It's normal to worry, but this is not the time to panic
Below is a slightly altered version of an email I recently sent to clients:
Dear Clients,
As you'll see next week, my client letter was written at quarter end and doesn't address recent market volatility. With that in mind and considering the recent market drop, I decided to throw together a quick email to all clients giving my opinion of what is happening and what my response is.
I've summarized my thinking in quick bullet points for those short on time or not as interested. Then below, I go into more detail on each point for those who want more info. Finally, my intent is to try to answer your questions as well as I can and to get a dialogue going if you are concerned. Please feel free to contact me at any time if you want to talk to me about what is going on. I will be available or quickly return your calls. This is a stressful time, and I'm here to answer your questions.
1. It's natural to be worried, but panic selling now will lead to regret in the long run.
2. Historically, this decline is not out of the ordinary.
3. I believe recent government action will work, although it will take some time and it will lead to higher inflation in the long run.
4. It's not possible to time the market, so trying to sell now and buy at the "bottom" almost always leads to worse results than holding on.
5. The market is throwing the baby out with the bathwater.
6. Our underlying businesses are strong even though their prices are going down.
7. This is a historic time to invest!
8. One of the reasons you hired me is to let me worry about the market for you. That's what I'm trying to do for you now.
Now, the details.
1. It's natural to be worried, but panic selling now will lead to regret in the long run.
Being worried is normal--I'm having no fun watching your and my portfolios decline. It's easy to anchor on recent market tops and expect the highs to continue--there was a lot of media coverage about the Dow hitting 14,000 this time last year. People are panicking because they are scared, but reacting by selling is the worst investment plan and will lead to tremendous regret when the market does rebound. Temporary highs and lows can make you feel better and worse than you want to. The market swings up and down dramatically, so it's best to focus on longer term averages. A wise person once said that courage is not the lack of fear, it's the ability to act in the face of fear. Right now, not selling is taking a lot of courage.
2. Historically, this decline is not out of the ordinary.
The stock market tends to decline an average of 40% when recessions hit, which is about every 5-10 years. We're down around 40%, so this decline is in line with history. As Mark Twain said, history doesn't repeat, but it sure does rhyme. Sometimes the market goes down by 20%, sometimes it goes down by more. No one knows where this one will bottom, and trying to pick the bottom is a fool's errand. Our economy and financial sector are facing the worst period since the Great Depression, but that doesn't mean it will look just like the Great Depression. Comparisons to history are useful, but expecting the same outcomes in the same way is a mistake.
3. I believe recent government action will work, although it will take some time and it will lead to higher inflation in the long run.
Current government plans have flaws, but I believe they will get credit markets and the economy going, eventually. The cost will be higher long term inflation and more regulation, but I do think it will work. The market tends to bottom 6-9 months before the economy does. Economic data comes out months and years after the economic bottom is clearly reached. Waiting for the economy to improve will lead you to miss the huge stock market rebound that will occur. It's hard to see past our current turmoil, but a long term focus helps.
4. It's not possible to time the market, so trying to sell now and buy at the "bottom" almost always leads to worse results than holding on.
Like the search for the Holy Grail and a perpetual motion machine, people are always trying to time the market by buying at the bottom and selling at the top. Unfortunately, this isn't possible, and every attempt to do so ends in tears. I remember buying a company called JLG in 2000 at $8.88 per share, watching it decline to $3.95, and then selling it when it climbed above $17. I had doubled my money when the market was doing terribly, so I felt good about myself. But then JLG climbed to $60. It's easy, in hindsight, to think I should have known that JLG was worth a lot more than $3.95 at the bottom and buy more. It's easy to think I should have waited for $60 to sell at the top. Having been through that ride, though, I know very well that it's not possible to pick the tops and bottoms. Instead, I focus on the underlying value of the business and buy when it goes down and sell when it goes up. I never pick the exact bottom or top, but over the long run, I've had very good results.
5. The market is throwing the baby out with the bathwater.
When the market panics, everyone feels so much pain they sell no matter what price they get. This leads people to throw the baby out with the bathwater, and that is what I've been seeing since Oct 1st. People are selling good companies and bad ones, small and big, everything. When that happens, it's very unprofitable to join the crowd and sell, too. This is a sign of how much pain people are in, not the underlying value of businesses. In the long run, the market will recognize underlying business value, even if it takes a while and some pain to get there.
6. Our underlying businesses are strong even though their prices are going down.
When I look at our underlying businesses, I feel very confident. Software companies will continue to sell software and make money, even in a down market. People will still subscribe to cable, even if they don't pay for HBO anymore. Smart insurance companies will continue to write insurance. Discount retailers are doing better than ever as people look for bargains. Europe's lowest cost airline is still lowest cost and, and with little debt, can continue doing business and make more money than competitors, smart holding companies have investment money on the sidelines and the inside scoop on the best deals in the market when everyone else has no cash to invest, well capitalized insurers are writing more insurance now that AIG and other insurance companies are in severe trouble, big pharmaceutical companies will continue to sell drugs to people who need the medicine to live longer, happier lives, great banks are expanding by buying competitors at a fire-sale price because most other banks are on the ropes, auto insurers will continue selling car insurance because people have to buy it to drive, smart chemical companies will continue to make vital chemicals and pay lower prices for gas and oil inputs, large integrated oil companies will continue producing and refining fuel for people who will continue to heat their homes and drive their cars, large international banks will continue to grow their international banking franchises and will be able to buy up competitors because they are more conservatively financed than competitors. Many companies are strong and exploiting the downturn--but their prices are going down! Why? Because people are panicking, not because the businesses are going bankrupt.
7. This is a historic time to invest!
If you look back at market history and see 2002, 1998, 1991, 1987, 1982, 1974, 1962, 1953, 1942, 1938, 1932, etc., you will see market bottoms where things were awful. 2002 was the bottom of the tech blowout. 1998 was the bottom of the Asian Contagion. 1991 was the Saving and Loan bailout and recession. In 1987, the market dropped over 20% in one day! 1982 was a sharp recession and the Time magazine article of the "End of Equities." 1974 was a terrible recession, extremely high inflation, the pullout of Vietnam, etc. And so on and so forth. They were each excellent times to invest and extremely tough moments to do so. What made them great times to invest? Because some people panicked and others didn't. The people who didn't panic made out like bandits. If you have extra cash to invest, put it to work now. If you don't, hold on for now. The roller coaster is on the way down, our stomach is in our throat, we know it will go back up again but can't think about that because we feel awful. But, holding on is the most profitable route.
8. One of the reasons you hired me is to let me worry about the market for
you. That's what I'm trying to do for you now.
An important part of my job, in addition to researching and picking investments, is to take the pain for you of watching the market go down. If you can, turn off the TV, get off the Internet, put down the business section of the newspaper. Go out and do something fun. Spend time with loved ones. I remember watching TV for 48 hours after 9/11 and after Hurricane Katrina, and I managed to convince myself that more doom was right around the corner. It wasn't, and it probably isn't now. Let me focus on this stuff for you, let me take the pain for you. That's what you pay me for.
I don't want to short change current events. These are tough times.
I don't want to undercut how miserable it is to watch our portfolios decline in value--I'm agonizing because I feel responsible for your money.
If you still have concerns, please call or write me. I'm standing by and waiting to talk to anyone who calls.
Take care and have a great weekend,
Mike
Michael Rivers, CFA
Athena Capital Management Corp.
719-761-3148
www.athenacapital.biz
Visit my blog: www.mikerivers.blogspot.com.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, October 10, 2008
Friday, October 03, 2008
It's ugly out there
The economy is getting to look downright ugly.
The reason why the U.S. government was working so hard on the bailout is because credit markets are frozen. For those who don't know, our economy operates mostly on credit. When most companies buy inventory, purchase property, plant and equipment, or pay wages and salaries, it's frequently done with credit.
So, when credit markets are frozen, businesses (and municipalities) can't keep operations going, they can't expand, and they can't pay their employees.
It's unclear that the government bailout will unfreeze credit markets. Banks aren't lending because their balance sheets are either close to or insolvent. They can't lend. Having the government purchase illiquid securities may facilitate the rebuilding of bank balance sheets, but it won't rebuild bank balance sheets directly.
The credit freeze has been slowing the economy remarkably over the last two months, and precipitously over the last two weeks. That is why Secretary of Treasury Paulson and Federal Reserve Chairman Bernanke have been running around like chickens with their heads cut off trying to get the bailout going.
Warren Buffett says this is the worst he's seen in his 50+ years of investing. The situation is being touted as the worse financial crisis since the Great Depression.
It's going to get worse before it gets better, but, if free markets are left alone to work, it will get better. The U.S. economy is the most dynamic and resilient in the world.
We may be over-leveraged with debt, we may have too much debt, we may not save enough, but we have the best protection of property rights and a relatively sound rule of law. That's all it takes, and individuals will do the rest.
It's always darkest before dawn. Things look pretty dark out there now. Believe it or not, that can be a great time to invest. By the time things look better, you will have missed the upswing.
I'm not saying investing at a time like this is easy, but it is smart. In the long run, investments made today will do very well, even if it's looking ugly out there right now.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
The economy is getting to look downright ugly.
The reason why the U.S. government was working so hard on the bailout is because credit markets are frozen. For those who don't know, our economy operates mostly on credit. When most companies buy inventory, purchase property, plant and equipment, or pay wages and salaries, it's frequently done with credit.
So, when credit markets are frozen, businesses (and municipalities) can't keep operations going, they can't expand, and they can't pay their employees.
It's unclear that the government bailout will unfreeze credit markets. Banks aren't lending because their balance sheets are either close to or insolvent. They can't lend. Having the government purchase illiquid securities may facilitate the rebuilding of bank balance sheets, but it won't rebuild bank balance sheets directly.
The credit freeze has been slowing the economy remarkably over the last two months, and precipitously over the last two weeks. That is why Secretary of Treasury Paulson and Federal Reserve Chairman Bernanke have been running around like chickens with their heads cut off trying to get the bailout going.
Warren Buffett says this is the worst he's seen in his 50+ years of investing. The situation is being touted as the worse financial crisis since the Great Depression.
It's going to get worse before it gets better, but, if free markets are left alone to work, it will get better. The U.S. economy is the most dynamic and resilient in the world.
We may be over-leveraged with debt, we may have too much debt, we may not save enough, but we have the best protection of property rights and a relatively sound rule of law. That's all it takes, and individuals will do the rest.
It's always darkest before dawn. Things look pretty dark out there now. Believe it or not, that can be a great time to invest. By the time things look better, you will have missed the upswing.
