Value Investing – Page 49

Sorted Recent Tweets

Posted on 6 February 2012 by David Merkel

Trying a new format here, I think readers will like it better.? Most things are better after additional effort.? Think of this as a news links by subject post.

Economics

If you look in the back, it seems that there were 58 respondents. From page 13: Methodology & Panel Selection Invi? http://t.co/p8sVZl9g Feb 06, 2012
Will the great interest rate gamble pay off? http://t.co/hgj5XSKc People want to believe that you can get something for nothing; ain’t true. Feb 05, 2012
Central Planning at the Federal Reserve http://t.co/X8qmqU6C Fed: we can create prosperity by holding interest rates down, right? $$ #wishes Feb 05, 2012
Labor Force Participation Rate: 28-year Low http://t.co/kLgQ61iK Everyone still happy about the lower unemployment rate? $$ Feb 05, 2012
Bill Gross: Free Money Ain?t Really Free http://t.co/LXWxpxp5 It will lead to stagflation, IMO, depending on what fiscal policy does $$ Feb 05, 2012
Life & Death Proposition http://t.co/XuZS5Snn Where does credit go when it dies? Back where it came. It delevers, slows & inhibits ec growth Feb 02, 2012
US unemployment ?progress? http://t.co/WoIVZPGp If you add back the discoraged workers, all of the improvement in U-3 goes away $$ Feb 02, 2012
The Perniciousness of ZIRP http://t.co/dYlFMbLe Gonzalo Lira on how ZIRP loses effectiveness b/c people think it’ll b there a long time $$ Feb 01, 2012
Why Neoclassical Economics Doesn’t Work In The Age Of Deleveraging http://t.co/D3IAhTyv Steve Keen explains y Krugman & others r wrong $$ Feb 01, 2012
Warning: Goat Rodeo http://t.co/JQ2FV9LS Hussman makes his case that equities are overvalued and could pull back 25% $$ Feb 01, 2012
Who Owns World’s Financial Assets? & Why R US Households So Fascinated W/Stocks? http://t.co/5rp52OM4 American Exceptionalism in investing Feb 01, 2012
As an aside, that is one reason why the US net foreign debt hasn’t spiraled up. We own equities abroad & they own our debt. $$ declines + Feb 01, 2012
$$ declines reduce the value of our debts, but not the value of r foreign holdings. I think the US will come out of this crisis rel well $$ Feb 01, 2012

Housing

Home Prices Tumble http://t.co/N1gdNslr No surprise here with all of the dark supply; houses come onto mkt when ppl can bear loss $$ Feb 01, 2012
Too lazy to be knowns http://t.co/flXRR6fM I know many who understood what would happen if home RE prices fell, but none who got the size $$ Feb 01, 2012
Freddie Mac’s “inverse floater” allowed more loan origination http://t.co/5devKZ17 Other side to the Propublica story http://t.co/KjXJHU1x Feb 01, 2012
I’m no fan of the GSEs; I think they should be abolished, but the GSEs have always made a variety of bets on prepayment over time. $$ Feb 01, 2012

International

On China, Henry Kissinger and Fareed Zakaria see Domestic Tension and Risk of Geopolitical Conflict http://t.co/1bhvrI3U Ferguson is wrong. Feb 05, 2012
Tightening lending standards vary materially across the Eurozone http://t.co/ciWUK9cm Conditions tight in Italy & France, but not Germany $$ Feb 02, 2012
Japan Auto Sales Notch Record Jump http://t.co/0VzF4WST Another small bright spot. Of course, bouncing back from a low level $$ Feb 02, 2012
Socialist Hollande, Who Wants Full European Treaty Renegotiation, Increases Lead Over Sarkozy http://t.co/J3qCpZZ3 Eurozone Wild Card $$ Feb 01, 2012
Hong Kong Homes Face 25% Drop as Loans Fall in Year of Dragon http://t.co/ifg1146H And this is with wealthy mainlanders fleeing China. $$ Feb 01, 2012

Markets

RBC Takes On High Frequency Predators http://t.co/MfA5qdxm Where there is offense, there will b defense; nothing goes unanswered in the mkts Feb 05, 2012
Global Strategists Abandoning Bearish Views http://t.co/dOXCUMA7 Makes me think we r getting close to a turning point. Feb 02, 2012
Dividend stocks: Buyer beware http://t.co/SvMCHtCj Makes the valid & missed point: high qual div paying stocks r stocks & can lose $$ #yeah Feb 01, 2012

Credit

6 High-Yield Canaries-in-the-Coalmine http://t.co/4pz6SSQc 6 reasons y high yield is overheated http://t.co/fKnHmBqD & http://t.co/UPVev0iD Feb 02, 2012
QOTD: Regulators Watching Aggressive Yield Chasing http://t.co/iWimo3eg FINRA warns of undue risk in income seeking. Advisors take note $$ Feb 02, 2012
Contra: The Safest 7% Yield in America http://t.co/VrXoLEFH Poor analysis does not take into account the highish leverage on mtge repo $$ Feb 02, 2012
Shipping Loans Go Bad for European Banks http://t.co/y5Z0wt3R Highly glutted area w/many dead firms walking; how far down will the losses go Feb 02, 2012

