing and analyzing the change in what's happening with analyst expectations because stock returns have high correlation to these changes. So we're looking at. You know, earning surprise. We're looking at, you know, whether the company is beating expectations or whether, analysts are starting to upgrade a stock because that's really indicative showing that the company is actually improving their results. So part of the equation is looking at expectations and another part is actually looking at what is actually printing and what the company is demonstrating with their fundamentals. So, that's why we want to have at least five analysts covering that. Another thing that we want to do is we want to, you know, like I had mentioned, we want to have rising dividends. So as we narrow that universe down, we're getting to a high quality basket of stocks that can build a reliable income source. Now the next step is to, I like to connect, kind of think of, building a portfolio like cooking. You know, it's like having a good recipe. So I'm really what I'm outlining for you right now is a recipe. So you want to build a tasty recipe to get better results. And that means you got to build and manage the portfolio. And select from this list of companies, you can just buy all of them if you wanted to, but if you want to get better results, I recommend, or I like to limit the sectors and the industry weights of companies. And I like to first look at them fundamentally. So. You know, looking at these companies from many different directions, you know, the first would be quality. How profitable are they? What is the return on capital? We like companies that are capital efficient. are they growing their sales and their earnings? And to what extent are they really printing good numbers there? the other thing I like to look at is, you know, there's just so many different things, but I mentioned the sentiment aspect about what the analysts are viewing, how they're viewing the company, but also we want to actually look at just the profitability, the quality, the valuation. So once that's been, analyzed, there's another, there's a qualitative thing that I like to look at and, I call it ADP, A as in apple, D as in dog, and P as in profits, . I outlined that in my book actually. the financial freedom blueprint. And you know, I'm really thinking about writing another book because I have a lot more that I want to share with people. But if you go to my book and you go to page 22,I outlined the ADP criteria and this is how focusing your capital on companies that have a few different characteristics. Number one, are they adaptable to changes in technology and innovation? And number two are, do they have desirable products and services, that are desirable now and likely to be desirable in the future? So it's not a fickle thing because for this portfolio, we're really looking for long term growth, right? And compounding growth and are they profitable? Is their business model such that they have getting, they're getting good? Returns on capital now and is likely to do so in the future. So it's really an assessment of now actually demonstrating it as well as, you know, when you're looking at the company's business model, is it likely to sustain in the future? So those three things can really help you. to have better returns than sticking your money under the mattress. And, and also, better returns are more likely than you would get in bonds, by a significant margin. Okay, so once we've done that, you know, we've done the fundamental aspects and looked at all the quantitative methods. basically, I like to quantify those into ranks. And that really keeps you disciplined so that you can compare companies to each other. So, I, the next step in this is something that's really important because what a lot of people don't understand, is that stock selection or investment selection is very important, but what is equally important and could be sometimes more important is how you blend And how you put the portfolio together. That's called portfolio construction. So there's some key elements and I'm just going to give you some of the broad strokes here, limiting your sector and your interest, what industry weights is important because you don't want to have too much concentration and you want to make sure that you're not. You know, 70 percent in tech stocks or, you know, 50 percent in energy stocks, anything like that. You want to have some balance there because that generally will improve your risk adjusted return because when you're retired or when you're generating income from pulling from your portfolio consistently, you need to have some more stability in the portfolio. So we also want to have individual position sizes. So the amount of capital allocated to each individual stock should also be,limited. So typically the range between one and 5 percent of, initial capital is a good place to go in terms of getting adequate diversification for a portfolio like this, looking at a lot of different ways you could go, really, 50 stock portfolio is a good starting point for a high net worth investor. You want to own those stocks individually rather than going out and buying some package product. This gives you a lot more ability to home in on exactly what you need. So once you've, you know, invested in these stocks, it's not just set it and forget it, it's an ongoing process. So you want to allow some drift with these stocks. And typically I like to let stock portfolios or individual stock positions drift about 30 percent from the target. So if we have a target weight of 5%, then it could go up, you know, point, 0. 3 times,0. 