EPIC INVESTOR

Berkshire Hathaway's Shareholders Meeting

2012-05-07T23:37:00.002-07:00

This past weekend Warren Buffett and Charlie Munger fielded some four dozen questions from shareholders, analysts and reporters on things as diverse as the shares buyback, how to become a successful investor and the notorious "Buffett rule".

Prostate cancer

I expected that this year the main topic would be Buffett's heatlh, given that he recently announced he's got prostate cancer. But it was barely mentioned during the meeting, except for when Andrew Sorkin asked him how he was feeling. Buffett said he was great. Munger took issue with so much concern about Buffett and not much about him. Munger claimed he probably had prostate cancer too, but he wouldn't let anyone test him. That made the crowds laugh.

How to be a successful investor

In two separate questions, shareholders asked Buffett what he would do if he were starting today, what to buy and what to avoid. His advice for someone starting now would be to start early, build up a very good history of returns quickly and raise money to buy entire companies. He said he would have started earlier and sped up his early career to achieve what he has achieved later with Berkshire. The later part of his career he wouldn't change.

He again referred to chapters 8 and 20 of the Intelligent Investor by Ben Graham as the two most important chapters one should read to be good investors. His ideal MBA course would teach students how to value companies and how to think about markets, which are exactly the topics of these chapters.

As for what to avoid, he mentioned again one should steer clear from IPOs, since those tend to be done at the best time for the company and not the investor and they are typically hyped by media and analysts due to the fees associated with their sale. "Special promotions and commissions almost guarantee prices won't be cheapest", said Buffett.

Buffett would also avoid buying medium or long-term sovereign bonds from any country, including the US, right now.

BRK buyback and dividend

As is already usual, a shareholder asked why a buyback instead of a dividend and Buffett again explained that a dividend is not as tax efficient for shareholders as a buyback.

He's willing to buyback stock in unlimited amounts, so long the stock remains at or below 110% of price-to-book ratio, which significantly undervalues it, and that he keep at least $20 billion of working capital -- that's Berkshire's safety net.

When asked about the buyback and why he implied the stock was undervalued but he never let shareholders know when the stock is overvalued, Buffett explained that it would make for a very awkward moment if he were to publicly announce when Berkshire stock was overvalued. Makes sense.

He also answered a question on why the BRK was undervalued now and whether it was due to the "Buffett rule" he proposed. He didn't speculate on why it was so, but just said these are things that happen in the stock market.

Another shareholder asked him whether a dividend would help stabilize the stock price and reduce volatility by setting a floor for the stock and Buffett vaguely replied that in fact it wouldn't, that volatility happens for dividend payers too and that a dividend could also help increase volatility, but he didn't elaborate.

Gold

I sent journalists a question about gold, but they didn't ask it. Luckily, a shareholder asked a related question pointing out that gold has outpaced the return of BRK stock in the last 10 years.

Buffett, always with numbers on top of his head, replied that the price of gold and BRK 47 years ago where $15 a share and $20 per ounce, respectively and that now BRK/A trades for $120,000 while gold is at $1600. The problem, he explained, is that people look at short periods of when a security or asset had a strong return and try to extrapolate from it. (Granted, 10 years is not exactly a short period, but Buffett is a very long-term investor.) Both Munger and him emphasized again that productive assets are better than inert ones -- and they are more fulfilling and rewarding to hold, because one can see them grow and produce wealth, while inert things like gold remain the same forever.

This is a very controversial point and I will just add that the distinction does not need to be black and white. Buffett is a businessman and likes to invest in companies. In the long run, an investment in well-managed companies at the right price should outpace the return of gold. But gold has its place in a well-diversified portfolio, especially because it's so hard to pick well-managed companies and buy them for the right price. So, sometimes a return of zero (after inflation), which is what gold offers, might be a good thing, when the economy is in trouble.

Buffett's personal account

When asked why he owned JP Morgan Chase for his personal account but Wells Fargo for Berkshire's account, Buffett explained that securities laws would see a purchase of the same stock in both accounts as a conflict of interest. He likes Wells Fargo more than Chase, but he is not allowed to buy Wells Fargo for his personal account, so he buys his second-best idea instead. He said he reserves his best ideas for Berkshire, always.

Purchase of a newspaper

A shareholder asked why he bought the Omaha World-Herald paper if he had said a while back that newspapers are a dying industry. The shareholder insinuated that Buffett might be self-indulgent by buying his home town's paper. Buffett then explained that he bought it because that particular newspaper has a very tight local community around it and local newspapers are still a reasonable business. No one buys a newspaper for looking up national news, stock quotes or classifieds anymore. But for local news, obituaries and other local information, they can be useful. Another good local paper is the one he already owns, in Buffalo, New York.

Google and Apple

Asked about technology, Buffett explained that both Apple and Google are incredibly profitable companies with large margins and they will probably do well 5 to 10 years from now. They are hard for competitors to dislodge. But he wouldn't buy either because he doesn't have any edge on studying them. He wouldn't short them either. Charlie said they have a reverse edge in analyzing deeply technological companies such as these giants.

How fast will the economy grow

While not a fan of predicting the future, Buffett entertained a question about how to get a 4% return per year. He said that GDP tends to grow with the population (my note: plus changes in efficiency typically due to technology) and so anything more than a 1% real (i.e. after-inflation) return would be already a wonderful result for such a mature economy as the american one. Charlie agreed. At this rate, they added, the economy would double every 72 years or so and with inflation an indexing portfolio should double every generation.

The "Buffett" rule

Buffett clarified that his proposed tax rule is meant to correct a deviation that has been increasing in the recent years. Currently, out of the top 400 highest individual earners in the country, a full 131 of them pay a tax rate below 15%. Years ago this number was only 16. This shift has been made possible by various loopholes and tax breaks given to the rich. He suggests a way to fix that so that he himself should be taxed at a higher rate than his secretary, Debbie.

Energy policy and foreign oil

Munger was vocal about people thinking about "energy independence" the wrong way. He thinks we should use foreign oil first and conserve our own oil for later. Most people get this backwards and think of energy independence as extracting our own oil to avoid buying foreign oil.

In summary, it was again a very useful trip. Every year I learn something new, though, the main tenets of his investment methodology are repeated every year. But since repetition leads to solidification, that's not a bad thing.

Disclosures: I own BRK at the time of writing and I will probably own even more by this time next year. :-)

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Two High-Yield Dividend Payers Worth a Look

2012-03-24T12:52:00.000-07:00

It's hard to spot a bargain these days, especially with the markets so fairly-priced as they have been in the last year or two. So, it's no surprise the two names I'm currently interested in are highly controversial. However, I do believe they're worth a serious look. Here they are.

Telefonica (TEF)

Telefonica is a fixed and mobile phone operator based in Spain. Over 60% of its revenues though, come from outside of Spain. A huge chunk of it (43%) comes from Latin America and within Latin America, Brazil is its biggest market with a 43% share of the LatAm market.

Here are some fundamental stats. TEF has:

An attractive dividend yield of around 12%.
Grown dividends at a compounded 23% annually for the last 7 years.
Grown earnings at a compounded 12% annually for the last 10 years.
A 10-year average earning P/E multiple of 12.
A current P/E multiple of only 3.6.
Sales (top-line) growth of 8% over the last 10 years.
A book value that has see-sawed in the last 10 years and is pretty much unchanged.
An average return on equity (ROE) of 25% with about 7x leverage.

Valuation:

Assuming the stock will go no where for the next foreseeable future, but assuming earnings will continue to grow at least at an 8% annual clip and dividends follow suit with a 7% annual increase, the intrinsic price of the stock on a purely dividend-growth basis should be around $21, with a 15% annual rate of return.

That is, the price at which an investor would receive a 15% annual return is $21.

Currently, the stock is trading for $17, so it's a screaming buy assuming the company is not about to jump off a cliff. For the current price and same assumptions, one would be getting a 17% return on investment from its dividends alone. Any capital appreciation would be icing on the cake.

