Why Peridot Capital?

Peridot Capital Management was founded based on the premise that the many investment advisory services mass marketed to individual investors left much to be desired. For the majority of investors there are four ways to manage your investments; via mutual funds, through a broker, via index funds, or by building a portfolio yourself. Sure there are hedge funds, private equity, and other opportunities, but they are mostly reserved for the very affluent. 

Examining the four options mentioned above sheds light on the pitfalls of each. Peridot Capital was formed to be a better alternative for those looking to build wealth over the long term. Here we will walk through each of the less appealing options and then explain why Peridot is both different and more desirable for most investors.

Mutual Funds

The majority of investment assets are held in mutual funds. Employer-sponsored 401(k) plans are the most popular vehicle for retirement savings and such investments are allocated to mutual funds, and in some cases, employer stock (if the firm is publicly traded).

While the positive arguments for mutual fund investing; professional management and diversification are important, the pitfalls within the mutual fund industry are abundant. These include lack of personalization, high expenses, and lack of performance.

Every investor in a mutual fund owns the exact same portfolio. The fund’s manager has no idea who his or her investors are. They could be recent college grads, baby boomers in their peak earning years, or the retired. Each of these investors will have different risk tolerances and investment time horizons, but this will not be reflected in the investments they hold through the fund.

The average equity mutual fund charges investors 1.5% per year in expenses. This figure does not include any sales loads or transaction fees that may be incurred, which can add up quickly. Some funds have upfront loads of as much as 8.5%, so investors have dug themselves a deep hole even before their investment has had a chance to earn a return.

It is possible that paying relatively high fees could pay off for investors, assuming the performance of these funds was superior. However, statistics continually show that over the long term, mutual funds trail the broad market averages, such as the S&P 500 index. In fact, it has also been shown that an investor who bought shares in the mutual fund company itself would have made much more money than an investor who invested in the company’s mutual funds. That should be glaring proof that these companies are rarely putting clients’ interests ahead of their own.

It is true that every year there are hundreds of funds that outperform, but those same funds have shown to be sub-par performers in the years after they showed superior returns. Very few funds are able to consistently outperform. Those that do either close to new investors because they attracted so much money, or they remain open but underperform due to the fact that they are so big.

It’s no coincidence that Warren’s Buffett’s investment performance has become less and less impressive as the size of his investment vehicle, Berkshire Hathaway, has gotten larger. In the end, mutual fund investing is not a promising way to earn above-average investment returns.

Stock Brokers

Finding a stock broker that you trust and who knows you personally can eliminate the problem that mutual funds investors face in lacking a personalized investment strategy. Brokers work with you individually and can customize a portfolio for your specific goals.

Unfortunately, of the three mutual fund pitfalls highlighted previously (lack of personalization, high expenses, and poor performance), only the first is solved by going the broker route. Full service brokerage firms charge outrageously high commissions for each trade and their investment recommendations come from the myriad of Wall Street research analysts who have shown little skill in picking winning stocks.

Paying $50 or $100 to buy a stock, when online brokerage firms charge $5-$10 for the same service, hardly seems worth it unless their investment recommendations are far superior. This follows the same logic of being willing to pay high expenses for funds that outperform consistently. It just fails to materialize and the same goes for broker recommendations. Research shows that Wall Street analysts are no better at picking stocks than monkeys throwing darts at the stock tables in the Wall Street Journal.

Working with a personal broker is certainly more comforting for many than sending money off to a mutual fund company, but the ultimate goal should always be to make above-average returns. History shows that few brokers can deliver such results for their clients.

To illustrate this point, consider a model portfolio published by Edward Jones, a St. Louis based full service brokerage firm with 9,000 branch offices and over 6 million customers across the United States. Since they began publishing their model portfolio in 1993, their investment recommendations have trailed the S&P 500 by about 1% per year through 2005. And yet, their customers pay anywhere between 0.5% and 2.5% per trade in commissions, so actual performance is far worse than that. As with mutual funds, few retail brokers can provide what is most important for investors, above-average returns.

Index Funds

It’s no wonder, after what we’ve discussed so far, that investors have flocked to index funds and exchange traded funds in recent years. Many were burned by broker recommendations and by mutual funds during the bear market that began in 2000. When trust is running thin and conflicts of interest abound, why not just buy the entire stock market and be shielded from a crash in technology stocks, executive misconduct, or corporate fraud?

On the surface, index funds appear to be quite an attractive alternative. Unfortunately, many investors are used to the stock market doing very well. After all, the greatest bull market ever ran from 1982 through 1999.  During that remarkable stretch, the S&P 500 returned an average of 19 percent per year and rose in 17 out of 18 calendar years. Index funds indeed shined during that time, and they will do wonderfully during bull markets.

However, bull markets occur less frequently than investors might think. It is true that since the 1800’s stocks have averaged double digit annual returns. Since no investor invests for that long, it is helpful to look at the various cycles that have occurred over time. Below are several examples of what can happen without raging bull markets like the one we saw from 1982 to 1999. The “market” refers to the S&P 500 index except for years prior to its creation. For those years we will use the Dow Jones Industrial Average.  