05, you know, so 30 percent of your target position could go up or down. Thank you. So you want to give some drift because you don't want to have,you want to give these companies some room and you don't want to rebalance too frequently because this will minimize, this needs to minimize your turnover. So we want to place those constraints on sectors and industries to ensure Good diversification and their businesses should have non correlated,factors of returns that, that, that generate revenue and expenses for the company. They should be relatively non correlated. Okay. So let's talk about like how much capital that you put in stocks over time. So my approach is to dynamically adjust the, target weights based on fundamental rankings, basically. And the fundamental ranking is all those factors that I mentioned to you, the quality of the valuation. And there's multiple dimensions, you know, and how you look at those companies, but how are they, are they improving? Are they not improving relative to the whole basket? And typically, if you look at the whole universe, we're typically focusing capital in the top quartile. of companies in there,in the universe. And if the companies fall out, maybe falling into the bottom quartile, typically they're going to be, removed from the portfolio. There's let's talk a little bit about selling and how important that is. So this strategy generally, it's a moderate,turnover strategy. So it's not a high turnover strategy, because you're really looking to You're really looking to hold on to those great stocks as long as possible and learn to earn the compounding dividends. But you also want to make sure these companies are doing well, fundamentally. So, one reason that a company can get pulled out of the portfolio would be if they cut their dividends, because they're no longer in the universe at that time. So if their dividends are getting cut, they'll, they're going to be eliminated from this strategy. if they are no longer as liquid as they need to be, they'll be eliminated. eliminated. That rarely happens. the other thing is if their fundamental fundamentals deteriorate enough, then we're going to need to pull that stock out of the portfolio because they no longer meet the criteria of strong fundamentals, which is a high,correlation to expected returns in the company. So, so those are the main reasons why you pull stocks out.this, you know, and you want to just do this continually. So there's really basically two processes. There's what's called reconstitution, which is basically when we say, okay, what does the universe look like? And then what are the rankings right now? And who's in and who's out. Right. And then there's rebalancing and that's the process of saying, okay, here's our target weights, based on the fundamentals now and the market cap, et cetera. and based on that. how far are we off from that? If it's within range, no problem. If it's out of range, then we need to pull that back. So let's talk a little bit about that. So we're talking about recognizing when you need to cash out, right? So just to recap, selling criteria is really straightforward. Stocks are removed if they cut their dividend. If they drop in their fundamental ranks, right, typically below the 25th percentile. And again, this approach helps you maintain our portfolio of top performing liquid stocks with a strong track record of dividend growth. It's a really simple concept that is very effective. So by adhering to these rules, the portfolio remains robust and avoids over concentration in one sector or industry, right? Because we have those constraints and is providing steady, reliable, Income and returns over time relative to more speculative investment strategies. So we're talking a little bit about the mindset of this strategy of some, you know, having this as a core part of a portfolio for somebody looking for rising income, you really should have a mentality of hold and prosper. I like to think of it that way. You want to hold and prosper because these, you really reap the rewards over time with these stocks as they're building their profits, they're growing, the dividends moving up and it just keeps going up and we're focusing our capital and our attention in those companies. So it's designed for longterm investors who are seeking that steady growth and income. It's not meant for market timing. It's again, it's meant for that reliable income, and the volatility of this strategy has been lower than the overall market. So one of the things we like to look at a standard deviation. You probably have heard of that before, but if you look at a simulated result of this It's a standard deviation is 13. 19 percent since February of 2004 and the beta is 0. 72 compared to the S& P 500. So it makes it suitable for a retirement portfolio where stability is important. Right? And historically, this strategy has performed well, too. It's annualized at 12. 2%. But whenever you're looking on at simulated strategies, it's important to understand as with any investment strategy, past performance doesn't always be an indication of future results, right? It's important to understand that and returns, you know, that I'm talking about here have a provision for transaction costs, but it doesn't include advisory fees. Okay. So that's just, you know, something to understand. So, The performance has shown to be very competitive and it's generating what we're looking for, a rising stream of income. So you want to choose the best stocks and let go of the rest. That's really the key on this. So historically this, again, this portfolio shows moderate turnover. It's been around 0. 