AstraZeneca (AZN)

AstraZeneca is the U.K. based pharmaceutical company that manufactures known drugs such as the popular cholesterol-lowering Crestor, among many others. It's been having some pipeline trouble recently and struggling to keep inventing new blockbuster drugs. It has gone through a $2.4 billion restructuring that has so far cost $2.5 billion to implement. It had 92 new drugs in its pipeline at the end of 2010, but 34 have been dropped so far.

With an aging global population, the growth story is that health care will continue to be a big part of people's expenditures. To counter, competition from generic drug makers is heating up, with some generic manufacturers speculatively launching clones even before the original's patent expiration happens, on a gamble to challenge the patents in court.

Blackrock, the big investment outfit, just recently bought 6.45% of the company.

As for fundamentals, AZN has:

A high yield, 6.5% dividend.
Grown dividends at a compounded 16% per year for the last 10 years.
Grown earnings at a compounded 12% per year for the last 10 years.
A 10-year average-earning P/E multiple of 13.
A current P/E multiple of only 6.
Sales (top-line) growth of about 8% annually for the last 10 years.
Book value that has grown at a 12% annual rate for the last 9 years.
An average return on equity (ROE) of 34% with about 2.2x leverage.

Valuation:

That is, the price at which an investor would receive a 15% annual return is $35.

Currently, the stock is trading for $45, so it's a bit pricey for the conservative assumptions above. For the current price of $45 and same assumptions above, one would be getting a 13% return on investment from its dividends alone. Again, any capital appreciation is pure extra goodness.

Wrap up

Both stocks are trading close to their 52-week lows. With the current economic climate in Europe being negative, I wouldn't be surprised if they continue to slide in the near future. I will be sure to be buying more on pull backs. As Buffett always says, if the steak is cheap, buy more.

As usual, do your own homework before investing.

Happy investing.

Disclaimers: I own TEF and AZN at the time of writing.

Should you buy YHOO now?

2011-09-16T21:47:00.000-07:00

I recently asked this question on my Google+ page. I got some comments there and a few good ones privately emailed to me or in other forums. Here's the wisdom of the crowds, colored with my own perception and understanding.

Pros

Traffic. YHOO still attracts a lot of eyeballs. It's one of the top 3 destinations on the web where people spend time. So, the potential is there for more revenue.
Valuation. About $1B in earnings expected this year, which would put the forward P/E at a reasonable 15.
Leadership. Shakeup could provide new steam for company.
Low expectations. $3B in cash, $14B in total equity and a total market cap of only $18B. Market expects little of this company going forward.
Buyout. Private Equity companies are already negotiating a buyout, which could lift the shares.

Cons

Downward trajectory. YHOO has been declining in traffic, revenues and pretty much everything else for a while now. This is hard to reverse.
Lack of innovation. Enough said.
Talent. Outflow of talent is certainly higher than inflow. This is a chicken-and-egg problem: it's hard to attract talent when the company is sinking, but hard to turn it around without new talent joining the workforce.
Limited upside. Any buyout will probably not pay a lot of premium for YHOO, given that they have few other options at this point.
Risky. Since YHOO is not exactly a super-bargain, risking real capital to hold the stock just to watch it go lower is, well, risky.

What do you think?

I decided to pass. Mostly because I think the turn around story is flawed and the buyout one is more likely, but with limited upside. However, buying some call options could be a good strategy, depending on valuation. I'm still to look at those.

Disclosures: No financial interest in YHOO (neither long or short) at the time of writing.

Is GM a Buy?

2011-08-21T19:15:00.000-07:00

I recently had a discussion about investing in General Motors (GM). I thought I'd share that discussion succinctly here.

Pros

GM is now profitable.
Trading close to book value. Buy the assets, get the income stream for free.
Car sales are up year-to-date.
Car manufacturers are stepping up ad spending, so this could spur even more sales.
The government has taken an interest in the company (the taxpayer still owns about 26% of GM). This could put a floor under the stock.
GM has experience in alternative ("green") fuels and electric vehicles, which is the current trend these days.
Insider buying is positive. The CEO keeps buying shares.
Internal organization is very different now than it was before bankruptcy.
The company is making progress towards fully funding its pension plan. The "hole" came down from $17 billion to just around $10 billion in the last six months.

Cons

The "free" income stream from the pros reason number two above can easily be destroyed by a downturn, poor management or more government intervention.
Government still owns about 26% of the company. History shows that government is terrible at handling companies (see Post Office and and Amtrak for examples).
Alternative fuels and electric cars are not the specialty of GM. There are better-equipped competitors out there that, albeit smaller, could eat GM's lunch in this growing sector (think Tesla, BYD).
GM does not yet pay a dividend.
The company's pension plan is still underfunded by a non-trivial amount ($10 billion).

Overall, I thought I'd take my chances and started a small position in GM.

Disclaimers: I own GM at the time of writing.

Notes from Berkshire Hathaway Shareholder's Meeting

2011-05-05T22:15:00.000-07:00

Once again, as became known as "Woodstock for Capitalism", Warren Buffett and his partner Charlie Munger fielded questions from shareholders and journalists from all around the globe. With an audience north of 17,000 people present in the Qwest center in Omaha, Buffett, 80, showed he's still in decent shape and perfect wit by withstanding a grilling session that lasted for about 6 hours.

David Sokol

Buffett started clarifying his mistake at publishing a press release about David Sokol, the Berkshire manager who bought shares of Lubrizol in the days leading Berkshire's offer to purchase the company outright, pocketing an estimated three million dollars.

Buffett explained why his much criticized press release was too positive on Sokol. Buffett felt like publishing a press release only criticizing David for his "inexcusable" mistake would be diminishing all the great work Mr. Sokol's done for Berkshire. Mr. Sokol did great things and Buffett didn't want them to be lost because of this one mistake.

Buffett also said he does not believe a man who was paid handsomely over many years (last year his compensation was US$ 14 million) would act in bad faith to earn another 3 million. He believes Mr. Sokol's lack of proper disclosures were an oversight, not an act of bad faith. But that nonetheless, they were inexcusable.

He then went on to mention Mr. Sokol's altruistic personality. When Berkshire first bought MidAmerican, Buffett offered a $50 million package to Mr. Sokol and $25 million to Greg Able (another executive at MidAmerican). But Mr. Sokol refused to accept such split and suggested a 50-50 split between the too.

Buffett also clarified that he didn't fire Mr. Sokol on the spot because he wasn't sure of the involvement of Sokol at first, but that when Sokol resigned Buffett decided to accept the resignation which is cheaper than firing an executive and less prone to law suits.

I think deep inside Buffett didn't want to let Mr. Sokol go, but was forced to act this way to keep his image clean and Berkshire's reputation pristine.

Investing in Gold

When asked about investing in gold, Buffett said gold "doesn't do anything". He said people can stare at gold, climb a ladder on top of a pile of gold and sit on it and claim to be the king of the hill. One can even fondle gold and rub it. But it doesn't generate any wealth.

He then proceeded to tell the same funny story he's told before: suppose Martians were watching the Earth. They would be quite confused by seeing people dig up gold from the ground in South Africa, transport it to New York and then bury it again in vaults.

Buffett simply prefers to invest in things that create economic value and tend to grow over time, such as well-managed companies with competitive advantages that require little re-investment of capital to maintain sales and grow, such as See's Candies.

I very much agree with this. In fact, I wrote about it very recently on my discourse on how to fight inflation.

Investment Vehicles

When answering a question about money, Buffett mentioned that there are three types of investment vehicles: currency-denominated investments, things that only have value because of prices people pay for them and businesses.

Currency-denominated investments are poor investments over the long run. All fiat currencies tend to go to zero over time. Even shorting currencies is not a great investment because one still needs to know which one will go to zero faster, but in the long run, they all go, because of inflation. So Buffett prefers to stay away from these, which include bonds, loans, IOUs and currencies. He did, however, short the dollar a few years ago for a handsome profit. But he doesn't believe he can consistently predict which currencies will lose value faster.

Things that depend on others to pay up later include gold, oil, and precious metals in general. Even though some metals have utility and oil is a finite resource, he doesn't have any edge on predicting what the demand is for these things. So he doesn't invest in them.