Politics

Group lists top stock investments by members of Congress http://t.co/CarxUCjS Top 50 hldgs -> in top 100 cos by mkt cap. Hard2manipulate $$ Feb 05, 2012
Obama Re-Election Odds Versus the Stock Market http://t.co/F5EETcve Example of 2 variables that r correlated b/c they anticipate GDP changes Feb 05, 2012
RE: @abnormalreturns Gold is mostly political philosophy. How much control do you want the government to have over mo? http://t.co/hRxIkaoo Feb 03, 2012
Getting back to the gold standard http://t.co/pCk8Ij6j Gingrich & Ron Paul have said they would like to appoint James Grant as Fed Chairman Feb 02, 2012

Companies

Carlyle’s proposed IPO disaster http://t.co/OqGke8eN So there’s no board. Most boards don’t do much. Mgmt will have no board 2 shield them Feb 05, 2012
For These Fans, a Day With Buffett Offers Wealth of Photo Opportunities http://t.co/UpcwVKe7 I think Buffett is enjoying life more now. Feb 05, 2012
Buffett Railroad Boosts Capital Plan to $3.9B http://t.co/9XEw2gyT Buffett changes; organic investment in capital-intensive biz $$ #olddog Feb 01, 2012
Pep Boys Seen Gaining 27% as Cheapest Value Lures Bids http://t.co/GyfH7qRL Could a bidding war start? Company is undermanaged $$ Feb 01, 2012
Jefferies Allows Bonus Recipients to Swap Stock 4 Cash With 25% Discount http://t.co/pfGB3Vmc Fair way2 let employees disconnect from $JEF Feb 01, 2012

Financial Services

I’ve just started “Acts of God and Man,” by Michael Powers. In the intro, he goes through the various meanings of th? http://t.co/tX7uAlWl Feb 05, 2012
When evaluating Investment Funds, use Dollar-weighted Returns http://t.co/N5g7PI0d This is a neglcted concept that is enjoying a rebirth $$ Feb 02, 2012
After a Delay, MF Global?s Missing Money Is Traced http://t.co/4s6U8yOe Investigation moves to how to recover the $$ and who is at fault. Feb 01, 2012
http://t.co/wBbJTe3D FINRA Alert: Do you use complex products? What additional work do you do 2 assure that they are being used properly? $$ Feb 01, 2012
Banks Need Higher Interest Rates to Start Making Money http://t.co/SneRACCi Flat front end of yield curve squishes bank interest margins $$ Feb 01, 2012
401(k) Plans Step Into the Sunshine http://t.co/fvKeup2L But as with DB plans, as costs rise, companies will offer them less. $$ Jan 31, 2012

Value Investing

The SEC’s “90% Convergence” Fantasy http://t.co/bkWaAS5S US GAAP has many flaws, but we know them. IFRS will introduce abusable flexibility Feb 02, 2012
But on the bright side, value investors may do relatively better as financials become less trustworthy; the accruals anomaly will sing $$ Feb 02, 2012
Need to consider (Cost of goods sold)/user $$ RT @ErikSchatzker: Facebook gets $4.39/yr of revenue per user. ESPN gets $4.69/mo. Feb 02, 2012
Berkowitz: Fund Plunge ?Makes Little Sense? http://t.co/pcoPLahW BB, appoint someone in your group 2 seek out opinions contrary 2 yours $$ Feb 01, 2012
@ADayforRabbit I have argued in the past that BB is not paying attention to the delevering, which is a real headwind for the banks. $$ Feb 02, 2012
New Fund Hopes to Prove Outspoken Analyst?s Thesis http://t.co/cuVpRzvO I bet @rcwhalen does well like my friends @ Hovde or M3 Partners $$ Feb 01, 2012

Hedge Funds

Are Hedge Funds Worthwhile Investments? http://t.co/Lw2EhRPr Yet another “Hedge Fund Mirage” citation; the book is having a lot of influence Feb 02, 2012
Are the hedge fund and private equity boys pulling a fast one? http://t.co/TNXFJo62 Beginning 2c the args of “Hedge Fund Mirage” everywhere Feb 02, 2012
Did Hedge Funds Trigger the Financial Crisis? http://t.co/lNIb2dgF Secured asset classes can be overlevered; when they collapse, big mess $$ Feb 01, 2012

Miscellaneous

Do the Job You’re Meant to Do http://t.co/wR3OX20N LIfe is too short to work with people you don’t respect, or tasks unfit for you $$ Feb 02, 2012
Millionaire adopts girlfriend as daughter http://t.co/zffGCWbu Asset shelter. Does incest rely on consanguinity or on legal relationship? Feb 02, 2012
Charles Murray Reiterates Willpower http://t.co/smeXZKNh Lack of self-control can destroy relationships, jobs, firms & lives $$ Feb 02, 2012
I ran into @twitalyzer today. Lots of interesting analytics for tweeting. Here are some for me: http://t.co/HDdcFYaU & http://t.co/8uFFOMuP Feb 01, 2012
At the first blogger summit at the UST, I recommended to the powers that be that they issue floaters. I also recommen? http://t.co/R3U8OHSi Feb 01, 2012
California Faces Cash Shortfall by March on Low Receipts, Controller Says http://t.co/QxH1a6Re Could be interesting given the elections $$ Feb 01, 2012

Industry Ranks February 2012

Posted on 4 February 2012 by David Merkel

I?m working on my quarterly reshaping ? where I choose new companies to enter my portfolio.? The first part of this is industry analysis.