• 1929-1954   The market peaked in 1929 and didn’t reach that level again for 25 years

• 1926-1976   The market returned an average of 3.5% per year for a 50 year period

• 1982-1999   The market averaged 19% annual returns with only 1 negative year

• 2000-2006   The market is down so far this decade

As you can see, index funds will produce awfully disappointing returns unless the stock market is booming. With the greatest bull market behind us, overall stock market returns in the short to intermediate term should likely fall far short of their historical average. Index funds work when most stocks are rising, but investors relying on such an environment will need to be very lucky and could very well be disappointed, even over long periods of time.

Do-It-Yourself

So now we’re left with the last of the four main methods of managing one’s investments; doing it yourself. There are a lot of people who do an excellent job running their own money. But it’s also amazing to see how many people pick their own stocks and have no idea how well they’re doing.

Individuals might know if they made money on a particular stock or not, but if you ask them how their total portfolio fared the prior year, they often have no idea. To find out how adept you are at outperforming the market, you must track your performance. That way, you’ll know if you are making the right decision by foregoing professional assistance.

Perhaps the biggest mistake people make when running their own money is exclusively picking companies they know, like, and spend money with. That could be the bank they use, the clothing stores they shop at, etc. Frankly, sometimes this strategy will work, for a little while anyway. Over the long term though, buying stocks based on what the company does, and not the stock’s valuation, is a losing proposition.

Well known consumer related stocks are very popular with investors, and as a result, they tend to trade at above-average valuations. For that reason alone, the stocks are setting up their investors for disappointment.  Expensive stocks (in terms of valuation metrics, not absolute share prices) do not perform well over the long term, on average. As a result, popular stocks, and popular companies, usually make for bad investments in relation to the overall market.

Consider Wal-Mart in 1999. The retail giant was growing rapidly and gaining market share with their everyday low prices. Wal-Mart stock was a favorite among investors, due to its perception as a great company that stood to do well for years to come.

And yet here we are 7 years later in 2006 and the stock has been a terrible investment. How can that be? After all, hasn’t the company grown by leaps and bounds since 1999? Yes, in fact Wal-Mart’s sales and profits have more than doubled between 1999 and 2005. So the stock has done well too, right? Well, not exactly. Investors who bought the stock 7 years ago have actually lost 30 percent of their money. 

This is a perfect example illustrating that great companies do not always make great stocks. Even when a leading retailer doubles its size in less than decade, its stock price is not assured of going up, and can actually fall by a rather large amount. How does this happen? Stock prices do not follow how well a business does. Instead, stocks go up and down based on well a company does, relative to investor expectations.

If investors expect big things from Wal-Mart, as they did in 1999, the stock’s price already reflects that optimism. Even if such stellar performance materializes over time, the stock price won’t rise unless Wal-Mart exceeds expectations.  In the case of Wal-Mart over the last 7 years, they have done extraordinarily well, but not quite as well as investors were expecting in 1999.

The takeaway from this section is, unless you are highly skilled in valuing stocks (not just identifying companies that are doing well) managing your own stock portfolio could result in no better performance than the other options we have spoken about already.

What Sets Peridot Capital Apart?

Peridot Capital was founded in order for individual investors to have another, far better, alternative to mutual funds, index funds, and stock brokers. For mutual fund investors and those who use stock brokers, it is a tough task to earn above-average investment returns. The combination of high expenses/commissions and average (at best) investment recommendations make it nearly impossible to beat the S&P 500 index’s return consistently.

Peridot Capital’s clientele avoid both of these traditional pitfalls. Our clients keep their accounts with discount online brokerage firms, paying between $5 and $15 per trade. By keeping transaction costs as low as possible, investors keep the majority of profits earned from their stock market investments. 

Since Peridot Capital leaves all of the account–related back office work to brokerage firms, we can spend all of our time doing what we do best, high quality independent, conflict-free research. Superior investment selection is the key to a winning investment strategy and we have delivered results to our clients. Whether you are just out of college or entering retirement, we can create a customized portfolio strategy for you and implement it without any impediments to success.

Since our portfolio management fees are calculated as a percentage of your investment assets, we have incentive to make you money, not to simply buy and sell many times over to generate commissions. We trade to make our investors money and for no other reason.

Rather than focusing on a “company” we focus on a “stock” instead. What growth expectations are built into the current stock price? What are the chances of such expectations being overly conservative or overly aggressive? The answers to these questions are what Peridot Capital focuses on, because they will ultimately determine the direction of a company’s stock, not whether or not the company is “doing well” or if it is “a great company.”

All in all, most investors earn below-average or average returns due to high expenses, poor investment selection, and little protection should the stock market not rise substantially over the course of one’s investment horizon. By keeping costs down, finding undervalued stocks, and having the flexibility to avoid investments that are overpriced and exposure to markets that have meaningful downside risk, Peridot Capital has been able to deliver market-beating returns for its clients and plans to continue doing so for many years to come.