Tuesday, December 28, 2010 3 comments

If you are bored during the holidays, here are some articles to kill time

Some people are on holidays; others have light loads—assuming you aren't one of those airport workers stuck trying to clean up from the snowstorms ;) Here is some reading material to keep you busy...

  • (Recommended) Potential actions by regulators to control the too-big-to-fail banks (Reuters Breakingviews via Financial Post): Regulators and government officials created huge moral hazard by creating the oxymoronically-named too-big-to-fail banks. Now they are trying to figure out how to regulate them and, ultimately, prevent the banks from turning into too-big-to-save (i.e. banks that will threaten sovereign solvency). This is a good article that presents several solutions and the ones likely to be followed by the government officials and regulators in the near to medium term... As I have mentioned in the past, the "proper" solution in a capitalist society is to punish the financiers who enable all the risk-taking. In this case, the bondholders have been spared (except for Lehman Brothers creditors) and they should be forced to take haircuts. There is no other free-market solution! Everthing else just creates bigger moral hazards in the future and, to use the beaten-to-death cliche, just re-arranges the chairs on the deck of the Titanic.
  • The ascent of gold (Bloomberg Businessweek): A lengthy article chronicling the rise of gold over the last decade. Part of a feature report that covers the dark side of the gold mining business.
  • Ten American brands that have dimmed (24/7 Wall St): Used to be leading brands but not anymore.
  • (Highly Recommended) Calculating free cash flow (GannonOnInvesting): Perhaps the most important metric for modern fundamental investors, free cash flow is not always easy to determine. Many data aggregators and automatic computations lead to big mistakes with the FCF calculation.
  • Useful article for Canadians thinking of buying residential real estate in the US (Financial Post): Good article providing an overview for any Canadian thinking of buying property down South, along with pitfalls that one may face.
  • Any Canadian thinking of retiring in the US? (Financial Post): Some Canadians may be thinking of retiring permanently in the US; or some Americans may want to move to Canada. This insightful article details the differences between the countries.
  • (Highly Recommended) Can KKR turn itself into a Berkshire Hathaway? (Bloomberg Businessweek): This is an old article from December of 2009. Although Kravis is a fan of Warren Buffett, comparing KKR to Berkshire Hathaway is one of the dumbest comparisons I have ever seen. Apart from the holding structure and the continuous purchase of assets (taking public companies private), I don't think there is much of a similarity. Having said all that, this is a good article (even if you are not interested in private equity, check it out; the accompanying video, which annoyingly starts playing by default, is also worth listening to).
  • Companies buying back stocks at the wrong time? (Saj Karsan for GuruFocus): Saj Karsan does a good job demonstrating how companies are buying back stock when prices are high and didn't buy back as much when prices were low an year-and-a-half ago... I wonder about these situations. Is it really the company making a dumb move? Or can it be that the effect is actually the cause? That is, what if prices move higher because of buybacks and not the other way around? I also wonder about capital flows, particularly from retail investors, which generally shows negative flows at low prices (near market bottoms) and strong positive flows when prices are high (and near market tops). What if we are observing the result of capital flows? I'm not too familiar with it but do recall how George Soros' Reflexivity theory suggests that market participants react to prices, but prices also react to market participants (i.e. unlike conventional thinking, markets are actually a two-way relationship). I wonder. The "dumb money" is almost always caught off-guard but can it really be so consistent? Always selling near a bottom and always buying near a top?
  • Apple vs Nokia patent dispute visualized (Fortune): If you have an interest in intellectual property disputes, do check out the FOSS Patents website run by Florian Mueller from where the source diagram comes from.
  • (entrepreneurship) Useful resources for entrepreneurs (The Globe & Mail): Useful websites, tools, and references for those into entrepreneurship. One useful site mentioned is the Canadian Intellectual Property Office, the government website where you can search patents, trademarks, and copyrights.
  • (entrepreneurship) Turnaround success in the kids games arena (Financial Post): A successful turnaround of a bankrupt games company.
  • (career) Four personality/trait/skill evaluation systems (The Wall Street Journal): An article from earlier this year, discussing four personality/career/trait/etc tests that are available. None of them are free, although you can find some some non-professional Myers-Briggs online tests, and some people find these tests useless. I personally think it can help one figure out details about themselves. It may not be perfect but at least it gives some ideas on what you should do with your life.
  • (non-investing) 100 science lectures from leading practitioners (BestCollegesOnline.com): If you are into science and want to kill time, check it out.

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Sunday, December 26, 2010 0 comments

Sunday Spectacle CII

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Thursday, December 23, 2010 5 comments

Natural gas - still quite contrarian

I'm bearish on commodities but the only commodity that I would consider is natural gas. Compared to the rest of the commodity complex, natural gas remains quite contrarian, with prices hovering near 7-year lows. Unfortunately for the bulls, nothing much has changed since I last wrote about it, about an year ago. The price is roughly what it was when I wrote that article:


Encana, a bellwether—I believe the largest natgas E&P in North America—is just a tad bit above when I wrote my prior post:


Note that just because prices are low doesn't mean it is a good contrarian opportunity. There is a good reason why natgas is trading where it is.