My main industry model is illustrated in the graphic.? Green industries are cold.? Red industries are hot.? If you like to play momentum, look at the red zone, and ask the question, ?Where are trends under-discounted??? Price momentum tends to persist, but look for areas where it might be even better in the near term.

If you are a value player, look at the green zone, and ask where trends are over-discounted.? Yes, things are bad, but are they all that bad?? Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled ?Dig through.?

If you use any of this, choose what you use off of your own trading style.? If you trade frequently, stay in the red zone.? Trading infrequently, play in the green zone ? don?t look for momentum, look for mean reversion.

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

Huh?? Why change if things are working well?? I?m not saying to change if things are working well.? I?m saying don?t change if things are working badly.? Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes.? Maximum pain drives changes for most people, which is why average investors don?t make much money.

Maximum pleasure when things are going right leaves investors fat, dumb, and happy ? no one thinks of changing then.? This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year.? It forces me to be bloodless and sell stocks with less potential for those with more potential over the next 1-5 years.

I like some technology names here, some energy some healthcare-related names, P&C Insurance and Reinsurance, particularly those that are strongly capitalized.? I?m not concerned about the healthcare bill; necessary services will be delivered, and healthcare companies will get paid.

A word on banks and REITs: the credit cycle has not been repealed, and there are still issues unresolved from the last cycle ? I am not interested there even at present levels.? The modest unwind currently happening in the credit markets, if it expands, would imply significant issues for banks and their ?regulators.?

I?m looking for undervalued and stable industries.? I?m not saying that there is always a bull market out there, and I will find it for you.? But there are places that are relatively better, and I have done relatively well in finding them.

At present, I am trying to be defensive.? I don?t have a lot of faith in the market as a whole, so I am biased toward the green zone, looking for mean-reversion, rather than momentum persisting.? The red zone is pretty cyclical at present.? I will be very happy hanging out in dull stocks for a while.

P&C Insurers and Reinsurers Look Cheap

After the heavy disaster year of 2011, P&C insurers and reinsurers look cheap.? Many trade below tangible book, and at single-digit P/Es, which has always been a strong area for me, if the companies are well-capitalized, which they are.

I already own a spread of well-run, inexpensive P&C insurers & reinsurers.? Would I increase the overweight here?? Yes, I might, because I view the group as absolutely cheap; it could make me money even in a down market.? Now, I would do my series of analyses such that I would be happy with the reserving and the investing policies of each insurer, but after that, I would be willing to add to my holdings.

Do your own due diligence on this, because I am often wrong.? One more note, I am still not tempted by banks or real estate related stocks.? I am beginning to wonder when the right time to buy them as a sector is.? As for that, I am open to advice.

Implications

So, given that the Industry Rank categories above come from Value Line, I went to their stock screener, selected the industries, and asked for all of the companies that:

are in their top 5 (of 9) categories for balance sheet strength, and
their horribly overworked analysts think can return at least 15%/yr over the next 3-5 years.

This combines safety, growth potential, valuation, and in my view, how promising industry prospects are.? Here are the results:

ABC ADM ADTN AKAM ALL AMAT AMX AOL APOL ARB ARRS BIDU BRKR BX CAH CBEY CECO CELL CKP CL CNQ CPB CPSI CREE CTRP DNR DRIV DV EBAY EDU EFX ERIC ESI FST GMCR GOOG HCC HRC IN INFA INTC ISIL ITRI IVC JNPR K KKR KR LIFE LRCX LTRE MASI MCHP MDCI MKC NFLX NIHD NILE NOK NTRI NVDA NXY ONNN OTEX QGEN QLGC QSII RAX RIMM RMD SHEN SOHU STM STRA SWKS SWY SYY T THG TMO TNDM TRH TRI TSM TSRA TUP TXN UNTD UPL UTHR VOD VOLC VZ WBMD WBSN YHOO ZBRA

When I do my next portfolio reshaping for clients in the next week or so, these stocks (and a few others) will compete against the 35 existing portfolio names for the 34-36 slots in the portfolio.

Full disclosure: Long HCC, INTC, THG, VOD

We Eat Dollar Weighted Returns — III

Posted on 2 February 2012 by David Merkel

Somebody notify the Bogleheads, they will like this one, or at least Jack will.? Yo, Jack, I met you over 15 years ago at a Philadelphia Financial Analysts Society meeting.

