Sunday, August 29, 2010 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle LXXXV

(source: "Government-bond yields," The Economist. August 19, 2010)

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Thursday, August 26, 2010 1 comments ++[ CLICK TO COMMENT ]++

The Beginning of the End of Barnes & Noble?

On the first page a donkey asks a monkey, "What do you have there?" The monkey replies: "It’s a book."

"How do you scroll down?" the donkey asks. "Do you blog with it?"

Then he asks: "Where’s your mouse? ... Can you make characters fight? ... Can it text? ... Tweet? ... Wi-Fi? ... Can it do this? TOOT!"

No, the monkey repeatedly replies. "It’s a book."

A few weeks ago, writing for GuruFocus, Geoff Gannon laid out the bullish thesis that underpinned his purchase of Barnes & Noble (BKS). For those not familiar, Barnes & Noble is the largest bricks & mortar book retailer in North America (and possibly the world?). Since this was a contrarian decision—many have given up on book retailers—and it involved a mid-cap company—I don't generally like investing in microcaps and smallcaps, which are common with many amateur value investors—it piqued my interest.

A Bullish Case for Banes & Noble

Initially, Gannon's investment seemed uncharacteristic of him. He doesn't disclose all his transactions so it's not clear what his strategies are but I always felt that Geoff Gannon was a classic value investor—very Benjamin-Grahamesque but possibly with concentrated holdings—and Barnes & Noble seemed like a specualtive bet on a merger. But reading some of his other articles and comments in some messages, it appears he has invested in similar takeover-type situations so this may not be as foreign for him as it seems. In any case, here is a bullish investment thesis for Barnes & Noble:
We all agree print is dead. So why am I buying Barnes & Noble stock at $15 a share?

I’m buying the stock at $15 a share, because Barnes & Noble (BKS) is not a cultural icon, a sign of the times, or a morality tale. Barnes & Noble is a stock. And that stock’s price is subject to supply and demand. In this case, supply is low and demand is high. Or it soon will be...

Barnes & Noble has less than 59 million shares of stock. Ron Burkle and his allies own just under 21 million shares. While Len Riggio and his allies own just over 21 million shares. That leaves 17 million shares of Barnes & Noble stock for outsiders. And those outsiders have sold short 12 million of those 17 million shares. Both Burkle and Riggio want to control Barnes & Noble. Each contender needs another 7.5 million shares to take majority control of the company. Since the two men hate each other and neither is willing to sell his shares to the other, the only supply of shares available to them is the 17 million shares in outside hands. And since Riggio and Burkle both need to keep all the shares they already own to fight for control of the company, the only supply for the short-sellers to buy back their stock is those same 17 million shares in outside hands.

That puts outside shareholders in the catbird seat. In this unique takeover battle, passive minority shareholders – folks like you and me – are in a better position than Burkle, Riggio, or anyone who has sold a lot of Barnes & Noble stock short. We can supply any of the parties: Burkle, Riggio, or the short-sellers.

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Tuesday, August 24, 2010 0 comments ++[ CLICK TO COMMENT ]++

Investment Jokes

I don't know if I'm the only one who finds these funny but I ran across some comments for an article on MarketWatch and found them funny.


"Infinity is just a number"
Federal Reserve Institute, Department of Mathematics

"Faith can be valued objectively"
Federal Reserve Institute, Department of Finance

"According to the latest government regulation; Goodwill can be 'printed'..."
Federal Reserve Institute, Department of Accounting

"Revolution? Well... that's why we need the gun control."
Federal Reserve Institute, Department of Political Science
"Run for your lives!"
Federal Reserve Institute, Department of Physical Education
Credit for all the phrases, except the last one, goes to user 'Profit' while the last phrase is by 'DavidRicardo.'
The following, which I find funny given the economic environment, is by 'DPinSoCal.'  
Second semester electives include-

"Hunting and Gathering in Suburban America"

"Can I Eat This Part? Do's and Don't's of Cooking Wild Game"

"Sticks and Stones Can Break My Bones, But They Also Make Good Handtools"

LOL hehe :)

Sunday, August 22, 2010 1 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle LXXXIV

(source: "For a Change, U.S. Debt Is Staying in the U.S." By Floyd Norris. The New York Times Published: August 20, 2010)

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Articles for a rainy August 22nd of 2010

The weather depends on where you are but it is raining in Toronto today. Although nothing appears to have happened in the last few months, with stock prices barely below how they started the year, I believe some major changes have occurred. US Treasuries have rallied way beyond what they were an year ago. In fact, depending on the bond you look at, they have declined below any point, except the late-2008/early-2009 crisis period.

September is often one of the most volatile months for stocks—both up or down—so it remains to be seen if we are in for a big move in either direction.

Not many articles this week...

