Progress Daily

If you want to be a successful stock market investor, buy pieces of “good” businesses at “bargain” prices.

A “good” business is a business that can earn a high return on capital.

Say you own a gum store that store costs $400,000 to build (including inventory, store displays, etc) and last year that store earned $200,000. This works out to a 50% yearly return ($200,000 divided by $400,000) on the initial cost of opening a gum store. This result is often referred to as a 50 percent return on capital. Without knowing much else, earning $200,000 each year from a store that costs $400,000 to build, sounds like a pretty good business.

But what if we compared that to another kind of store, say a store that sells only Broccoli. What if it also costs $400,000 to open a Just Broccoli store? But what if that store only earned $10,000 last year? Earning $10,000 a year from a store that costs $400,000 to build works out to a one-year return of only 2.5 percent, or a 2.5 percent return on capital.

A business that earns a 50% return on capital is better than one that earns a 2.5% return on capital.

A cheap business is one with a high earnings yield.

Take two businesses, one earned $300,000 last year, one earned $100,000. Both are for sale for $1 million. If we buy the first, we get an earnings yield of 30% ($300,000 in earnings divided by the $1 million purchase price). The second has an earnings yield of 10% ($100,000 in earnings divided by the $1 million purchase price). The company that earns more relative to the price we’re paying is cheaper than the one that earns less. Getting a 30% earnings yield is better than a 10% earnings yield — a high earnings yield is better than a low one.

This is the magic formula. If you just stick to buying “good” companies (those with a high return on capital) but you buy them only when they are available at bargain prices (when they have a high earnings yield), you can more than double the market’s average annual return. And you can do it with very low risk. A study we conducted over the last 17 years shows that holding a portfolio of stocks with the best combination of a high earnings yield and a high return on capital produced over 30% annual returns vs. just 12% for the overall market during the same period.

The Magic Formula in Action

Magic Formula {S&P 500}

1988: 27.1% {16.6%}
1989: 44.6 {31.7}
1990: 1.7 {-3.1}
1991: 70.6 {30.5}
1992: 32.4 {7.6}
1993: 17.2 {10.1}
1994: 22.0 {1.3}
1995: 34.0 {37.6}
1996: 17.3 {23.0}
1997: 40.4 {33.4}
1998: 25.5 {28.6}
1999: 53.0 {21.0}
2000: 7.9 {-9.1}
2001: 69.6 {-11.9}
2002: (4.0) {-22.1}
2003: 79.9 {28.7}
2004: 19.3 {10.9}

AVG 30.8% {12.4%}

Over 17 years, earning 30% a year means $11,000 would have turned into over $1 million!

“The Little Essay That Beats The Market,” by Joel Greenblatt

Magic Formula Investing

In 1950 only one-third of American women of working age had a paid job. Today two-thirds do, and women make up almost half of America’s workforce. Since 1950 men’s employment rate has slid by 12 percentage points, to 77%.

In the emerging East Asian economies, for every 100 men in the labour force there are now 83 women, higher even than the average in OECD countries. Women have been particularly important to the success of Asia’s export industries, typically accounting for 60-80% of jobs in many export sectors, such as textiles and clothing.

The increase in female employment has accounted for a big chunk of global growth in recent decades. GDP growth can come from three sources: employing more people; using more capital per worker; or an increase in the productivity of labour and capital due to new technology, say. Since 1970 women have filled two new jobs for every one taken by a man. Back-of-the-envelope calculations suggest that the employment of extra women has not only added more to GDP than new jobs for men but has also chipped in more than either capital investment or increased productivity.

Surveys suggest that women make perhaps 80% of consumers’ buying decisions.

Kathy Matsui, chief strategist at Goldman Sachs in Tokyo, has devised a basket of 115 Japanese companies that should benefit from women’s rising purchasing power and changing lives as more of them go out to work. It includes industries such as financial services as well as online retailing, beauty, clothing and prepared foods. Over the past decade the value of shares in Goldman’s basket has risen by 96%, against the Tokyo stockmarket’s rise of 13%.

At school, girls consistently get better grades, and in most developed countries well over half of all university degrees are now being awarded to women. In America 140 women enroll in higher education each year for every 100 men; in Sweden the number is as high as 150. (There are, however, only 90 female Japanese students for every 100 males.)

Women account for only 7% of directors on the world’s corporate boards — 15% in America, but less than 1% in Japan. Yet a study by Catalyst, a consultancy, found that American companies with more women in senior management jobs earned a higher return on equity than those with fewer women at the top. Studies suggest that women are often better than men at building teams and communicating.