How bad are individual investors? at investing?? Bad, very bad.? But what if we limit it to a passive vehicle like the Grandaddy of all ETFs, the S&P 500 Spider [SPY]?? Should be better, right?

I remember a study done by Morningstar, where the difference between Time and Dollar-weighted returns was 3%/year on the S&P 500 open end fund for Vanguard, 1996-2006.

But here’s the result for the S&P 500 Spider, January 1993- September 2011.? Time-weighted return: 7.09%/year.? Dollar-weighted: 0.01%/yr.? Gap: 7%/yr+

Why so much worse than the open-end fund?? Easy.? Unlike the professional managers at Vanguard, and the relatively long term investors they attract, the retail short term traders of SPY trade badly; they arrive late, and leave late on average.

There is far more analysis to be done here, but to me, this confirms that Jack Bogle was right, and ETFs would be a net harm to retail investors.? The freedom to trade harms average investors, and maybe a lot of professionals as well.? It may also indicate that short-term trading as practiced by technicians may underperform in aggregate.? Not sure about that, but the conclusion is tempting.

One thing I will say: I am certain that profitable trading is not easy.? If you are tempted to trade for a living, the answer is probably don’t.

Anyway, here’s my spreadsheet on the topic:

Full disclosure: I have a few clients short SPY, hedged against my long positions.

A Book on Value Investing

Posted on 1 February 20121 February 2012 by David Merkel

A medium-sized publisher has approached me to write a book on value investing.? I might do it, or I might not.? I also might try to do it with another publisher, or I might do it through Amazon.? I solicit advice from my readers on the prospect.

Anyway, I thought about what the book might look like, and to do so, I went through the entirety of my Value Investing category, and my page called Major Article List,? which described my best articles from my RealMoney days.

What you will see after this is less than a first draft of chapters.? I plan on categorizing it and simplifying, but here it is for now:

Bonds
Use of cash ? buybacks, dividends, strategic use, delay
Valuation
Cycles
On being wrong ? planning for failure
On financial companies
Growth expectations
Following leaders vs surfacing your own ideas; who are you playing with/against?
Weighing vs Voting
Use of free cash by management
Avoid buggy whips
Industry analysis and economic sensitivity
Embrace trends, resist trends
Take prudent risks
Three year horizon
Understand balance sheets; quality, anomalies
Management incentives
Discipline: tie your hands, do something, but don?t react; you are you own worst enemy
Risks, not risk
Markets are mostly, but not entirely efficient
Margin of safety
Diversify, but not too much
Safe assets and Risk assets
Avoid complexity; embrace complexity
Sum of the parts
Realistic expectations
On shorting
Ask the opposite question
Rank your ideas
No, macroeconomics *does* matter

This could be one, two or three books depending on me and the goals of the publisher.? As I read through my blog, I realized that I wrote a lot more about value investing at the beginning of this blog.? I think the crisis caused me to shift.

But as I went through what the book could look like, I got more excited about it — there is a lot of potential here to explain value investing in a comprehensive? way to readers.

PS — Any publisher contacts that you want to share are appreciated.? Thanks to those who have given me advice so far.

On Corporate Cash

Posted on 31 January 2012 by David Merkel

In human terms, we are most often best off with the via media, that is, the middle way.? So it is with corporate cash.??? The first article I wrote on the internet (in 2003) argued for the value of excess cash in the hands of intelligent management teams.

But there is a limit to that, and more so when many companies build up large slack cash balances.? Think of the converse: only one really intelligent company has a lot of slack cash.? That company starts buying up other companies like a clever private equity buyer, but taking account of synergies with existing companies in the process.

Such a buyer would understand the value of each company purchased, and how much fat could be cut out, synergies realized, etc.? But even as that one company acted, valuations would rise with each purchase, until the “intelligent company” stopped buying, because it was no longer reasonable to buy at the higher valuations.

If this is true with one clever buyer, it is true with many not-so-clever-buyers, but it takes longer, and there will be errors, failures even, and more.

It is hard to deploy cash effectively as a corporation, aside from the simple routes of dividends and buybacks.?? But companies that are good at doing small acquisitions that improve organic prospects can do far better than companies that blindly acquire for reasons of scale.

The company with a lot of cash will look for a scale acquisition, and will overpay, or, will overpay for an acquisition in an unrelated industry, creating a conglomerate that is hard to manage.

It would be far better to pay it out as a dividend, or buy stock back.? The shareholders as a group have a better idea of what is valuable in the public markets than the management team does, particularly aas public valuations get high.

Thus, I agree with Michael Santoli of Barron’s in his recent article.? The additional cash in the hands of many growth companies is depressing valuation measures, and should be paid out as dividends, or with an eye to the price, buy back stock.

And, I disagree with the fellow who wrote this article, that large corporate cash hoards are a reason to buy equities.? That might make sense if one knew what companies would get bought? out, but no one knows that.? In general, it is hard to pick acquisition targets profitably.? If major corporations can’t do it, odds are you can’t do it either.