I'm not saying investing at a time like this is easy, but it is smart. In the long run, investments made today will do very well, even if it's looking ugly out there right now.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, September 26, 2008
With trouble comes opportunity
Things look pretty grim out there right now.
Credit markets are freezing up. Unemployment is climbing. Housing sales, both existing and new, are hitting new lows. Orders for durable goods are down signficantly.
Our government has helped bail out 3 of the 5 largest investment banks. Fannie Mae and Freddie Mac, upon which the housing market depends so much, are in our government's conservatorship. The largest insurance company in the world, AIG, has sold itself to our government's majority ownership. Washington Mutual, the largest thrift bank in our nation, was siezed last night and parts were sold off to JPMorgan.
The U.S. executive and legislative branches are struggling to put together a multi-billion dollar plan (the bill will probably come to over a trillion, in my opinion) that will allow the government to purchase and liquidate currently illiquid securities. The Securities and Exchange Commission is preventing a growing number of companies from being sold short.
Baby, it's cold outside.
So, where are the opportunities? Let me tell you!
The only thing building up faster than the credit market "snow" outside: bargains! I've never seen so many great quality companies selling at cheap prices. And, best of all, the strongest companies are able to grow while weak companies are wallowing in too much debt.
It's always hard to buy when things look bleak, because they almost always seem to get bleaker. But, that shouldn't prevent a long term investor from taking advantage of the great opportunities available right now.
It's hard to remember how things looked in the fall of 2002 and spring of 2003. It's hard to remember how bad the market and economy looked in the fall of 1990 and spring of 1991. It's hard to remember the brutal recession of 1982 that followed a recession in late 1979 and early 1980. Same for 1974 and 1970, and on back in history.
The best time to invest is when things look terrible! That doesn't mean we are at a bottom in the stock market--no one can predict that with any degree of accuracy. But buying when things look terrible has been a pretty good method to use over time, and now looks pretty dreadful.
With touble comes opportunity. This is an outstanding time to invest, and I will be glad to point back to this point in time several years from now and say, "wasn't that a GREAT time to invest!"
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Things look pretty grim out there right now.
Credit markets are freezing up. Unemployment is climbing. Housing sales, both existing and new, are hitting new lows. Orders for durable goods are down signficantly.
Our government has helped bail out 3 of the 5 largest investment banks. Fannie Mae and Freddie Mac, upon which the housing market depends so much, are in our government's conservatorship. The largest insurance company in the world, AIG, has sold itself to our government's majority ownership. Washington Mutual, the largest thrift bank in our nation, was siezed last night and parts were sold off to JPMorgan.
The U.S. executive and legislative branches are struggling to put together a multi-billion dollar plan (the bill will probably come to over a trillion, in my opinion) that will allow the government to purchase and liquidate currently illiquid securities. The Securities and Exchange Commission is preventing a growing number of companies from being sold short.
Baby, it's cold outside.
So, where are the opportunities? Let me tell you!
The only thing building up faster than the credit market "snow" outside: bargains! I've never seen so many great quality companies selling at cheap prices. And, best of all, the strongest companies are able to grow while weak companies are wallowing in too much debt.
It's always hard to buy when things look bleak, because they almost always seem to get bleaker. But, that shouldn't prevent a long term investor from taking advantage of the great opportunities available right now.
It's hard to remember how things looked in the fall of 2002 and spring of 2003. It's hard to remember how bad the market and economy looked in the fall of 1990 and spring of 1991. It's hard to remember the brutal recession of 1982 that followed a recession in late 1979 and early 1980. Same for 1974 and 1970, and on back in history.
The best time to invest is when things look terrible! That doesn't mean we are at a bottom in the stock market--no one can predict that with any degree of accuracy. But buying when things look terrible has been a pretty good method to use over time, and now looks pretty dreadful.
With touble comes opportunity. This is an outstanding time to invest, and I will be glad to point back to this point in time several years from now and say, "wasn't that a GREAT time to invest!"
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, September 19, 2008
Dumbfounded
It first started to occur to me around 5 years ago that the housing market would probably crash and that it would almost certainly drag credit markets down with it along with home builders, mortgage insurers, bond insurers and several financial institutions.
But, if you had asked me 5 years ago what the Dow Jones Industrial Average (DJIA) would trade at given that:
1) 3 of the top 5 investment banks in the US would no longer be independent and the final 2 would be tottering
2) the US government would take over Fannie Mae and Freddie Mac because they were insolvent
3) the US government would own 80% of AIG's equity because it was also insolvent
I would have said the DJIA would be at $5,000, not $11,388.
What color is the sky in most investors' world? Does anyone really believe all these bailouts will be cost free?
I'm dumbfounded.
Don't get me wrong, my investors and I are doing very well both absolutely and relatively to the market.
But, isn't the US economy entering what could be the worst recession since the early 1980's? Isn't government intervention on a scale not seen since the Great Depression an indication of how bad things are? Isn't the world economy entering the first widespread slowdown in a generation?
Then, why is the market down so little?
I have no idea. In fact, I'm dumbfounded.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
It first started to occur to me around 5 years ago that the housing market would probably crash and that it would almost certainly drag credit markets down with it along with home builders, mortgage insurers, bond insurers and several financial institutions.
But, if you had asked me 5 years ago what the Dow Jones Industrial Average (DJIA) would trade at given that:
1) 3 of the top 5 investment banks in the US would no longer be independent and the final 2 would be tottering
2) the US government would take over Fannie Mae and Freddie Mac because they were insolvent
3) the US government would own 80% of AIG's equity because it was also insolvent
I would have said the DJIA would be at $5,000, not $11,388.
What color is the sky in most investors' world? Does anyone really believe all these bailouts will be cost free?
I'm dumbfounded.
Don't get me wrong, my investors and I are doing very well both absolutely and relatively to the market.
But, isn't the US economy entering what could be the worst recession since the early 1980's? Isn't government intervention on a scale not seen since the Great Depression an indication of how bad things are? Isn't the world economy entering the first widespread slowdown in a generation?
Then, why is the market down so little?
I have no idea. In fact, I'm dumbfounded.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, September 12, 2008
The (temporary) triumph of momentum over value
As I've mentioned before, momentum investments have been out-performing value investments over the last couple of years.
If you had just picked what had gone up in the past, it continued to go up.
Value investing, instead, focuses on understanding the value of a business and trying to buy below that value, thus providing a margin of safety (like building a bridge to handle more than you think it will bear over time).
Value has been, over the long run, one of the (if not the) smartest ways to invest.
Just because it hasn't done well lately doesn't mean it won't do well in the future. In fact, quite the opposite is true--value investing is VERY likely to out-perform momentum investing in the near future.
As additional support for this contention, take a look at a recent Motley Fool article by Andrew Sullivan, CFA. In it, he gives you a flavor of the returns that are possible for value after it has under-performed.
Trying to time when momentum will out-perform value and vice versa is a fools errand, but, at times like this, it's very easy to be patient and wait for value to begin out-performing again.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
As I've mentioned before, momentum investments have been out-performing value investments over the last couple of years.
If you had just picked what had gone up in the past, it continued to go up.
Value investing, instead, focuses on understanding the value of a business and trying to buy below that value, thus providing a margin of safety (like building a bridge to handle more than you think it will bear over time).
Value has been, over the long run, one of the (if not the) smartest ways to invest.
Just because it hasn't done well lately doesn't mean it won't do well in the future. In fact, quite the opposite is true--value investing is VERY likely to out-perform momentum investing in the near future.
As additional support for this contention, take a look at a recent Motley Fool article by Andrew Sullivan, CFA. In it, he gives you a flavor of the returns that are possible for value after it has under-performed.
Trying to time when momentum will out-perform value and vice versa is a fools errand, but, at times like this, it's very easy to be patient and wait for value to begin out-performing again.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, September 05, 2008
The Wall Street Journal gives short sellers a hand
In October 2007, I took the Wall Street Journal to task for a weak article hammering Wal-Mart. Their timing turned out to be impeccable, as I wrote about in July of this year. Wal-Mart's stock has handily beat the market since the October 2007 article.
Last week, I think the Journal may have done it again, this time with Sears (full disclosure: my clients and I own shares of Sears Holdings).
The Wall Street Journal's article, titled "Mr. Lampert, Fire Thyself," again seems thin on facts and long on generalized evaluations.
The gist of the article is that Eddie Lampert, Chairman and majority owner of Sears Holdings, should fire himself because his strategy with Sears has failed.
To support this claim, the article says another dismal quarter at Sears proves its strategy is failing. The article states that rivals are eating its lunch, too. Missing from the article is any support for these contentions. Which rivals? What made Sears' quarter so dismal? How has Sears done versus rivals both in terms of stock performance and fundamental economics? None of this information is provided.
The article goes on to mischaracterize Lampert's strategy with Sears. It claims that Eddie simply decided not to invest in Sears in hopes that would jack up return on investment. If you read any of what Lampert has to say, you'll see that he would love to invest more in Sears as long as it provides an adequate return on investment. That's what companies are supposed to do. The author either deliberately or ignorantly misses this distinction.
The article highlights same store sales are down 6% at Sears, but no mention is made of how Kohls, JC Penney, Nordstrom, Target, or any other competitors are doing. The author seems to believe these facts are not important, only the negative evaluation of Sears.
The article does point out that Sears has had a revolving door of executive managers. That's fair. And, the author points out that Lampert will have a hard time using financial engineering with crunched credit markets and a difficult real estate market. That's true, too.
But, a couple of facts and a lot of evaluative statements not supported by facts isn't good reporting. Sears is generating a ton of cash, and its balance sheet is more solid than many rivals. This can be seen in share buybacks if nothing else. Why isn't that mentioned, I wonder?
Sears isn't investing much in stores, but perhaps that's a smarter strategy than throwing good money after bad. Why isn't that highlighted? And why didn't the author differentiate between not investing in stores as a strategy versus not investing in inadequate return on capital projects?
I have a guess. I think short sellers are eager to see Lampert and Sears fail. At the same time, Wall Street Journal journalists are hungry for a sensational story. Combine these two ingredients and mix liberally with lack of scruples, and you get a Wall Street Journal article thin on substance and high on sensation.
Perhaps the Journal has called the bottom on Sears like they did on Wal-Mart. I'll be eagerly watching to see what happens.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
In October 2007, I took the Wall Street Journal to task for a weak article hammering Wal-Mart. Their timing turned out to be impeccable, as I wrote about in July of this year. Wal-Mart's stock has handily beat the market since the October 2007 article.
