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Profits Are Optional


Investing is a discipline of choices, so let’s start off this edition of Positions with a choice between two hypothetical mutual funds. Both funds are low cost and diversified among many different companies. However, Fund A exclusively buys companies that earn higher profits and have lower valuations (i.e. cheap on a price-to-book value basis) relative to the broader market. Fund B takes the opposite approach, only buying companies with the lowest profits and most expensive valuations. Which fund would you choose?

Most prudent investors would prefer Fund A, and have historically been rewarded with higher returns for their selection. Higher profits and cheaper valuations are the value investor’s sweet spot. Yet if you chose Fund A at a New Year’s Eve cocktail party last December, you would look like a fool! As of June 30th, Fund B outperformed Fund A by a whopping 23%. Our investing sweet spot, highly profitable companies trading at cheap prices, was severely punished in the first half of this year! According to Mr. Market, profits are optional.


We believe profits and relative prices do matter long term, despite their current unpopularity. There have been many instances in stock market history where business fundamentals take a back seat to overly optimistic assumptions and the fear of missing out on the next great thing. Only the patient investor can capitalize on the opportunities that those times present. So which fund would we choose? Fund A, and we will be patient.

Matthew Adamson, CFA
Portfolio Manager
First National Wealth Management



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