For one more point on corporate cash generally, don’t pay much attention to it, because corporate cash often serves as collateral for futures positions, and other derivatives.? Cash on the balance sheet is often encumbered.? Maybe accounting standards should be modified to reflect that, because knowing the true liquidity of a company is valuable.

Against Simple Valuation Metrics

Posted on 24 January 2012 by David Merkel

There have been a lot of articles dealing with use of corporate free cash flow lately:

Dividends — get them, are they sustainable?
Buybacks — do they add value or not?
Acquisitions — are they overpaying?? What are the synergies?

But you never hear about the last one — internal investment for organic growth.? There is a simple reason why — it is silent as night.? No one makes announcements on it.? If done properly, it is as quiet as a plant growing.

Dividends are simple — is there enough free capital to issue them, and do the other three priorities?? It is useful to ask how much room there is to increase the dividend, and how well the company can grow its earnings at the present rate.? Companies that pay a dividend understand that equity deserves a return, and are more careful with their capital as a result.? They often grow faster than companies that do not pay dividends.

But I never analyze a company primarily on its dividend yield.? I would rather look at the full set of the drivers of value.

Buybacks are harder because we don’t really know what the company is worth, and buybacks add value when you buy below the value of the company, and lose value when you buy above it.? In the reinsurance industry, it is understood that buybacks above 1.3x tangible book destroys value.? The threshold will be different in other industries because the value of intangibles will differ — but for industries where intangibles mean little, that 1.3x tangible book can be a useful limit.

We can do pro-forma analyses on acquisitions to see if they add value or not.? The best simple proxy is how large the acquisition is relative to the acquirer.? Small acquisitions typically add value? because they add a complementary product, a new marketing channel or region, lower costs, or raise product quality.

Large acquisitions typically lose value because acquirers overpay and integration is difficult.? One exception: negotiated sales by large private sellers.? There is no auction, and no winner’s curse.

The best acquisitions are small, but lead to an increase in organic growth.? Also, the best acquisitions are early; the worst acquisitions are imitative and late.? Typically the best deals get done first.

But much as I like managements who think that the equity deserves a return, via dividends and intelligent buybacks, the hard stuff gets done in organic growth: how are last year’s profits being increased on the existing infrastructure?? In mature industries, this is tough, which is why they typically return free cash flow to shareholders.? But when you find a company that can eke out improvements in a mature industry, finding changes that no one else does, hang onto that company, because it is driving profitable change in the industry.? (And probably taking share from others…)

The less mature the industry, the more room for organic improvement, and thus more free cash flow is dedicated to internal investment, and less to rewarding current shareholders.? In such a situation, it pays less to look at dividend yields, and more at dividend growth, adjusted for ability of growth to be sustained.

-=-=-=- begin rant mode -=-=-=-

This is why I am not crazy about simple articles that say:

Here are the five highest yielding companies of this industry, or
Here are the seven highest yielding investments of [famous investor, or company], or
Here are the companies that are buying back stock rapidly, or
Look at the combined dividend plus buyback yield of these companies…

Everyone wants to squish value investing into one simple metric and from what I have seen, it does not squish well.? That is one reason why I try to view companies off of the competitive dynamics of the industry in question, and adjust the metrics accordingly.? After all, no matter how cheap a company looks in an industry that is obsolete, like newspapers, it is rarely a good idea to buy.

Thus, I am skeptical of the many articles that are spit out by inexperienced investors that have a computer and can crank out a few simple ratios, and spew out some canned facts about a company — these articles are widespread, and not limited to writers on Seeking Alpha, or Zacks, or those that submit to Yahoo! Finance, and they have some canned and wrong way of identifying competitors.

Avoid these articles, and instead, look for some degree of qualitative reasoning — some depth that shows genuine industry knowledge, and not an ability to automate the provision of web “content.”

-=-=-=- end rant mode -=-=-=-

Maybe I should be quiet.? After all, the provision of bad advice on the web is a good thing for me.? The more people are misled, the better value investors with broader skill sets do.

But that’s not why I started writing on investments.? I was not a professional investor until I turned 39.? I read widely, and spent a lot of time reading the works of many different investors as I worked to develop a theory that encompassed most of it.? No, I don’t see how to encompass all of it… and what I can encompass is understood with some amount of error.

My view as I write is not so much to give “buy this” or “sell this” ideas so much as to get people to think differently about investing.? I recently looked at the amount of business/economics/finance/investment books that I have read over the past 25 (post-academic) years, and it would fill 3-4 bookcases.

So try to think of the companies that you own, or might own, like businesses.? Look at the dividends, and to buybacks at bargain prices, and analyze sustainability and growth prospects, but also look at opportunities for growth.? Many aspects of value can’t be encapsulated in simple ratios or rankings, but sadly, the majority of articles touting stocks will do just that, and for the most part, they are useless.