The third category is his favorite: well-managed companies that require little re-investment of capital to function. He cited an example of See's Candies which went from $30 million to $300 million in sales with just a $31 million investment (from $9 million in assets when he purchased it to $40 million now). So, a 10x gain was obtained with less than 10x investment, which is a property of great businesses.

Again, I agree completely with Buffett. I also classified different types of investments recently. Although not exactly like Buffett, my categories are similar.

Investing in Oil

When an investor asked if she should short oil or go long, Buffett answered that instead she should teach us how to do it, because he didn't have any insight. He simply said he has no edge on picking the direction of commodities and as such he doesn't get involved in doing it.

Too Big To Fail

An investor and small business owner asked whether there should exist a business that is "too big to fail", which was the case of many US banks in 2008 and 2009 and also AIG, Freddie and Fanny as well as General Motors.

Buffett said that these businesses do exist and in fact, there are now countries that are too big to fail. This is simply unavoidable, in his view. However, he doesn't believe in free bailouts either. He suggested a policy where shareholders should get wiped and the CEOs and their families should lose all their money, certainly all their money earned when at the helm of such big institutions. Such treatment would protect investors and the population by discouraging CEOs from taking huge risks.

In the case of GM, Buffett said he was on the fance on whether it should have been bailed out, but he said that in hindsight it was a good move by the government. I disagree. GM was not too big to fail and it sucked up resources and market share that could have gone to more efficient players.

In the case of banks, I'm sympathetic to Buffett's view, since a run on banks and massive unemployment could have destabilized the country and generated massive domino effects elsewhere. However, it's clear more responsibility is necessary on the part of executives. The trick is to achieve this without too much regulation and without stifling innovation and competitiveness -- if other countries can do it, then the US will lose out by not allowing their banks to do it too. Balance is the key.

Expanding the Circle of Competence

A shareholder asked: "if given another 50 years to live, which new circle of competence would you like to develop?" Buffett first answered with "I really like the preamble", and the crowd laughed. He then proceeded to say that he would learn about tech, because it's a very large field and there will certainly be a few big winners in it.

Charlie agreed and also said that energy would be a good area, because with enough energy all problems of civilization are resolved, such as clean water. Charlie mentioned having read "In the Plex", a book about Google, which he certainly enjoyed reading and learned a lot from it.

Best Businesses To Invest

A shareholder asked Buffett whether an asset-heavy business would perform well during periods of inflation versus a business with fewer assets. His theory was that tangible assets such as factories, machinery, power plants, etc would work as a store of value.

Buffett was unequivocal about this: no, the best business is the one that doesn't depend on too much capital invested in it and can generate profits with minimal capital reinvestment. He again cited the example of See's Candies and compared it with Lubrizol and utilities, which can be lucrative, but are not as good as businesses with moats and low capital requirements.

On Inflation

Buffett dislikes inflation like everyone else. He said that the dollar from when he was born is only worth six cents today. But despite that, he and Charlie did well over time. So inflation is bad, but not as bad as it sounds.

I suppose he was trying to say that controlled inflation is not a very big deal. But that somehow goes a little against his disdain for cash-denominated investments. I guess what he meant by this all is that inflation is only a problem if one is not invested in great businesses and instead holds cash or cash-denominated investments.

Jamie Dimon

Like two years ago, this year again Buffett praised the CEO of JP Morgan, Jamie Dimon, and said it's worthwhile reading his shareholder's letter. Maybe again this year, like two years ago, yours truly will read it and summarize it here. Stay tuned.

On BRK Dividends

This year again, as is common for several years now, people ask when Berkshire will pay dividends. Buffett thinks it's best not to, as long as a dollar retained produces more than one dollar of economic value for the stock. So far this requirement has been met.

The day Berkshire pays a dividend, says Buffett, is the day they admit defeat and can no longer invest money profitably. On this day, the stock price should go down, according to him.

Buffett joked that he wishes his friends live until BRK pays a dividend.

Misc

Many other topics were debated, including a charitable giving program that was discontinued several years ago; Charlie's love for Costco; Ajit Jain's workaholic habit of flying to London on Thanksgiving to continue on working; and the one diploma Buffett has on his wall: "Dale Carnegie's Course on how to communicate effectively".

Buffett also commented that the government not raising the debt ceiling would be the biggest asinine thing it could do. That the debt capacity of the US is larger than it was when the ceiling was instated and that, in his opinion, there should be no limit.

All told, it was worthwhile flying to Omaha to see the Sage. (Even better, on a private jet with a couple friends of mine). I expect to repeat this again in the years to come. Long live Buffett.

Disclosures: I own BRK at the time of writing. I do not own an airplane.

You can follow me on Twitter @pinhe1ro.

What To Do In The Current Inflationary Climate?

2011-04-23T17:44:00.000-07:00

It's no secret that the dollar is turning into dust. It has been depreciating since it went off the gold standard over 40 years ago. And it is now depreciating faster given current government intervention. Just check out the news and expert commentaries:

Of course, there are those who believe the opposite is true, such as Mish and Vijay Boyapati. The argument pro deflation is that the government won't have the political will to allow rampant inflation and their means to trickle down newly-printed money within the economy is limited, barring political suicide.

The truth is that no one on the deflation camp believes the dollar is getting any stronger nor that inflation will not return in the future.

Inflation is the tried and true method that works to reduce government debt. It's what's been going on for decades ever since we've had fiat money. And it will continue in the future, in spite of short periods of deflation.

Becoming Inflation Agnostic

Regardless of what will happen in the next six months or a year, the fact is that investing is about the long term. And long term we will have inflation, like we've always had, plus more, given the increasing deficit this country is running.

So, what's the best way to protect hard-earned money?

There are many ways of doing this, and they all have pros and cons. Here are the ones I know of. I'll break them down into smaller categories, even though everything eventually rolls up as either "cash-flow positive assets", "limited supply entities" or "mixed".

Business Interests (stocks, private businesses)
Precious Metals (gold, silver)
Commodities (gas, oil and agriculturals such as corn, wheat and cotton)
Collectibles ex-precious metals (art in general, rare objects)
Real Estate (land, houses)
Paper Instruments/Derivatives (TIPS, bonds, futures)
Other income-producing assets (patents, royalties)

For simplicity, I will ignore the bottom two classes. I'll just say this about TIPS: while an interesting asset to have some exposure to, its inflation-protection comes from the people creating inflation (i.e. government), so in the long run TIPS are unlikely to offer much real purchasing-power protection.

Business Interests

I believe this is the best way to generate wealth. Having businesses generating income for me is the most scalable way to attract money. After all, I can't have ten day jobs to generate 10x my income. But by owning businesses (or their stock) not only is this realistically achieved, but even more is possible.

And having multiple sources of income is, in my mind, the best way to offset inflation. After all, profitable businesses want to stay profitable, so they increase prices with inflation when they can (unless they are airlines, in which case just don't invest in them, like I did and regret).

But stocks are unpredictable in the short-run and they can be at times grossly over-valued.

The other way is to create businesses from scratch or invest in them privately (private equity) or very early (angel investing). I've tried my hand at all of these. Results will vary and these are hard things to do well. So, if you're not in this camp yet, start to learn or move on to the next one.

Precious Metals

There is no way to value precious metals. And they don't pay a dividend either.

Nonetheless, precious metals have historically more or less retained purchasing power relative to fiat currencies. They can be especially useful in times of crisis when a race to the bottom in currency debasement is in effect, like it is right now.

I would advise people to have some small amount of physical gold or silver with them, such as 5% of their net worth. Timing the purchase of these metals is tricky. I wouldn't hurry to buy right now that they've gone up by record amounts. If you haven't exhausted other alternatives yet, hold off on buying metals until no one is talking about them again. However, if you buy as a contingency reserve and never sell otherwise, then almost any time is a good time to buy.

Commodities

With commodities I see roughly two classes that mostly only exist in theory: those that should go down in price over time, such as agriculturals, and those that should go up, such as oil and gas.

The reason why agriculturals should go down in price over time (all else equal) is because agriculture is becoming more efficient and mechanized -- we produce more food per acre than we've ever did in the past. Oil and gas, on the other hand, are being depleted and we'll eventually run out of them.

