Eat Cake

photo courtesy of tarakanova07

Remember how we used to eat muffins for breakfast? We scarfed them between gulps of grande coffee and felt terribly virtuous. It was the breakfast of champions, not guilt-inducing cake. (“Dude, it’s cake.”) Muffins have all the sugar, fat and calories of cake without any of the pleasure of eating a real, honest-to-goodness cake.

Often we act in ways that are not altogether rational and are ultimately counter-productive. This can end up costing us more than we think. (See the latest research on sugar substitutes and their link to obesity and illness.)

Years ago I was on a business trip in Paris and a colleague and I went window-shopping. By pure chance we happened upon the Hermes boutique on Rue Faubourg St. Honoré. We climbed the stairs and entered handbag heaven. Our eyes popped over the vast array of styles and colors. We sighed over the sky-high prices. Some day, we vowed, in the far, far distant future, we would give ourselves permission to buy just one.

As we left the store, my colleague turned to me and said, “You know, we’ve probably spent way more money on crap we no longer like or use. If we had just bought the thing we really wanted, it would’ve been a lot cheaper.”

Lately, I’ve been cleaning out my closets and her comment has hit home. Piles of clothing and accessories that I no longer wear have found second lives. Sometimes at the neighborhood charity shop—sometimes straight into Lady Gaga’s closet. (She swept into town in late summer and bought some of my Issey Miyake dresses and Yves Saint Laurent evening clutches from an upscale resale boutique here. God bless her fashion lovin’ heart.)

During my pruning season, I learned an uncomfortable lesson: It’s designer label or bust. All those charming dresses in mint condition by homegrown designers? Resale poison. Or, in investment terms, zero liquidity. Bupkis.

As investors, we’re often tempted by what we think of as bargains. Is a 10-cent stock cheap and a $100 stock expensive?

The answer is, it depends. The micro-cap likely has no earnings, a lot of debt, low liquidity, and a spotty cash flow. On the other hand, the $100 stock may have robust earnings, be growing rapidly, be in a favored sector, pay regular and growing dividends, have great cash flow, no debt, high liquidity, and lots of cash on its books. Now which one is expensive?

Owning a large cap stock is like owning a top designer label:

• There’s good liquidity. If you need to raise cash or simply want to take some profits, somebody will be on the other side of the trade. There’s always a buyer for a Chanel handbag. Not so for a Lida Baday coat.
• It will be relatively easy to assess its intrinsic value. Even a novice can quickly access information about the company’s key metrics like dividend yield, cash flow, and earnings estimates. Likewise, everyone knows the market value of an Hermes Kelly.
• Top large cap stocks, like top brands, retain or grow in value over time. A Van Cleef and Arpels necklace will never be on sale; a mid-tier name like David Yurman will.
• A top company is covered by many analysts so it’s easy to keep up with news and material changes that could affect the value of the stock. Ditto for designer labels. They have lots of fans, not to mention powerful ad campaigns, to talk them up and keep prices plumped. Louis Vuitton is not running those ads for charity. (And, by the way, doesn’t Michelle Williams look darling in the fall campaign?)

The world would be a boring place if we only wore big brands and bought big caps. But when it comes to your wardrobe—and stock market investing—strategic asset allocation rules the day. Why not buy some high yield large caps and then spring for a nice Chanel something with the divvies? Have your cake and eat it too.