There.? I said it.? But it needs to be said.? The practical question to me is whether I should stop submitting my content to sites like Seeking Alpha, which to me have become a lot of noise, and which I wish I could get Yahoo! Finance to allow users to filter out of the news stream.

I let almost anyone republish my content, so dropping anyone would be unusual for me.? Or, should I drop all external users of my content, and allow no republishing?? If you have a strong opinion, submit it in the comments.? I’ve been a nice guy with all of this, but if you have good reasons for exclusivity, let me know, and I will consider it.

But to close I will say, look at a full range of valuation and performance metrics when buying a stock, and consider the industry dynamics to understand what matters most given the maturity of the industry.? That takes some work, but guess what?? Working intelligently and hard leads to better profits in investing.

The Rules, Part XXX (30)

Posted on 22 January 2012 by David Merkel

In the recent run-up, there was talk of the infallibility of equities.? This led to a higher level of variable compensation in the economy through option and share issuance and low pressure to raise fixed wages.? This was yet another form of hidden leverage, which hid the unprofitability of enterprises through share dilution.

That was written in 2001, after the flop of the Nasdaq.? I have sometimes said that bubbles are financing phenomena.? That’s true, but we can phrase it more generally: bubbles occur because of an asset-liability mismatch.? People go long a long-duration asset with short-duration funding.? The short duration funding can be borrowing, or vendor finance, or it can be a labor commitment in order to get equity or option awards.

People chase the long-term asset that seems so valuable, and give up time and interest (money’s version of time) to get it.? They give up more than they imagine for something of uncertain value.? In other words, a mania.? Give up something relatively certain in the short run for something with uncertain long run potential.

The attitude could be summed up with a conversation I heard in early 1998 between my boss and his best salesman, where the salesman said, “It’s a no-brainer, have the market pay your employees.”? His idea was that a constantly rising stock market would provide compensation to employees through stock awards, options, 401(k)s, etc., even as the market was straining at valuation limits.? It is probably a sign that the market is overheated, when market-based rewards become common.

Startups by their nature require that employees be flexible, and give up a lot of fixed guarantees.? What payments they receive at the beginning are small, and less than their work might deserve in most established contexts.? But there is the possibility of the big payoff, and the possibility of total loss.? The asset in question has a lot of variability, but the liability, the work that must be put in, is big, and may not vary much for success or failure.

In the tech bubble, many parties extended vendor credit because there were big profits to be made in the future.? Alas, but they lent to those with very uncertain prospects, and in March of 2000, the chain of leverage started to collapse, both for vendors, and for those that worked in the industries.? Just as hedge funds have a hard time holding onto good employees when performance goes bad, so it is for tech companies when financing dries up, and the stock price craters.? Rats desert the sinking ship.

“Free money” brings out the worst in people.? Do something small in the present and reap a huge future.? Sadly, it rarely works that way, except at the very beginning of a boom.? At the end of the boom, it is a maelstrom, with many people demanding to throw their money away in search of riches that will never be.

From a dated piece:

Crowd-following is common to humanity.? It takes a lot to stand apart from highly correlated behavior.? I?ve told this story before, but in late 1999, I was talking with my mother (a very good self-taught investor), she told me about many of my cousins who were speculating in tech stocks.? I said to her, ?They don?t know anything about investing!?? My mom replied, ?Oh, David.? You?re such a fuddy-duddy.? I just bought some Inktomi!?

Now, to set the record straight, that was just 1% (or less) of my mom?s assets, so an occasional flyer is acceptable.? Call it ?Mad Money.?? ? For my cousins, it was most of their investable assets.? My mom is fine, and the fuddy-duddy did all right also, but the cousins swore off stock investing.

I am close to concluding that it is impossible to teach the average person how to do well in investing.? They don’t have the patience or the willingness to learn. (Few want to be called “fuddy-duddy” by their mothers.) 😉

Getting rich quick is very rare, but it entrances some people several times in their lives, and rarely does it end well.? It is far better for most people to work hard in areas of the economy that are being rewarded, and invest excess cash in a mix of? stocks, long-dated investment grade bonds, money markets, and a little gold.

After all, it’s not what you make, it’s what you keep.

What’s Up? What’s Down?

Posted on 19 January 2012 by David Merkel

I can’t remember who gave me this idea, but sometimes I troll through the raw PPI data to get ideas on pricing power.? Here’s a list of the top 50 rising items in the PPI:

Code	2011 Px Increase	Commodity Name
WPU01130102	125.3%	Dry pinto beans
WPU01710802	109.8%	Checks and undergrades
WPU023307	90.7%	Liquid raw whey
WPU01130101	87.0%	Dry pea beans
WPU01130104	84.9%	Dry pink beans
WPU011301	84.1%	Dry vegetables
WPS017108	74.5%	Breaker stock and checks and undergrades
WPU01210105	71.3%	Hard amber durum wheat
WPU01710801	70.1%	Breaker stock
WPU01130215	68.4%	Lettuce
WPU01130103	68.0%	Dry great northern beans
WPS0181	64.5%	Alfalfa hay
WPU01830121	61.9%	Cottonseed
WPU01830111	45.2%	Peanuts
WPU02230101	44.9%	Haddock
WPU01830161	44.6%	Sunflower
WPU431105	41.7%	Other nonresidential buildings, gross rents
WPU4423	39.7%	Truck trailer, utility trailer, and RV rental and leasing
WPU06380304	39.6%	Calcium channel blockers and other vasodilators
WPU06220209	39.4%	Titanium pigments
WPU05320108	37.8%	Ethane, gas mixtures and other natural gas liquids
WPU02350303	37.3%	Bulk liquid milk products, including feed grade
WPU058103	37.0%	Other petroleum and coal products, including coke oven products, n.e.c.
WPU01190104	36.9%	Walnuts
WPS058	36.1%	Asphalt and other petroleum and coal products, n.e.c.
WPU058102	34.8%	Asphalt
WPU012201	34.5%	Barley
WPU01130105	33.3%	Dry peas
WPU021302	32.5%	Other milled rice and byproducts
WPU033701	32.5%	Greige cotton broadwoven fabrics
WPU06520136	32.5%	Urea
WPS065201	31.3%	Nitrogenates
WPU06520135	31.2%	Synthetic ammonia, nitric acid, and ammonium compounds
WPS0271	30.5%	Animal fats and oils, made in slaughtering plants
WPU07130371	29.8%	Flat rubber and plastics belts and belting
WPU02210126	28.3%	Boneless beef, fresh/frozen, inc. ground bulk/patty
WPU01710705	28.0%	Eggs, small
WPU0283	27.2%	Processed eggs, liquid, dried, or frozen
WPU01130404	27.0%	Round red potatoes
WPU06140341	26.8%	Ethanol (ethyl alcohol)
WPU067906	26.7%	Gum and wood chemicals, including wood distillation products
WPU0613020T	26.4%	Inorganic acids, inc. hydrochloric, sulfuric acid and other
WPU11490202	26.3%	Ball valves
WPU091502141	26.2%	Uncoated paper grocers’ bags and sacks
WPU091502142	26.1%	Uncoated paper variety bags and pouches (merchandise) and shopping bags
WPU58F101	26.1%	Automotive fuels and lubricants retailing
WPU013103	26.1%	Slaughter vealers
WPS0652	26.0%	Fertilizer materials
WPS013201	25.8%	Slaughter barrows and gilts
WPU01190101	25.8%	Pecans

A few notes:

Checks and Undergrades are chicken eggs of low grade.
Breaker Stock are eggs that are slightly better, but not good enough for retail.
Greige = Un-dyed
Vealers = Calves, used for veal
Barrows and Gilts = Hogs

When I look at the top 50 risers, I think the following are in demand:

Specialty hydrocarbons
Dried peas, beans, nuts, etc.
Fertilizer
Eggs
Some types of meat

Most of it boils down to a demand for food and energy.? These are very basic things, and to me indicate that there is demand for the basics.? I think this demand is global, as middle classes arise over much of the globe, food and energy will become more expensive.? A pity that the FOMC does not consider what people need to be material to their monetary decisions, despite the fact that food and energy have always had higher inflation rates, and there are better ways to deal with volatility (median, trimmed mean).

But what about the bottom 50?

Code	2011 Px Increase	Commodity Name
WPU1022	-10.7%	Primary nonferrous metals
WPU10230102	-11.3%	No. 2 copper scrap, including wire
WPS0292	-11.5%	Soybean cake, meal, and other byproducts
WPSSOP1300	-11.9%	Crude fuel
WPU01830131	-12.0%	Soybeans
WPU10250237	-12.1%	Copper and copper-base alloy sheet, strip and plate
WPU10250239	-12.2%	Copper and copper-base alloy pipe and tube
WPUID6222	-12.2%	Unprocessed fuel
WPSSOP1320	-12.3%	Nonmanufacturing industries
WPUID62222	-12.5%	Unprocessed fuel to nonmanufacturing industries
WPU022301	-12.7%	Unprocessed finfish
WPU0111	-12.9%	Fresh fruits and melons
WPU11510115	-13.6%	Portable computers, laptops, PDAs and other single user computers
WPU01130228	-14.2%	Green peppers
WPU10230101	-14.5%	No. 1 copper scrap, including wire
WPU11510114	-14.6%	Personal computers and workstations (excluding portable computers)
WPU441	-14.7%	Passenger car rental
WPU102102	-15.4%	Copper ores
WPU01110226	-16.8%	Cranberries
WPU091207	-17.1%	High grades wastepaper (pulp, substitutes & deinking)
WPUSI01102B	-17.1%	Berries
WPU01130212	-17.2%	Carrots
WPU02230502	-17.4%	Crabs
WPU01130226	-17.5%	Endive
WPU13710116	-17.6%	Other gypsum products
WPU012203	-18.1%	Oats
WPU06380105	-18.5%	Hormones and oral contraceptives
WPU084904	-19.3%	Sawn wood fence stock, wood lath, and contract resawing and planing
WPU0531	-19.3%	Natural gas
WPU091202	-19.5%	Mixed wastepaper
WPU01130222	-19.6%	Broccoli
WPU115202	-20.5%	Parts and components for computer storage devices
WPU01130223	-20.7%	Cauliflower
WPU01130211	-20.8%	Cabbage
WPU01210103	-21.3%	Soft white wheat
WPU01210104	-22.2%	Soft red winter wheat
WPU0912	-22.2%	Wastepaper
WPU09120801	-22.9%	Exports (all grades)
WPU02230131	-23.2%	Flounder
WPU01110109	-25.1%	Tangelos
WPU02230133	-25.4%	Pollock
WPS091203	-25.5%	Corrugated wastepaper
WPU01110101	-27.0%	Grapefruits
WPU01130216	-28.2%	Dry onions
WPU01130213	-31.3%	Celery
WPU01130234	-35.1%	Cucumbers
WPU01130218	-44.5%	Snap beans
WPU01130231	-44.6%	Squash
WPU011103	-64.2%	Melons
WPU01110301	-77.6%	Cantaloupes