Unlike oil, natgas is localized and there has been massive production from unconventional sources (particularly shale gas). In fact, Big Oil has become gassy over the last few years—not sure if this is good or bad for the industry??—and it isn't shy to spend money on drilling for more gas. Believe it or not, many are drilling even if profitability is questionable. Apparently, as this Reuters article (picked up by the National Post) makes clear, the excessive drilling is due to drill-it-or-lose-it concessions signed by the E&Ps:

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Newbie Thoughts: The risk with warrants from buyouts

Anyone investing in junior miners would be familiar with warrants; they are a popular means to leverage returns. For those unfamiliar, warrants are derivatives that are identical to options except for some differences: warrants are issued by the company itself so they dilute shareholders (they are similar to employee stock options); and warrants tend to have long expiries, often as long as 5 years. Warrants are common in junior resource capital raisings but not so common elsewhere (mostly because they destroy shareholder wealth due to their dilution). There are some risks in using them and one of them is when the company is bought out.

M&A takeovers are a big problem for warrantholders.

Many who buy warrants do so for their long expiry date but, generally, these warrants are way-out-of-the-money—the hope is that the price will rally significantly over the years before the warrants expire. So, if a company is bought out, the buyout price may be below the strike price, rendering the warrant worthless. Such a scenario unfolded in the recent buyout of Gold Wheaton, a gold company, by Franco-Nevada. As the Financial Post reports,

Ever since Toronto-based Franco agreed to buy rival Gold Wheaton on Dec. 13 for $830-million in cash and stock, Gold Wheaton's warrantholders have been in an uproar. They have watched helplessly as the exchange-traded warrants have plunged nearly 70%.

...

According to the terms of the Franco-Nevada offer, Gold Wheaton's warrants will remain outstanding and can be exercised to acquire the same cash and stock consideration from Franco as Gold Wheaton's common shareholders.

That is a problem, because the publicly listed warrants have an exercise price of $10 per share and an expiry date of July 2013. Franco's offer is worth just $5.20 a share, meaning they are not "in the money." However, unlisted warrants are in the money.

Almost instantly following the deal announcement, the price of a single warrant started to fall. They dropped more than 50% in one day, to 26¢ from a high of 57¢ the day before. Since then, the warrants have traded as low as 15¢ and yesterday closed at 18¢.

"I've followed a lot of different mergers with companies that have warrants, and this is the worst situation that I have seen," said Dudley Pierce Baker, editor of Precious Metal Warrants, an investment publication in the United States.

Over the past week, he has received dozens of inquiries from angry Gold Wheaton warrantholders, many of whom want a class-action suit against the merging parties to be launched.

Warrants come with much higher risk than stocks, and sources suggested that Gold Wheaton's warrantholders did not understand all the risks of what they were buying.

"It was highly liquid, it was highly volatile, [retail investors] were having fun with it," said one analyst who did not want to be identified. "But you know, buyer beware. Look at the class of shares you're buying."

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Sunday, December 19, 2010 0 comments

When will China's GDP surpass USA's?

For some reason, I notice that I tend to write about China on Sundays... hmm... Anyway...

When Goldman Sachs made its first forecasts for the BRIC economies (Brazil, Russia, India and China) in 2003, it predicted that China would overtake America in 2041. Now it says 2027. In November Standard Chartered forecast that it will happen by 2020. This partly reflects the impact of the financial crisis. In the third quarter of 2010 America’s real GDP was still below its level in December 2007; China’s GDP grew by 28% over the same period.

If real GDP in China and America continued to grow at the same annual average pace as over the past ten years (10.5% and 1.7% respectively) and nothing else changed, China’s GDP would overtake America’s in 2022. But crude extrapolation of the past is a poor predictor of the future: recall the forecasts in the mid-1980s that Japan was set to become the world’s largest economy. China’s growth rate is bound to slow in coming years as its working-age population starts to shrink and productivity growth declines.
The above, from an interesting article in The Economist, speculates about when China's GDP may surpass USA's GDP. The Economist continues,
Our best guess is that annual real GDP growth over the next decade averages 7.75% in China and 2.5% in America, inflation rates average 4% and 1.5%, and the yuan appreciates by 3% a year. If so, then China would overtake America in 2019 (see chart).
Two thousand and nineteen is not very far from now. It would be a spectacle and an historic point in world history when that happens, if the assumptions hold true.

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Sunday Spectacle XCXI




(charts from "Go Big, The Investment Case for Multinationals," Robert Hagstrom. LMCM, Nov 2010)


Shouldn't be surprising to see that larger companies in the S&P 500 earn more overseas. The difference is very pronounced for S&P 100, which is a subset of S&P 500 and contains the largest companies in America. Around 68% of the companies in the S&P 100 earn 25%+ of their revenue overseas.

The bottom chart, showing the local vs foreign profit margin, shows how profit margins have collapsed in America in the last few years. You can read this two ways. The first way is to follow the suggestion of the author of the document containing these charts and favour companies earning foreign income. The profit margins have remained high overseas so a bullish outlook will try to capitalize on that.

The alternate view is to remain contrarian. Not only are the foreign profit margins higher than the local (US) one, they have also been higher in the last decade than in the 90's. Unless you have a good reason to justify why foreign profit margins should be higher now than in the past, you should remain cautious. In my view it is far more likely for the profit margins to mean-revert to what they were in the late 90's. In fact, it does seem like the foreign profit margins peaked in 2006 and have been trending down somewhat. My guess is that the higher profit margins are from the commodity complex but I can't say for sure without analyzing the data. Needless to say, it is very easy to cook up scenarios for commodity prices to revert to what they were ten years ago (in real terms).

I also wonder if the market is concerned with the latter point I made above. I haven't been following markets for very long but one striking thing is how the market is pricing megacaps at low P/E multiples. The best-of-the-best are priced at lower multiples than smallcaps or midcaps. I wonder if the market is doing this because a lot of the profits for the larger companies come from overseas business, and as you see in the chart above, the overseas profit margin looks abnormally high compared to recent history. I wonder if the market is pricing in the possibility of profit margin contraction in overseas markets?