57 percent annually, 57 percent I should say. And the average holding period over is over years. Typically winners are held on average 646 days. So that's well over a year while losers are held for roughly on average 300 days. So you want to have, you know, we're not trying to generate a lot of short term gains here, right? We're trying to build longterm capital appreciation. But one of the key aspects is you will, you'll notice is that the days held for losers is a lot lower than the days held for winners. And sometimes you can hold winners for years and years. Like for example, Costco or Microsoft, you know, Apple. You know, Nvidia has been in there is in there now, so you want to understand that there's going to be some outlier stocks that you hold for a very long period of time and you're, and, but this, these are just average statistics to understand, but this discipline longterm approach helps you balance this risk and return target that you're looking for and gives you that steadier, return. So just overall, this is a big. bedrock. I consider it a bedrock strategy for people who are retired. it adds for stability. and one of the things you can do with this is you can blend in other portfolios around it as satellite positions. For example, you can have high quality municipal bonds to save on taxes and that could give you a different return stream and more conservative. same with corporate bonds if that makes sense for you and your tax bracket or the type of account that you have. private real estate can be very good. in this, and, you know, that is something to really consider, depending on, which areas look the most attractive there, but that can enhance your income and mitigate risk during market downturns.Because again, this is a stock portfolio, so it's going to fluctuate. It generally has historically fluctuated less than the overall market. Most people the S& P 500 type companies, and those stocks have fluctuated more, which makes sense because these are lower duration stocks that are paying you dividends now,And then, you know, owning around 50 stocks offers diversification across those industries and it can help you counter that inflation and the tax problem that people have over time, over retirees lifetime, which could be 20, 30 years. So, that's pretty much it, that I had for you today. I hope you've gotten some ideas, insights, maybe on how to incorporate a dividend investing strategy. Thank you. for yourself, even for people who aren't retired. A portion of your portfolio in this type of strategy is a great compliment to more aggressive, fast growing type company strategies. there's another strategy that I managed called the fundamental trend strategy that is more geared towards fast growing companies. They could be younger companies, more dynamic. Companies like that. it's a great compliment to that type of strategy. When you put those two strategies together, you get a really nice blend. So, thank you for listening. And, you know, hopefully you get some ideas about, dividend strategies. And if you found this helpful, share it with your colleagues, any friends or family. And, you know, follow me for more and, like and subscribe. Hope you're doing well. And we'll talk to you next time.

November 18, 2024

AI Driven Investment Breakthroughs | EP 96

<center><iframe width="560" height="315" src="https://www.youtube.com/embed/ZX1P0FU7KG0?si=Y1Wof7ncQgwCIBcy" title="YouTube video player" frameborder="0" allow="accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture; web-share" referrerpolicy="strict-origin-when-cross-origin" allowfullscreen></iframe></center> In this episode of the Market Call Show, I dive into the transformative role of artificial intelligence in wealth management. Together, we’ll explore how AI is reshaping portfolio management, moving beyond a mere tool to become a revolutionary force in investment strategies. Drawing on groundbreaking insights from Brooklyn Investment Group’s latest white paper, we’ll uncover how AI enables wealth managers to scale their operations, cut time commitments, and reduce costs, all while enhancing the quality of client service. AI's ability to automate complex tasks like portfolio rebalancing allows managers to oversee hundreds of accounts more accurately and efficiently. AI can cut a portfolio manager’s time spent on routine tasks by up to 82% and reduce computational costs by as much as 85%. Join me as we discuss why adopting AI-driven strategies isn’t just beneficial—it’s essential for staying competitive in today’s fast-paced investment world. Whether you're a wealth manager or someone interested in the future of investing, this episode offers practical insights into how AI is setting new standards in wealth management, making it possible to serve clients with precision and speed.   SHOW HIGHLIGHTS <ul style="list-style-type: disc"> <li>I explore how artificial intelligence is revolutionizing wealth management, offering significant improvements in efficiency and personalization.</li> <li>The episode discusses insights from the Brooklyn Investment Group's research, highlighting AI's potential to scale operations and reduce time and computational costs.</li> <li>AI technology allows wealth managers to oversee numerous unique accounts with precision and speed, enhancing client service without increasing workload.</li> <li>According to research, integrating AI into portfolio monitoring can reduce a portfolio manager's time commitment by up to 82% and computational costs by up to 85%.</li> <li>AI-driven strategies are becoming essential in delivering exceptional client service, making personalized investment management more accessible to a wider range of clients.</li> <li>AI models predict when accounts need attention, optimizing tasks such as cash management, risk assessment, and tax loss harvesting.</li> <li>Advanced AI techniques, like zero-shot and multi-shot learning, enhance the adaptability and accuracy of investment strategies.</li> <li>The importance of human judgment in AI-supported systems is emphasized, ensuring decisions are reviewed and validated for consistency and accuracy.</li> <li>Challenges in AI implementation, such as handling complex conditions, are addressed by simplifying calculations and ensuring human oversight.</li> <li>Continuous improvement and evaluation of AI models are crucial, as AI is set to become an integral part of the finance world, enhancing efficiency and decision-making.</li> </ul>   PLUS: Whenever you're ready... here are three ways I can help you prepare for retirement:  1.  Listen to the Market Call Show Podcast or Watch on Youtube One of my favorite things to do is to talk with smart people about investing, financial planning, and how to live a full life.  