  • Differences between Canadian and American poison pills (DealBook, The New York Times): Mining super-giant BHP Billiton made a proposal to Canada-based Potash Corporation's management. The offer was rejected and Potash enacted a poison pill. This article talks about some major differences between Canada and USA. Risk arbitrage investors who invest in Canada should check out the article. The impression I get is that Canadian laws are more favourable to bidders while American poison pill laws seem to favour management and takeover target... I don't know much about either of these companies but my cursory opinion is that BHP is probably overpaying for Potash. This is a commodity business and unless you expect potash prices to skyrocket permanently—the risk with commodity prices is not that they won't go up, but that they won't stay there—this is a costly ego trip for BHP.
  • Does income inequality lead to financial crises? (The New York Times): Hard to say with inconclusive evidence so far. The big one that supports the thesis is the 1929 vs 2007 one: "Income disparities before that crisis [1929] and before the recent one were the greatest in approximately the last 100 years. In 1928, the top 10 percent of earners received 49.29 percent of total income. In 2007, the top 10 percent earned a strikingly similar percentage: 49.74 percent. In 1928, the top 1 percent received 23.94 percent of income. In 2007, those earners received 23.5 percent. Mr. Moss and his colleagues want to know if huge gaps in income create perverse incentives that put the financial system at risk."
  • An inside look at a fake shoe-making factory in China (The New York Times Magazine): A detailed look at the counterfeiting business.
  • Slideshow: The trades that made these 14 investors (Business Insider; h/t Financial Post): Mostly covering short-term investments by traders
  • Slideshow: Worst trades of all time (Business Insider): I'm sure there are even worse trades
  • Slideshow: 20 ways to become rich (Bloomberg Businessweek): Well, pick one... ;)
  • Slideshow: Popularity of various items around the world (Bloomberg Businessweek): If you have time to kill, check out some of the popular brands in various countries.

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Wednesday, August 18, 2010 5 comments ++[ CLICK TO COMMENT ]++

Do profit margins have to mean-revert?

"If profit margins do not mean revert, capitalism is broken."
— Jeremy Grantham

How true is that? Do margins have to revert to the mean?

Sticking with the theme of exploring dissenting views (at least relative to my beliefs), let's consider one reason some people like me are very sanguine and bearish about the stock market. Namely, people like me have been concerned for a while that corporate profit margins are unsustainably high.

There are many measures of corporate profit margins and each data series is a bit different but the trend is generally the same. Here is one from Wiliam Hester of Hussman Funds, clearly illustrating how high profit margins have been in the last decade:

(source: "An Update on Valuation and Forward Earnings Assumptions" by William Hester. Hussman Funds. March 2010)

In the chart above, blue is the historical number while red is based on analyst forecasts of earnings and sales (this article was published in March of 2010.)


The case against deflation... from one analyst

The Globe & Mail quotes a Scotia Capital analyst's arguments against deflation. Derek Holt, the Scotia Capital analyst, gives the following reasons [my comments in square brackets in italics]:

  • "Goods price deflation was what the 1930s was all about. Today's U.S. economy is two-thirds service sector oriented, and service sector prices are stickier than tradeable goods. Have the prices you pay for hair cuts, the trades, and auto repair fallen like the prices of flat screen TVs?" [I don't think there is any evidence of this. About 60% of Japan's GDP is consumer spending and about 66% is the service economy and prices have actually fallen in Japan in the last decade.]
  • "Main street doesn't believe it. Price components to consumer surveys like the Conference Board's consumer confidence index point to inflation expectations that are far removed from the price pressures economists point to in CPI releases. As such, there is no evidence right now that households are beginning to formulate expectations for falling prices across a range of goods and services." [This is a reasonable argument against deflation. Inflation expectations are a key part of the matter and if consumers and investors don't expect it, it may not materialize.]
  • "Emerging markets may be the safety valve against global deflation risks today, versus their absence in the 1930s Western-dominated global economy that was the only game in town back then. Price pressures in emerging markets are not typically acute right now, but higher than in developed economies, and often occurring behind fixed currency pegs. The pressures to possibly pass on higher costs through trade linkages into the developed economies today are more material than the 1930s." [EM suppliers had an aweful tough time passing along cost increases when the US economy was stronger 5 years ago and if anything, they will have an even tougher time now.]
  • "The spread between nominal and real U.S. Treasuries has narrowed so sharply not just as a bet against inflation or a bet in favour of deflation, but also because the nominal benchmark gets an added boost from the liquidity premium compared to less liquid real bonds that don’t perform as well on safe-haven flows.[I don't buy this. Long term Treasuries are definitely more liquid but I would say stocks and some corporate bonds are also very large markets.]
  • By setting a series of low year-over-year inflation readings in the near-term, then one or two years down the road the readings get a mild lift from the weak base. [True]
Anyway, I like considering people who takes opposite views from me so I thought I would throw this out at you. It's always worth considering your opponent's views.

Sunday, August 15, 2010 2 comments ++[ CLICK TO COMMENT ]++

Chinese Real Estate - Bulls & Bears

The skyline never stays still in Beijing...
(source: "Beijing's Changing Skyline," Time)

From her leafy, 11th-floor rooftop terrace at the headquarters of Soho China Ltd., billionaire Zhang Xin scans the relentlessly expanding Beijing skyline she helped create. Zhang’s avant-garde buildings -- some sleek as chopsticks, others stepped like rice terraces -- became part of the hottest real estate market on Earth in 2010.

Zhang says she’s well aware of the chorus of investors and economists who predict that China’s property boom is about to go bust, taking the global economy down with it. The doomsday scenarios don’t intimidate Zhang, a onetime penniless sweatshop worker who ascended to Wall Street by defying the odds. She hopes to prove skeptics wrong again this year by betting hundreds of millions of dollars on new buildings in Beijing and Shanghai, Bloomberg Markets magazine reports in its September issue.

“I don’t see any bubbles,” says Zhang, dressed in a white V-neck zippered top, black slacks and red heels. “The next few months will be a fantastic time to buy.”
Bloomberg Markets magazine has a nice profile of Zhang Xin, arguably the most successful real estate developer in China, which dovetails nicely into the theme on the minds of many macro-oriented investors. Namely, is there a real estate bubble in China?

The article does a good job of presenting the views of some bears and bulls and I thought I would quote some of their views. Anyone interested in this story should definitely read the full article.