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Friday, December 17, 2010 0 comments

Articles for a Friday - December 17, 2010

Hope everyone had a good year and is looking forward to the holidays. Investingwise, it has been a very poor year for me, but, careerwise and in other matters, the year started off rough but it has been good so far.

  • Google introduces Books Ngram viewer (AtlanticWire): Amazing free tool called Books Ngram Viewer that lets users view trends in words on roughly 10% of books printed, in six languages, between 1500 and 2008 (approximately 5.2 million books).
  • Biggest drug recalls in US history (24/7 Wall St): Some of it is not pretty, especially if you consider how humans were harmed.
  • The iPhone increases US trade deficit (The Globe & Mail): A good article that refers to the study, " How the iPhone Widens the United States Trade Deficit with the People’s Republic of China," that suggests that Apple's iPhone, although owned, designed and sold by an American company, actually increases the US trade deficit. I was going to write about this in a standalone post but I just don't feel like it right now and it is a complicated matter. The issue touched on by this paper is extremely important in the long run and it shows how trade deficits are not what they seem and much harder to tackle. Once upon a time, all you did was to try to promote or advance your local companies and this increased the trade surplus. Right now, that is not sufficient. Nowadays, you probably shouldn't care whether a company is local or not, and instead worry about whether a company employs workers locally, pays taxes locally, and so forth. There is less capital control these days so a local company may actually be owned by foreigners and hence profits will flow to them than the locals.
  • (Recommended) Satellite images of ghost cities in China? (Business Insider): Interesting analysis but attempts like these can be severely flawed. Looking at city activity from the sky can be influenced by the time of the day (industrial towns won't have too many people wandering around during work time), wealth level of the city (poorer cities won't have cars), holidays (cities are deserted during some holidays in some countries), and so on. Nevertheless, this article does provide one data point for the China bears. (This analysis shows the power of Google, or more precisely, low-cost mass information. Such as thing wouldn't have been possible a decade ago. Too bad the bureaucrats and politicians are cracking down on free speech, Internet in general, and Google specifically :( )
  • Alternate measure of China's economic performance (The Economist): WikiLeaks revealed last week that Li Keqiang, future potential leader of China, does not trust Chinese GDP numbers. Instead, he is said to favour, according to The Economist, "the cargo volume on the province’s railways, electricity consumption and loans disbursed by banks." Note that the first metric is one that is favoured by Warren Buffett — rail shipments.This article presents a chart of an alternate index composed of those metrics and compares it to the reported GDP. From the chart, I don't see anything that deviates materially from the GDP in the long run. The alternate index is more volatile but seems to track the reported GDP numbers.
  • China's labour market problems (Fortune): Structual issues with China's labour market...
    "Now the number of migrant workers is shrinking. The U.S. census bureau predicts that the number of 15 to 24 year old Chinese nationals ready to work will fall by almost 30% over the next 10 years. Even this past year, excess workers were scarce, particularly in eastern China. Some factories couldn't fill all their orders.

    ...

    At the same time, the unemployment rate among college-educated Chinese youth is rising. According to a recent paper from the National University of Singapore, 30% of the 6 million graduates who enter China's job market each year can't find work. The number of applicants for public servant jobs, for instance, surged from 87,000 in 2003 to 1.4 million in 2009, according to official data. This may point to China's increasingly patriotic Gen Y, but it also reveals the sheer number of college-educated workers looking for jobs outside of factories and farms."

    "In a normal economy, the unemployed urban youth would start to compete with the migrants for jobs," says Dr. Mary Gallagher, a professor and China specialist at the University of Michigan. "But they're not. Both sides need to adjust their expectations."

    In some respects, the labor mismatch can be chalked up to a cultural side effect of China's one-child policy. A study recently published by the Chinese Academy of Social Sciences and reported in state-run media found that Chinese university graduates receive almost equal starting salaries as migrant workers: graduates' starting monthly salary was $226, compared to $181 for migrant workers.