I share this on my podcast the Market Call Show.  To watch on Youtube  – <a href="https://youtu.be/7bM-geh0pyE">Click here </a>  2.  Read the Financial Freedom Blueprint:  7 Steps to Accelerate Your Path to Prosperity If you’re ready to accelerate your path to prosperity, the Financial Freedom Blueprint lays out a proven system for planning and investing to secure your financial independence. You can get a personalized signed hardcover copy – <a href="https://www.pathtorealwealth.com/the-book/p/financial-freedom-blueprint">Click here</a> 3.  Work with me one-on-one If you would like to talk with me about planning and investing for your future. – <a href="https://meetings.hubspot.com/louis-llanes?uuid=979d970e-5869-43f5-87f7-0c20ea991e6e">Click here</a>       <center> TRANSCRIPT (AI transcript provided as supporting material and may contain errors) </center> Louis: Hi, I'm Louis Llanes, and this is the Market Call Show. Today, I'm going to be diving into a topic that's really reshaping the way wealth managers work. I'm going to be talking about how artificial intelligence can not only help wealth managers manage large numbers of investment portfolios more effectively, but also improve the results for investors, which is very, very important. Our discussion really was inspired by a white paper that I read. It was put out by Brooklyn Investment Group and it's titled AI and Portfolio Management Portfolio Monitoring. It was put out the third quarter of 2024. This research provides what I consider eye-opening data on how generative artificial intelligence is really able to help wealth managers scale operations, save time and reduce costs and also produce better results for clients. So I wanted to kind of break this down, because this is not an area that is optional anymore. This is something that is actually mandatory now in order to do a very good job for clients. So the first part I want to talk about is just the concept of offering personalized investments, very personalized investment management, more so than could have been done in the past, and being able to do it at scale, doing a lot of it. So one of the biggest takeaways that I've been reading in a lot of different research is that making personalized investments more accessible is really important. Making personalized investments more accessible is really important. So, people you know, historically, separate account management or direct indexing with tax loss harvesting, it was really only reserved for high net worth clients because it was so resource intensive. It took a lot of resources to get the job done, both with technology and with people. But now with AI, wealth managers can really scale personalization to a wider range of clients without there being like a proportional increase in the workload. This is really good news for a lot of investors. So imagine if you're a wealth manager that you can handle hundreds of separate accounts, each with a unique profile. The artificial intelligence can step into that automation and make many of those operational tasks a lot easier to do and much more accurate, freeing up a lot of time for portfolio managers. And this means that, instead of being restricted to a smaller group of clients, wealth managers can actually have more time and they can broaden their significant reach to more people and give you more individual attention. That's a big important takeaway here. The other thing I took away from my research recently is that the time and the cost efficiency is really going to be improved. So I want to talk a little bit about numbers. According to that research report that Brooklyn Investment Group put out, integrating artificial intelligence into portfolio monitoring and specifically can cut down on the portfolio manager's time by up to 82%. That's not just a little gain in efficiency, it's literally a game changer. And it's not just the time saving, it's also that there's potentially 63 to 85% reduction in the computational costs. You know, I've been in this business for a long time close to 30 years and actually over 30 years now and you know when we first started rebalancing portfolios, it was very intense and it's just gotten better and better. But now we've really had some breakthroughs on reducing the computational costs, so we're able to get much more precision and speed. So this is achieved by using that artificial intelligence and looking at accounts that need to be rebalancing. So a big part of our job is to make sure that all of our clients have their portfolios rebalanced and we need to know if something needs to be changed. So we're spending our time more on what we should be investing in and why we should be investing in a certain way, but the actual execution of making sure that we're aligned with that strategy is really a portfolio monitoring task, so we can allocate more resources truly on what's more important, which is understanding what we want to be investing and why we want to be investing in certain investments, and more time discussing with clients issues and customizing portfolios, and less time computating. So the other thing that I have taken away is that we've got a smarter portfolio monitoring, really algorithm. So the human brain can do a lot of things and we can really capture exceptions, but we can only do a certain number of things at a time, whereas in the technology world, we can give it guidelines and guardrails and rules to help us make sure that we are being consistent, which is really important in delivering consistent results. So how does artificial intelligent monitoring work? Well, basically, we have models that can predict when an account needs attention, whether it's deploying access to cash, if it needs more cash or less cash, or if the management of risk is an important element, what's happening with risk and is there some change in the risk relative to how we want it to be to be, whether or not there's an ability and an opportunity to harvest tax losses, to lower the tax bills. The system