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Sunday Spectacle LXXXIII

The Drug Trade & the Bogus War on Drugs

Afghan Opium Production - Druglords Back in Control?

(source: "U.S.-built bridge is windfall — for illegal Afghan drug trade," Tom Lasseter, McClatchy Newspapers. June 28, 2009. Original image edited to show Afghan chart only.)

Mexican Drug Cartels and Drug Flow

We may be witnessing the final stage, a failure, in the so-called "war" on drugs. As the Afghan opium production numbers show, things are getting totally out of control. Admittedly the chart only goes up to 2008 and I think it did drop in the last year but contrary to what some claim, I believe the drop was due to the economic recession than any success in combating drugs.

In what can only be characterized as shocking, and something that would have been thought impossible even 6 months ago, the Mexican president, who is very anti-drugs and has sacrificed the lives of many drug agents, police officiers and military personnel with his war on drugs—admittedly heavily supported by Mexican citizens so this isn't a misguided strategy by one man and his inner circle (a la the Iraqi war)—appears to consider the legalization of drugs. A key player is California which I think may legalize marijuana within 10 years. As the linked Economist article mentions, as much as half the income comes from marijuana so the Mexican drug cartels will be much weaker, and many of them will go bankrupt, if that income stream dissapears.

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Saturday, August 14, 2010 5 comments ++[ CLICK TO COMMENT ]++

Newbie Thoughts: Actual returns after all outlays

I ran across a report illustrating the returns that accrues to investors after all expenses, taxes, etc have been paid and I thought some of you may, especially those who are new to investing, may find it useful. The report is by Thornburg Investment Management—I thought Thornburg, which dealth with prime real estate mortages, went bust but looks like this survived—and was brought to my attention by Morningstar.

Historical "Actual" Return

The following chart, excerpted from the Thornburg report, illustrates what remains after taking out various expenses. It covers the period from 1979 to 2009. As usual on my blog, click on the image for a larger picture (sometimes not available.)

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Tuesday, August 10, 2010 2 comments ++[ CLICK TO COMMENT ]++

Opinion: A parallel to the Great Depression & Other thoughts on Unemployment

One of the shocking things I encountered when reading up on the Great Depression was how wages actually went up. Yet, huge swaths of the population were unemployed and suffering. One of the things, perhaps the key one, that was driving that scenario was the fact that productivity gains were accruing to those who had jobs while those without jobs barely could find a decent job. Maybe I'm an egalitarian at heart—my egalitarian side and my capitalist side often fight deep inside me—but there's almost something cruel about that.

I hate to say it but a similar thing appears to have unfolding right now in America. The New York Times reports on the similarity to the Great Depression:

In the deep economic slump of the mid-1970s, the average hourly pay of rank-and-file workers — who make up four-fifths of the work force — fell 6 percent, adjusted for inflation. In the early 1980s, the average wage fell 3 percent. Even in the mild 1990-91 recession, it fell almost 2 percent.

But since this recent recession began in December 2007, real average hourly pay has risen nearly 5 percent. Some employers, especially state and local governments, have cut wages. But many more employers have continued to increase pay.

Something similar happened during the Great Depression, notes Bruce Judson of the Yale School of Management. Falling prices meant that workers who held their jobs received a surprisingly strong effective pay raise.

This time around, nominal wages — the numbers people see in their paychecks — have risen throughout the slump, as companies have passed along some of the impressive productivity to their (remaining) workers. Meanwhile, inflation has been almost non-existent, except for parts of last year, when real wages did briefly fall.

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Some details about the money-market fund crisis of 2008

Associated Press, via Yahoo! Finance, has an interesting story on the extent of the crisis faced by money-market funds during the financial crisis. The story quotes analysis done by Moody's on the extent of the chaos during that period. For those not following the story back then, a prestigious and influential money-market fund "broke the buck" during the financial crisis because it held some "bad" Lehman Brothers debt. Money-market funds are thought to be "near-cash" and practically no one investing in them expects to lose money in nominal terms (the only possible losses that investors expect is real losses if inflation ends up being high.) So, it goes without saying, it was a big shock when a major fund lost money.

At least three dozen money-market mutual funds were at risk of failing during the financial crisis, besides one that did end up collapsing, Moody's Investors Service said Tuesday.

The report shows how shaky the nearly $3 trillion money-fund industry was after Lehman Brothers' September 2008 collapse.

Around the time that a soured Lehman investment triggered the demise of the $64 billion Reserve Primary Fund, Moody's says at least 36 other U.S. money funds were also at risk of "breaking the buck" -- failing to ensure clients could get back at least a dollar for each dollar they put in.

But investors avoided losses because at least 20 companies spent billions to prop up their funds, Moody's said. Support included purchasing the soured investments that put the funds at risk, funneling company money directly into the fund, or securing a letter of credit.

Moody's also found 26 European money funds that were endangered. All told, companies with U.S. and European funds that were at risk spent about $12.1 billion, before taxes, to prop them up, Moody's found.


The report also found 146 instances before the crisis where fund companies had to rescue funds to prevent them from breaking the buck.

A researcher with another firm tracking the money-fund industry, Peter Crane of Crane Data, said the $12.1 billion in pretax expenses cited by Moody's as having been spent to prop up funds far overstates the long-term costs. Many fund companies that tried to shield clients from losses by purchasing failed portfolio investments ended up selling those holdings later, sometimes without big losses, Crane noted. Money from those sales could eventually absorb some of the upfront costs to prop up a fund.


Money funds' largely unblemished safety record took its biggest hit when the value of Reserve Primary's assets dipped to 97 cents per share.