Last week, I think the Journal may have done it again, this time with Sears (full disclosure: my clients and I own shares of Sears Holdings).
The Wall Street Journal's article, titled "Mr. Lampert, Fire Thyself," again seems thin on facts and long on generalized evaluations.
The gist of the article is that Eddie Lampert, Chairman and majority owner of Sears Holdings, should fire himself because his strategy with Sears has failed.
To support this claim, the article says another dismal quarter at Sears proves its strategy is failing. The article states that rivals are eating its lunch, too. Missing from the article is any support for these contentions. Which rivals? What made Sears' quarter so dismal? How has Sears done versus rivals both in terms of stock performance and fundamental economics? None of this information is provided.
The article goes on to mischaracterize Lampert's strategy with Sears. It claims that Eddie simply decided not to invest in Sears in hopes that would jack up return on investment. If you read any of what Lampert has to say, you'll see that he would love to invest more in Sears as long as it provides an adequate return on investment. That's what companies are supposed to do. The author either deliberately or ignorantly misses this distinction.
The article highlights same store sales are down 6% at Sears, but no mention is made of how Kohls, JC Penney, Nordstrom, Target, or any other competitors are doing. The author seems to believe these facts are not important, only the negative evaluation of Sears.
The article does point out that Sears has had a revolving door of executive managers. That's fair. And, the author points out that Lampert will have a hard time using financial engineering with crunched credit markets and a difficult real estate market. That's true, too.
But, a couple of facts and a lot of evaluative statements not supported by facts isn't good reporting. Sears is generating a ton of cash, and its balance sheet is more solid than many rivals. This can be seen in share buybacks if nothing else. Why isn't that mentioned, I wonder?
Sears isn't investing much in stores, but perhaps that's a smarter strategy than throwing good money after bad. Why isn't that highlighted? And why didn't the author differentiate between not investing in stores as a strategy versus not investing in inadequate return on capital projects?
I have a guess. I think short sellers are eager to see Lampert and Sears fail. At the same time, Wall Street Journal journalists are hungry for a sensational story. Combine these two ingredients and mix liberally with lack of scruples, and you get a Wall Street Journal article thin on substance and high on sensation.
Perhaps the Journal has called the bottom on Sears like they did on Wal-Mart. I'll be eagerly watching to see what happens.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, August 22, 2008
Credit markets still crashing
Although I'd love to see the US economy recovering, I believe that the credit meltdown is still on-going.
After listening to several conference calls, including American Express, Target, CarMax and Lab Corp, it sounds like the US consumer is still struggling in a major way.
Another sign of credit market malaise can be seen in yield spreads. The spread between low and high quality credits keeps getting wider, and this is a sign of continued credit market weakness.
How big of an impact do credit markets have on the US economy and US businesses? Very big.
It's easy to see why businesses must borrow frequently--they must produce before they can sell, and many businesses borrow to do that. But, many don't seem to grasp to what degree US consumers have been living beyond their means for the last decade.
US consumer debt is at record highs when compared to income and assets. Consumers are having a harder time paying their bills and their debt levels aren't helping.
US consumers borrowed against their homes to buy stuff over the last decade.
American Express highlighted this in their recent conference call. Their customers in markets with declining housing prices are spending much less than they were a year ago--across all income levels!
Target is also experiencing difficulties with their credit racked customers. CarMax is struggling to sell cars because customers can't get loans. Why? Because the credit markets aren't buying car loans.
Even Lab Corp, a company that specializes in running tests for hospitals and physicians, is feeling the credit pinch. On their conference call, analysts hammered company management about their receivables and why customers weren't paying. The answer--US consumers are strapped.
Credit markets will not recover until banks rebuild their balance sheets. Banks won't rebuild their balance sheets until the US consumer recovers. And, the US consumer will not recover until housing bottoms.
I don't know when that will happen, but I know it hasn't happened, yet.
Stock markets may do well as election year uncertainty clears up this fall. But, when that is past, investors will refocus on corporate earnings, credit markets, the financial services industry, and the housing market. Until those things improve, I wouldn't expect too much from stock markets.
(Full disclosure: I don't own any shares of American Express, CarMax, Target or Lab Corp).
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Although I'd love to see the US economy recovering, I believe that the credit meltdown is still on-going.
After listening to several conference calls, including American Express, Target, CarMax and Lab Corp, it sounds like the US consumer is still struggling in a major way.
Another sign of credit market malaise can be seen in yield spreads. The spread between low and high quality credits keeps getting wider, and this is a sign of continued credit market weakness.
How big of an impact do credit markets have on the US economy and US businesses? Very big.
It's easy to see why businesses must borrow frequently--they must produce before they can sell, and many businesses borrow to do that. But, many don't seem to grasp to what degree US consumers have been living beyond their means for the last decade.
US consumer debt is at record highs when compared to income and assets. Consumers are having a harder time paying their bills and their debt levels aren't helping.
US consumers borrowed against their homes to buy stuff over the last decade.
American Express highlighted this in their recent conference call. Their customers in markets with declining housing prices are spending much less than they were a year ago--across all income levels!
Target is also experiencing difficulties with their credit racked customers. CarMax is struggling to sell cars because customers can't get loans. Why? Because the credit markets aren't buying car loans.
Even Lab Corp, a company that specializes in running tests for hospitals and physicians, is feeling the credit pinch. On their conference call, analysts hammered company management about their receivables and why customers weren't paying. The answer--US consumers are strapped.
Credit markets will not recover until banks rebuild their balance sheets. Banks won't rebuild their balance sheets until the US consumer recovers. And, the US consumer will not recover until housing bottoms.
I don't know when that will happen, but I know it hasn't happened, yet.
Stock markets may do well as election year uncertainty clears up this fall. But, when that is past, investors will refocus on corporate earnings, credit markets, the financial services industry, and the housing market. Until those things improve, I wouldn't expect too much from stock markets.
(Full disclosure: I don't own any shares of American Express, CarMax, Target or Lab Corp).
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, August 15, 2008
Value investor drought
Pity the poor value investors.
Although they have excellent long term records, value investor results over the past couple of years have been poor relative to the market.
Consider Bill Miller at Legg Mason. After beating the S&P 500 for 15 years in a row, he has had a dreadful 2 1/2 years. His performance has been so bad his mutual fund investors are leaving in droves.
Does this mean value investing no longer works? Should investors pursue another methodology? If value investing hasn't worked, what has?
The answer is momentum. If you simply invested in the things that were going up, you would have easily beaten the market. Invest in natural resources, such as oil or gold, after they went up and they'd just keep going up.
Is that a good way to invest now? Not normally, and probably not going forward.
You see, the market goes through periods when one thing works and others don't. This rarely lasts because everyone jumps on the bandwagon until it's full and no one else is left to jump on board. I think we're close to that point now.
The last time momentum out-performed value investing was in the 1998-1999 period. After that, value investing clearly beat momentum investing for several years running.
Usually, when the market goes down, value investing handily out-performs. But in this down market, momentum has been winning. You have to go all the way back to the early 1990's to find a similar situation. Guess what happened after that? That's when Bill Miller's record 15 years of out-performing the S&P 500 began.
Don't pity the poor value investors--JOIN THEM. Every time value investing has performed poorly in the past has proven to be an excellent time to get on the value investing bandwagon. Right now, people are getting off, and that's precisely why you should be getting on!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Pity the poor value investors.
Although they have excellent long term records, value investor results over the past couple of years have been poor relative to the market.
Consider Bill Miller at Legg Mason. After beating the S&P 500 for 15 years in a row, he has had a dreadful 2 1/2 years. His performance has been so bad his mutual fund investors are leaving in droves.
Does this mean value investing no longer works? Should investors pursue another methodology? If value investing hasn't worked, what has?
The answer is momentum. If you simply invested in the things that were going up, you would have easily beaten the market. Invest in natural resources, such as oil or gold, after they went up and they'd just keep going up.
Is that a good way to invest now? Not normally, and probably not going forward.
You see, the market goes through periods when one thing works and others don't. This rarely lasts because everyone jumps on the bandwagon until it's full and no one else is left to jump on board. I think we're close to that point now.
The last time momentum out-performed value investing was in the 1998-1999 period. After that, value investing clearly beat momentum investing for several years running.
Usually, when the market goes down, value investing handily out-performs. But in this down market, momentum has been winning. You have to go all the way back to the early 1990's to find a similar situation. Guess what happened after that? That's when Bill Miller's record 15 years of out-performing the S&P 500 began.
Don't pity the poor value investors--JOIN THEM. Every time value investing has performed poorly in the past has proven to be an excellent time to get on the value investing bandwagon. Right now, people are getting off, and that's precisely why you should be getting on!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, August 08, 2008
Short versus long term
In a stock market like we're in today, it's not easy to focus on the long term.
Volatility is high as bad news and good news seems to be announced every day.
What's an investor to do? Think long term.
The best investments are made when the market is getting beat up. The best investments are not those that will perform well today, this week, this month, or this year. The best investments are companies that can fund growth during bad times.
You see, many companies operate on a razor's edge. They don't prepare for down times. They try to maximize short term profits by taking risks either operationally (jumping into the latest craze) or financially (loading up with debt).
The best companies and the best investments operate conservatively, so when bad times come, they can grow their businesses precisely when other companies are over a barrel.
But, conservative companies don't do as well in good times, so most people ignore them. And, when bad times come, their stock prices get beat up even further because they are spending like crazy to foster future growth and thus reporting lower earnings in the present and near future.
The stock market focuses on the short term, and doesn't like to hear that a company is expanding during tough times. But, that's what great companies do, and that's what makes them great investments over the long haul.
I'm finding a tremendous number of great companies that are expanding into the downturn, planting seeds that will lead to outstanding and profitable growth when things start to improve. Interestingly, their stock prices are taking a beating because they are spending heavily during tough times. But, if you lift your head up to a 5 year investing horizon, you can see just how great an investment they will be.
I'm not saying it's easy to invest in a company whose stock price is going down. It isn't.
I am saying that such an investment can look very smart if you're not investing for the short term. That's what I'm doing both with my own dollars and my clients' dollars, and I'm very excited about the results I believe we'll get over the next 5 years.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
In a stock market like we're in today, it's not easy to focus on the long term.
Volatility is high as bad news and good news seems to be announced every day.
What's an investor to do? Think long term.
The best investments are made when the market is getting beat up. The best investments are not those that will perform well today, this week, this month, or this year. The best investments are companies that can fund growth during bad times.