    Yet this generation of "only children" has a different idea of modern life than their factory-working forefathers, and it looks like they are holding out for something better.
  • The difference between capital-intensive Internet businesses and capital-efficient, scalable, Internet businesses (New Yorker): The ideal company to own is one that is not capital intensive (hence each incremental customer doesn't cost much and you don't need to keep deploying millions into maintaining the business), has a moat, is almost a monopoly, and deploys all its profits into the business (i.e. doesn't pay dividends or buy back shares). The Internet is a new environment where many new businesses are being created. A company like Amazon is an example of the ideal business—not perfect but good enough for me to consider it great. But you also have capital intensive Internet businesses that are emerging. An example of that is Groupon. This article touches on the characteristics of Groupon, which makes it different from, say, Amazon. (note: the article suggests that a company like Amazon is capital intensive and is like Groupon but I disagree and think it is more like Google or Ebay.)
  • What is Icahn planning to do with Dynegy? Hard to say. (Fortune): I have been following this company recently—both shares and bonds—and Icahn recently proposed buying out the whole company. His strategy seems unclear.
  • (recommended) A primer on poison pills (Dealbook for The New York Times; h/t GannonOnInvesting): Poison pills differ by jurisdiction and this article is about USA. If you are into risk arbitrage, it's important to understand poison pills. I haven't given it much thought but for what it's worth, my feeling is that poison pills often destroy shareholder value and, hence, I'm not a fan of them (I'm also not a fan of golden parachutes and various other schemes to block hostile takeovers). If shareholders don't like a hostile bid, they can vote it down.
  • "Stop, Look, Listen! The Shareholder's Right to Adequate Information" by William Z. Ripley (The Atlantic): An article from the January 1926 The Atlantic magazine that apparently influenced the establishment of the SEC. This is a good example of how unfettered capitalism, as desired by many extreme libertarians and free-market-oriented individuals, is actually not the best solution. Although criticized by many with an extreme free market stance, the SEC has done far more good than any private institution in advancing shareholder rights.
  • (recommended for insurance industry investors) David Merkel's detailed thoughts on the insurance industry from his many years of experience- part 1, part 2, part 3, part 4, part 5, part 6, part 7, part 8, part 9, part 10, part 11, part 12 (Aleph blog): After investing in Ambac and Montpelier Re, I have come to the conclusion that the insurance industry is outside my circle of competence. It's too much of a black box and too complicated for me. But I know a lot amateur value investors invest heavily in insurance companies so you may want to read this long series on the insurance. David Merkel does a good job channeling his years of knowledge into explanations of the insurance industry.
  • (Recommended) (non-investing) Ron Paul defends WikiLeaks (Huffington Post): I don't agree with everything that US Congressperson, Ron Paul, stands for—I completely disagree with his misguided views that the gold standard is better; that the Federal Reserve should be abolished; that taxes should be almost nothing; etc—but I do agree, and indeed respect him, on many issues related to liberty—free speech, property rights, individual rights over government power, etc. Ron Paul puts his reputation on the line and stands up for his libertarian views by defending WikiLeaks in this speech (contrast this with other hypocritical big-L and small-l "Libertarians" who speak of liberty but are the first ones to become slaves of the government, especially when it comes to security or war). Too bad the rest of the US government doesn't cherish liberties like the Founding Fathers did. The biggest dissapointment to me is Barack Obama, who is was suposed to be liberal on many of these issues but has turned into another George Bush. The biggest joke of all is giving Obama the Nobel peace prize a while ago (not that the prize means anything these days).
  • (non-investing) Best NASA photographs of 2010 (New Yorker): Nothing spectacular in this list but it's worth checking out the photos given that it's the 20th anniversary of the Hubble Space Telescope.
  • (non-investing) Ten important photos from 2010 (New Yorker): Powerful images from the year it was...

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Thursday, December 16, 2010 3 comments

Greed has no boundaries... SEC charges several with securities fraud and wire fraud

The Bernie Madoff debacle, whereby the SEC completely missed his illegal activities, has certainly lit a fire under the SEC. There have been several charges against those benefitting, or abetting, insider trading and the trend continues with four managerial-level employees arrested today. According to MarketWatch,

Federal authorities said Thursday that they arrested four people on insider-trading charges, including three former employees of technology companies Advanced Micro Devices, Flextronics International and Taiwan Semiconductor Manufacturing Co.


Another person — Daniel DeVore, 46, formerly a global supply manager for Dell Inc. — pled guilty on Dec. 10 to wire fraud and conspiracy to commit wire fraud and securities fraud, the authorities said. He’s cooperating with prosecutors, according to a plea agreement released Thursday.

Among the allegations, filed in the U.S. District Court for the Southern District of New York, authorities claimed that the former Flextronics employee leaked highly confidential information about Apple Inc.’s iPhone before it was unveiled.

...

One of the people arrested Thursday was James Fleishman, an institutional equity sales executive at Primary Global Research, an “expert network” firm based in Mountain View, Calif. Read about Primary Global here.


Fleishman, 41, of Santa Clara, Calif., faces wire fraud and conspiracy charges for conspiring to provide confidential information, including material inside information, to the research firm’s clients, including hedge funds, the authorities said.

Mark Anthony Longoria, 44, of Round Rock, Tex., who was a supply chain manager at Advanced Micro Devices was also arrested, along with Walter Shimoon, 39, of San Diego, Calif., who was a senior director of business development at Flextronics; and Manosha Karunatilaka, 37, of Marlborough, Mass., who was an account manager at Taiwan Semiconductor.

They face charges of wire fraud and conspiracy to commit securities fraud and wire fraud in connect with their employment as consultants for Primary Global, the government said.
Apparently, one of those charged leaked information about some Apple products before it was publicly released:

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Delusional expectations of private equity investors

The Globe & Mail has a brief story on the high expectations of private equity investors (refer to the article for the link to the study):

With returns in other asset classes depressed, almost two-thirds of investors surveyed by research firm Preqin say they expect private equity managers to post returns that trump public markets by at least 4.1 percentage points. Three years ago, that number was 17 per cent.

A further 23 per cent in the latest survey said they expected at least 2.1 percentage points over public markets returns.

Given what some studies have shown, that seems a lot to ask.

A recent study by London Business School Professor Chris Higson concluded that investors get "at best a market return."

Mr. Higson looked at returns from 1980 to 2005. His conclusion was that only about a quarter of funds outperformed, while the rest underperformed.
The survey appears to have sampled over 100 private equity investors—sample size is reasonable—and it seems many have rose-coloured glasses. Beating the market by 4.1% in one year, which is what the study is quoted as saying, is within reach; but if investors are expecting private equity to beat the market by 4.1% in the long run, forget about it. They would be lucky to beat the market by 1% in the long run.

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Tuesday, December 14, 2010 0 comments

Is inflation imminent? I doubt it...

It looks like my post on Keynes from a few days ago got picked up by FT Alphaville, setting a record for page hits on my blog... anyway...

Those following the markets closely may have noticed that US government bond yields have ticked up, while the US$ has sold off (the Canadian dollar index, which includes the US$ as a major component, has been somewhat flat and this leads me to believe the US$ isn't as weak as it appears). So the question is, are we seeing the beginning of the inflation that inflationists have bet on for years? Let's take a look.