achieves nearly a perfect recall, meaning that there's almost no important rebalancing opportunity that is missed because these screens are looking at everything. So this predictive accuracy it really ensures that we, as wealth managers, investment managers we can trust our systems and identify the right moments for action without having to sift through every portfolio one by one. That's crucial when you're managing a large number of accounts. So I want to talk about another takeaway that's really important. Advanced AI techniques now are allowing us to do even more, so the technology is really fascinating. If you use large language models, these abilities really give you a performance that is much more extensive when we train the data, and so we can train the data based on how we trade and what certain things that we really want to be prioritized, and this can help identify even more effectively things that need to be done. And there's different, I guess, methodologies. One is zero-shot or multi-shot learning approaches and, in simple terms, zero shot learning allows artificial intelligence to make decisions with little or no context, which is not always what we want, whereas multi-shot learning allows us to use past examples to further enhance performance, and these techniques ensure that your predictions are more accurate and adaptable to what's happening in the portfolio and in the markets. So, and always, we have decision support. It's always ultimately human-based, but it's just a tool to help us to identify things and then make the ultimate decision as to what needs to happen. As we all know, even AI, you know it's wise, but you have to trust, but verify every approach. So you want to have the human in the loop, which we do, and we want to ensure that these guardrails are in place to oversee every aspect and to make sure that things are flagged for trading only and when there's certain breaches or certain limits that we are looking at and it's automatically marked for human review. So each one must be reviewed, and that's a really important part of this. So the combination of AI's computational power and human judgment makes for a robust system that's efficient and reliable. That, by the way, is also a big part of how we manage money itself. So there's a lot of human judgment about, for example, the valuation of a stock or what may be happening with interest rates, and that can be overlaid on top of quantitative analysis. That helps to make sure that you're on track and you can use it as guardrails. It gives you much more consistency in your decision making Another, I guess, takeaway that I've gotten from research is that there's challenges and solutions, so let me explain a little bit. Like any innovation that you have when you use AI and portfolio management, it isn't without challenges. When you use AI and portfolio management, it isn't without challenges. One issue that this paper mentioned, that kind of brings us to light, is that sometimes you can struggle with complex conditions, such as comparing small percentage values, but there are solutions to this. To simplify, you can convert these values into basis points, you can make calculations more straightforward, and simplifying is always a good idea. So I forget who actually said it. It might have been Einstein, but you always want to have the simplest solution that is the most effective. You don't want to have something overly complex, because the more something that is complex, the harder it is, the less reliable it is, the less robust it is complex. The harder it is, the less reliable it is, the less robust it is. So the research that I've been looking at really is a balance between precision and recall, so you want to note that it's better to have false positives than to risk missing a necessary trade, something that you need to do. So that's why you need human review. So you want to be more stringent and it's better to have something tagged that is a false positive, meaning that it looks like it might be something you need to do, but you don't need to do it, so you can say, no, we don't want to have that, because that makes sure you don't want to miss something that's really important. You don't want to miss training opportunities that could impact the portfolio's performance. So, as I've been looking at this, you know this continuing improvement is really kind of the future and the future steps. So what's next? I mean, I think there's evaluation of new models, there's new AI type algorithms that are coming out and they're always going to be part of the finance world from here on out. We just have to get used to that because truly, it makes you smarter. Actually, it just makes you more efficient, and the human ingenuity and having that overlay with human touch is so important. But we want to have these algorithms and we want to make sure these algorithms are better and better. That's really all I have. I want to just to wrap it up AI really isn't just a buzzword. It's a really a practical, powerful tool for wealth managers. It allows us to scale our operations, save a lot of time, cut costs, provide better service for you, the client. And, like I said, the future of portfolio management is going to have AI in it, whether you like it or not, but it's always best to be smarter and faster and more efficient with human judgment, because truly nothing will replace human beings in the end, and our clients are not a number, and we want to have that ability to be as customizable and to offer the best solutions that we can at the lowest price and have the best experience we possibly can, and technology and AI really is helping us in that realm. Okay, so that's it for now. That's the Market Call Show for this round. If you've enjoyed today's episode, don't forget to subscribe. Leave us a review. I'm Louis Llanes. I'll catch up with you next time, where I'll dive into more insights to stay ahead of the investment management world. I hope you have a great day. Talk to you later.