However, theory and practice are very different. While oil is going up in price due to depletion (and also instability and speculation), reserves of natural gas are a lot bigger. Natural gas prices have been all over the place and can remain like that for a long time, depending only on supply and demand, both variables which I cannot predict.

Meanwhile, agriculturals have gone up in price, mostly because oil has gone up and the dollar is losing value.

So, what's an investor to do? I believe a diversified portfolio needs some exposure to commodities. However, the vehicles for that exposure are complex and time-consuming. Pure commodities ETFs and ETNs such as OIL, USO and DBA, are not ideal. In fact, they are harmful, because traders take advantage of them in ways I don't want to delve into right now.

My recommendation: if you have the inclination, time and stomach to use futures, go for it. Setup a small account and keep rolling some exposure to grains.

If you don't want to go into the futures market, then get some exposure to the agricultural commodities sector by buying stock in companies such as ADM. Or, for a more diversified (and more expensive) exposure to agribusinesses, try MOO or PAGG.

The disadvantage of having stock in agribusiness companies is that it increases one's exposure to stock market and hence this may offset some of the benefit of being invested in commodities.

As for oil and gas, I believe it's best to own exploration and pipeline companies instead of futures. The reason is that owning oil futures or oil in the ground is very similar: the stock price of companies like XOM should go up as oil goes up (with agriculturals, the wheat and corn are not there all the time, they must be grown, so owning the business is not a great proxy for owning the commodity). So for oil and gas, there's no need to forfeit getting the juicy dividends these companies pay just to offset the stock market risk. But again, if you have the inclination to do futures, that's a fine option too.

Collectibles

Owning a Picasso painting or a Rodin sculpture is a great way to store wealth. It seems to be a trick the rich know and that the poor don't usually understand -- many people think buying art is squandering money, a vain waste of resources. But the value of these rare objects should go up over time. So it serves a dual purpose of decorating the home and storing wealth.

However, the drawbacks are obvious: they are illiquid, non-fungible and extremely hard to deal with.

During times of extreme distress (wars), good luck trading your Rembrandt for food at a decent exchange rate. You may have better luck with a Patek Phillippe, but you first need to find an original item and a qualified buyer.

Finally, this leads us into another category.

Real Estate

Real estate was the darling of the easy-money policy era. Until 2007.

And then it became taboo to even talk about a "recovery" in real estate prices.

Real estate cooled in America and became hot in other parts of the world such as China, Australia and Brazil. In fact, the last two seem to be nearing bubbly conditions, though the make up of these conditions are very different than those in the go-go years of free-houses-to-everyone-with-a-pulse in America.

That's exactly why real estate is now the right place to invest -- because no one is talking about it other than saying how bad it is and how slow it will be for a long time.

What most are missing though is that price appreciation is only part of the equation. Income is the other. Even though prices can continue to tumble into the near future, they must eventually find a floor on rents. Especially in desirable and growing areas.

It is now possible to own real estate essentially for free in many desirable zip codes across America. Right now. For example, in Silicon Valley, companies are hiring, builders have slowed down and yet there are houses on the market that after a down payment can generate enough rent to cover mortgage, closing costs, insurance, taxes and even HOA fees (in case of condos).

Now, depending on the terms, it might even be possible to generate a 6% annual return on investment. Plus any future price appreciation. And that with almost full immunity to inflation, since rents will keep pace with inflation. Add to this equation a fixed-rate mortgage and I see not better inflation protection right now than a cash-flow positive rental property.

Of course, there are drawbacks: the market is not very liquid, tenants are not all the same and managing rentals can be a time-consuming and headache-prone activity. If you're not up for it, the alternative is to go the ETF route, such as RWR or IYR.

Final Thoughts

When fighting inflation there is no silver bullet. It's important to be broadly diversified. And that doesn't mean having many mutual funds. One needs to think in terms of assets that tend to retain value. My favorites are those in the category of income-generating assets, especially business ownership and real estate rentals.

I think now is a good time to buy real estate in America, particularly in areas with positive job growth. Prices may continue to slide, but timing purchases perfectly is tricky. Plan on buying properties that can generate enough income to at least pay for the mortgage. In 2-3 years they will likely turn cash-flow positive and in 5-10 years you'll get price appreciation on top of that.

In the end, you get inflation protection, income and price appreciation. It doesn't get any better than this.

Disclosures: I own RWR at the time of writing.

Never Fall In Love

2011-02-09T11:08:00.000-08:00

Falling in love with a company, its services or its products is well-known to cause its stockholders more financial harm than good. Avoiding this trap is a common advice. And it's a good one.

A Concrete Example

As a real past example, let me tell you about when I invested in Jamba Juice (JMBA), the smoothie shop that is so ubiquitous and keeps expanding. I thought the concept was great. After all, being from Brazil, I know how popular freshly-squeezed fruit juice and smoothies are over there. The fact that Jamba was aggressively expanding outside of its home state of California was a big plus.

This was back in 2005, and I had just discovered Jamba Juice. I immediately fell in love with the idea and wanted to invest in it. But Jamba was a private company back then and all they gave me was a discount coupon when I offered to invest some money into the company. Silly me.

So I waited for its IPO and then waited some more for the post-IPO hype to die down. In 2007, I finally decided to buy, based on its expansion plans, and a lot of excitement about its products and business model. After all, who wouldn't want to buy a Jamba Juice smoothie?

Result?

Price paid: $6.49 per share in 2007.
Current price: $2.37.
Maximum price in the last two years: $3.83.
Dividends paid: $0.

Now you do the math.

What went wrong? First, I didn't stop to analyze the market. I assumed everyone must love smoothies. But it turns out that outside of California, Hawaii and Florida people don't care as much about smoothies. Moreover, only during the summer months do people care enough to look for Jamba's colorful stores. Also, Jamba's expansion plans were so aggressive and it expanded so quickly that it had to close some poorly-performing stores, hurting the bottom line.

And how could this business model be so popular in Brazil? Despite the weather differences, juice and smoothie shops in Brazil typically freshly squeeze their fruits in front of customers, while Jamba mainly freshly blends fruit concentrate with a sugary "dairy base", according to their own in-store information.

I took my losses on JMBA today, after keeping a shred of hope for the last 3+ years.

Conclusion: it pays to look beyond products and services before investing. Look at the market, management quality, financial situation and company expansion plans.

Avoiding a Current Trap

With the lesson learned from Jamba Juice, I recently avoided a similar trap.

I'm a big fan of Vitacost, my supplier of vitamins, herbs, protein, etc. Their products have the lowest price, they ship super fast and their customer service is great. In fact, over the many years I've been using them, I've only had two minor problems with shipping, which they resolved so quickly and satisfactorily that I even wonder if they caused the problem on purpose so that I would fall in love with their speedy customer service.

Sounds like an ad for them, right? But I'm in no way affiliated with them. And that's for the betterment of my pocket.

You see, I wanted to invest in Vitacost for a while and like with Jamba Juice, it was still private when I first thought about investing in them. Today, I discovered that they've been public since 2009, ticker VITC. So I started looking into a possible investment.

Even before turning to their financials I find a slew of terrible news about the company. First, it failed to file for the required paperwork with NASDAQ and it is at risk of being delisted. The CEO has left recently, and it is postponing its shareholder meeting. Worse, it's being sued by not one, but three law firms for security irregularities. Something about its executive team having allegedly lied about its products, services and financial strength to mislead investors into a higher valuation.

Of course, all the bad news could mean that the stock price is depressed and when things are resolved this could be a terrific opportunity to buy. However, for a company with such short track record and with so many problems accumulating right out of the gate, I can't even start considering an investment in it.

I will continue to enjoy Vitacost's good product selection and quality service. But I'm not buying any piece of the company any time soon.

Conclusion

The advice "don't fall in love with your stock" is a good one. Treat all your investments as anonymous machines working for you. If they fail to work for your best interests, it's time to replace them. There's a large pool of good ones out there. All you have to do is do your due diligence, look at the fundamentals and choose carefully.

Disclosures: No position in any of the above mentioned securities as of the time of writing.