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Monday, December 13, 2010 0 comments

US credit rating may downgraded in as little as two years

From The Globe & Mail:

The deal reached by U.S. lawmakers to extend tax cuts and unemployment benefits will spur economic growth, but brings the country’s vaunted triple-A credit rating one step closer to the chopping block.

Moody’s Investors Service Inc. on Monday warned the proposed package will worsen the country’s already stretched finances. That deterioration increases the likelihood that the rating agency will change its outlook on the U.S. rating to “negative” over the next two years, it said. Such a shift would signal that a downgrade lies ahead.

The U.S. rating isn’t in imminent danger, but the caution from Moody’s is a sign that the country’s triple-A status is far from guaranteed and will face pressure sooner than expected.
Not imminent and doesn't mean it will happen but this is the first time I have heard any of the rating agencies seriously suggest that USA may be placed on credit watch negative within 2 years.

The article also provides a handy list of countries presently rated AAA:
Australia
Austria
Canada
Denmark
Finland
France
Germany
Luxembourg
Netherlands
New Zealand
Norway
Singapore
Sweden
Switzerland
United Kingdom
United States
A credit downgrade won't impact USA that much. It will just raise the cost of financing but even that won't increase that much since it will still be rated better than the vast majority of credit instruments. Recall that Japan got downgraded and nothing much happened.

However, since the bond market prices assets off US government bonds—the "risk-free" rate—any downgrade will have a greater impact than Japan or some other country being downgraded.

I personally think USA is one of the strongest credits out there—stronger than most on that list above—and don't think it will get downgraded unless economic growth comes in at less than 2% per year for the next decade and/or USA undertakes additional large spending, like starting a war with Iran or something (depending on how you count, USA spent around $1 trillion on the Iraq and Afghanistan wars and an Iranian war will probably cost upwards of $5 trillion).

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Sunday, December 12, 2010 0 comments

Sunday Spectacle XCX


All You Wanted to Know about Gift Cards

(source: "What goes into a gift card" by Jessica Shambora. Graphic by Jason Lee. Fortune, November 26, 2010)

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Saturday, December 11, 2010 24 comments

John Maynard Keynes - A great investor

John Maynard Keynes

Many readers have likely heard of John Maynard Keynes, arguably the most influential economist of the 20th century. Keynes is most famous for debunking the old theories of classical economics and developing a systematic way of analyzing macroeconomics with consideration of politics and philosophy. Yet, I'll bet that only a few readers would know that he was also one of the top investors of all time. Investing wasn't Keynes' main job and he wasn't exactly a money manager so his investing activities aren't widely known.

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Some stuff you may want to read

Too many things to read...

  • (Recommended) Benjamin Graham on intelligent vs unintelligent speculation (CanadianValue for GuruFocus): I'm not a classic value investor and think Graham is wayyy too conservative, but it's still good to think about risk.
  • One distressed company to watch: Deans Foods (Bloomberg): Contrarians and distressed value investors may want to check out Dean Foods (DF), the largest dairy in America. Dean Foods is off around 66% in the last 3 years and is apparently struggling due to, what else, too much debt. I don't like companies like this but I notice many value investors like these old-school companies. One of the big risks with situations like this is a take-under. There is nothing to stop someone from coming in and buying this company at a really low price, especially if the stock keeps sliding for a while.
  • WikiLeaks reveals Pfizer pressured Nigerian officials to drop suit by trying to uncover corruption (New York Times): According to one of the leaked cables from WikiLeaks, it appears that Pfizer was trying to avoid paying damages from its drug tests, by trying to dig up corruption charges against the Nigerian officials investing the case. Not too surprising but it just goes to show how far companies will go to defend themselves, even when they may be at fault.
  • Tata Nano sales slipping in India (New York Times): Introduced to much fanfare in India, the tiny Tata Nano was supposed to make cars affordable in poor countries like India. Sales took off with a bang but appears to have stalled due to various problems with the car and its marketing. Competitors with similar cars appear to be taking away market share.
  • The almost out-of-control drug war in Mexico starting to take a toll on small businesses (Bloomberg Markets magazine): I've commented on the bogus "war" on drugs in the past so I'm not going to go into it here. But if the trend described in this article, where small and medium-sized businesses are suffering due to the kidnappings, bombings, shootouts, and the like, continue, it is going to have a catastrophic impact on the economy. A lot of the wealthy don't care about starting bogus wars, like the war on drugs, but when the economy falls out, they will start to care. So will the rest of the world.
  • (Recommended) Profile of Bruce Berkowitz of Fairholme Funds (Fortune; h/t Geoff Gannon for GuruFocus): I don't understand Bruce Berkowitz! He has a good track record but I don't even know what type of investor he is. Geoff Gannon seems to suggest he is a distress investor but to what degree? Latest forays into financials—a very high risk move, unless you assume US govt will bail out the banks again if something goes wrong—is definitely investments in distressed assets but his investments in Sears a few years ago isn't quite distressed—contrarian but not exactly distressed IMO. In any case, good article.
  • (Recommended) Canadian superinvestor, Paul Desmaris of Power Corporation (Geoff Gannon for GuruFocus): Good article recapping the history of Paul Desmaris, who is not widely known outside Canada.
  • (Recommended) Canadian superinvestor, Prem Watsa of Fairfax Financial (Geoff Gannon for GuruFocus): Well known in value circles but very few others know much about Prem Watsa. Gannon's work shows how spectacular Watsa's record has been (at least in growing book value).
  • (Recommended) New Rules of Investing interiews Jeff Annello (New Rules of Investing): Some of you may remember Jeff Annello, who ran the short-lived Circle of Competence blog. I always got the impression that Jeff was a sharp investor and I'm glad to see him running his own fund now. If you are interested in running your fund, do check out this interview.
  • Open-source electronics? (Bloomberg): Interesting story about an entrepreneur whose business provides open-source hardware kits and tools. The article talks about hobbyists using Microsoft's Xbox360 Kinect, a motion-sensor device that was introduced recently, in their robotics and automation programs. After initially disapproving of the use, Microsoft seems supportive of it if the Kinect itself is not modified. I wonder if this is a good thing or a bad thing for Microsoft. It comes down to how much money Microsoft makes off Kinect versus the amount they project to make off Kinect services and games.
  • The emergence of online rental markets (Bloomberg Businessweek): One of the major impacts of the Internet is its ability to provide better match-making services between buyers and sellers of almost any good. This article talks about the emergence of online sites that allow individuals to rent out their property.
  • The downside to totalitarian-type systems... can Russia ever reform itself? (The Economist): Even if Putin and Medvedev do a good job running Russia, the risk, as with China, is that future leaders may mess everything up. Russia, not surprisingly, is starting to stagnate and turn into a rigid system.
  • (non-investing) Ten key dissidents in China (The Globe & Mail): A slideshow of ten key Chinese activists who have stood up against the state. Ironically, given the latest saga with WikiLeaks and similar stories, it appears some countries in the West are sliding towards the Chinese model.