The fund disintegrated after announcing that the $785 million it held in Lehman debt had become worthless when the investment bank filed for bankruptcy protection. Institutional clients demanded cash back, and the fund's managers were forced to sell the fund's assets at steep discounts during the market plunge in September 2008.

While nearly all shareholder cash has since been returned, it was the first time individual money fund investors suffered losses since Reserve Primary launched the industry in 1972. The fund's collapse shocked Wall Street and stoked fears of a full-blown economic collapse.
In a hundread years, people will look at an event like this to feel the severity of the recent crisis. Economies contract and companies go bust—even big banks—but I'm sure that a money-market fund losing 3 cents on the dollar would be a shock even to someone living 100 years from now.

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Sunday, August 8, 2010 1 comments ++[ CLICK TO COMMENT ]++

The end of Big Oil?

No, it's not what it seems like. Oil companies aren't going to dissapear. But we are seeing a shift in the oil & gas industry and it's not clear to me if this is something temporary. Breaking Views, via The New York Times, points out the shift:

U.S. oil companies are becoming less liquid - but not in a financial sense. With natural gas so plentiful Big Oil is fast becoming Big Gas. Shareholders may be underestimating the impact of the shift on future returns while an unexpected advantage is tipping to the oiliest majors.

America's energy titans are finding it ever harder to ramp up oil output. Exxon Mobil is on track to pump 5 percent less this year than in 2005 according to Barclays Capital forecasts. Instead the company has turned to gas for growth. A big project in Papua New Guinea and the XTO acquisition are accelerating the shift. Gas which accounted for 38 percent of Exxon's output in 2005 could account for up to 48 percent next year.

Exxon isn't alone. Rivals ConocoPhillips and to a lesser extent Chevron are also bloating with gas. The trend looks ominous. Oil offers much fatter margins and in the United States sells for almost three times more than gas for the same quantity of energy.


With even oily Chevron drifting towards gas, Occidental Petroleum - which still gets 75 percent of its output from the black gold - may wind up the last of the majors to deserve the moniker Big Oil. It is pricier than its three biggest rivals - trading at 14 times expected 2010 earnings compared to an average of about 9.5. But its significantly lower exposure to gas justifies the premium and then some.
If you are investing in the energy complex, you may want to consider the implications of the shift towards natgas. The article seems to imply that oil has higher profit margin than natgas so that's something to keep in mind when looking at historical data.


Will you match the long-term historical market return?

Here's an interesting revelation, courtesy of Crestmont Research:

The long-term average return from the stock market is 9.75%. As the elder baby boomers are now beginning to retire, they will be relying upon their investments and pensions for income. The youngest boomers have less than two decades to compound their savings into a retirement payload. Many boomers young and old—so to speak—have a vested interest in stock market returns for a secure retirement. So, from 2010, what length of time is needed to assure the long-term average return?
What do you think the answer to that question is? How long would it take someone to generate a 9.75% annualized return going forward?

(Note that we are not talking about posting 9.75% in a particular year but, instead, generating that as an annualized return over a period of time. Also note that, like most discussions, this is nominal return. Crestmont Research is using Morningstar data, sourced from Ibbotson, that starts in 1926. The long-term return number may change slightly depending on the data you use; overall, it tends to be around 10%.)


Sunday Spectacle LXXXII

(source: "Secular Cycles Explained," Crestmont Research. Updated to end of 2009)

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Saturday, August 7, 2010 0 comments ++[ CLICK TO COMMENT ]++

Articles for the week ending Aug 7 2010

Sorry about the lack of posts. Hopefully the linked articles will keep you busy :)