Researchers have also concluded that women make better investors than men. A survey by Digital Look, a British financial website, found that women consistently earn higher returns than men. A survey of American investors by Merrill Lynch examined why women were better at investing. Women were less likely to “churn” their investments; and men tended to commit too much money to single, risky ideas.

Less than 50% of Italian women and only 55-60% of German and French women have paid jobs. But Kevin Daly, of Goldman Sachs, points out that among women aged 25-29 the participation rate in the EU (ie, the proportion of women who are in jobs or looking for them) is the same as in America. Among 55- to 59-year-olds it is only 50%, well below America’s 66%. Over time, female employment in Europe will surely rise, to the benefit of its economies.

A study last year by the World Economic Forum found a clear correlation between sex equality (measured by economic participation, education, health and political empowerment) and GDP per head.

There is strong evidence that educating girls boosts prosperity. Not only are better educated women more productive, but they raise healthier, better educated children. More than two-thirds of the world’s illiterate adults are women.

Countries with high female labour participation rates (such as Sweden) tend to have higher fertility rates than countries (such as Germany, Italy and Japan) where fewer women work.

Countries in which more women have stayed at home, namely Germany, Japan and Italy, offer less support for working mothers. This means that fewer women take or look for jobs; but it also means lower birth rates because women postpone childbearing. Japan, for example, offers little support for working mothers: only 13% of children under three attend day-care centres, compared with 54% in America and 34% in Britain.

“A Guide to Womenomics,” The Economist

The “prisoner’s dilemma” game undertaken by Robert Axelrod at the University of Michigan requires each of two players to choose simultaneously one of two actions, “cooperate” or “defect.” The way the payoffs work is that both players do better by cooperating than defecting, but whatever one player does, the other player does better by defecting. For example, the payoff to mutual cooperation is 10 for each, the payoff to mutual defecting is 5 for each, but the payoff to defecting when the other player cooperates is 15 for the defector and 0 for the cooperator. The iterated prisoner’s dilemma is simply repeated play of the game with “winners” being those with high cumulative scores over however many rounds are played.

Axelrod asked a number of game theorists, economists, political scientists, sociologists, and psychologists to submit computer programs giving complete strategies for playing the game successive rounds of which were repeated with the same partner. Each program was pitted against every other program, as well as itself and a program that randomly chose to cooperate and defect. The winning strategy (submitted by game theorist Anatol Rappoport), called tit-for-tat, was the simplest. Tit-for-tat cooperates on the first round, and then does whatever its partner did on the previous round.

Tit-for-tat has three attributes essential for cooperation. (1) It’s nice: it begins by cooperating, and it is never the first to defect. (2) It’s punishing: it retaliates relentlessly once the other party defects. (3) It’s forgiving: as soon as a defecting partner returns to cooperating, tit-for-tat does the same.

In the “ultimatum game” one subject is the responder, the other the proposer. The proposer is provisionally awarded an amount (”the pie” — typically $10) to be divided between proposer and responder. The proposer offers a certain portion of the pie to the responder. If the responder accepts, the responder gets the proposed portion, and the proposer keeps the rest. If the responder rejects the offer both get nothing. In experiments conducted in the United States, Slovakia, Japan, Israel, Slovenia, Germany, Russia, and Indonesia, the vast majority of proposers offer between 40% and 50% of the pie, and offers lower than 30% of the pie are often rejected. These results have occurred in experiments with stakes as high as three months’ earnings.

In an n-player public goods experiment ten players are given $1 in each of ten rounds. On each round, each player can contribute any portion of the $1 (anonymously) to a “common pool.” The experimenter divides the amount in the common pool by two, and gives each player that much money. If all ten players are cooperative, on each round each puts $1 in the pool, the experimenter divides the $10 in the pool by two, and gives each player $5. After ten rounds of this, each subject has $50. By being selfish, however, each player can do better as long as the others are cooperating. By keeping the $1, the player ends up with “his” $10, plus receives $45 as his share of the pool, for a total of $55. If everyone is selfish, however, then no one gives to the pool, and each receives only $10.

In such experiments, only a small fraction of players contribute nothing to the common pool. In the early stages of the game, people generally contribute half their money to the pool. In the later stages of the game, contributions decay until at the end, they are contributing very little. The economist James Andreoni suggests that cooperation decays because public-spirited contributors want to retaliate against free-riders and the only way available to them in the game is by not contributing themselves. If players are permitted to retaliate directly against non-contributors, but at a cost to themselves, they do so. In this situation, contributions rise in subsequent rounds to near the maximal level.