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Friday, December 10, 2010 0 comments

What is Google?

In 1998, two American university students founded a company called Google. This post is to record the reasons Google came to dominate the online search business. As is the case with success—or failure—no one can pinpoint the exact reason for why things happned the way they did; nevertheless, I think it's good to consider what authors covering the subject matter think.

A few weeks ago, I linked to an essay in the December 9th, 2010, issue of New York Review of Books, "Google and Money!," where Charles Petersen reviews a few books on Google and pens an essay of what Google was, is, and may be. I decided to extract that essay since it is worthwhile as a standalone post—at a minimum, for future record-keeping purposes (yes, part of the reason I write this blog is to record).

Consider this as the second source of Google's success. Some people really have no clue about Google—How could it earn billions off search advertising? It must be a scam!—and the linked article should help clarify some aspect of Google. You may want to also refer to my June 12th, 2009 post to read the other source of Google's success, the auctioning system. In my opinion, there is another aspect of Google that I haven't covered yet, the technology implementation, which relies heavily on low-cost, easily-scalable, open-source software, and cheap Internet infrastructure (partly due to the overcapacity from the dot-com bubble in the 90's—yes, some bubbles do leave a lasting positive impact).


What made Google what it is? It's difficult to say but here is one interpretation of history (as usual, bolds are by me unless otherwise stated):
Google’s vast improvement on other search engines is usually attributed to a new algorithm, called PageRank, that made use of the links between sites to more accurately determine relevancy. In contrast to other search engines, which ranked results according to the number of times a searched-for word was used, Google ranked its results based on the number of links a site received, a method that revealed the “wisdom of crowds.” The pages to which many people link were, by Google’s model, listed higher than pages that were less popular, and if a particularly popular site linked to a page, that link would be given greater weight in determining relevancy. But Google’s success was not due primarily to its technical ingenuity; other search engines, including Lycos, used a similar ranking technology.

Google’s advantage over Lycos only became apparent when Page and Brin, still intent on pursuing their Ph.D.s, tried to sell their technology to another search engine, Yahoo. As Ken Auletta writes in Googled:
[The Yahoo founders] were impressed with [Google’s] search engine. Very impressed, actually; their concern was that it was too good…. The more relevant the results of a search were, the fewer [pages] users would experience before leaving Yahoo. Instead of ten pages, they might see just a couple, and that would deflate the number of page views Yahoo sold advertisers.
In the early years of the Web, a search engine was considered only one of many attractions on sites like Yahoo and Lycos, which were attempting to become, in the language of the time, a “portal,” or a site that served as an entry point to the Web and provided links to various kinds of content....

Hence the emphasis on “page views.” Instead of a promise of an ad in a newspaper’s “A” section, sites like Yahoo and Lycos sold advertising based on how many times each page on their site was viewed (a statistic easily tracked online)....

Page and Brin decided to continue improving Google’s search algorithms, while disdaining the efforts of Yahoo, Lycos, and other portals to maximize the number of pages—and hence ads—that visitors might see. More than any innovation, this decision allowed Google to become the best search engine available. But it also left Google with almost no source of revenue, since users did not see many different pages and the site consequently could not compete in selling ads based on page views.

...

Google’s executives realized that ads on search engines reach users at a singularly receptive time: unlike readers browsing through articles on a news website, users of search engines are often looking for something very specific. A user who asks a search engine, for instance, “Where can I find the best car insurance?” would be a more promising potential customer than a visitor to a news website, because by searching for car insurance a user signals that he or she is, at that moment, in the market for car insurance. A car insurance ad programmed to appear next to the results of such a search would allow the advertiser to target its most desirable audience.

This approach, a form of what’s known as a “cost-per-click” advertising system, charges advertisers for each time a user clicks on an ad that is displayed next to related search engine results. To implement it, Google developed a program to link specific ads to millions of different search terms that prospective customers might use (from “car insurance” to “French horn” to “cat grooming in New York”), as well as a program to ensure that the ads sold through this system would be priced fairly (the program uses a simple bidding system, vetted by economists).