Why Abbott Looks Cheap

2011-01-31T11:03:00.000-08:00

The pharmaceutical juggernaut Abbott Laboratories looks reasonably cheap these days. Its shares have been going down for the past few weeks and it's a good buying opportunity in my opinion. Here's why.

Consistent Dividend Growth

Abbott has grown dividends consistently for over 25 years. It's part of the Dividend Aristocrats index maintained by S&P. Not only that, but ABT has grown dividends an annualized 9.33% over the last 11 years. On average, the year-over-year dividend growth has also been around the same ballpark, 9.45% (the average and the annualized 11-year return can differ in case most of the growth was in one or just a few years as opposed to consistent over time. When they match, it's a sign the growth has been sustained over time).

Consistent Earnings Growth

A consistent dividend growth needs to be accompanied by a consistent earnings growth too or the dividend is not sustainable. Over the same last 11 years, ABT has had an annualized earnings growth of 9.31%, which comes in very close to its annualized dividend growth. This means that dividend growth is supported by earnings growth directly, which is a good sign. It means the company is passing through all of its extra earnings back to shareholders via dividend increases.

Some people prefer to see earnings growth slightly surpass dividend growth to be on the safe side. But by doing so, it means the company is increasing its cash reserves and I would want to understand why. It could mean an acquisition is coming up or the company is expecting to have higher expenses going forward (patent disputes, lawsuits, etc). So, higher earnings growth per se is neither good or bad, but must be understood. In the case of Abbott, for the past 11 years earnings and dividend growth have matched, which can only mean the company is growing smoothly and not becoming lopsided in anyway, neither increasing cash reserves nor depleting it, hence a very good sign in my opinion.

Consistent Sales Growth

Just because earnings growth have been consistent during this time does not necessarily mean the company is actually generating more cash since earnings can be so easily manipulated. However, 11 years is a long time, especially when the earnings can be seen in form of dividends during this time (it's a lot harder to fake real cash in your pocket than it is on an income statement). Nonetheless, let's see how Abbott fares in sales growth, which is a more direct way of assessing where growth is coming from.

For the past 10 years, sales have grown an annualized 8%. This is only slightly less than the 9% earnings growth, which indicates that for the most part sales have kept pace with earnings. It also indicates that the company has been aggressive at cutting costs at a rate of 1% per year. In the long run I'd expect earnings and dividend growth to slow down to catch up to sales growth. Still, 8% is a good growth rate to have.

Dividend Yield is Moderately High

At a price of approximately $45.50 and with an annual dividend of $1.76, ABT sports a dividend yield of 3.8%, which is pretty decent in today's market. When factoring in a 8-9% growth, it means investors can expect a return of 11-13% on their investment going forward, minus inflation and plus any share price appreciation.

Implied Price using Dividend Discount Model

Treating a share of ABT as a bond and investing in it just for the dividend using the Dividend Discount Model, I came up with a price range for ABT of between $59 and $44. This means that ABT is undervalued at the time of writing. My assumptions were a 10-11% discount and 7% dividend growth, which, given the track record of sales growth of 8% is still a little conservative.

Other Considerations

Other things to consider before investing: why is ABT going down in the past several weeks? No single news piece accounts for this decline, but a more thorough investigation is warranted.

One a price-to-earnings basis, ABT looks fairly valued with a tailing P/E of about 15. However, its forward P/E is only 10, since ABT expects to earn between $4.54 and $4.64 per share in 2011.

Conclusion

All things considered, ABT looks cheap to me. I'm buying shares of Abbott (ABT) at the time of writing. Please do your own analysis before buying.

Disclosures: I own shares of ABT at the time of writing.

Are Muni Bonds Cheap Again?

2011-01-23T21:30:00.000-08:00

Back in 2009 Munis got a lot of attention because several states were in trouble, meaning they couldn't service their debt loads. The situation is not much different now and still most muni issues are still being serviced.

So, what has changed?

For one, their credit ratings. Specifically, two California issues I own (one of which I discussed back in 2009) are now back in investment-grade camp. Both 13062TPU2 and 13062TSB1 started 2009 as A+ issues and were downgraded to BAA1 (or BBB as Fitch calls it). Both are now back to A-, as of late 2010. And yet, their prices have fallen recently, probably in anticipation of more ugliness ahead.

However, these two issues are still paying their coupons and both are fully backed by the state's taxing authority. No disclosures of other material events have been filed with the MSRB.

In this case, should a California-based investor buy more?

I can't see why not, at least in the short term. Even if inflation picks up, it's unlikely to pick up so fast as to obsolete these papers, whose coupons are 4.5%, but are yielding now about 6.2%, tax free, at approximately $78 per issue.

Therefore, I'm officially adding to my position. The only trick is that the market is so illiquid now that these bonds are not being offered on a daily basis. Investors must request offers, which are hard to come by. Patience shall be rewarded.

Disclosures: I own both bond issues mentioned above. Consult your financial advisor before making any investment.

S&P 500 Fair Value: What to Expect in 2011

2011-01-18T23:24:00.000-08:00

About two years ago I posted my mathematical assessment of the market's fair value. It's still a widely-referenced article. Given your interest and my own curiosity as I prepare my investment route for 2011, I thought I'd repeat that study using more recent data.

But this time, I'll use both a dividend discount model and an earnings growth model.

S&P 500 Fair Value from a Dividend Perspective

Using the Dividend Discount Model here's a quick summary of the market today and what is in store for 2011, if history helps.

If we treat a stock as a bond and nothing else, we're expecting to get in the future our model for dividends that we got in the past, plus some growth. This is one of the most conservative ways I know to value a stock and hence why I'm using it here to value the index.

Here are the numbers:

All-Time Dividend Growth. Since 1960, the S&P 500 has grown dividends an average of 5.04% per year (note: variance is large, meaning some years this number is much higher, others much lower).
10-Year Dividend Growth. The last 10 years have seen a lower dividend growth, just 3.58% annually.
Today's Fair Value. Assuming a 5% growth ad infinitum a 7.5% discount rate based on an estimated dividend for 2011 of $24.28, today's fair value is 971, meaning the market is overvalued by 33%.

Modeled value vs. real value for S&P 500 using DDM.

S&P 500 Fair Value from an Earnings Perspective

Earnings provide another way to assess the fair value of an index. By looking at historical growth and current earning yield, we can put a fair price on the index. However, earnings are a secondary measure of what one can get out of an index, since not all earnings flow to the investor as dividends.

While earnings can give us a good feel for how the market is doing, it can't tell us what the companies will do with their earnings nor how they will return them to us investors. Dividends can be cut, but earnings are flakier, given that they're not usually thought as belonging to shareholders, which is a shame, but quite true of most companies.

Here are the numbers:

All-Time Earnings Growth. Since 1960, S&P 500 earnings have grown an annualized 6.81%.
10-Year Earnings Growth. For the trailing 10 years, earnings have grown 4.07%.
Today's Fair Value. Assuming 2011 earnings of 87.84 and applying a P/E multiple of 15, the S&P would be valued at 1318 today, meaning the market is undervalued by 1.7%.

Modeled value vs real value for S&P 500 using earnings.

Conclusion

Whether you choose to believe the DDM is more accurate or the earnings approach is more accurate, both currently indicate that the S&P is anywhere from fairly-valued all to the way to grossly overvalued.

However, this numerical assessment assumes a smooth continuation of history without taking into account all that is going on with the economy, international affairs and expectations of inflation/deflation. Use this to help you make informed decisions, but do not rely entirely on it.

The source of raw data is still here (no affiliation with the authors or their institutions).

Disclosures: I own SPY and many other whole market-tracking indices at the time of writing.

Portfolio Returns for 2010

2011-01-08T05:09:00.000-08:00

2010 is now history and it's time to update my portfolio returns to check on my progress so far.

In 2010, my US portfolio, which excludes real estate and foreign accounts, returned (including dividends) approximately 11.3%. Comparing with the S&P 500, which returned (including dividends) approximately 15.1%, my returns are not great.

But my results don't bother me at all, because my portfolio has less risk than the S&P and does better than the S&P in down years. Let's see why. But first, let me define risk.