November 3, 2024

Fishing in Less Crowded Technology Stocks | Ep 95

<center></center> Today, on the Market Call Show, we dive into smarter tech investing, I paint a vivid picture of the current tech sector, likening it to overfished rivers where investors crowd around large-cap stocks, inflating prices and squeezing out value. We come up with a fresh approach: focusing on smaller tech companies and early-stage private equity to achieve better diversification and risk reduction. We explore the valuation landscape as of October 22, 2024, shedding light on the significance of return on invested capital for predicting returns. We reveal that only a small fraction of U.S. tech companies achieve over 10% in return on invested capital, while high cash flow ratios make even profitable companies seem overvalued. Tune in to hear why I believe looking beyond the usual tech giants can open doors to sustainable growth in this crowded market.   SHOW HIGHLIGHTS <ul style="list-style-type: disc"> <li>I explore hidden investment opportunities in the tech sector with Luis Llanes, emphasizing the value of looking beyond large-cap stocks.</li> <li>Louis uses the metaphor of overfished rivers to describe the crowded and overvalued large-cap tech market, suggesting a shift towards small tech companies and early-stage private equity.</li> <li>We discuss the current valuation landscape of the U.S. tech sector, highlighting that only a small percentage of companies achieve a return on invested capital above 10%.</li> <li>Louis notes the median price to cash flow ratio for profitable tech companies is 25, indicating high valuations even among successful firms.</li> <li>We analyze the tech sector's high median price to book ratio of 5.11 and its implications for investors.</li> <li>The conversation touches on the challenges of navigating the crowded index world and the benefits of a bottom-up investment approach.</li> <li>Louis discusses the impact of artificial intelligence on the tech sector, drawing parallels to the dot-com bubble and the need for risk management.</li> <li>We consider the advantages of targeting small tech companies with strong fundamentals, profitability, and growth potential.</li> <li>The episode emphasizes the importance of a diversified investment strategy, combining both indexing and active equity management.</li> <li>Throughout the discussion, we encourage listeners to assess investments based on fundamentals and to be prepared for potential market volatility.</li> </ul>   PLUS: Whenever you're ready... here are three ways I can help you prepare for retirement:  1.  Listen to the Market Call Show Podcast or Watch on Youtube One of my favorite things to do is to talk with smart people about investing, financial planning, and how to live a full life.  I share this on my podcast the Market Call Show.  To watch on Youtube  – <a href="https://youtu.be/7bM-geh0pyE">Click here </a>  2.  Read the Financial Freedom Blueprint:  7 Steps to Accelerate Your Path to Prosperity If you’re ready to accelerate your path to prosperity, the Financial Freedom Blueprint lays out a proven system for planning and investing to secure your financial independence. You can get a personalized signed hardcover copy – <a href="https://www.pathtorealwealth.com/the-book/p/financial-freedom-blueprint">Click here</a> 3.  Work with me one-on-one If you would like to talk with me about planning and investing for your future. – <a href="https://meetings.hubspot.com/louis-llanes?uuid=979d970e-5869-43f5-87f7-0c20ea991e6e">Click here</a>       <center> TRANSCRIPT (AI transcript provided as supporting material and may contain errors) </center> Louis:Hi, this is Louis Llanes for the Market Call Show. Today I'm going to be talking about fishing for less crowded technology stocks and it's really a suggestion to help you reduce risk and diversify your portfolio. So I live in the beautiful state of Colorado, which offers excellent fly fishing for trout, and when I first moved here I learned that the fish on the Blue River in Silverthorne. You had to be a really good fisherman. The fish was. There was a lot of fish there. The rivers were full of trout, but it was located behind a popular outlet mall and it drew a lot of tourists to that mall. So there was a lot of men out there who would leave their wives to go shopping and they'd head down to the river and it to that mall. So there was a lot of men out there who would leave their wives to go shopping and they'd head down to the river and it made the river really crowded and you could see the trout everywhere. They were all over the place. The water was very clear and you could perfectly present your fly because we were fly fishing, you could perfectly present that fly and you could even be bumping them on the nose with the perfect fly and they would still not bite. They would just leave it alone, and that's what happens when an area is overfished. That's what I'm feeling the tech sector feels like. The tech sector feels real similar, because there's tons of money that has been chasing these tech stocks and in the market where the large cap tech stocks dominate and the IPO market has dried up, it makes more sense to seek opportunities in less obvious places, in my opinion, like select small tech companies and early stage private equity. Instead of putting all your money into well known names that dominate the large portion of the S&P 500 that everybody's talking about, it's more logical to look for less crowded