You can see how this looks today: a user searching for “pet food,” for exam ple, is greeted not only by a ranked list of sites containing information about pet food, but also by three “sponsored” links at the very top of the page, as well as a column of pet food ads in the right margin. These “sponsored” links and ads in the margin are paid for by online pet food stores and related ventures.

Back in the early 2000s, though, another company, Overture, which was far more focused than Google on making money online, had already developed such a system. Google copied much of the system from Overture in 2001; Overture sued Google in 2002; and Overture was itself bought by Yahoo in 2003. Yahoo settled the lawsuit against Google out of court for $275 million in 2004, and the system, modified over time, still provides the vast majority of Google’s billions of dollars in revenues.
(source: "Google and Money!," Charles Petersen for The New York Review of Books. December 9, 2010)

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Monday, December 6, 2010 0 comments

Some American banks may see their ratings cut

From The New York Times' Dealbook:

One of Wall Street’s most influential securities analysts is telling investors to brace themselves: some of the nation’s biggest banks could be on the cusp of a credit rating downgrade.

In a new report, Glenn Schorr, who covers brokerage firms and banks at Nomura, says that while “it’s not a done deal, at present, Bank of America, Citigroup and Morgan Stanley appear most at risk of being downgraded to Tier 2 status.”

...

“While balance sheets are in better shape and fundamentals are improving, the pace of recovery is likely a bit slower than the agencies were expecting,” Mr. Schorr wrote in his report. Among other things, banks are facing new challenges like European sovereign risk and the negative impact of regulatory reforms on revenue.

The lower credit ratings could reflect changes in the assumed levels of government support that the rating agencies have assigned the banks.

Mr. Schorr says in his report that the rating agencies assume a certain level of government backing of banks, meaning the agencies don’t think the system or the government is going to let banks fail if they got into trouble. Some firms like Bank of America have four notches of government support in their Moody’s rating, he writes. Meanwhile, other banks, like JPMorgan Chase, have no assumed government support in its S.&P. rating, he says.

The bottom line: Downgrades would ultimately drive up financing costs and make it more difficult for the affected banks to compete in businesses like prime brokerage.
The analyst suggests any cuts, if they happen at all, will be manageable but I have my doubts. It would not surprise me if these banks enter a cycle of deterioration if ratings are cut.

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Sunday, December 5, 2010 0 comments

Opinion: Jamie Dimon, Last Man Standing... Still Not Out of the Woods


During the mortgage debacle, Dimon’s reputation for averting risk suffered a hit. Oddly, the executive who worried about 100-year storms failed to challenge the industry models on home defaults. Many banks, including Chase, issued “stated-income loans” on which applicants were not required to document their income. Some mortgage brokers clearly encouraged borrowers to lie. Dimon says he thought Chase had enough information, electronically, to police such loans. “We didn’t anticipate the lying,” Dimon says, harping on a familiar theme — that bankers were not the only ones at fault. The blame for lying may have been his customers’, but the responsibility is Dimon’s. As Warren Buffett once observed: every bank is offered bad loans; it is the banker’s job to reject them. At Bank One, Dimon had ceased buying mortgages from outside brokers because their performance was poor. At Chase, he bought them. When I asked why, Dimon said underlings convinced him they were exercising proper caution, adding, “It was a huge business, packaging and selling [the loans] to Fannie Mae.” Turning silent, Dimon rotated his palms face up — as if nothing could excuse his error. “I bought that crap,” he concluded.

...

Judy Dimon says the crisis took a toll on him. He used to stand up to bullies who threatened his smaller twin; now he felt as if he, and bankers in general, were being bullied. There is a picture in the Dimons’ Park Avenue home of James Dean in a sidelong pose and a leather jacket; it reminds Judy Dimon of the contrarian business-school student who also wore black leather and seemed, even as he raced up the corporate ladder, not quite establishment. Jamie Dimon, of course, is a rebel with a very pinstriped cause. I saw him entertaining corporate clients over dinner, rousing his guests to “fight for what you believe in” in Washington, meaning turning back the tide of what he regards as ill-considered regulation. During the Dodd-Frank debates, he argued with a U.S. senator, and later, during a family dinner at the Four Seasons restaurant, he spoiled the family’s night out by ripping into a politician who innocently wandered by his table. He seems to not quite connect the backlash against bankers to the deep recession that Wall Street did in fact trigger.
(source: "Jamie Dimon: America’s Least-Hated Banker" by Roger Lowenstein. New York Times Magazine, December 1, 2010.)

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Sunday Spectacle XCIX

(source: "Don Draper's Revenge," Felix Gillette for Bloomberg Businessweek. November 24, 2010)


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Saturday, December 4, 2010 1 comments

Some articles you may find interesting - December 4th of 2010

Here are some articles I found interesting. I have a bunch related to politics and this may anger some of you so if you don't want to hear it, skip over the WikiLeaks stuff near the bottom. As usual, not in any particular order...