Risk

I don't consider risk to be equal to beta or the Sharpe ratio. That's because I don't mind price swings (which increase beta) as long as I believe that in the long run, my buying power will be maintained or increased versus inflation.

In other words, I consider risk to be the degree with which I may lose principal, either via loss of capital (due to bankruptcy, long-term loses in the underlying companies, etc) or inflation.

With that, let's dissect my portfolio a bit to understand where I trailed the market and why I should not worry about it.

Portfolio Drag

Looking at my holdings and the weights they play on my overall allocation, I found out that the main reason for underperformance in 2010 was due to my bias towards large value companies. These are mainly blue chips that pay steadily-growing dividends such as HD, WMT and JNJ.

Let's look at a couple of those:

Johnson & Johnson (JNJ). The BandAid maker opened the year at $64.41 and closed it at $61.55, hence returning -4% in share price appreciation. When adding the 3.2% dividend, JNJ's total return was a negative 0.8%.

Walmart (WMT). The world's largest retailer opened the year at $53.45 and closed it at merely $54.09, thus returning 1.19% in share price. When adding its dividend of 2.2%, WMT's total return was 3.39%.

Home Depot (HD). The home-improvement retailer opened the year at $28.93 and closed at $30.21, thus returning 4.4% in share price. Adding its 3.3% dividend, HD's total return was 7.7%.

Therefore, my over-reliance on these big names caused my portfolio to lag behind the larger market.

However, as I've mentioned before, I believe my capital will be preserved better if I stay with these stocks for the long-run, as opposed to rotating in and out growth or "story" stocks throughout the year.

Goals, Restated

For the largest part of my portfolio, my goal is on dividend growth and capital preservation. As such, I believe these companies will continue doing the job. All three have been increasing dividends over the years (HD did pause for a while though, but I believe they will resume soon) and as long as my capital is safe with them, I will reap the benefits of the increasing dividends over time.

To recap my investing approach: When I invest, I look for companies with a history of sustainable dividend growth. Then I factor in this growth and current share price to determine a price I should pay now that will yield at least 11-12% dividend return over many years, with a margin of safety of between 10 and 15% (depending on various fundamental and historical factors).

For this reason, I'm quite happy with my returns so far. I will lag the S&P in good years, but I will do better in the down years (like I did in 2008).

Disclosures: I own every stock mentioned above at the time of writing.

Two High-Yield Funds To Consider In 2011

2011-01-01T09:50:00.000-08:00

In my quest for high returns, high yield is an obvious candidate. It's also a tricky one for the same reason: if it's so obvious, it probably won't last long or is very risky.

Nonetheless, a little bit of research can help mitigate these things a bit. Research won't guarantee anything -- nothing is ever guaranteed in investing. But I digress.

Here are the two funds that may help boost a small part of your portfolio the same way they're boosting a small part of mine (emphasis on small).

CEF Income Composite (PCEF)

The PowerShares* Closed-End Fund Income Composite (ticker: PCEF) is a fund of closed-end funds seeking high current income. It tries to achieve this by rotating in and out of closed-end funds when they offer a discount to NAV (net asset value) and good risk-reward prospects based on PowerShares proprietary trading technology. It currently yields about 8% and pays out monthly dividends. It has a very steep fee: 1.81% (0.50% for the ETF and the rest as per the underlying funds).

What I like about this fund is in part derived from what I like about CEFs (Closed-End Funds): they often trade at a discount to NAV and attract less attention than other funds. CEFs are often leveraged and they use long and short strategies to boost performance (and thus increase risk). The subject of closed-end funds is very interesting, but long. I'll reserve the details for another post.

With PCEF in particular, the yield and the monthly payouts are very nice. I looked at the top 5 funds that compose this ETF and they are reasonable funds with the typical risk profile of CEFs: some leverage (20-30%), a good diversifications of securities and most are not managed payout funds, which in my opinion are horrible funds (managed payout funds are those that make a distribution whether or not they have gains, which means that in lean times they will return capital to shareholders, which is a waste of time). Sadly, out of the top five funds, two are returning capital to shareholders.

Here is the breakdown of investment of PCEF, according to PowerShares:

(source: PowerShares.com)

High Yield Bond Fund (DHY)

The Credit Suisse** High Yield Bond Fund (ticker: DHY) is a simple CEF, not a fund of funds. It invests primarily on US corporate "junk" bonds. These are bonds rated "below investment grade" by the credit agencies. What this means is that these securities are less likely to re-pay their debts than the theoretically safest bond out there: US treasury bonds. In reality, no company wants to default on their bonds, which would imply having to file for bankruptcy protection and possibly liquidate the company. But in practice, this does happen, so the credit rating is important. Just keep in mind that low doesn't mean investors won't get paid. It means investors should demand higher yields.

DHY offers a monthly "dividend" (treated as regular income at tax time) that yields about 11% annualized. The underlying portfolio has a medium duration -- 4.75 years -- which means that the portfolio is not super sensitive to interest rate changes like, say, a 30-year bond. But it is not immune either.

The fund is leveraged, about 29% and has an expense rate that is very steep: 2.65%. Typically, I don't invest in funds with high fees, but in the case of CEFs I allow a few exceptions when I can get the funds at a discount.

This fund in particular is offering about 1-2% discount to NAV right now (it was 1.1% when I bought it). But it recently traded at a large premium (see graph below), which means that an attentive investor may capture outsized returns.

(source: CEFConnect.com)

It has, however, traded at significant discounts to NAV in the previous 3 years, which means this is a short-term play only.

Conclusion

I consider both of these investments to deviate from my value strategy. First, they are expensive and leveraged and second, at least DHY is a short-term investment only given its long history of premium/discount. So, consider yourself warned. However, the yields are decent and given that inflation is pretty much staying under wraps for a short while (at least until the Fed hits again with QE3), these two funds can offer a nice current yield.

Have a profitable 2011 everyone.

Disclosures: I own both of these funds at the time of writing.

* I'm not affiliated with PowerShares in anyway. Moreover, I usually don't endorse their dynamic way of portfolio construction and higher fees. This is one of the exceptions.

** I'm also not affiliated with Credit Suisse either.

The Problem With Investing in High-Tech

2010-11-04T17:10:00.000-07:00

As a high-tech engineer and a value investor, I'm often caught in the middle of what might be seen as a conflict between the two: should value investors shun high-tech?

Hardcore value investors often quote Warren Buffett's reasons for not investing in technology companies: Buffett admits he does not understand the world of high technology well enough to be sure of which companies will still dominate their core area in 10, 20, or even 30 years from now. Despite being friends with and admirer of Bill Gates, Buffett has never invested in Microsoft nor any other high-tech company. The closest he got to high-tech was investing in Chinese fuel-cell maker BYD.

The Case in Favor of High-Tech

Predicting dominant position in 20 or 30 years is not really what value investing is all about. There's plenty of money to be made by companies that don't fully dominate their markets. After all, not every company can be a dominant player in its market, and there are way more profitable companies than markets out there.

Moreover, being the dominant company in the next 10 to 30 years is probably asking too much of tech, where many of its fields did not even exist 5 or 10 years ago. Fortunes can be made in a short span of time in technology, since consumer preferences change quickly, specially for online services (think social networking, search, micro-blogging platforms, etc).

Also, high-tech is where a lot of attention is. And following attention, many times is reward. And attention should be there in case of tech. With simple changes millions of lives can be changed (typically for the better, but not always).

Think of how people found addresses until recently: physical maps. Then printed maps online, GPS devices and now phones and watches can guide you from Timbuktu to Kathmandu.

Or how many expecting mothers couldn't see if their babies had any problems before they were born because ultrasound imaging technology didn't exist.

The Case Against High-Tech

That said, there are real criticisms for investing in tech that are not related to the difficulty in predicting dominant positions in the future.

The problems are many.

Need for constant innovation. How can one ever be sure that the next product to come out of Apple will be a blockbuster? Motorola all but disappeared from the market after its success with the Razor phone. One day the Apple's iPhone is all the rage, the next day, Google's Android is outselling it. High-tech companies need to invest a lot of effort into innovative new products to keep people buying new ones. And that entails spending money on research and development and also retaining talented employees. Compare Apple or Nokia with Coca-cola and WD-40. Which ones haven't changed their product in 20 years?

