The terms opening, middle game, and endgame are used to describe the phases of a chess game. These terms are often used outside of chess to describe the phases of an endeavor, but rarely are they applied to investing. In chapter nine of How Life Imitates Chess Garry Kasparov points out there are no distinct definitions for the three phases of the game. But even so each phase has distinct characteristics and each poses problems that benefit from different modes of thinking. With different modes of thinking being applicable, chess players find they have strengths in one phase and weaknesses in another.

The body of knowledge of chess openings is compartmented into various sets of opening moves and these are assigned names ranging from the descriptive ones (e.g. King's Gambit), to those named for individuals (e.g. Marshall Attack), to those named poetically (e.g. Sicilian Dragon). Aspiring chess students often approach learning this phase by memorization of opening sequences. Grandmasters universally agree this is a mistake (never mind that they have already memorized them!) as the players are not thinking for themselves. When your opponent departs from the book line you may not grasp the rationale as to why their pieces are placed where they are. Mistakes ensue. While I see their point, I cannot fully agree: memorizing a few opening moves can get you into a respectable position for the remainder of the game.

An aspiring investor may embrace an opening approach with a chosen set of moves. These approaches may be named descriptively (e.g. CANSLIM), named for an individual (Benjamin Graham approach), or poetically named (e.g. Motley Fool Rule Breaker). These modes of thinking are good and fine as they get the investor into the game with a respectable portfolio. But when the approach fails on a few trades, one may not realize the markets have departed from the book line and the approach no longer works. Mistakes ensue.

The middle game is approached with tactical finesse and strategic positioning into the endgame. The middle game requires alertness in general and alertness to patterns in particular. There are no book lines to rely upon. Tactics can of course be taught but the learning key is the more you do, the better you become. Tactical prowess is essential in this phase.

The middle game of investing is when the size of one's trades exceeds its periodic accumulations. Calculation, reasoning, and alertness lead the investor out of their initial positions and into aggressive positions. Tactics such as market timing, limit orders, and selling covered calls are teachable but you gain finesse only by doing them.

A game of chess transitions to endgame when major pieces have been exchanged and the energy and excitement of the middle game has diminished. There are fewer surprises to be had, the moves are sterile, and there is little room for style. With fewer possibilities it is almost possible to calculate the outcome of every move. Successful endgame players are cautious, patient, and calculating.

While chess has a distinct endpoint, an investing endpoint is elusive. It is true your options may be decreasing in terms of the risk you accept, the years to recover from a dip, or the ability to offset losses with wages. But ever-changing markets will not decrease their options or the surprises they can spring on you. Indeed the variety of financial instruments offered is rapidly increasing.

Nevertheless, it is commonplace to envision an investing endgame where one exchanges their equity wealth for fixed income wealth upon retirement. Consider one who accepts the conventional guidance and puts 90% of their wealth into CDs and retains 10% in equities. I contend that 10% is still playing the middle game. Consider one who receives a lump-sum pension payment and puts 90% of it into CDs and puts 10% into equities. I contend that person's 10% has just entered the opening. One's wealth is never entirely in an endgame.

Comments: View Comments |  Monday May 26, 2008

In chapter eight of How Life Imitates Chess Garry Kasparov discusses exploiting lack of symmetry in Exchanges and Imbalances.

A casual glance at a chess position leads to an immediate question: whose move is it and what is their best move from this position? This is followed by an inevitable exercise of trying one move after another while missing the big picture of strategic possibilities present in the position. This is quite natural. Indeed the player whose turn to move has an action to make. But it leaps over the essential step of evaluating position.

Got money to invest? You indeed have a move to make. As investors we often fall into a trap of the immediate question: where's the best place to invest these funds? This is followed by the inevitable exercise of running our favorite screen, or seeing what our favorite guru is recommending, or conversing with friends about what they are buying. But have we evaluated the market's macro trends and our whole portfolio's strategic positioning into these trends? Have we evaluated our portfolio in terms of its imbalances?

Kasparov describes a teaching technique where chess students are taught to evaluate structure and space quantitatively by showing chess positions without revealing whose move it is. Thereby students are forced into an assessment of the position's imbalances.