You see, many companies operate on a razor's edge. They don't prepare for down times. They try to maximize short term profits by taking risks either operationally (jumping into the latest craze) or financially (loading up with debt).
The best companies and the best investments operate conservatively, so when bad times come, they can grow their businesses precisely when other companies are over a barrel.
But, conservative companies don't do as well in good times, so most people ignore them. And, when bad times come, their stock prices get beat up even further because they are spending like crazy to foster future growth and thus reporting lower earnings in the present and near future.
The stock market focuses on the short term, and doesn't like to hear that a company is expanding during tough times. But, that's what great companies do, and that's what makes them great investments over the long haul.
I'm finding a tremendous number of great companies that are expanding into the downturn, planting seeds that will lead to outstanding and profitable growth when things start to improve. Interestingly, their stock prices are taking a beating because they are spending heavily during tough times. But, if you lift your head up to a 5 year investing horizon, you can see just how great an investment they will be.
I'm not saying it's easy to invest in a company whose stock price is going down. It isn't.
I am saying that such an investment can look very smart if you're not investing for the short term. That's what I'm doing both with my own dollars and my clients' dollars, and I'm very excited about the results I believe we'll get over the next 5 years.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, August 01, 2008
Being a value investor requires painful patience
I'll spare you the academic citations, but there's a solid body of evidence that value investing beats growth investing over the long run.
If it works so well, why isn't everyone a value investor?
Because it hurts.
Value investing is based on a couple of key principles:
1) you can determine the value of a business
2) the price of a business on a stock exchange diverges from value
3) at some point in time, stock price converges on value
The hard part in value investing is point 3).
No one is surprised that you can determine the value of a business.
Not many are surprised (finance and economics academics excluded) that stock prices diverge from value.
The hard part is that first phrase in point 3), "at some point in time." How long do you have to wait for "at some point in time"? As Shakespeare put it, there's the rub.
No value investor knows when the herd mentality of the stock market will converge on underlying value. Why not? You might as well as ask why a weather expert can't predict how many inches of rain will fall on one square inch of land in Bowie, Maryland during a 12 hour period on June 30, 2014. The system is simply too complex for an accurate prediction to be made.
And, as any value investor can tell you (ask Bill Miller), it seldom works the way you think it will.
If the company you've bought consistently reports growing earnings per share, surely then the market will converge. No, it doesn't.
Sometimes price converges on value without any news whatsoever. Sometimes price converges when a company announced declining earnings for quarters on end. Most of the time, while you wait, it doesn't converge at all.
You simply can't know when it will happen.
I've seen it happen in one day, and I've seen it take over 7 years.
And, that's why it works. Most people don't have the patience to wait. They want prices to go up soon...today...RIGHT NOW!!!
Value investing works because few people have the intestinal fortitude to wait.
It's like asking an overweight person about losing weight or a poor person how to become wealthy. They both know the answer. The overweight person will tell you it requires a good diet and exercise, but they won't do it. The poor person will explain that you need to spend less than you make to become wealthy, and yet they won't do it.
The reason it works is not because people don't understand what to do, but because it hurts to do it.
That's why I say that value investors get paid to endure pain. It's painful to wait if you don't know when price will reflect value. It's painful to buy something cheap just to watch it become dramatically cheaper. It's painful to watch fundamental performance deteriorate even though you know it will improve several years from now.
Anyone who has done their homework knows what it takes to beat the market. Value businesses, buy when price is significantly below value, sell when price reflects value. Everyone knows it, but hardly anyone does it.
Why? Because it's painful. But, boy, does it work!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
I'll spare you the academic citations, but there's a solid body of evidence that value investing beats growth investing over the long run.
If it works so well, why isn't everyone a value investor?
Because it hurts.
Value investing is based on a couple of key principles:
1) you can determine the value of a business
2) the price of a business on a stock exchange diverges from value
3) at some point in time, stock price converges on value
The hard part in value investing is point 3).
No one is surprised that you can determine the value of a business.
Not many are surprised (finance and economics academics excluded) that stock prices diverge from value.
The hard part is that first phrase in point 3), "at some point in time." How long do you have to wait for "at some point in time"? As Shakespeare put it, there's the rub.
No value investor knows when the herd mentality of the stock market will converge on underlying value. Why not? You might as well as ask why a weather expert can't predict how many inches of rain will fall on one square inch of land in Bowie, Maryland during a 12 hour period on June 30, 2014. The system is simply too complex for an accurate prediction to be made.
And, as any value investor can tell you (ask Bill Miller), it seldom works the way you think it will.
If the company you've bought consistently reports growing earnings per share, surely then the market will converge. No, it doesn't.
Sometimes price converges on value without any news whatsoever. Sometimes price converges when a company announced declining earnings for quarters on end. Most of the time, while you wait, it doesn't converge at all.
You simply can't know when it will happen.
I've seen it happen in one day, and I've seen it take over 7 years.
And, that's why it works. Most people don't have the patience to wait. They want prices to go up soon...today...RIGHT NOW!!!
Value investing works because few people have the intestinal fortitude to wait.
It's like asking an overweight person about losing weight or a poor person how to become wealthy. They both know the answer. The overweight person will tell you it requires a good diet and exercise, but they won't do it. The poor person will explain that you need to spend less than you make to become wealthy, and yet they won't do it.
The reason it works is not because people don't understand what to do, but because it hurts to do it.
That's why I say that value investors get paid to endure pain. It's painful to wait if you don't know when price will reflect value. It's painful to buy something cheap just to watch it become dramatically cheaper. It's painful to watch fundamental performance deteriorate even though you know it will improve several years from now.
Anyone who has done their homework knows what it takes to beat the market. Value businesses, buy when price is significantly below value, sell when price reflects value. Everyone knows it, but hardly anyone does it.
Why? Because it's painful. But, boy, does it work!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, July 25, 2008
What's beating the market down?
A lot of things are coming together to cause the market to go down, recently.
One issue is lower earnings forecasts for the 3rd and 4th quarter. Companies reporting 2nd quarter earnings are saying things don't look that great for the rest of the year. This is knocking down stock prices. As investors optimistically begin to look forward to 2009 this fall, I expect the stock market to rally.
Another issue is uncertainty over upcoming elections. Markets hate uncertainty, and until it becomes clear who will win upcoming elections (both Presidential and Congressional) and what those elected will do, the market will do poorly. As that uncertainty clears up this fall, I expect the stock market to recover.
A third issue is the housing market. Housing inventories are very high, home sales volumes are low, and home prices continue to decline. Not only is housing an important part of our economy, it's also a major part of most consumers' wealth. Depressed consumers spend less, and that is reducing stock prices. When the housing market shows concrete signs of recovering, and I have no idea when that will happen (although I'm guessing late this year or early next), I expect the stock market to resume its climb.
A fourth issue, strongly related to the third, is the financial services sector. Banks are seeing their loans to consumers and businesses sour. At the same time, consumers and businesses need the money they put with banks as deposits to cover their needs as the economy slows. This perfect storm is hurting banks in a major way. After the housing market, and thus consumers and businesses, begin to recover, so will the banks.
A fifth issue is energy prices. Although energy prices have pulled back, no one is certain whether they will continue down or climb again. My guess is that high energy prices have both brought more supply online and reduced demand, so I expect energy prices to continue to decline in the short run. If such a decline becomes more clear, I think the market will rebound.
The way I see it, there are both short and long term issues at hand.
One short term issue is the market's transition from looking at 3rd and 4th quarter earnings to looking forward to 2009 earnings. Another short term issue is election season. Those two issues are relatively easy to predict and should tend to lift market prices some time this fall.
Two long term issues are the housing market and financial services sectors. I don't know when these two will recover, but when they do it will be a major and longer term lift to market prices.
Energy is both a short and long term issue. In the short run, I believe energy prices will come down and tend to support the economy and market prices, especially this fall. In the long run, I don't believe it will be easy to find supply to keep up with growing demand, and higher energy prices will tend to undercut the economy and market prices. This dynamic is very difficult to predict.
I expect market prices to continue to decline into early fall, as investors focus on current economic conditions and election uncertainty. Such a decline will be tempered by declining energy prices and accelerated by rising energy prices.
In the longer run, the market will not begin a long term climb until the conditions in the housing market and financial sector improve. I can't predict when this will happen, but it may happen this fall or some time next year.
In the much longer term, as the economy recovers and demand picks up, so will energy prices. This will dampen the market's rally to some degree.
Although I don't use market predictions to time the market, I believe an understanding of market dynamics are useful for investors who are trying to understand what is happening and when it will improve.
The best time to buy is when things look terrible, and the best time to sell is when things look great. Whether the market rallies this fall, next year, or 3 years from now, I believe this is a great time to invest.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
A lot of things are coming together to cause the market to go down, recently.
One issue is lower earnings forecasts for the 3rd and 4th quarter. Companies reporting 2nd quarter earnings are saying things don't look that great for the rest of the year. This is knocking down stock prices. As investors optimistically begin to look forward to 2009 this fall, I expect the stock market to rally.
Another issue is uncertainty over upcoming elections. Markets hate uncertainty, and until it becomes clear who will win upcoming elections (both Presidential and Congressional) and what those elected will do, the market will do poorly. As that uncertainty clears up this fall, I expect the stock market to recover.
A third issue is the housing market. Housing inventories are very high, home sales volumes are low, and home prices continue to decline. Not only is housing an important part of our economy, it's also a major part of most consumers' wealth. Depressed consumers spend less, and that is reducing stock prices. When the housing market shows concrete signs of recovering, and I have no idea when that will happen (although I'm guessing late this year or early next), I expect the stock market to resume its climb.
A fourth issue, strongly related to the third, is the financial services sector. Banks are seeing their loans to consumers and businesses sour. At the same time, consumers and businesses need the money they put with banks as deposits to cover their needs as the economy slows. This perfect storm is hurting banks in a major way. After the housing market, and thus consumers and businesses, begin to recover, so will the banks.
A fifth issue is energy prices. Although energy prices have pulled back, no one is certain whether they will continue down or climb again. My guess is that high energy prices have both brought more supply online and reduced demand, so I expect energy prices to continue to decline in the short run. If such a decline becomes more clear, I think the market will rebound.
The way I see it, there are both short and long term issues at hand.
One short term issue is the market's transition from looking at 3rd and 4th quarter earnings to looking forward to 2009 earnings. Another short term issue is election season. Those two issues are relatively easy to predict and should tend to lift market prices some time this fall.
Two long term issues are the housing market and financial services sectors. I don't know when these two will recover, but when they do it will be a major and longer term lift to market prices.