  • (Recommended) Top-down look at Microsoft (Bronte Capital): John Hampton of Bronte Capital takes a detailed industry-level look at Microsoft. The comments by readers is also worth reading IMO. I haven't looked closely at Microsoft but my feeling is that it is probably an investment that will produce market(or maybe 1% or 2% more than market) returns. The problem for companies like these is that they are very large and its hard to see a big upside. As for the downside, it is probably exaggerated. As long as Microsoft produces high profits and reinvests a lot in R&D, its downside won't be that large. Microsoft's historical strength is in turning products, often after competitors get first-mover advantage, into relatively lower cost, mass-market, products... Investing in Microsoft is kind of like inesting in Coca-Cola in the 70's or 80's. That is, you really need some high growth markets opening up (like emerging markets) or some out-of-the-blue product innovation. Coca-Cola was probably saved by emerging markets; otherwise, it, just like Microsoft now, would undergo profit margin compression (because the product isn't innovative and special anymore.) Hampton's bullish view seems to rest on emerging markets.
  • Housing situation in Canada (The Globe & Mail): A good summary, along with many key charts, of the current state of real estate in Canada. Based on prices, housing seems expensive in Canada but one of the charts showing percent of income spent on ownership costs doesn't look extreme (although it only goes to the mid-80's.)
  • Quick book summary of the book, Buying at the Point of Maximum Pessimism by Scott Phillips (Larry McDonald @ SeekingAlpha): Kind of bizarre to be calling something "value investing trends"; I always thought everything was a "macroeconomic trend" since these trends are speculative in their nature. I haven't read the book and probably won't for a long time, if ever, but it looks like an interesting macro-type book and here are apparently the key trends that are identified in the book:
    • Ascent of consumerism in China and other EM: It's probably safer to wait and see if this takes off before investing. Many developing countries were never able to transition from low-income exporters to higher-income service economies. For instance, most of East Asia—Indonesia is a good example—haven't had much success increasing the consumer wealth of their citizens.
    • Bullish call on "...fertilizer, farm-equipment and Brazilian agribusiness companies catering to the demand for higher protein diets made possible by rising income in developing countries...": This has been a favourite of Donald Coxe for years. I have a feeling this is too played out. For instance, the market bid up potash companies to some stratostrophic levels a few years ago. In my opinion, agriculture is a minefield since it is heavily controlled by governments, especially in poor countries like China and India. Historically it hasn't been a great industry but I think agricultural equipment, as well as high-tech seed companies, are a better bet, given their higher returns on equity and stronger moats.
    • Bullish call on crude oil: Risky bet from a contrarian point of view since crude oil has gone up 300% in 10 years. Major commodities rarely ever go up much beyond that unless there is a disruption to markets (war, embargoes, etc) or there is a paradigm shift. The author is expecting a paradigm shift here but I remain bearish. My wild guess is that the world economy probably can't support oil prices higher than around US$110.
    • "...bright future for aquaculture (fish farming) arising from the “tragedy of the commons” playing out in the overexploitation of ocean fish stocks along with rising demand for fish protein from emerging nations": Interesting call and one I think that is slowly coming true. Changing people's diets is much harder than you would imagine and people, even poor people, pay premiums to maintain their diet (for instance, even if there is a shortage of, say, wheat, people generally don't switch to, say, rice or corn even if excess amounts were available.) Since a huge chunk of the population relies on fish, especially so outside North America, I can see acquaculture taking off. On top of environmental concerns with these operations, the difficulty will be earning high returns. It's easy to say this or that trend will materialize but hard to find companies that will earn above-market returns.
    • "...educational firms providing online/computer-based training, prep courses, tutoring books, etc. to students in China and other emerging countries, where the value of education is deeply embedded in the culture": I have had similar thoughts for years and think this is an interesting macro trend. The Internet, like the printing press a few hundread years ago, has lowered the cost of information and allowed poorer people access to it. I think we will see the demand for online education to increase. Even within wealthy countries, the shift in the economy towards knowledge-oriented industries has forced people to continually seek information. I think there is a huge opportunity here but it's an industry in its infancy with uncertain business models, dubious operators, and the like. The author of the book apparently lists companies such as "ATA Inc. (ATAI), China Distance Education Holdings Ltd (DL)., Aptech Ltd. and MegaStudy Co. Ltd."
    • "rising demand for rare-earth elements, driven by growth in high-end consumer and green technologies and supplied mostly by China": I think this trend won't materalize as suggested. Yes, rare earth materials will be used more and more; but I doubt the investment opportunities will be any better in those goods. There are two problems with it. First of all, the market will likely remain very small. Many of these industries will never be multi-billion-dollar industries since they are, by defintion, rare and can never be used widely in goods. They can never scale up and engineers/designers will take that into consideration when building products. Secondly, I know the author is calling for a paradigm shift (due to high-end consumer goods and green tech) but if we assume the future will sort of repeat as in the past, one probably wouldn't be so bullish. If you look at the commodity complex and look at the areas that have created the greatest wealth, they tend to be in mundane and common commodities like oil, natural gas, copper, iron ore, silicon, and the like. Rarer stuff like platinum, gold, germanium, uranium and the like, haven't really created much wealth. If the cost is too high, the rare ones are substituted—even if it can't be substituted now, businesses spend billions researching and developing substitutes that may exist in the future—and they probably don't achieve the economies scale of the common commodities. As many have said, a low-cost business tends to win the commodity game and economies of scale is probably the #1 method of lowering the production cost.
  • (Recommended) Special situation investing articles (Various sources via Old School Value): In a post dealing with reading material, Old School Value links to two useful articles on special situation investing - article 1 & article 2 (Security Analysis excerpt).
  • (Highly Recommended) McElvaine Investment Management - Partners' Investment Conference, May 7 2010 (McElvaine Investement Management; h/t Pakiya Funds): Lengthy transcript detailing some history of Tim McElvaine. Good stuff.
  • The end of the Bush tax cuts (Bloomberg Businessweek): The Bush tax cuts, aka 'tax cuts for the wealthy,' will arguably go down in history as one of the worst fiscal decisions by any US government. Many readers here probably won't like my thoughts on the matter (since they profit from the capital gains and dividend tax cuts that was the core element of those tax cuts) but it was a disaster for USA. On top of significantly enlarging government deficits, my opinion is that most of the benefits were recycled into dubious investments—namely residential real estate. Tax cuts that boost investment is only benefitial if the investment is in productive assets. Countries like Ireland also pursued a low-tax strategy whereby most of the investment appears to have gone into residential real estate. The only thing that makes these tax cuts not as disastrous as it may have been is the bull market in bonds. If interest rates hadn't fallen in the last decade, US government interest payments would have been far larger. In any case, my opinion isn't the only argument against these tax cuts; as the article mentions, even the proponents and architects of the tax cuts, such as Glenn Hubbard and Alan Greenspan, have admitted it was a colossal mistake... As I have speculated in the past, one the major macro trends I'm expecting is the increase in tax rates across the developed world. Taxes declined from, say, the 1960's to the 2010's but I suspect they will rise from the 2010's to, maybe, 2040's.
  • Inside Las Vegas: Gary Loveman & Harrah's (Bloomberg Businessweek): Haven't read the full article but those interested in gambling, entrepreneurship, or Las Vegas may find the article worth reading when you have nothing better to do.
  • S&P 500 foreign sales data (S&P via Bloomberg Businessweek): Not every company reports detailed information but here is what S&P has pieced together from reporting S&P 500 companies (click here for the report):
    • Of the reporting issues, 46.6% of all sales were produced and sold outside of the United States, down from 47.9% in 2008, 45.8% in 2007, and 43.6% in 2006.
    • In 2009 S&P 500 foreign sales decreased 16.0%, while domestic sales decreased 11.2%.
    • European sales declined to 25.6% from 27.7% of S&P 500 foreign sales, as Asia increased to 17.6% from 13.2%. Canada representing largest single country at 7.4% is down from 9.3% in 2008.
    • Information Technology continued to be the dominating sector with over 56% of its declared sales being foreign in nature; the sector represents 20.4% of all U.S. foreign sales.
  • (Recommended, especially for Graham-oriented investors) [audio] Geoff Gannon interviews Jonathan Heller of Cheap Stocks (Geoff Gannon; h/t Controlled Greed): I didn't realize Gannon also did interviews...haven't listened to this fully yet but it's an interesting one.
  • Amazon facing anti-trust problems? (Financial Post): One of the toughest things in an economy is to decide if businesses are selling items below-cost to drive competitors out of business, in the hope of charging a fortune in the future. What confuses matters is that consumers benefit in the short-run and it's never clear what the real strategy of the company is. It looks like Amazon is being investigated for a practice it undertook between 2007 and 2009. During that period, Amazon apparently sold e-books books at $9.99, even though it cost $12.99 to $14.99 (that's the price publishers charged everyone.) Loss leaders are common in retailing but given Amazon's size and its ability to destroy competition, this is more than a temporary loss-leader product.
  • Charlie Rose interviews Wilbur Ross (Charlie Rose via Greenbackd): Thanks to Greenbackd for bringing this Wilbur Ross interview to my attention.
  • The bond market survives catastrophe? (Buttonwood @ The Economist): As many may recall, the bond market was pricing in catastrophic outcomes two years ago, but managed to avoid any blow-ups. In fact, the corporate bond market has rallied so much that it is arguably over-valued relative to the stock market. Is it out of the woods or is all this just an illusion before corporate bonds return to reality? Remains to be seen.
  • Wells Fargo and its drug trafficking problems (Bloomberg Markets Magazine): On top of a balance sheet loaded with toxic mortgages, one of the things Wells Fargo seems to have inherited from Wachovia is their illicit dealing with the underworld. Namely, Bloomberg is reporting that Wachovia, along with Bank of America, is a big facilitator of money earned through illegal drug trafficking. I'm sure it's very difficult to spot these transactions but it's going to be a bigger problem as we move forward. The drug war in Mexico seems to be totally out of control, with police, state and city leaders, bought off by drug lords, and only the military remaining somewhat neutral. At the rate things are unfolding, it wouldn't surprise me if the druglords infiltrate the Mexican military within 10 years. When that happens, it's all over for Mexico. Drugs will become a "normal" industry in Mexico, kind of like how poppy/opium is a big contributor to the GDP of Afghanistan. Some readers may be shocked to read that I'm in favour of legalizing drugs. Although politically impossible right now, it wouldn't surprise me if the bogus "war" on drugs ends within a decade and some loosening of drug possession, a least in liberal or libertarian-oriented states, occurs within my life. In fact, some have speculated that California may legalize marijuana and tax it, solely to alleviate some of the financial problems and to reduce spending on police, prisons, and immigration.