areas. In my opinion, there's way too much money chasing the same indexes and that's also pushing up those tech stocks, because the tech stocks represent almost a third or, depending on how you categorize tech stocks, it represents over a third even of the S&P 500. So here's the valuation picture today, and today is October 22nd 2024. To put things in perspective, I ran some numbers on the US technology sector using the GIX standards. The GIX is a it's basically it's a standard for categorizing tech stocks, or really all the stocks. Now there's 638 companies that are in the technology sector in the United States, but only 21.2% have a return on invested capital above 10%. So I like to buy companies that are profitable, that have good returns on capital, because that is a big determinant of expected returns. So most companies in the tech sector right now have a negative return on invested capital. For those with a reasonably good return on invested capital, the median price to cash flow ratio is 25.26 and the median return on invested capital is 19 in just in the tech sector. So these companies trade at a median price to book ratio of 5.11. So, based on using a multi-stage fair value calculation, which a lot of analysts would do for companies that are growing fast and then they start slowing their growth and then go into more of a steady state, if you just use reasonable expectations for companies in the tech sector, you find out that you generally rarely would be in a situation where your price to cash flow ratio is above 20. Yet the median right now is 25. So for even the most profitable tech companies they're very expensive. So, if you know, take a look at them in terms of percentile. You'll see that. You know the vast majority of the tech companies are really below the line and a lot of them are significantly below the line, like at the 10th percentile in return on invested capital. The average return on capital invested capital is like negative 27% negative 27% and even when you go to the most profitable, if you look at the decile, the top 10% of return on invested capital in the tech sector, the average return on capital is 21%. So you know, I mean we're in a situation. My main point, I guess, is that we're expensive right now. So finding opportunity and better rivers is really what we want to do. We want to look at areas where there's a bigger return potential and maybe smaller companies are a better place to look, companies that have higher returns on capital and strong business models with smaller allocations to maybe early stage private equity, things like that, because in the index world today it's overcrowded, like we talked about. And, to make matters worse, a lot of the brokerage firms and a lot of advisors are indexing right now and a lot of people are offering a lot of like. Investment advisors are offering direct indexing, where you're able to buy the stocks directly in an index, and many RIAs or registered investment advisors they're adopting this. Registered investment advisors, they're adopting this. I see a lot of advisors who are, you know, maybe not quite as experienced, out there looking at how well indexing has done recently and kind of extrapolating that's how indexes are gonna do in the future and they're making that assumption. So they're choosing to go this way and this is really in their minds makes them feel like, hey, indexing is a no brainer and I'm not anti-indexing and I think a proportion of portfolios could be indexed. In fact, we have strategies that are a core plus, where there's some indexing and then some active. But if I look at things kind of more the investment landscape, more from a rational standpoint in terms of expected return based on fundamentals, I think you have to kind of be prepared for either a melt-up or a melt-down situation, and you hear this a lot. There's certain research firms that will talk about this melt-up concept where you have stocks running up really rapidly because we're printing money and there's money is trying to find a place to go and that's probably gonna go into stocks, and then other people say, hey, this is just the opposite. Inflation's going to get high, interest rates are going to go up and then we can have like a meltdown. So the truth of the matter is we don't know exactly which direction this is going to go, and that the best way to invest really is to have more of a bottom-up approach, where you're looking at individual businesses based on fundamentals and, like I, always talk about the quality, et cetera, et cetera. So I want to be prepared for either scenario and that means just going bottom up. Now this type of environment is kind of more ripe for volatility spikes. In fact, I've heard some analysts are expecting volatility to increase after the election. So, but volatility spikes can catch investors off guard. In my view, it's prudent to incorporate active equity management with indexes like the core plus year bound that invests in both indexing as well as active strategies that concentrate their holdings in the active strategies. Concentrate their holdings on those stocks that have the best fundamentals and I think if investors do that, it puts you in a better position. If the market heats up, then you'll have a sensible allocation to the indexes and then you also have a fundamental approach and that blend. I would expect to have better risk-adjusted returns over time. This approach is really often what I tend to take with