Energy is both a short and long term issue. In the short run, I believe energy prices will come down and tend to support the economy and market prices, especially this fall. In the long run, I don't believe it will be easy to find supply to keep up with growing demand, and higher energy prices will tend to undercut the economy and market prices. This dynamic is very difficult to predict.
I expect market prices to continue to decline into early fall, as investors focus on current economic conditions and election uncertainty. Such a decline will be tempered by declining energy prices and accelerated by rising energy prices.
In the longer run, the market will not begin a long term climb until the conditions in the housing market and financial sector improve. I can't predict when this will happen, but it may happen this fall or some time next year.
In the much longer term, as the economy recovers and demand picks up, so will energy prices. This will dampen the market's rally to some degree.
Although I don't use market predictions to time the market, I believe an understanding of market dynamics are useful for investors who are trying to understand what is happening and when it will improve.
The best time to buy is when things look terrible, and the best time to sell is when things look great. Whether the market rallies this fall, next year, or 3 years from now, I believe this is a great time to invest.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, July 18, 2008
Is the banking crisis over?
For those of you who want to see my latest quarterly client letter, it's here.
Banks stocks took a beating over the last several weeks, and it created some wonderful opportunities to buy top-notch banks at rock bottom prices.
Not only was I a buyer, but an eager buyer of certain companies. But, not all banks are equally good, and just because I'm buying specific companies at specific prices is not a statement that banks stocks have hit bottom.
I don't try to pick bottoms because I don't know that anyone can. It's like forecasting the weather, you can get in the ballpark with some guesses, but you never really know exactly what's going to happen.
If you don't believe me, look at the annual hurricane forecasts over the last several years. They are pretty far off on an annual basis, but pretty accurate over 5 year time frames. Sounds like the stock market in many ways....
Back to bank stocks. I don't know if crowd psychology has signaled capitulation in bank stocks in general. I don't believe so. I think poorly run banks will be announcing significantly worse results as the impacts of a slower economy ripple up into more loan defaults and delinquencies.
I'm buying now because good banks hit very good prices, not because I know when bank stocks will bottom. In fact, I may very well have opportunities to buy the companies I just bought at even lower prices.
As the stock market continues to recognize that the 3rd and 4th quarter won't be so peachy, I'd expect it to roll over further. It also wouldn't surprise me that what we're currently seeing is short covering and mere reactions to short term noise.
When will the market and banks stocks really bottom? I don't know, but my guess is that people will be talking less about buying bargains at that point, and more about running for the hills.
As Rothschild said, "Buy when there's blood in the streets."
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
For those of you who want to see my latest quarterly client letter, it's here.
Banks stocks took a beating over the last several weeks, and it created some wonderful opportunities to buy top-notch banks at rock bottom prices.
Not only was I a buyer, but an eager buyer of certain companies. But, not all banks are equally good, and just because I'm buying specific companies at specific prices is not a statement that banks stocks have hit bottom.
I don't try to pick bottoms because I don't know that anyone can. It's like forecasting the weather, you can get in the ballpark with some guesses, but you never really know exactly what's going to happen.
If you don't believe me, look at the annual hurricane forecasts over the last several years. They are pretty far off on an annual basis, but pretty accurate over 5 year time frames. Sounds like the stock market in many ways....
Back to bank stocks. I don't know if crowd psychology has signaled capitulation in bank stocks in general. I don't believe so. I think poorly run banks will be announcing significantly worse results as the impacts of a slower economy ripple up into more loan defaults and delinquencies.
I'm buying now because good banks hit very good prices, not because I know when bank stocks will bottom. In fact, I may very well have opportunities to buy the companies I just bought at even lower prices.
As the stock market continues to recognize that the 3rd and 4th quarter won't be so peachy, I'd expect it to roll over further. It also wouldn't surprise me that what we're currently seeing is short covering and mere reactions to short term noise.
When will the market and banks stocks really bottom? I don't know, but my guess is that people will be talking less about buying bargains at that point, and more about running for the hills.
As Rothschild said, "Buy when there's blood in the streets."
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, July 11, 2008
Wal-Mart is dead, long live Wal-Mart
Full disclosure: my clients and I own shares of Wal-Mart.
Back on October 3rd, 2007, I posted a blog criticizing a Wall Street Journal article that claimed "Wal-Mart Era Wanes Amid Big Shifts in Retail; Rivals Find Strategies to Defeat Low Prices; World Has Changed."
More specifically, I claimed the author of the article had picked the bottom for Wal-Mart's stock.
On October 3rd, the stock closed at $45.13 per share. The most recent low for Wal-Mart had been $42.27 posted on September 10th, 2007.
Today, the shares trade at around $56 and have been as high at $59.80. At $56 a share, that's a 24% gain in value, not including dividends.
On October 3rd, 2007, the S&P 500 closed at $1,539.59. Today, the S&P 500 is around $1,235. That's a 19.8% loss (once again, without dividends).
In other words, the performance difference between Wal-Mart and the S&P 500 from October 3rd, 2007 until now was a whopping 43.8%!!!
Now, why am I bringing this up? Just to toot my own horn and brag how smart or lucky I got? No (okay, maybe a little).
My reason for bringing this up is the same reason I made the post on 10/3/2007, to highlight how far astray you can be lead by following the popular press for investment advice.
By the time the Wall Street Journal, or any other popular periodical, comes out with news about a company, it's almost always figured into the price and then some.
In fact, the time to buy a company is when the popular press is saying it's dead. The time to sell is when they are singing its praises.
As I said on 10/3/2007, "I'll bet that in a few years I'll be writing a blog saying that I've sold Wal-Mart because the popular press is reporting that Wal-Mart is back at the top of its game again."
Perhaps that time will come sooner than I think...
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Full disclosure: my clients and I own shares of Wal-Mart.
Back on October 3rd, 2007, I posted a blog criticizing a Wall Street Journal article that claimed "Wal-Mart Era Wanes Amid Big Shifts in Retail; Rivals Find Strategies to Defeat Low Prices; World Has Changed."
More specifically, I claimed the author of the article had picked the bottom for Wal-Mart's stock.
On October 3rd, the stock closed at $45.13 per share. The most recent low for Wal-Mart had been $42.27 posted on September 10th, 2007.
Today, the shares trade at around $56 and have been as high at $59.80. At $56 a share, that's a 24% gain in value, not including dividends.
On October 3rd, 2007, the S&P 500 closed at $1,539.59. Today, the S&P 500 is around $1,235. That's a 19.8% loss (once again, without dividends).
In other words, the performance difference between Wal-Mart and the S&P 500 from October 3rd, 2007 until now was a whopping 43.8%!!!
Now, why am I bringing this up? Just to toot my own horn and brag how smart or lucky I got? No (okay, maybe a little).
My reason for bringing this up is the same reason I made the post on 10/3/2007, to highlight how far astray you can be lead by following the popular press for investment advice.
By the time the Wall Street Journal, or any other popular periodical, comes out with news about a company, it's almost always figured into the price and then some.
In fact, the time to buy a company is when the popular press is saying it's dead. The time to sell is when they are singing its praises.
As I said on 10/3/2007, "I'll bet that in a few years I'll be writing a blog saying that I've sold Wal-Mart because the popular press is reporting that Wal-Mart is back at the top of its game again."
Perhaps that time will come sooner than I think...
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Thursday, July 03, 2008
Book recommendation: The Little Book That Builds Wealth
I have a book recommendation to make: The Little Book That Builds Wealth by Pat Dorsey.
Dorsey has helped Morningstar (known for their mutual fund research) develop their individual stock research team over the last several years.
This book is not a quick and easy guide to investing, but a book focused on one of the most important aspects of investing: understanding a company's sustainable competitive advantages.
You see, long term investment research is best done when it focuses on 3 areas: business economics, management and valuation.
This book analyzes a sub-component of business economics, competitive advantage.
Warren Buffett once said that the best businesses are like a castle with a big moat around it. The moat is a company's sustainable competitive advantages. And, that is what Dorsey writes about in the book.
This is probably one of the most if not the most important thing to look at and understand about a business, but it's frequently overlooked because it's not strictly quantifiable. You can't go look up Intel's sustainable competitive advantages on Yahoo! Finance and come back with the answer: 3.
Competitive advantages are not quantifiable, but they are vitally important.
The book is well written and an easy read. He give a lot of good examples and the writing style is relaxed and humorous.
The book makes clear what gives a company a large moat and allows them to keep it. He highlights what are not moats, like management (although I don't entirely agree with him on that point), and how to tell when moats are sustainable.
Dorsey does a great job of spelling out what provides moats, like intangible assets (think patents like pharmaceuticals), switching costs (think software like Oracle), the network effect (think eBay), cost advantages (think Dell), and size advantage (think Wal-Mart).
Dorsey provides a very readable guide of what to look for and why.
Although this is a framework I've been using for years to look at companies, I must admit that Dorsey provided excellent food for thought that will keep my noodle spinning as I look at companies in the future.
A worthwhile read for the layman to the expert, in my opinion.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
I have a book recommendation to make: The Little Book That Builds Wealth by Pat Dorsey.
Dorsey has helped Morningstar (known for their mutual fund research) develop their individual stock research team over the last several years.
This book is not a quick and easy guide to investing, but a book focused on one of the most important aspects of investing: understanding a company's sustainable competitive advantages.
You see, long term investment research is best done when it focuses on 3 areas: business economics, management and valuation.
This book analyzes a sub-component of business economics, competitive advantage.
Warren Buffett once said that the best businesses are like a castle with a big moat around it. The moat is a company's sustainable competitive advantages. And, that is what Dorsey writes about in the book.
This is probably one of the most if not the most important thing to look at and understand about a business, but it's frequently overlooked because it's not strictly quantifiable. You can't go look up Intel's sustainable competitive advantages on Yahoo! Finance and come back with the answer: 3.
Competitive advantages are not quantifiable, but they are vitally important.
The book is well written and an easy read. He give a lot of good examples and the writing style is relaxed and humorous.
The book makes clear what gives a company a large moat and allows them to keep it. He highlights what are not moats, like management (although I don't entirely agree with him on that point), and how to tell when moats are sustainable.
Dorsey does a great job of spelling out what provides moats, like intangible assets (think patents like pharmaceuticals), switching costs (think software like Oracle), the network effect (think eBay), cost advantages (think Dell), and size advantage (think Wal-Mart).
Dorsey provides a very readable guide of what to look for and why.
Although this is a framework I've been using for years to look at companies, I must admit that Dorsey provided excellent food for thought that will keep my noodle spinning as I look at companies in the future.