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Tuesday, August 3, 2010 3 comments ++[ CLICK TO COMMENT ]++

Accounting changes can impact short-term investors

This probably isn't news to anyone but I thought I would reiterate the point...

One of the benefits of long-term investing is that accounting changes can generally be ignored. In contrast, shorter-term investors have to be careful in reading the financials. For example, consider Amazon's accounting change that is described in an article in The Globe & Mail:

But a recent accounting change by the company will effectively goose Kindle revenue for all of 2010.

Amazon says in its disclosures to investors that it has become an early adopter of a new accounting standard called ASU 2009-13, addressing “revenue arrangements with multiple deliverables.”

In Amazon's case, the “multiple deliverables” are the Kindle hardware, the ongoing wireless connectivity, and any subsequent software upgrades for the device. Apple Inc., which has also adopted the standard, said earlier this year that its iPhones and Apple TV services fall under the standard.

Under previous accounting rules, Amazon recognized revenue from a Kindle in pieces over the life of the device, which it estimated at two years. So if a customer spent $400 (U.S.) on a Kindle, the company would recognize about $50 of revenue per quarter over eight quarters.

New rules allow Amazon to recognize a “substantial portion” of the entire purchase price upon delivery of the Kindle.

What's that worth to Amazon? It doesn't release Kindle-specific numbers, but analysts such as the team at Deutsche Bank Securities Inc. estimate Amazon will sell about $1-billion worth of Kindles in 2010.

Under the previous method, Amazon would book less than $300-million of that revenue in 2010, with the remainder pushed out into 2011 and even 2012. By recognizing about $1-billion instead, Amazon would add about three percentage points to its revenue-growth rate.

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Monday, August 2, 2010 0 comments ++[ CLICK TO COMMENT ]++

Some Chinese companies starting to resemble their Japanese counter-parts from the 80's

Thanks to a mention at Calculated Risk, I ran across an interesting article in The New York Times on the shift of some state-owned and municipality-owned Chinese corporations into the real estate business.

Anhui Salt is hardly alone among big state-owned companies. The China Railway Group is developing residential complexes in Beijing after winning the auction for a huge piece of land there.

Likewise, the China Ordnance Group, a state-led military manufacturer best known for amphibious assault weapons, paid $260 million for Beijing property where it plans to build luxury residences and retail outlets.