Communication among participants prior to the game, or experimental conditions that reduce the subjective “social distance” among participants, lead to higher and more sustained levels of generosity and cooperation.

We can generalize from these and similar experiments that: (1) People exhibit significant levels of generosity, even towards strangers. (2) People share more of what they acquire by chance rather than by personal effort. (3) People contribute to public goods and cooperate in collective endeavors, and consider it unfair to free-ride on the contributions and efforts of others. (4) People punish free riders at substantial costs to themselves, even when they cannot reasonably expect future personal gain from doing so. (5) Each of these aspects of reciprocity becomes more salient when the social distance participants perceive among themselves is smaller.

In an unpublished paper studying a 1990 sample of the General Social Survey, Christina Fong found that only 18% of respondents who cited “lack of effort by the poor themselves” as a reason for poverty thought “too little” was spent on welfare, while 49% thought that “too much” was being spent. In contrast, among those who thought that lack of effort was “not important,” 44% thought that we were spending too little on welfare, compared to 28% for “too much.” Fong found that a belief that effort is important to “getting ahead in life” has a considerably larger impact on opposition to aiding the poor than does one’s income, years of schooling, and parents’ socioeconomic status combined.

Fong found that statistically controlling for race, schooling, income, religion and other variables, the self-employed tend to oppose such policies, and that much of their opposition is statistically associated with a belief that individual effort makes a difference in getting ahead. In his forthcoming Why Americans Hate Welfare, political scientist Martin Gilens notes that during recessions people are less likely to explain poverty by “lack of effort by the poor,” and more likely to support egalitarian programs.

Steve Farkas and Jean Robinson (The Values We Live By) note that, by more than four to one, Americans say the most upsetting thing about welfare is that “it encourages people to adopt the wrong lifestyle and values,” not that “it costs to much tax money.”

68% said (59% of welfare recipients) that welfare is “passed on from generation to generation, creating a permanent underclass.”

70% (71% of welfare recipients) said welfare makes it “financially better for people to stay on welfare than to get a job.”

57% (62% of welfare recipients) think welfare encourages “people to be lazy” and 60% (64% of welfare recipients) say the welfare system “encourages people to have kids out of wedlock.”

Whites were much more likely than African Americans to attribute negative attributes to welfare recipients, and much more likely to blame an individual’s poverty on lack of effort. The survey data show that whites’ race-based opposition to welfare stems from the specific perception that, as a group, African Americans are not committed to the work ethic.

The U.S. public strongly supports income support measures when asked in ways that make clear the deserving nature of the poor: a 1995 CBS/New York Times poll found that twice as many agreed as disagreed that “it is the responsibility of the government to take care of people who can’t take care of themselves.”

“Is Equality Passé?” by Samuel Bowles and Herbert Gintis

In a study conducted by by Timothy Wilson, Dolores Kraft, and Dana Dunn, people in one group were asked to list the reasons their relationship with a romantic partner was going the way it was, and then rate how satisfied they were with the relationship. People in another group were asked to rate their satisfaction without any analysis; they just gave their gut reactions. It was the people in the “gut feeling” group whose ratings predicted whether they were still dating their partner several months later. As for the navel gazers, their satisfaction ratings did not predict the outcome of their relationships at all.

Self-reflection is especially problematic when we are feeling down. Research by Susan Nolen-Hoeksema, a clinical psychologist at Yale University, shows that when people are depressed, ruminating on their problems makes things worse. In one study, mildly depressed college students were asked to spend eight minutes thinking about themselves or to spend the same amount of time thinking about mundane topics like “clouds forming in the sky.” People in the first group focused on the negative things in their lives and sunk into a worse mood. People in the other group actually felt better afterward.

In an extensive review of the research, a team led by Richard McNally, a clinical psychologist at Harvard, concluded that debriefing procedures after a traumatic event have little benefit and might even hurt by interrupting the normal healing process. People often distract themselves from thinking about painful events right after they occur, and this may be better than mentally reliving the events.

Social psychologist Daniel Batson and colleagues at the University of Kansas found that participants who were given an opportunity to do a favor for another person ended up viewing themselves as kind, considerate people — unless, that is, they were asked to reflect on why they had done the favor. The trick is to go out of our way to be kind to others without thinking too much about why we’re doing it. As a bonus, our kindnesses will make us happier.