A worthwhile read for the layman to the expert, in my opinion.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, June 27, 2008
The stock market is down, but is it cheap?
Caution: please remove sharp objects from arms reach before you read this!
The S&P 500 is almost in bear market territory, down just short of 20% since its most recent high.
This fact leads market commentators to question if the market is getting cheap.
My answer: looking at long term, historical evidence, the market is not cheap. In fact, it would have to drop another 23% from current levels or remain flat for 4 1/2 years before trading at historical, fair value.
Before you read my reasoning below, please keep in mind that you don't have to invest in the market as a whole. In fact, there are times when it's better to invest in active managers who are trying to beat the market (but make sure they really can beat the market). Because I believe we are in a secular bear market that started in 2000, I think this is one of those times.
I'm finding some of the best bargains I've seen in my 12 1/2 years of investing. I'm absolutely giddy about the great companies I'm finding at great prices. This evaluation does not, however, include the stock market as a whole.
Why do I think the market is expensive. In a word, history. Looking at the history of the S&P 500, you can clearly see that earnings per share grow at around 6% a year over the long term. A plot of S&P 500 earnings per share with a simple exponential fit is a wonderful thing to behold (send me an email if you want to see it). Every time earnings per share deviates from the long term average, it regresses to the mean. Every time.
Using such a plot, I can see what the average, forward price to earnings ratio has been since 1948 by simply dividing year end price by the one year forward estimate of earnings (using the 6% growth rate fit on historical S&P 500 earnings per share).
Since 1948, the forward price to normalized earnings ratio has been 14.85. Let's keep things simple by rounding up to 15. That allows for the fact that price to earnings ratios have been creeping up over time.
Using my plot of normalized earnings per share for the S&P 500 of $65.70 (June 30, 2009 normalized earnings per share for the S&P 500) and an historic price to forward earnings of 15, I come up with a fair value for the S&P 500 of $985.50, or 23% below current levels ($1,280 at the time of this writing).
By my reasoning, the S&P 500 wouldn't be at fair value unless: 1) it drops another 23% tomorrow or 2) remains at $1,280 for the next 4 1/2 years.
I don't mean to scare anybody with my forecast, I'm simply showing that, in the long term, price follows earnings. And, if earnings grow at historic rates and the market is willing to pay in the future what it was in the past for those earnings, then the S&P 500 is anything but cheap right now.
I wouldn't assume a lot better results if you're invested in the market, or with a professional investor who is so diversified as to essentially be mimicking the market (a lot of them are, a whole lot).
Take heart, though. You don't have to invest in the market. Look for stocks that are better quality and cheaper than the market and you'll do just fine. Or, better yet, find a professional who can do it for you.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Caution: please remove sharp objects from arms reach before you read this!
The S&P 500 is almost in bear market territory, down just short of 20% since its most recent high.
This fact leads market commentators to question if the market is getting cheap.
My answer: looking at long term, historical evidence, the market is not cheap. In fact, it would have to drop another 23% from current levels or remain flat for 4 1/2 years before trading at historical, fair value.
Before you read my reasoning below, please keep in mind that you don't have to invest in the market as a whole. In fact, there are times when it's better to invest in active managers who are trying to beat the market (but make sure they really can beat the market). Because I believe we are in a secular bear market that started in 2000, I think this is one of those times.
I'm finding some of the best bargains I've seen in my 12 1/2 years of investing. I'm absolutely giddy about the great companies I'm finding at great prices. This evaluation does not, however, include the stock market as a whole.
Why do I think the market is expensive. In a word, history. Looking at the history of the S&P 500, you can clearly see that earnings per share grow at around 6% a year over the long term. A plot of S&P 500 earnings per share with a simple exponential fit is a wonderful thing to behold (send me an email if you want to see it). Every time earnings per share deviates from the long term average, it regresses to the mean. Every time.
Using such a plot, I can see what the average, forward price to earnings ratio has been since 1948 by simply dividing year end price by the one year forward estimate of earnings (using the 6% growth rate fit on historical S&P 500 earnings per share).
Since 1948, the forward price to normalized earnings ratio has been 14.85. Let's keep things simple by rounding up to 15. That allows for the fact that price to earnings ratios have been creeping up over time.
Using my plot of normalized earnings per share for the S&P 500 of $65.70 (June 30, 2009 normalized earnings per share for the S&P 500) and an historic price to forward earnings of 15, I come up with a fair value for the S&P 500 of $985.50, or 23% below current levels ($1,280 at the time of this writing).
By my reasoning, the S&P 500 wouldn't be at fair value unless: 1) it drops another 23% tomorrow or 2) remains at $1,280 for the next 4 1/2 years.
I don't mean to scare anybody with my forecast, I'm simply showing that, in the long term, price follows earnings. And, if earnings grow at historic rates and the market is willing to pay in the future what it was in the past for those earnings, then the S&P 500 is anything but cheap right now.
I wouldn't assume a lot better results if you're invested in the market, or with a professional investor who is so diversified as to essentially be mimicking the market (a lot of them are, a whole lot).
Take heart, though. You don't have to invest in the market. Look for stocks that are better quality and cheaper than the market and you'll do just fine. Or, better yet, find a professional who can do it for you.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, June 20, 2008
If the economy is limping along okay, then why are FedEx and UPS down so much?
It's always interesting to watch reports about the broader economy and compare them to what's happening to large corporations, like FedEx and UPS, that may more clearly indicate what's really going on in the U.S. economy.
This week, people claiming unemployment insurance declined. Also, leading economic indicators were up for the second month in a row. Perhaps things aren't so bad?
But, at the same time, FedEx reported its first quarterly loss in 11 years and reduced expectations going forward.
The stock of FedEx is down over 20% during the last year. UPS is down around 10%.
How can the economy seem to be motoring along when companies like UPS and FedEx seem to be doing poorly?
When given the choice between economic statistics (that get revised over and over again, and are heavily dependent on many shaky assumptions) and the performance of large corporations, I'll take the performance of large corporations any day.
I think UPS and FedEx are indicating what's happening in the economy better than broad economic statistics, and it isn't pretty. Growth is slowing or declining, and you can see it in the volume and profits of the shippers.
In time, economic statistics will reflect this. In the meantime, I'm watching the major companies and what they're saying is happening instead of focusing on the economists.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
It's always interesting to watch reports about the broader economy and compare them to what's happening to large corporations, like FedEx and UPS, that may more clearly indicate what's really going on in the U.S. economy.
This week, people claiming unemployment insurance declined. Also, leading economic indicators were up for the second month in a row. Perhaps things aren't so bad?
But, at the same time, FedEx reported its first quarterly loss in 11 years and reduced expectations going forward.
The stock of FedEx is down over 20% during the last year. UPS is down around 10%.
How can the economy seem to be motoring along when companies like UPS and FedEx seem to be doing poorly?
When given the choice between economic statistics (that get revised over and over again, and are heavily dependent on many shaky assumptions) and the performance of large corporations, I'll take the performance of large corporations any day.
I think UPS and FedEx are indicating what's happening in the economy better than broad economic statistics, and it isn't pretty. Growth is slowing or declining, and you can see it in the volume and profits of the shippers.
In time, economic statistics will reflect this. In the meantime, I'm watching the major companies and what they're saying is happening instead of focusing on the economists.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, June 13, 2008
It's a great time to invest!
As pessimistic as many of my blogs sound about the stock market as a whole, I must admit I'm very bullish about the specific investments I'm making today.
You see, the market as a whole can be over-valued, or in for a rough ride, and yet you can find specific, long term investments that are very enticing.
I'm finding the best investment opportunities I've seen since the 2002-2003 market trough (when we were coming out of the 2001 recession).
Not only are the investments I'm finding likely to provide excellent returns, they are also higher quality companies than I usually get the opportunity to invest in.
Usually, large, high quality companies are priced at a premium to the market. Today, though, many great businesses are selling at prices that are at distinct discounts to the market and to my assessed business values.
I can't remember a time in the last 12 years where I've been able to buy such premium companies at such low prices!
I don't know when the market will turn, or when my specific investments may out-perform, but I do know I've spent a lot of time assessing their value and I'm very confident that high returns are quite likely over the next 3 to 5 years.
Now, I just need to be patient and wait for the seeds I've planted to sprout and grow. This is a high quality "problem" to have.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
As pessimistic as many of my blogs sound about the stock market as a whole, I must admit I'm very bullish about the specific investments I'm making today.
You see, the market as a whole can be over-valued, or in for a rough ride, and yet you can find specific, long term investments that are very enticing.
I'm finding the best investment opportunities I've seen since the 2002-2003 market trough (when we were coming out of the 2001 recession).
Not only are the investments I'm finding likely to provide excellent returns, they are also higher quality companies than I usually get the opportunity to invest in.
Usually, large, high quality companies are priced at a premium to the market. Today, though, many great businesses are selling at prices that are at distinct discounts to the market and to my assessed business values.
I can't remember a time in the last 12 years where I've been able to buy such premium companies at such low prices!
I don't know when the market will turn, or when my specific investments may out-perform, but I do know I've spent a lot of time assessing their value and I'm very confident that high returns are quite likely over the next 3 to 5 years.
Now, I just need to be patient and wait for the seeds I've planted to sprout and grow. This is a high quality "problem" to have.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, June 06, 2008
What's next for the banking sector?
What's made the stock market so jittery lately? Was it oil prices or commodity run-ups? I don't think so. I think what's bugging investors is: will something bad happen in the banking sector?
So far, the banking sector has suffered from defaults on higher risk mortgage investments. Some of these were subprime, some were Alt A (a step up from subprime, but not prime), and some have been home equity loans. All were bad loans and bad investments to begin with.
Because many market participants were buying mortgage investments with other people's money (read: borrowed money), this part of the market really suffered when it became clear that almost no one knew what the mortgage investments they bought were worth.
But, so far, the banking sector hasn't really suffered from major defaults on business loans, credit card loans, auto loans, prime mortgages, etc. In other words, the banking problems that started in March of 2007 have almost entirely been an investment phenomenon, not a broader bank lending problem, per se.
The question now is: could that change? Could the problems seen so far be the tip of a broader loan default problem? Could the economy be rolling over into recession and signaling that loan defaults will increase across the board?
If the answers to these questions are yes, the the problems in the banking sector, and the rest of the economy for that matter, may only be getting started.
Can the Federal Reserve fix these problems? Many people believe they can, but some strong dissenting opinions, even from within the Fed, are starting to question the validity of this premise.