High-tech companies are typically young and without a solid track record. That's just the nature of their businesses. While this is not true for some more mature companies such as Microsoft and Intel, others are still not exactly on Value Line's 10-year index either.

Most tech companies don't pay dividends. And the few that do typically don't pay meaningful dividends. They keep the cash around for making deals, acquiring smaller upcoming companies and defending their positions, which can typically be attacked very quickly by faster, more nimble smaller competitors.

Repeat business. While not all tech companies are single-sale business, some are. How many times can someone buy a new video game, laptop, cellphone, etc? Having repeat customers can often yield superb results. Think Starbucks coffees and Gillette razors. Warren Buffett once said about his investment in Gillette that he takes comfort in knowing that 2.5 billion males will be shaving in the morning.

Too much attention. As discussed before tech draws a lot of attention and it's harder to find inefficiencies and mispriced securities when everyone is dissecting these companies. Value investing has a lot to do with discovering hidden gems in balance sheets.

Conclusion

All told, I love innovation and the occasional high-tech gadget. And I do reserve a small pool of money to invest in promising new technologies and solid high-tech companies when they fit my investing criteria.

But when it comes to investing the bulk of my money, it goes into companies that are simple, have been established for long, draw less attention, don't require a lot of innovation to maintain and, of course, pay out lots of dividends.

Disclosures: I own shares of PG, KO, GOOG at the time of writing.

Starting Your Own Business

2010-10-17T22:00:00.000-07:00

I want to apologize. It's been quite a while since I last wrote here. You'll know why in a moment. But first, I want to recap what I consider to be "the" formula for getting financially independent.

The Get Rich Constantly Formula

Long time readers of this blog will know what I consider to be the formula to get rich. It boils down to constantly building cash flow that gets reinvested into more cash-flow-generating investments.

To get there, the formula goes like this:

First, invest in yourself with whatever means you have.
Get a job where you can get raises often.
Save money and invest. Focus investments on...
Dividend-paying stocks.
Real estate, for the rent and proceeds from sales by building it yourself.
A small part should be invested in a mix of bonds (municipals or corporate preferred), commodities (gold, oil, agricultural), foreign currencies, and to a lesser extend speculative capital gains opportunities.
Private equity (angel investing, small startups).
Building a business.

The last one, Building a Business, I have alluded to a few times, but haven't discussed in detail. So, today I'd like to focus on it.

Starting a Business

Starting your own business is a big decision. One that needs to be fully thought-out before embarking on the entrepreneurial ship.

On the other hand, a business, if built right, can help one grow cash flow. The idea is to leverage resources -- money, hard assets, other people's time and effort -- to solve a problem that people are willing to pay money for. With the proceeds from sales (of service or goods) one reinvests in the business to make it grow to its full potential. As an entity, a business lives forever and if profitable, that theoretically infinite stream of income can generate salary for many as well as dividend to shareholders (you, the business owner).

Fallacies of Starting a Business

Note that I suggest starting a business as yet another source of cash flow, similar to buying dividend-paying stocks. The idea is to leverage "the system", which is the sum of assets (patents, machinery), employees, and a plan (the business plan), to generate this cash flow.

But many people confuse working on your business with working in your business. One's goal should not be to create a new job for oneself. That you already did on step 2.

Instead, one should focus on working on the business. This means building a rock-solid plan that is so simple anyone could execute. Why? Warren Buffett once explained why: "I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will".

Hence, your goal should be to come up with a simple system that can be applied repeatedly to generate money as a business structure. Of course, this is not to say that there is no work involved in the business at first. If it were that easy, anyone would do it. The goal though, is to make it simple to operate and free yourself to work on it -- that is, generating improvements, new ideas, closing deals -- instead of doing all the jobs that can be outsourced like accounting, paper filing, greeting customers (if that's not what you're good at) or talking to suppliers (unless you're a good negotiator and enjoy doing that).

Take, for example, a restaurant. Many people can cook. Many people can cook well. But cooking well doesn't mean being able to have a restaurant. In fact, cooking well can easily get in the way of building a great restaurant. Why? Because as a restaurant, one needs to be able to provide fresh and tasty food in a short amount of time to many people. Even if you have a small restaurant that only serves four to five tables at a time, you still need to cook their meals within 15 to 25 minutes. No one will wait an hour until you roast that pork and no one will want yesterday's pork either.

In this case, cooking like your grandma used to may be a detriment to the business. The trick, so I'm told by a friend who owns a great restaurant, is to develop recipes that are fresh, delicious and can be prepared relatively quickly in a consistent and repeatable manner. Pre-cooking that pork will not work unless you know how to keep it fresh and moist and ready to serve while your customers wait.

My New Business

Okay, so you got the message. You may still be wondering why it took me so long to post something new here.

The reason is that I've been busy working on one of my passions outside of investing: nutrition and fitness. And as an investor and entrepreneur I decided to follow my own formula and turn this passion from a hobby into a business.

Today, I'm proud to present my new venture: Entropy Energy Replenishment Drink. Entropy is an anti-aging drink that helps the body's own mechanisms turn fat into mental focus (these statements have not been evaluated by the FDA. Entropy is not intended to treat, cure, prevent or diagnose any disease). Entropy was developed after many years of experimentation and studies. You should try it out. To boot, you get a 10% discount by using coupon code EPINV2010X.

Besides creating it out of passion, I partially did this to learn the steps and later be able to tell others about it. With this new business, I've now executed on all steps of my Get Rich Constantly formula above.

So now you know why the long absence. Next time, I will discuss how I put the company together and how I plan on working on it instead of in it.

My goal is to slow cook that meal once and then find ways to make it repeatable in under 20 minutes. In the beverage world, it takes a long time to come up with a good formula and flavor, but once that's done, you as a consumer get to drink it right away. And that's how it should be.

Investing in Real Estate in Emerging Markets

2010-08-04T22:03:00.000-07:00

While the economy in the US and Europe continue to melt, savvy investors are turning their eyes to "alternative" investments, such as gold, venture capital, and foreign real estate. Today, I want to talk about one of these alternative investments, which readers of this blog are now familiar with: foreign real estate.

Every emerging country is different and the one I'm following more closely is Brazil. Just watching the stock prices of Brazilian home builders -- many of whom IPOed or raised more money in the last couple of years such as Gafisa, Mills and Rossi -- and their underlying fundamentals, it becomes apparent that they're making money, and a lot of it.

But there is no need to watch the stock market for this if one is attuned to what's happening with the real estate market. Brazil has a strong economy where the lower class is getting richer, thanks to a solid economic policy in the last couple of years and a myriad of government subsidies and protectionist laws (the latter two of which, by the way, have their many downsides in the long run, but that's another story).

Good deals don't last long, but they're happening everywhere. I'm aware of new high-end beach houses in gated communities in the south, commercial buildings in the financial town of Sao Paulo all the way to low-end popular apartments in Rio de Janeiro, right where the World Cup 2014 and the summer Olympic games 2016 will take place.

Out of these, the popular apartments in Rio caught my eye. One particular set of buildings is planned for 2012. The builder is offering very low financing, according to government rules to incentivise the low middle-class to buy their first home, and financing is eligible for such government credits. It's as sweet a deal as the cash for clunkers was in the US. These are modest two-bedroom, one bath small units about 10 minutes from the beach, right where the bulk of the Olympic games are supposed to take place.

The risks:
1. Too many investors and speculators driving up the price to the point they can only resell to other investors and not to their target audience. That's the basis to form a bubble.
2. Overbuilding. This shouldn't be a problem for at least the next two years or more, since Brazil has a shortage of homes and pent-up demand. But the market is local and each area has a given capacity for building and demand that are unique. Those with first-hand knowledge of their region will have the upper hand.

The benefits:
1. The upside is tremendous. Some investments are returning anywhere from 20 to 60% a year.
2. In the worst case, investors can rent their units. Demand exists.
3. Qualifying for credit in Brazil is tough, but when buyers are approved, they really are creditworthy and chances of investors getting the short end of the stick are low.