And in one of China’s biggest land deals yet, the state-run shipbuilder Sino Ocean paid $1.3 billion last December and March to buy two giant tracts from Beijing’s municipal government to develop residential communities.

All around the nation, giant state-owned oil, chemical, military, telecom and highway groups are bidding up prices on sprawling plots of land for big real estate projects unrelated to their core businesses.

Land records show that 82 percent of land auctions in Beijing this year have been won by big state-owned companies outbidding private developers — up from 59 percent in 2008.

A recent study published by the National Bureau of Economic Research in Cambridge, Mass., found that land prices in Beijing had jumped by about 750 percent since 2003, and that half of that gain came in the last two years. Housing prices have also skyrocketed, doubling in many cities over the last few years.

The report pegged a big part of the increase to state-owned enterprises that have “paid 27 percent more than other bidders for an otherwise equivalent piece of land.”


Asked why Anhui Salt wants to be a developer, Mr. Su said the central government had encouraged state companies to be more profitable, and that real estate was incredibly lucrative.

Sunday, August 1, 2010 5 comments ++[ CLICK TO COMMENT ]++

Articles for a mid-summer night

I hate losing articles and such was the case with one I was typing up earlier this week grr :(

One area I have been researching lately is the historical behaviour of large-cap and mega-cap stocks. Some of you may have noticed it but I find it very bizarre that the market is pricing large-cap and mega-cap American stocks at relatively low valuations. In fact, depending on the measure you use, the market is pricing them lower than small-caps and mid-caps even. As an example, consider the P/E ratios of the following (I'm not recommending any; just picked some random big ones):

Microsoft has a forward P/E of 9.7 and a trailing P/E 12.3.
Intel (cyclical) has a forward P/E of 9.7 and a trailing P/E of 12.3.
IBM has a forward P/E of 10.4 and trailing P/E of 12.1.
ExxonMobil (cyclical) has a forward P/E of 8.8 and trailing of 13.4.
JP Morgan (vulernable to dervatives implosion) has a forward P/E of 8.8 and trailing of 11.9.
Pfizer (potential value trap) has a forward P/E of 6.7 and a trailing one of 14.

I just don't get why the market is pricing these widely followed, well understood, safer, bigger-moat, long-history companies at these valuations!!! These aren't in some dark corner of the investment universe; or ones that have been hammered after a big bubble or a panic. No; these are some of the most popular companies on the whole planet. Each of these companies have upwards of 20 knowledgeable, highly-paid, talented analysts following them. A company like Microsoft has 31 analysts following it (according to Yahoo! Finance) and it doesn't even include the foreign, European/Asian, analysts.

I have been trying to figure out why the market is pricing these companies as such and haven't developed any strong convictions. If you have some theories, feel free to leave a comment or fire off some e-mail to me.

It's almost at the point that, if the market isn't anticipating some huge macro risk—an example would be heavy taxation of large companies—then there is little reason for amateur investors to be dabbling in small-caps and mid-caps. These large-caps may end up generating 10%+ per year with much lower risk and better corporate governance.

While I'm at it, if anyone knows where I can get free historical information on small-cap and mid-cap indexes--basically looking for valuation measures like P/E but something like P/BV or P/CF is ok too--stretching back to the 1950's, please let me know. I'm trying to figure out if the market has priced large-caps at these valuations while keeping the smaller ones at higher valuations. For example, the DJIA hit a P/E of 8 in 1932 but I believe the whole market sold off (i.e. smaller companies also had a low P/E.) What is striking right now is that most of the low valuation is only with the large-caps and mega-caps.

Anyway, on to some articles (as usual not in any order)...