The Fed may control interest rates and be able to bail out banks, but not without cost. The cost, in most cases, is higher inflation. With soaring energy and food prices, this will not be welcome news.
The other problem is that Fed actions are creating moral hazard. When you bail out stupid risk takers, they learn a bad lesson: they either make a ton of money making risky bets or they get bailed out. "Heads I win, tails you lose." This may be leading to even more bad lending and highly levered investing.
What's next for the banking sector?
It all depends on fundamentals at this point. Either banks have made good loans and have enough reserves to weather tougher times, or they don't.
If they don't, then expect the banking sector to hit new lows as more and more news comes out that broader loans--like credit card, auto, business, commercial real estate, prime mortgages--are hitting higher default levels.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
What's made the stock market so jittery lately? Was it oil prices or commodity run-ups? I don't think so. I think what's bugging investors is: will something bad happen in the banking sector?
So far, the banking sector has suffered from defaults on higher risk mortgage investments. Some of these were subprime, some were Alt A (a step up from subprime, but not prime), and some have been home equity loans. All were bad loans and bad investments to begin with.
Because many market participants were buying mortgage investments with other people's money (read: borrowed money), this part of the market really suffered when it became clear that almost no one knew what the mortgage investments they bought were worth.
But, so far, the banking sector hasn't really suffered from major defaults on business loans, credit card loans, auto loans, prime mortgages, etc. In other words, the banking problems that started in March of 2007 have almost entirely been an investment phenomenon, not a broader bank lending problem, per se.
The question now is: could that change? Could the problems seen so far be the tip of a broader loan default problem? Could the economy be rolling over into recession and signaling that loan defaults will increase across the board?
If the answers to these questions are yes, the the problems in the banking sector, and the rest of the economy for that matter, may only be getting started.
Can the Federal Reserve fix these problems? Many people believe they can, but some strong dissenting opinions, even from within the Fed, are starting to question the validity of this premise.
The Fed may control interest rates and be able to bail out banks, but not without cost. The cost, in most cases, is higher inflation. With soaring energy and food prices, this will not be welcome news.
The other problem is that Fed actions are creating moral hazard. When you bail out stupid risk takers, they learn a bad lesson: they either make a ton of money making risky bets or they get bailed out. "Heads I win, tails you lose." This may be leading to even more bad lending and highly levered investing.
What's next for the banking sector?
It all depends on fundamentals at this point. Either banks have made good loans and have enough reserves to weather tougher times, or they don't.
If they don't, then expect the banking sector to hit new lows as more and more news comes out that broader loans--like credit card, auto, business, commercial real estate, prime mortgages--are hitting higher default levels.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Thursday, May 22, 2008
Picking natural resource investments
It's hard to avoid headlines about the price of natural resources.
Oil has been hitting new highs almost every day this week. Iron ore and coking coal have become hot investments because they're major inputs for steel production. Even stodgy agriculture is seizing the headlines.
So, how should one go about picking a natural resource investment to benefit from the boom?
First, it's probably too late to join the party because prices reflect a lot of the boom already. There may be some bargains to be had, though, if the global economy continues to slow down.
What should one look for in a natural resource investment?
The first thing I like to find is low costs. Low cost producers, especially in commodity products, have a huge competitive advantage. The companies with the lowest costs to extract oil, gold and iron ore, or produce wheat, soybeans and corn will exhibit higher profit margins and returns on capital.
Scale may be one reason for such an advantage. Another may be a proprietary production process or unique access to geologic locations. Yet another may be a management team that can motivate and hire more productive employees. One of the most important advantages is a management team that knows how to allocate capital to the best returning projects.
The second thing to consider is the sustainability of such costs. Some advantages are easily competed away as soon as others recognize them. To benefit from a specific cost structure, it must be sustainable over time.
One example is oil sands. Oil sands have much higher costs of production than other oil extraction projects. But, they have reserve lives of 50 years versus reserve lives of 10 to 15 for most large, integrated oil companies. (full disclosure: my clients and I own a position in an oil sands company)
Low costs and the sustainability of a cost structure are very important in looking for natural resource investments. Does that mean you should find the company with the lowest, most sustainable cost structure and purchase it? Emphatically: NO!
It depends on the price you pay for that company. The math behind investing is simple, but not easy to implement. To find the best investment, you have to compare the economics of a business to the price you pay for it. Frequently, this means buying a second tier company whose price doesn't currently reflect its cost structure and sustainability. The best company in an industry rarely goes on sale for a rock bottom price.
Picking a natural resource investment requires a focus on the economics of a business and its sustainability, its management, and its price relative to economics and management. If that sounds like a generalization for picking any investment, that's because it is.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
It's hard to avoid headlines about the price of natural resources.
Oil has been hitting new highs almost every day this week. Iron ore and coking coal have become hot investments because they're major inputs for steel production. Even stodgy agriculture is seizing the headlines.
So, how should one go about picking a natural resource investment to benefit from the boom?
First, it's probably too late to join the party because prices reflect a lot of the boom already. There may be some bargains to be had, though, if the global economy continues to slow down.
What should one look for in a natural resource investment?
The first thing I like to find is low costs. Low cost producers, especially in commodity products, have a huge competitive advantage. The companies with the lowest costs to extract oil, gold and iron ore, or produce wheat, soybeans and corn will exhibit higher profit margins and returns on capital.
Scale may be one reason for such an advantage. Another may be a proprietary production process or unique access to geologic locations. Yet another may be a management team that can motivate and hire more productive employees. One of the most important advantages is a management team that knows how to allocate capital to the best returning projects.
The second thing to consider is the sustainability of such costs. Some advantages are easily competed away as soon as others recognize them. To benefit from a specific cost structure, it must be sustainable over time.
One example is oil sands. Oil sands have much higher costs of production than other oil extraction projects. But, they have reserve lives of 50 years versus reserve lives of 10 to 15 for most large, integrated oil companies. (full disclosure: my clients and I own a position in an oil sands company)
Low costs and the sustainability of a cost structure are very important in looking for natural resource investments. Does that mean you should find the company with the lowest, most sustainable cost structure and purchase it? Emphatically: NO!
It depends on the price you pay for that company. The math behind investing is simple, but not easy to implement. To find the best investment, you have to compare the economics of a business to the price you pay for it. Frequently, this means buying a second tier company whose price doesn't currently reflect its cost structure and sustainability. The best company in an industry rarely goes on sale for a rock bottom price.
Picking a natural resource investment requires a focus on the economics of a business and its sustainability, its management, and its price relative to economics and management. If that sounds like a generalization for picking any investment, that's because it is.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, May 16, 2008
Food prices run amuck!
There's been a lot of interest in food prices spiking, and there are many opinions on why food prices are running.
The most popular "cause" is, of course, speculation by hedge fund managers, futures traders, etc. Although this may be causing some of the short term spikes we are seeing, I don't believe it's the real, underlying cause.
In my opinion, there are significant, fundamental, underlying trends that are causing food prices to run up.
The first, and one I've written about before, is underlying inflation. When the central banks of the world print money to fight various economic problems, the result is almost always inflation.
Another major cause is government policy encouraging (read: subsidizing) bio-fuels production. When almost 20% of U.S. corn production goes to produce fuel instead of food, then food supply decreases and prices will rise (all things equal)--welcome to Economics 101.
Demand itself--especially from the rapidly growing developing economies in Asia, Latin America, the Middle East, etc.--is indeed a major factor in food price increases. We in the developed world cannot expect those in the developing world to continue living on the same amount and type of food they've been living on forever. This trend isn't going away any time soon.
Another less talked about reason is water. Yes, water. Water for growing crops is not as easy to come by in many parts of the world. Saudi Arabia is a great example of a country that must spend tremendous amounts of resources to produce water that can be used for growing food.
A bad crop in Australia is also to blame. Bad crops are not that unusual, though. In fact, they are quite predictable (that they will happen, not when). This only exacerbates the problem. It's not a primary cause.
So, food prices are going up and there are underlying, fundamental causes that probably won't make this issue go away quickly. So what?
If the global economy slows down, as it looks to be doing, then look for food prices to fall back a bit. But, as long as the underlying causes mentioned above persist--central bank money printing, bio-fuel subsidies, demand from developing countries, difficulties in producing usable water--food prices will probably remain higher than in the last 20 years.
Higher food prices matter because they have led to many wars throughout history. This isn't a prediction, merely an observation that when things get bad enough--people don't have enough food to eat--they can become angry enough to go to war.
Food prices don't seem like that big of a deal in the developed world like the U.S., western Europe and Japan, because food makes up only a small portion (10-15%) of the developed world's family budgets. In the developing world, though, food is a huge portion (80%). If 80% of our costs doubled or tripled, as food prices have in some parts of the world, you'd even see Americans ready and willing to go to war.
What's a poor investor to do? Prepare for this possibility. The forces of capitalism will tend to drive prices of commodities down over time. When these forces are interrupted, as described above, you get price spikes, shortages, surpluses, etc.
The backlash caused by food price spikes will, eventually, lead to the removal of the barriers to capitalism. Until these barriers are removed, expect food prices to remain high and perhaps even continue to climb.
As an investor, you can protect yourself by investing in areas with pricing power. Businesses with pricing power can do okay during difficult periods periods, and, if/when food prices decline, they will thrive. Win win.
Trying to bet on commodity price swings is risky business, and I wouldn't recommend it. If you don't know who the patsy is, then it's you.
Instead, look to quality businesses that can raise their prices without crushing the demand for their products. Such companies will always do well over the long term.
Another idea is to invest in areas of the food market that haven't yet benefited from price run-ups. First it was energy, then base metals, now food crops. As inflation works its way through the system each player along the way goes from being hurt to being benefited.
For instance, pork, chicken and beef producers have been hammered by higher input costs--corn, soybeans, wheat--but the price for their end products haven't climbed, yet. They are facing the perfect storm of higher costs and lower product prices! Perhaps this will change as marginal producers go bust and large producers trim back production until it's profitable again. It's Economics 101 again!!! (full disclosure: I and my clients are invested in a large pork producer).
Don't let higher food prices get you down. Invest wisely and you can benefit!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
There's been a lot of interest in food prices spiking, and there are many opinions on why food prices are running.
The most popular "cause" is, of course, speculation by hedge fund managers, futures traders, etc. Although this may be causing some of the short term spikes we are seeing, I don't believe it's the real, underlying cause.
In my opinion, there are significant, fundamental, underlying trends that are causing food prices to run up.
The first, and one I've written about before, is underlying inflation. When the central banks of the world print money to fight various economic problems, the result is almost always inflation.
