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November 17, 2006 9:04 pm

Ask before you dive in and buy

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While reading The Only Three Questions that Count, you get the impression that its author, Ken Fisher, does not often find himself short of things to say. The stream of consciousness that flows through the book can be distracting but it is impressive and certainly never dull.

That words come easily to Fisher should be no surprise. An asset manager for more than 30 years, he is perhaps best known for his portfolio strategy column in Forbes. He is the fifth longest running columnist in the magazine’s 89-year history.

The three questions that count for investors, according to his latest book, are fairly simple. But having stated each in laymen’s terms, he proceeds to make things more complex quickly.

The first question is: “What do you believe that is actually false?” Fisher argues that in a world where so much of the investment industry’s applied craft has morphed into long-held mythologies, we are all guilty of believing things that are in fact false.

He adds that accepting this is the first step in the process of gaming other investors. Among commonly held beliefs that Fisher says are partially, if not wholly, false are that a weak dollar is bad for US stocks, that higher oil prices are bad for stocks and the economy, that current account and trade deficits are bad for stock markets and that the US has far too much debt.

While some of Fisher’s points can start out sounding flimsy, he quickly uses publicly available statistics to support his points. On the commonly held belief that high price/earnings stock markets are risky with subsequent below-average returns, he points out that statistical analysis actually shows high p/e markets are not predictive of poor returns. “Not even remotely,” he writes. “In fact, they have led to some pretty good returns.”

The second question he asks is: “What can you fathom that others find unfathomable?” He uses his discussion of this question to make interesting points about the information explosion and the challenges it can pose to investors.

“If you read about some investment idea or of a significant event in the media more than once, it won’t work. By the time several commentators have thought and written about it, even new news is too old. Now everything moves faster and gets discounted into pricing faster. The older an argument is, the less power it has.”

He adds that any category of security that was hot in the past five years will not be in the next five and vice versa. “Still true, always true. And yet investors still fall prey to this one.” He cites energy in 1980, technology stocks in 2000 and small value stocks in 2007.

“That they were hot in the last five doesn’t mean they will be the coldest in the next five, or even necessarily cold at all, but no category stays hot for 10 years. And if one did one day, that would be a double warning to seek safer and higher future returning turf elsewhere.”

The third question is: “What the heck is my brain doing to blindside me now?” Here Fisher uses the example of mutual fund flows to illustrate the point that “a frenzied mob of loser lemmings” is often found “lumbering in and out of the market precisely backwards”.

His assertion is borne out, to some extent, by the figures. Inflows for stock mutual funds were highest during February 2000, which turned out to be about the best time to get out of stocks. Fast forward to 2002 and the reverse was true.

James Cramer, host of CNBC’s Mad Money, says Fisher’s book could be “the kind that entirely changes the face of investing from here on out”, although he admitted most fund managers are too set in their ways for that to happen.

Fisher’s theoretical work in the early 1970s yielded the price-to-sales ratio, now a core element of the financial curriculum. In the 1980s, he and Fisher Investments’ research team helped create an equity style called “domestic small cap value equity”, now a must-have category for investors.

As his three key questions imply, his recent research focuses on the emerging field of behavioural finance. He has been working with Meir Statman of Santa Clara University.

The son of legendary investor Philip Fisher, he began managing discretionary assets based on a fundamental belief in capitalism. Since it was founded in 1979, and later incorporated in 1986, Fisher Investments, which now runs about $34bn, has focused on the science of capital markets as the best means of posting excess returns.

He is also the top ranked “market guru” according to CXO Advisory Group’s website. CXO tabulates the market forecasts of 31 well-known market commentators and posts them in its Guru Grades report.

One example, which suggests that investors should take note of the thoughts in his book, came in his March 6 2000 column for Forbes. He wrote: “Tech stocks are in a late-stage bubble. It should break later this year.” In fact, it broke within a week.

Of the 31 gurus listed by CXO, 16 got it wrong more often than they got it right. Only five of the listed gurus got it right at least 60 per cent of the time. Of those, Fisher, with a 69 per cent accuracy rating, was the top performer. So if he tells you there are only three questions that count, it might just be worth asking them.

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