The author states evaluation is not only a search for advantage but is also a search for compensation for disadvantage. For every offensive weakness is there some gain in defensiveness? For every weakness in material is there a gain in space or attacking opportunities?

The strongest holding in a portfolio is an easy search but a more challenging search is: what is its weakest holding? An even more difficult search is: am I receiving compensation for it? A declining stock may represent a hedged offset for a rising stock. Perhaps its longer term prospects exceed the temporary price decline. Perhaps it is still earning a dividend. Perhaps you perceive a value that is not presently valued by the market.

Whatever weakness is revealed in a portfolio's strategic evaluation, an assessment of offsetting compensation should precede the decision to trade it.

Comments: View Comments |  Sunday May 4, 2008

One of my three themes for SLO2 is consumer stocks. While watching an episode of the country's highest-rated show, American Idol, I noted each commercial I saw with intentions of constructing an American Idol portfolio. While initially a whimsical exercise, I was smitten by the stellar collection and have been thinking such a portfolio might be quite lucrative. The nineteen publicly-traded stocks have a combined market cap of more than a trillion dollars.

First, the value of consumer branding is based on repeated positioning of its image in the minds of consumers. By placing ads on such a highly-viewed broadcast, these companies are increasing their intangible goodwill. These are growers - their median EPS growth is 12%.

Second, the ability to promote oneself on the show is not cheap suggesting these companies have cash to spend on branding themselves via this vehicle. Reportedly, AT&T, Coca-Cola and Ford are each paying about $35 million for commercial time, online content, co-branding and to be featured during American Idol. These are cash producers - fourteen of them pay dividends.

Finally, consumer stocks have been avoided by a market that assumes the consumer is "tapped out." This has resulted in some compelling values. Half of these are trading below their 200-day moving average.

The following is the list of all ads I saw on the night of the exercise. First is product advertised, second is the symbol of the parent company, and third a brief comment. Note some of these may be locally placed ads or cable company overwrites so your ads may vary.

• AT&T (T). Exclusive provider of phone service for Apple iPhone users.
• Olay (Proctor & Gamble - PG). Pervasive consumer consumables company continues to grow.
• Toyota (TM). Global automaker making entry into India.
• Vitamin Water and Minute Maid (Coca-Cola - KO). Beverage purveyor continues to see volumes rising.
• Apple (AAPL). Continued strong earning and revenue growth. One of the SLO contest largest collective holdings.
• McDonalds (MCD). Global fast food giant has no peers.
• Kraft (KFT). Packaged food company recently reaffirmed 2008 guidance..
• Waterhorse movie (Sony - SNE) Global electronics giant appears fairly priced.
• Colgate (CL). Company expects double digit earnings per share growth this year.
• Fox Shows (News Corp - NWS). Media conglomerate continues to aggressively acquire more media properties.
• Avon (AVP). Beauty products company is expanding sales in Latin America.
• Ford and Mazda (F). Despite slipping North Amercian sales, the company managed to post a profit in the most recent quarter.
• H&R Block (HRB). Services company recently unloaded its Option One mortgage loan servicing unit.
• Weight Watchers (WTW). Weight management company growth is in double digits.
• Hanes (HBI). Apparel maker tripled profits in its last earnings announcement.
• Wendy's (WEN). Being acquired by Triaric.
• Payless Shoes (Collective Brands - PSS). Shoe company's gross margins are increasing.
• Applebee's (IHOP Corp - IHP). Same store sales at both IHOP and Applebee's restaurants are increasing.
• Arby's (Triarc TRY). Acquiring Wendy's.

These ads do not appear to have a parent company tradable for this contest.
• Loreal and Garnier (traded on Paris exchange)
• Subway (Doctor's Associates - privately held)
• New Balance (privately held)
• Krystal (privately held)
• Local Fox Affiliate (privately held)

Finally these ads were from nonprofits.
• Alliance Climate Change (lobbyist - N/A)
• DTV Answers (lobbyist - N/A)

I plan to watch for good entry points for these companies as the consumer portion of my SLO2 portfolio evolves.

Comments: View Comments |  Saturday May 3, 2008