One note: Finfish = real fish, as opposed to shellfish

When I look at the bottom 50 risers, I think the following are not in demand:

Melons
Many other fruits and vegetables.
Low grade paper
Some fish and shellfish
Copper and other base metals

PPI File 12-2011

The above file contains all of the data for all categories in the PPI report.? My view of the data tells this story, which is consistent with what I have been writing for the last eight years: Resources are in short supply relative to capital and labor, for the most part, but not absolutely.

I still think that energy is an investable theme, agriculture and fertilizer may be so also.

Stock Idea Series

Posted on 8 January 2012 by David Merkel

Every now and then an idea strikes me, and I wonder if it would be worth trying.? Here’s one: much of the stuff that passes for analysis of stocks on the web leaves me cold.? It feels like a computer spit out a few ratios, with standard verbiage.

What if I chose some stocks at random, and analyzed them?

I set up a random selector for 10 stocks relative to their market capitalization.? My first group of 10 came out as follows:

Sun Life Financial Inc. (USA)
Vodafone Group Plc (ADR)
ORIX Corporation (ADR)
C.H. Robinson Worldwide, Inc.
Nippon Telegraph & Telephone C
Ms&Ad Insurance Group Holding
National Grid plc (ADR)
Greenhill & Co., Inc.
Carnival Corporation
TTM Technologies, Inc.

I’ve heard of #10, but don’t know what it does.? I have not heard of #6, despite my knowledge of the insurance industry.? The other 8 I know something about.? My inclination would be to go for the ones I know nothing about.? Odds are there is no coverage of them at all, at least in the US.? I would likely choose #6.? So what is it?

MS&AD Insurance Group Holdings, Inc. is a Japan-based holding company. Through its subsidiaries and associated companies, the Company operates four business segments in both domestic and overseas markets. The Domestic Non-Life Insurance segment is engaged in non-life insurance businesses. The Domestic Life Insurance segment is engaged in the life insurance businesses. The Overseas segment is engaged in the overseas related businesses. The Financial Service and Risk Related segment is involved in two divisions. The financial service division is engaged in the asset management, financial security, 401 k, alternative risk transfer (ART), personal loan and venture capital businesses. The risk related service division is engaged in the risk management, nursing care and asset evaluation businesses, among others. As of March 31, 2011, the Company had 121 subsidiaries and 28 associated companies.

It’s not a small company.? The market cap is $11 billion.? This one seems complex — looks like fun. 🙂

Run the random selector again, and I get this:

Gladstone Commercial Corporati
Alliant Techsystems Inc.
Cemex SAB de CV (ADR)
3D Systems Corporation
Canandaigua National Corporati
Goodyear Tire & Rubber Company
PHI Inc.
Royal Bank of Canada (USA)
Edison International
Rayonier Inc.

I know something about 7 out of 10. Numbers 1, 4, and 5 are a mystery to me, and respectively, they are a REIT, a 3D printer company, and a small bank holding company.? I would probably choose #4 for the analysis, because it is more fun for me to analyze a nonfinancial company.? Maybe I should choose differently because I understand financials better than many.? Advice is requested.

I filter out companies with less than $10 million of market cap, and CEFs & ETFs.? Now, I’m not sure how much time it would take me to write these out.? If it’s too much, I won’t do it.? But if I did do it, how much interest would you have?

Now, the natural inclination is for those with some interest to write me, and those with no interest to be silent.? I’d really like to hear from those with no interest.? Regardless, let me know in the comments section.? Thanks.

Industry Ranks January 2012

Posted on 7 January 20127 January 2012 by David Merkel

I?m working on my quarterly reshaping ? where I choose new companies to enter my portfolio.? The first part of this is industry analysis.

If you are a value player, look at the green zone, and ask where trends are over-discounted.? Yes, things are bad, but are they all that bad?? Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled ?Dig through.?

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

P&C Insurers and Reinsurers Look Cheap