high net worth investors. In the active equity portion of the portfolio, I like to target companies with strong fundamentals, like I mentioned, and a real chance to outperform the index, and you don't want to have too many stocks in there because you want to have some level of concentration in that portion, and it's a great example of diversification. You could go all into one strategy, but why limit yourself? You're better off having a blend, in my opinion. Now, all the buzz right now in tech has to do with artificial intelligence, and to me that kind of echoes the dot-com bubble, and I know that history rhymes and it's not always exactly the same, but there are some corollaries. Artificial intelligence is heavily and it's clearly going to change the world. That we know. That's an easy conclusion to come to. But what's harder to know is which companies are going to be the ones who are going to be the winners, which will thrive and which will literally disappear. We have to make some educated guesses and apply risk management when dealing with artificial intelligence. So if you kind of look at the dot-com bubble, that's exactly what we saw. We knew the internet was going to be transforming everything, and here we are looking back and we say, yeah, that's exactly what happened. Yet most of those companies that had the huge valuations ended up collapsing over time and a few did very well, but overall the business became more efficient across the economy. So that increase in efficiency using the Internet boosted the entire economy in a lot of different ways and it led to a lot of new industries. And I think that's likely what's going to happen with artificial intelligence. I think AI will follow a similar path. I have charted what it looks like with the market cap as a percentage of the S&P 500. And if you look at the kind of the graph of that percentage, so basically how much concentration does tech represent in the S&P 500,? And we're near the peaks that we saw at the dot-com era. So we're not quite up there as we were. We pulled back a little bit from there, but we're pretty close. So in history you could make an argument that we're, you know, we have to be somewhat careful, you would think. So small tech companies on the positive side that meet my criteria, I think is a good way to go. I like to invest in these smaller companies that exhibit certain characteristics and I modify them somewhat for the smaller companies. But I really am looking at three categories and the first category is sentiment, which involves the shift in the brokerage firm's recommendations, the shift in the earnings. You know how well we want to see you know the estimates moving up. The company is doing better. The revenue is moving higher. There's growth in the smaller companies. We're looking for them to be moving up the market cap rank, moving from a smaller company to a larger company. The second category I like to focus in, obviously, is quality, which includes how profitable they are. What are the returns? What are the return on invested capital and the strength of their balance sheet? And, lastly, I like to look at the valuation assessing the company's metrics compared to free cash flow, asset sales and earnings per share. You know how much are you paying for those metrics of cash flow and assets. So there's a few companies out there right now that we own. Now, in investing in these strategies, it's definitely more dynamic, and so companies can fall in and out depending on how they rank on these issues, because we're trying to focus our capital in those companies that are doing well. So there are a few companies. I don't want to necessarily mention tickers, because these are smaller companies and I don't really want to have that out there right now, but that is, and so I like to have some money there and another way to fish in kind of less crowded streams is to you know you don't want to, instead of focusing where everybody knows I'm looking for under a great like mid caps and private equity. So I'm underweighted large cap tech names right now, and these are the names that mostly everybody knows about. They're kind of priced to perfection. So I'd like to think I'd like to hear more about what your thoughts are about this. I am bullish on technology, I'm bullish on a, I'm bullish on the United States and I'm bullish on our overall future. I think it's just a matter of saying what price, or I should say asking ourselves what price are we paying for these investments and does it make sense? So that's all for now. I hope you got some value out of this. Feel free to contact us if you have any questions about any type of investment strategies. I'm Luis Llanos, market Call Show signing out. Have a great day. Outro Sequence For the latest episode of the Market Call Show. Make sure to like, subscribe and follow us on X, formerly known as Twitter, and YouTube. Go to wwwmarketcallshowcom for all our past episodes and sign up to get alerts. If you enjoy the content of this episode, please share it and comment. The information in this podcast is general in nature and does not take into consideration the listener's personal circumstances. Therefore, it is not intended to be a substitute for specific, individualized financial, legal or tax advice. To determine which strategies or investments may be suitable for you, consult the appropriately qualified professional prior to making a final decision.

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