  • Some Canadians snapping up US residential real estate (MoneyVille): Real estate bulls such as John Paulson have said that it's a great time to buy American real estate but I am not so sure. Although not as risky as buying near a peak, I can see someone not making any money for years. Having said that, the funds mentioned in this article are buying prime Florida real estate—I assume they are prime?—so they should be ok in the long run. After all, they don't build those sandy white beaches in America.
  • A bubble in private Internet companies? (Dealbook): The privately rumoured valuations of Internet companies like Twitter, Groupon, Zygna, and others, often reach billions of dollars. Some of these companies are revolutionary and likely will dominate their respective fields for years—think Ebay—but I wonder about others. One thing that concerns me about Internet service companies is their over-reliance on advertising. Yes, the whole television industry was built on advertising but I think it would be healthier for the Internet service industry is they generated some income by selling products or from pay-per-use.
  • GE tries to climb out of the hole (New York Times): As recently as 3 years ago, GE was the largest non-bank financial company—I haven't done any research but I think it still is??—GE is trying to go back to its industrial roots. I haven't looked at the company since the financial crisis hit but some of the damage by Jack Welch likely can't be undone. My wild guess is that GE will be broken up within 10 years.
  • Will Google stay dominant? (The Economist): As the web matures, will Google hold onto its leading position?
  • Commercial real estate takes off... at least when it comes to hotels (New York Times): Private equity and some wealthy investors are zeroing in on hotel properties. Does this mark the bottom? One thing I notice is that a lot of bulls, not just with hotels but in other assets as well, suggest that the present will rhyme with the early 90's when distressed property buyers made a fortune; while many bears are almost certain that the present state of affairs will differ from the recent past. Pick your history for the rhyming lesson.
  • Canadian companies at the forefront of semiconductor reverse engineering (The Globe & Mail): I think I applied for a job in similar companies when I was in school (never got any jobs or interviews though :( ). Interesting field, where you reverse engineer products, either to gain an understanding of competitor's technology or to see if your patents have been violated.
  • The decline of the US-side of Niagara Falls, NY (Bloomberg Businessweek): Apparently, one of the topic romantic destinations in the world, so do take your loved one over to Niagara Falls, Canada. The Ontario economy badly needs your tourist dollars ;) This story, though, is about the US side of the falls. Apparently things have been heading downhill.
  • Tale of two regions in Australia (The Globe & Mail): The Western part of Australia is booming due to the commodity boom. The East, not so much. It reminds me of Canada and how the resource-oriented West is booming but the manufacturing/service-oriented centre is struggling.
  • Ontario Teachers' Pension Fund & Jim Leech (The Globe & Mail): As head of one of the largest pension funds in Canada—probably 3rd largest fund in Canada—Jim Leech has done remarkably well. Avoiding the debacles of University endowments in the US and elsewhere, and private equity competitors, the fund has managed to avoid any serious mistakes in the last few decades. The fund is still under-funded and may end up selling Maple Leaf Sport and Entertainment, which owns sports teams such as the Toronto Maple Leafs and Toronto Raptors.
  • Should China scale back its high-speed train build-out? (The Atlantic): This is what the bears have been saying for a while—remember what Hugh Hendry—but even the official Chinese agencies are starting to wonder. Building a rail is all good but if no one can afford it, or conversely, it has to be run at huge losses, is that benefitial to the country in the long run?
  • The Economist's books of the year (The Economist): A big list of books covering various topics. Unlike many lists you'll see in the business press, this list contains uncommon books and many British ones.
  • (not related to investing) Private companies—Amazon and Ebay so far—refuse services to WikiLeaks (The Globe & Mail): I am in favour of freedom of speech so I am in favour of WikiLeaks—as I have said in the past, it is similar to the Pentagon Papers incident; WikiLeaks is censoring personnel info so it's not as if lives are at risk as the governments claim—so it's dissapointing to see private companies like Amazon and Ebay refuse to service WikiLeaks. Private companies can obviously decide who they want to service and I would agree with these two giants if WikiLeaks was doing something illegal. However, it's dissapointing to see these companies refuse service without anything being decided in a court of law. Paypal, a subsidiary of Ebay, kicked off WikiLeaks by saying it was doing something illegal but why not get the courts to rule on the legality of all this? The problem, of course, is that the publishing done by WikiLeaks, and other media organizations, is likely legal in USA. If neo-Nazis can put up websites promoting hatred, or some black separist can write hateful messages, WikiLeaks likely can post documents as well. What may be illegal is the leaking of the info which is why Bradley Manning is held for trial by the US military. The actions of these two Internet giants will likely also have long-term consequences for cloud computing. The actions Amazon's cloud computing service likely won't give much confidence to future customers, if the company can kick off a company almost arbitrarily (TOS violation) within a short period of time. Imagine if you were a small entrepreneur spending millions of dollars setting up shop and then Amazon just kicks you off their cloud because you violated their Terms Of Service and wouldn't even give any details... Some of the actions by the US government also show how the Barack Obama, who even claimed to represent transparency, is anything but. Obama administration has probably attempted to roll back civil liberties and freedoms more than anyone else in the last 20 years, except the George Bush administration. The recent airport scanning scandal—needless to say, will not improve security at all—kind of shows how this administration is. 
  • (not related to investing) (opinion) "The shameful attack on Julian Assange" by David Samuels (The Atlantic): At least some Americans don't roll over for their government... On a different note, it's not that surprising but it's still kind of surreal to see everything unfold so quickly. On top of those DDOS attacks on WikiLeaks—is this the government or someone else—we have either (i) some foreign governments attempting to leak information they couldn't have otherwise, or (ii) disinformation campaign initiated by the US or someone else (by possibly leaking fake diplomatic cables). What I am referring to, is this story in The Atlantic about a Lebanese newspaper publishing diplomatic cables appearing to have not been released by WikiLeaks or any other media that was granted access by WikiLeaks.
  • (not related to investing) WikiLeaks: The tussle between China & Google (New York Times): Do keep in mind that the cables provide the American perspective so you can never tell what is true and what is speculation by the diplomats filing the cables. In any case, this story provides some context into how the conflict between Google and China started and how the American diplomat(s) view the Chinese information controls. It looks like the key censorship guy in China is someone by the name of Li Changchun.

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