A study by University of California, Riverside, social psychologist Sonja Lyubomirsky and colleagues found that college students instructed to do a few acts of kindness one day a week ended up being happier than a control group of students who received no special instructions.

“Don’t Think Twice, It’s All Right” by Timothy Wilson

A brain-imaging study led by Nora Volkow, at the Brookhaven National Laboratory, sheds light on the mechanism that makes the mere presence of food alluring. When people were allowed to see and smell their favorite chow, a deep-lying brain structure called the dorsal striatum was activated and the subjects reported feeling hungrier. Though it sits right next door to one of the brain’s most important pleasure centers, it is not itself a generator of warm, fuzzy feelings. Indeed, being hungry in the presence of forbidden food is distinctly un-pleasurable.

What this and similar research implies is that the reward of eating is not the sole thing motivating us to eat. The dorsal striatum draws us to food (and other objects of addiction) even when we are not hungry.

This system was once very important for survival,” Volkow says. “It was important to want food whenever you could get it, because you never knew when it was going to be around.”

A structure called the nucleus accumbens lies right beneath the dorsal striatum. Like the dorsal striatum, it is rich in the neurotransmitter dopamine, a brain chemical associated with feelings of satisfaction and reward. But unlike its upstairs partner, the nucleus accumbens is a bona fide pleasure center. It is activated by food, sex, drugs, money, victory, just about anything that feels rewarding. It helps animals to form pleasure-related mental associations and to stay motivated in the pursuit and repetition of positive experience.

The nucleus accumbens also turns out to be crucial to our taste for novelty. “It is very deeply ingrained for us to associate potential reward with things that are new and unexpected,” says Gregory Berns, an Emory University neuroscientist. Tying perceptions of novelty into the reward system makes good evolutionary sense as it’s an excellent way to keep animals attuned to changes in their environment.

One recent brain-imaging study found that the nuclei accumbentes of young heterosexual males were activated by beautiful female faces. Plain female faces and male faces that the subjects rated as extremely good-looking had no effect.

Neuroscientists have made good headway in recent years figuring out why emotionally charged experiences get turned into stronger, more vivid memories than do humdrum and routine events. The key player is another limbic system structure called the amygdala. When revved up by a potent emotion — which a good thrumming in the nucleus accumbens will generate — the amygdala stamps the engendering event firmly into memory. Memories stored by the amygdala are extremely powerful because from then on, whenever you re-encounter that stimulus you will immediately associate it with the pleasure or aversion you first experienced.

“Madison Avenue and your brain” by Matthew Blakeslee

Polls show Americans are no happier today than they were 50 years ago despite significant increases in prosperity, decreases in crime, cleaner air, larger living quarters and a better overall quality of life.

Happiness is 50 percent genetic, says University of Minnesota researcher David Lykken.

10 percent of American women 18 and older and 4 percent of men take antidepressants, according to the Department of Health and Human Services.

Money that lifts people out of poverty increases happiness, but after that, the better paychecks stop paying off sense-of-well-being dividends, research shows.

Sonja Lyubomirsky of the University of California at Riverside has discovered that the road toward a more satisfying and meaningful life involves a recipe repeated in schools, churches and synagogues. Make lists of things for which you’re grateful in your life, practice random acts of kindness, forgive your enemies, notice life’s small pleasures, take care of your health, practice positive thinking, and invest time and energy into friendships and family.

The happiest people have strong friendships, says Ed Diener, a psychologist University of Illinois. His research finds that most people are slightly to moderately happy.

“There are selfish reasons to behave in altruistic ways,” says Gregg Easterbrook, author of The Progress Paradox: How Life Gets Better While People Feel Worse. “Research shows that people who are grateful, optimistic and forgiving have better experiences with their lives, more happiness, fewer strokes, and higher incomes.”

“The Keys to Happiness, and Why We Don’t Use Them” by Robin Lloyd

The brain is made primarily of two different types of tissue, called gray matter and white matter. A new study, led by Professor Richard Haier of the University of California, Irvine, reveals that men think more with their gray matter, and women think more with white. Their findings show that in general, men have nearly 6.5 times the amount of gray matter related to general intelligence compared with women, whereas women have nearly 10 times the amount of white matter related to intelligence compared to men.

In human brains, gray matter represents information processing centers, whereas white matter works to network these processing centers.