Another major cause is government policy encouraging (read: subsidizing) bio-fuels production. When almost 20% of U.S. corn production goes to produce fuel instead of food, then food supply decreases and prices will rise (all things equal)--welcome to Economics 101.
Demand itself--especially from the rapidly growing developing economies in Asia, Latin America, the Middle East, etc.--is indeed a major factor in food price increases. We in the developed world cannot expect those in the developing world to continue living on the same amount and type of food they've been living on forever. This trend isn't going away any time soon.
Another less talked about reason is water. Yes, water. Water for growing crops is not as easy to come by in many parts of the world. Saudi Arabia is a great example of a country that must spend tremendous amounts of resources to produce water that can be used for growing food.
A bad crop in Australia is also to blame. Bad crops are not that unusual, though. In fact, they are quite predictable (that they will happen, not when). This only exacerbates the problem. It's not a primary cause.
So, food prices are going up and there are underlying, fundamental causes that probably won't make this issue go away quickly. So what?
If the global economy slows down, as it looks to be doing, then look for food prices to fall back a bit. But, as long as the underlying causes mentioned above persist--central bank money printing, bio-fuel subsidies, demand from developing countries, difficulties in producing usable water--food prices will probably remain higher than in the last 20 years.
Higher food prices matter because they have led to many wars throughout history. This isn't a prediction, merely an observation that when things get bad enough--people don't have enough food to eat--they can become angry enough to go to war.
Food prices don't seem like that big of a deal in the developed world like the U.S., western Europe and Japan, because food makes up only a small portion (10-15%) of the developed world's family budgets. In the developing world, though, food is a huge portion (80%). If 80% of our costs doubled or tripled, as food prices have in some parts of the world, you'd even see Americans ready and willing to go to war.
What's a poor investor to do? Prepare for this possibility. The forces of capitalism will tend to drive prices of commodities down over time. When these forces are interrupted, as described above, you get price spikes, shortages, surpluses, etc.
The backlash caused by food price spikes will, eventually, lead to the removal of the barriers to capitalism. Until these barriers are removed, expect food prices to remain high and perhaps even continue to climb.
As an investor, you can protect yourself by investing in areas with pricing power. Businesses with pricing power can do okay during difficult periods periods, and, if/when food prices decline, they will thrive. Win win.
Trying to bet on commodity price swings is risky business, and I wouldn't recommend it. If you don't know who the patsy is, then it's you.
Instead, look to quality businesses that can raise their prices without crushing the demand for their products. Such companies will always do well over the long term.
Another idea is to invest in areas of the food market that haven't yet benefited from price run-ups. First it was energy, then base metals, now food crops. As inflation works its way through the system each player along the way goes from being hurt to being benefited.
For instance, pork, chicken and beef producers have been hammered by higher input costs--corn, soybeans, wheat--but the price for their end products haven't climbed, yet. They are facing the perfect storm of higher costs and lower product prices! Perhaps this will change as marginal producers go bust and large producers trim back production until it's profitable again. It's Economics 101 again!!! (full disclosure: I and my clients are invested in a large pork producer).
Don't let higher food prices get you down. Invest wisely and you can benefit!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Thursday, May 08, 2008
The returns you get on your money matter...A LOT!!!
Although I understand clearly the argument for low cost index funds, especially for more risk averse people, I want to briefly make the argument for going after above average returns.
Why? Because it can have a HUGE impact on your quality of life. Getting above average returns can greatly improve your safety and security both before and during retirement.
Let me give you some a examples to clearly illustrate my point.
Suppose Bob starts saving at 30, retires at 65 and dies at 95. Also, suppose he saves $100 a month from the time he's 30 until he reaches 65. Finally, suppose he gets 7% returns from age 30 to 95. How much will Bob have to live on? Around $13,400 a year from the time he's 65 until he dies at 95.
Now, suppose Fred does the exact same thing as Bob, except he gets 8% returns from 30 to 95--only 1% better than Bob! Fred will have around $18,400 a year to live on from the time he's 65 until he dies at 95. That's 37% more a year to live on!
Using slightly different savings inputs, that's the difference between having $50,000 a year in retirement versus having $68,500 a year! That's HUGE!!!
You can plug any numbers you want to in the scenario above, and you'll get the same general answer. Getting better returns--even mere 1% better returns--can hugely raise your standard of living in retirement, thus giving you more peace of mind, safety and security.
More provocatively, let's suppose you don't know when you're going to die--most people don't! How long will your money last when your retire?
Let's use the same numbers above, except let's assume both Bob and Fred don't know when they are going to die, so they spend $17,500 a year. How long will their money last if Bob gets 7% returns and Fred gets 8% returns? Bob's money will last 17 years--he'll run out of money at age 82. Fred's money will last 38 years--he'll have money until 103 years old!
Can you imagine running out of money at 82 versus having enough to last to 103? That's a huge change in safety and security!
My point here is not that everyone should try to get above average returns. My point is that getting above average returns may REALLY be worth it if you have the tolerance and ability to go after above average returns.
I've been beating the market, after fees, by around 3.5% a year for the past 12 years (past results are no guarantee of future performance). Want to guess what my retirement projections look like? Want to guess how much peace of mind I have?
If you have the right temperament and the right financial situation to go after above average returns, it can have a huge impact on your current and future lifestyle. In my opinion, it's well worth going after.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Although I understand clearly the argument for low cost index funds, especially for more risk averse people, I want to briefly make the argument for going after above average returns.
Why? Because it can have a HUGE impact on your quality of life. Getting above average returns can greatly improve your safety and security both before and during retirement.
Let me give you some a examples to clearly illustrate my point.
Suppose Bob starts saving at 30, retires at 65 and dies at 95. Also, suppose he saves $100 a month from the time he's 30 until he reaches 65. Finally, suppose he gets 7% returns from age 30 to 95. How much will Bob have to live on? Around $13,400 a year from the time he's 65 until he dies at 95.
Now, suppose Fred does the exact same thing as Bob, except he gets 8% returns from 30 to 95--only 1% better than Bob! Fred will have around $18,400 a year to live on from the time he's 65 until he dies at 95. That's 37% more a year to live on!
Using slightly different savings inputs, that's the difference between having $50,000 a year in retirement versus having $68,500 a year! That's HUGE!!!
You can plug any numbers you want to in the scenario above, and you'll get the same general answer. Getting better returns--even mere 1% better returns--can hugely raise your standard of living in retirement, thus giving you more peace of mind, safety and security.
More provocatively, let's suppose you don't know when you're going to die--most people don't! How long will your money last when your retire?
Let's use the same numbers above, except let's assume both Bob and Fred don't know when they are going to die, so they spend $17,500 a year. How long will their money last if Bob gets 7% returns and Fred gets 8% returns? Bob's money will last 17 years--he'll run out of money at age 82. Fred's money will last 38 years--he'll have money until 103 years old!
Can you imagine running out of money at 82 versus having enough to last to 103? That's a huge change in safety and security!
My point here is not that everyone should try to get above average returns. My point is that getting above average returns may REALLY be worth it if you have the tolerance and ability to go after above average returns.
I've been beating the market, after fees, by around 3.5% a year for the past 12 years (past results are no guarantee of future performance). Want to guess what my retirement projections look like? Want to guess how much peace of mind I have?
If you have the right temperament and the right financial situation to go after above average returns, it can have a huge impact on your current and future lifestyle. In my opinion, it's well worth going after.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, May 02, 2008
It's stimulus check time!
That's right, boys and girls, it's that time again to get the economy going with stimulus checks!
But, wait a minute. Where do those stimulus checks come from anyway?
Does the government have a magical money tree that creates value? No, probably not that.
Does the government take in more money in tax revenue than they spend? No, not that, either.
Does the government borrow from others by issuing government bonds? Yes, that's the one.
Okay, so who buys those bonds? Is it savers, foreign and domestic? Yes, indeed.
So, that means the money is going from people saving to people spending, right?
So, the way to get the economy going, forever after, is to stop saving and start spending? Hmmm...that's some interesting logic.
Let's take this to its logical conclusion. Growth comes from consuming, according to this thinking.
So, if we just consume everything we've produced, we've maximized growth?
That doesn't seem to make sense.
Oh yeh! Now I get it! The way to grow is to save some of what you produce, and then use those savings to produce more next time around.
For example, the farmer who eats his seed corn will never grow production. But, the farmer who saves a bit his corn each year as seed for the next year will produce larger and larger crops each year as he saves more and more seed corn.
The only way to have growth is not to consume all you produce, but to save some of it over time and plow that saving back into production. You can't eat corn you haven't produced. You have to produce before you can consume. Production, built from saving, is the way to growth--not consumption.
So, what in the heck is borrowing money from savers and giving it to consumers going to do? Reduce future growth. Does that sound like a good plan for getting the economy growing again?
Only if you measure growth by adding up consumption.
I think I'll put my stimulus check into savings. Then, maybe, we'll have a snowball's chance in hell of competing with the foreigners we're selling the asset of our country to.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
That's right, boys and girls, it's that time again to get the economy going with stimulus checks!
But, wait a minute. Where do those stimulus checks come from anyway?
Does the government have a magical money tree that creates value? No, probably not that.
Does the government take in more money in tax revenue than they spend? No, not that, either.
Does the government borrow from others by issuing government bonds? Yes, that's the one.
Okay, so who buys those bonds? Is it savers, foreign and domestic? Yes, indeed.
So, that means the money is going from people saving to people spending, right?
So, the way to get the economy going, forever after, is to stop saving and start spending? Hmmm...that's some interesting logic.
Let's take this to its logical conclusion. Growth comes from consuming, according to this thinking.
So, if we just consume everything we've produced, we've maximized growth?
That doesn't seem to make sense.
Oh yeh! Now I get it! The way to grow is to save some of what you produce, and then use those savings to produce more next time around.
For example, the farmer who eats his seed corn will never grow production. But, the farmer who saves a bit his corn each year as seed for the next year will produce larger and larger crops each year as he saves more and more seed corn.
The only way to have growth is not to consume all you produce, but to save some of it over time and plow that saving back into production. You can't eat corn you haven't produced. You have to produce before you can consume. Production, built from saving, is the way to growth--not consumption.
So, what in the heck is borrowing money from savers and giving it to consumers going to do? Reduce future growth. Does that sound like a good plan for getting the economy growing again?
Only if you measure growth by adding up consumption.
I think I'll put my stimulus check into savings. Then, maybe, we'll have a snowball's chance in hell of competing with the foreigners we're selling the asset of our country to.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
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