  • Li Lu, a future co-CIO of Berkshire Hathaway (The Wall Street Journal; h/t GuruFocus): The mainstream media finally catches up with a story widely discussed in value investing blogs many months ago. It looks like Li Lu will be one of the investment managers at Berkshire Hathaway. It looks like Li Lu's major investment success is BYD and I am still unsure of his skill with his other picks... in any case, Li Lu's character seems top-notch—anyone who demonstrates against the government for freedom is a good guy in my books.
  • FT Lunch with Alan Greenspan (Financial Times (may not be free); h/t Economist's View): Alan Greenspan is an interesting character. Started off as a hardcore Randian, heavily in favour of gold standard and distrustful of the state, became a popular conservative supporting Nixon and others, and ended up as a big proponent of the crony capitalism that is epitomized by the bailouts-for-all-capitalists thinking. Either he changed with age, or he was always a chameleon who changes stripes to suit the environment—kind of like those Afghani warlords who switch alliances at will, even in the middle of combat. Regardless of what one thinks of Alan Greenspan, he will go down as the most influential central banker of the last 20 years and possibly the last 50 (yes, he is even more infuential and had a greater impact on society than Paul Volker.)
  • US GDP comes in at 2.4% for Q2 (Calculated Risk): My forecast for the next few years is 2%, which is very bearish. I really hope I am wrong (people will suffer and even I may lose my job if its only 2%; who knows?) but I have a feeling we would be lucky to hit 3% for any sustained period over the next few years. Once the government stimulus is reduced, growth is going to be hard to come by. On top of the de-leveraging by consumers and financial institutions, the problem is that USA (Canada and others too) are shifting from a manufacturing society to some post-manufacturing economy. These things take time and the economy of the last 20 years will not resemble the future—at least in most developed countries.
  • (Highly Recommended) Accounting metrics to detect problem companies (MarketWatch): Anyone serious about fundamental analysis should actually read a book on this matter but, nevertheless, this is a good article that highlights some accounting items to watch. The article highlights the following red flags: inventories ("...inventories should rise at about the same pace as sales. If a company's inventories are growing faster than sales or expected sales growth, it's a clue that products aren't moving. In that case, gross margins could get squeezed."); free cash flow ("In 1999, the company [Worldcom] reported free cash flow of $2.3 billion. A year later, free cash flow was negative $3.8 billion. Such a large swing in free cash flow is a warning sign"); accounts receivable ("What you don't want to see is receivables rising at a much faster pace than sales. This suggests a company is shipping too much product into the channel and possibly extending collection payment terms.") Other red flags to watch include "always making the number" (GE under Jack Welch was notorious for this), "continual restructuring charges", "how thick the financial docs are" (I don't agree with this.)
  • John Mauldin's views on deflation (John Mauldin's Thoughts from the Frontline): A good overview of some numbers that seem to imply we are facing deflationary threats. Even one FedRes inflation hawk appears to be more concerned with deflation these days. Some have suggested the US central bank is about to pursue another round of quantitative easing. As John Mauldin suggests in his conclusion, if deflation becomes a serious threat, the FedRes will likely have to bypass the banks.
  • The Volker Rule (New Yorker): The battle over financial reform. Rumour always had it that former FedRes chairperson, Paul Volker, was more for show than anything serious the Obama administration was considering. I have avoided any comment on the massive financial legislation because it's way too complicated and I have no idea what any of it means. All I know is that it can radically alter banking or end up doing absolutely nothing. Yes, that isn't saying much and that's probably why I'm keeping shut ;)
  • First serious oil-spill lawsuit against BP (Fortune): A flounder gigger—apparently some recreational fishing-type "sport"—is suing BP after inhaling/digesting/touching the oil-contaminated water and suffering rashes, nosebleeds, and the all-too-popular "emotional distress." It remains to be seen what the ultimate damages end up being.
  • (Highly Recommended for growth investors) Google hits young-adult stage (Fortune): Google's core business is slowing; investors are getting nervous; and it is aging. A good article touching on where Google stands and where it may head. If you invest in, or are interested in, technology, this is a good overview of what typically happens in the sector.
  • Businessweek interview with Nassim Nicholas Taleb (Bloomberg Businessweek): I'm not a fan of Nassim Nicholas Taleb but some of you are so here is an interview I ran across. Nothing earth-shattering in the interview other than Taleb's suggestion that the next big negative event may be government deficits.
  • A look at Consumer Reports (Bloomberg Businessweek): A detailed story of Consumer Reports, the 74-year old venerable publication famous for unbiased product reviews.
  • The revival of Lego (Bloomberg Businessweek): People don't realize it but Lego almost lost its crown in the building-block toy category a few years ago. But it managed to fight back.
  • (Recommended) The rise of commodity ETFs & the wealth lost by investors (Bloomberg Businessweek): A very good, lengthy, overview of commodity ETFs, including various issues that make them unsuitable for most investors. Too many newbies caught up in these instruments, given how it's almost impossible to gain exposure to commodities through other means.
  • (Recommended for those interested in entrepreneurship) The Greek Canadian who bought the Pontiac Silverdome (Bloomberg Businessweek): As is the case with almost anything in and around Detroit, the giant Pontiac Silverdome stadium has been in decline for decades. A Canadian real estate entrepreneur placed a low-ball bid of around $600k and actually ended up owning it—this, for a stadium that cost $56 million to build ($220 million in 2010 dollars.) This is the story of what Andreas Apostolopoulos, the buyer, plans to do.
  • Slideshow: America's 50 laziest states (Bloomberg Businessweek): hmm... who is the unlucky—or is that lucky?—soul that lives in Louisiana? ;)
  • (Recommended) (not related to investing) Rebel with a cause: Julian Assange and his pursuit of total transparency (New Yorker): I have always been of the opinion that the Internet is the most signficant scientific/engineering/technological development in the last few hundread years. It is very similar to the printing press, which is another significant development. Unlike something like flight or automobile, the printing press permanently altered society by destroying the Church, as well as the unholy alliance between the tyrants (monarchs) and religion. Not only would people not be as free, thoughts that challenged the Church, such as scientific thinking, wouldn't be quite what it is today. The power of the Internet hasn't been unleashed but we are getting a taste of it. Julian Assange, an Australian with no permanent fixed address, is a controversial character these days. He runs, an Internet site dedicated to releasing information from whistleblowers, insiders, and others. WikiLeaks recently released a massive dossier of classified data from the Afghan war and some in USA (and elsewhere) consider WikiLeaks to be harming the war effort. Some even charge Assange with working for the enemy. There are also question marks about libel, falsified data, and various other issues that plague information. Regardless of what one thinks, they cannot deny what just happened. All of a sudden the public isn't beholden to the elites at the high level or the mainstream media for information. Anyone and everyone can go straight to the source. It remains to be seen what transpires but I don't think I'm exaggering in saying that we may be witnessing the beginning of the decline of modern government power. The printing press destroyed the Church because anyone could read the bible all of a sudden and didn't have to wait for transcriptions or official word from the Church and its agents. Could the day come when mainstream media loses its relevance and government officials and corporate officiers can't keep information from the public?

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Sunday Spectacle LXXXI

A True Growth Stock

(source: "How Apple maintains explosive earnings growth" by Andy M. Zaky. Fortune, July 12)

Richly valued and possibly overvalued but Apple is definitely a true growth stock. Similar to the performance of another famous growth stock from the 1930's, Coca-Cola, Apple has managed to increase sales and profits in the thick of the worst recession in decades.