The results from this study may help explain why men and women excel at different types of tasks. For example, men tend to do better with tasks requiring more localized processing, such as mathematics, while women are better at integrating and assimilating information from distributed gray-matter regions of the brain, which aids language skills.

This research gives insight to why different types of head injuries are more disastrous to one sex or the other. In women 84 percent of gray matter regions and 86 percent of white matter regions involved in intellectual performance were located in the frontal lobes, whereas the percentages of these regions in a men’s frontal lobes are 45 percent and zero, respectively. This matches up well with clinical data that shows frontal lobe damage in women to be much more destructive than the same type of damage in men.

“Men and Women Really Do Think Differently,” by Bjorn Carey

Think, for a moment, about an acquaintance you have recently met. Why do you feel the way you do about this person? A considerable amount of research indicates that answering this question can change your attitude toward your acquaintance. Thinking about reasons has been found to change people’s attitudes toward a variety of attitude objects, including other people, food items, puzzles, and works of art. Wilson and Kraft (1993), for example, asked college students involved in steady dating relationships to think about why they felt the way they did about their relationships. Compared to a control group who did not analyze reasons, these students were significantly more likely to change their minds about how they felt about the relationship.

When thinking about reasons, people focus on attributes of the attitude object that are accessible in memory, plausible as causes of their feelings, and easy to verbalize. Because people do not have perfect access to the reasons for their attitudes (Nisbett & Wilson, 1977; Wilson & Stone, 1985) the reasons that are plausible, accessible, and easy to verbalize are often unrepresentative of the actual causes of their attitudes, and thus can imply a somewhat different attitude than they held before they thought about reasons.

People’s reasons often are constrained by the limits of human introspection, and yet people do not seem to recognize this fact. That is, people are often unaware of their own unawareness (Nisbett & Wilson, 1977).

Seligman et al. (1980) asked dating couples one of two types of questions about why they were attracted to their dating partner. Half of the couples were asked questions designed to elicit intrinsic reasons; for example, they were to complete the sentence, “I date my girlfriend/boyfriend because I . . . ” The others were asked designed to elicit extrinsic reasons; for example, they were to complete the sentence, “I date my girlfriend/boyfriend in order to . . . ” People did not seem to recognize that their reasons were biased by the wording of the questions, as indicated by the fact that they assumed that their reasons matched their current attitudes: Those in the intrinsic condition reported significantly more love for their dating partner, and reported that it was significantly more likely that they would marry their partner.

“Effects of Introspecting about Reasons: Inferring Attitudes from Accessible Thoughts,” by Timothy D. Wilson, Sara D. Hodges, and Suzanne J. LaFleur

Researchers examined 500 Americans age 60 to 98 who live independently and had dealt with cancer, heart disease, diabetes, mental health conditions or a range of other problems. The participants rated their own degree of successful aging on scale of 1-10, with 10 being best. Despite their ills, the average rating was 8.4.

“People who think they are aging well are not necessarily the (healthiest) individuals,” said lead researcher Dilip Jeste of the University of California at San Diego. “In fact, optimism and effective coping styles were found to be more important to successfully aging than traditional measures of health and wellness.”

A study released last year found that people who described themselves as highly optimistic a decade ago had lower rates of death from cardiovascular disease and lower overall death rates than strong pessimists. Research earlier this year revealed that the sick and disabled are often as happy as anyone else.

“Happiness in Old Age Depends on Attitude,” by Robert Roy Britt

In two separate animal studies researchers have found social contact speeds healing rates.

In the first case, hamsters with small skin wounds - and placed under slight duress — healed nearly twice as fast when a sibling was close by. The scientists also found that paired hamsters had lower levels of cortisol, a hormone related to stress, than lone individuals.

A similar experiment carried out on monogamous deer mice found that they too are up and around quicker when their mate joined them in the cage.

But the males of another type of deer mouse that mates with more than one female during the breeding season showed no preference for sharing their sick bed. They healed just as fast as the paired monogamous mice, no matter if they had company or not.

It suggests that the beneficial effects of social housing aren’t equivalent for all species, and may be limited to those that are monogamous or otherwise highly social.

The benefits of companionship may one day be available in pill form. Courtney DeVries of Ohio State University administered oxytocin, a hormone tied to social bonding in monogamous animals, to a separate group of hamsters. They found that these animals healed 25 percent faster than the solitary hamsters.

This suggests that oxytocin is the main buffer against delays in wound healing.

“Get a Buddy: Closeness May Breed Wellness” by Michael Schirber