Unfortunately, none of the opportunities I mentioned above are available anymore. Good deals don't last long. But others will come up. Readers interested in finding out about upcoming deals and similar opportunities should get in contact through the comment section below.

Disclaimers: No shares in companies mentioned. I own real estate in Brazil.

Sources of Personal Income

2010-07-24T04:52:00.000-07:00

This article originally appeared on The Div-Net on 2010-07-13.

Last time we talked about sources of income it was in the context of where companies get their income from. We discussed one specific company and how healthy and durable that source was.

Today, I want to talk about your personal source of income. Like companies, you too probably want to make sure you have a diversified stream of income from reliable and durable sources. For most people, that source of income consists of salary, savings accounts, stocks and bonds and perhaps even a rental property. If you have any two of these you are already better than most people on this planet in terms of income.

But chances are you're a reader of this blog because you would like to have more income. And we do cover a lot of ground regarding stocks, dividends and even real estate. But the investment world is not limited to those and perhaps you should consider adding other income streams flowing directly into your pocket.

Let's take a look at some of the possibilities.

Salary

Adding more salary to your income stream is probably something you're already doing now. Getting a raise or a bonus is what you work so hard for. We even discussed the topic of return on salary previously. But once you get it, chances are that to get another one you have to work even harder or longer. And at some point this plan doesn't scale anymore -- it can't continue to grow and grow.

So, what should you do? Get another job? Well, that's always a possibility. One can work part-time or on weekends or after-hours or double shift. But again, this only goes so far.

Is all lost then? Not at all. Keep working on (and in) your job but start to look at other possibilities too. Have you considered...

Angel investing

We discussed that by looking to invest on small or startup companies that other investors cannot invest on (because they lack the personal connections), one can even beat Warren Buffett at his own game as well as big-shot venture capitalists who are looking for the next Google and will probably miss the next corner store, butcher shop or flower stand.

If you keep your eyes peeled and your ears tuned, perhaps you could even invest in the next Walmart before the big shots. But if not that, investing in your next neighborhood bar or local gas station might be a start and a solid plan, depending on your capital and expected return.

Investment clubs

Investment clubs are nothing new. But they can be overlooked by many investors because investing often feels like it should be a solitary activity. Nonsense! Investment clubs can actually scale better than solo investing because by pooling together people with similar goals, it's easier to benefit from each other's knowledge and time to analyze companies and find new opportunities.

Often times, investment clubs that are flexible enough may even want to pool their resources together to invest in private companies, do some angel investing or move into real estate.

The benefit is clear: leverage each other's time, money and all get to share the benefit of new ideas from others who may think alike but do so independently.

Start your own business

This is also a topic I've alluded to before but have yet to discuss further. Opening up your own business -- whether part-time or home-based -- can be easier and safer than one imagines.

First, there are many businesses that don't require huge upfront investments nor huge effort or high cost to operate. And while one may think these are easy to replicate and thus should return close to zero to their owners, think again. The trick is to do something you love or have a strong interest in or something you'd love to have but somehow is not available yet or is not easy to get in your area. Or you just need to do it better than the competition. In many cases, you don't need to do all of these, so long as you have the passion or interest.

Let's just consider a few examples that are close to me. I'm sure you can think of a hundred other example of small businesses that you could create easily and that are meaningful to you.

Growing escargot. Yeah, the slimy snails that some people love to eat (especially the french). Turns out my dad used to create escargot in our backyard when I was little. He had plans to sell them, but he never developed the business around it and chose to eat them all instead. Growing escargot is easy -- they reproduce faster than rabbits -- and extremely cheap -- they eat lettuce and other greens. If you have even a medium-sized backyard, you can build a little shed and grow escargot in simple to build boxes. Just make sure you have all the necessary sanitary and business permits and you could sell them fresh or frozen to your local specialty store, restaurants or even grocery shop chains.

Pizza dough. Growing up, I remember us buying pre-made pizza dough from a friend's neighbor. They made the dough at home and packaged them in four or fives and sold them to order. If I were to do this today I'd probably offer multiple options such as whole wheat, yeast-free, gluten-free, special multi-grains, vegan. All organic and natural and 100% preservative-free.

The pill. Yes, believe it or not I have a friend whose grandparents used to make women's anticonceptional pills at home. They had all the permits and licenses and sold them under their own brand name. They never felt much competition from the big brands because they had their local niche market. I would probably be more careful on this one given the risks, but with proper knowledge and insurance this just comes to show that one can get as entrepreneurial as one wants. The sky is the limit.

Homemade jewelry. I actually know two people (not related to each other in anyway) who used to make earrings, rings, pendants and other jewelry at home or at small local shops from cheap metals or semi-precious ones, with semi-precious stones or other good-looking materials. In one case, the person would sell everything she could make to big-name retailers who would sell under their exotic or one-of-a-kind departments.

There. Four small but very real ventures created and run by people like you and me, most of which had a job and a family to attend to.

Know how to cook? Love dogs? Can build children's toys out of stuff in your backyard? Can teach piano lessons over the internet? What are you waiting for?

This article was written by EPIC INVESTOR.

Building a Strong Dividend Growth Portfolio

2010-07-10T16:12:00.000-07:00

When it comes to indexing I usually have two views: it's a great tool if one doesn't have the time or inclination to analyze stocks, but it's also a wide catch-all net that brings in the tuna along with the catfish.

So, what should a time-constrained investor do if one doesn't want to invest in the entire market or a sector at once and get the chaff along with the wheat? Answer: Buy the strongest dividend payers from selected industries. And to find out who these dividend payers are one can do their own detailed analysis or read this blog.

Selected pharmaceutical index

The list below is a non-diversified list of strong pharmaceutical companies that have a history of paying dividends. Not all are cheap, but the point of indexing a sector is to get the benefit of the industry as a whole without having to guess or investigate which company has the best pipeline, the best strategy or the best cash position to go after acquisitions.

If one believes, like I do, in the future of the pharmaceutical industry -- which is home to great companies, many international, and robust dividend payers -- then buying the strongest companies is a wise strategy.

Dividend yield-based weighting

Should one buy an equal-weighted index of these companies? Well, first, if by equal-weight one means same number of shares, the answer is no. Share price is too dependent on number of shares, which is arbitrary and as such this index would be arbitrary as well. If one buys an equal number of dollars per company, that's a more suitable strategy but it would still assume that all companies are equivalent, which is not a good assumption.

A better way to index is to use a dividend yield-based indexing: buy more dollars worth of companies with higher dividend yields. This approach has two benefits: 1) one buys more of the higher-dividend companies which in turn boosts the yield of the portfolio and 2) higher yielding companies in the same industry are typically considered cheaper than peers since the yield is higher because the price is lower, so one ends up buying more of the cheaper companies.

However, this pure yield-based approach also has drawbacks: 1) high yielding companies can be cheaper for a reason, and a thorough investigation of these reasons defeats the purpose of this lazy indexing approach; and 2) high current yields could mean the companies have little growth ahead of them and as such the dividend may not keep up with inflation or growth elsewhere.

So, what's the alternative?

Dividend growth-based index

Factoring in current dividend yield as well as dividend growth should provide a much better index because current yield plus dividend growth equals total dividend returns. So, this indexing method is equivalent to saying "buy more of the companies that will return more money to you in form of dividends".

Of course, dividend growth involves making predictions about future dividends. However, armed with fundamental analysis and a long history of dividend growth one can make informed assumptions about future growth and thus minimize the risk of making a bad call.

With this, here's my dividend growth-based index of pharmaceutical companies based on 10-year historical growth rates and current yield and their respective weights.

Ticker	10-yr div. growth	Curr yield	Curr Price	P/E	Weight
NVS	13.74%	3.93%	49.55	12.07	2.36
JNJ	12.84%	3.57%	60.54	12.72	2.19
LLY	7.86%	5.57%	35.17	9.07	1.8
ABT	9.26%	3.66%	48.03	14.08	1.73
PFE	7.87%	4.87%	14.77	11.89	1.7
GSK	5.53%	5.28%	34.84	10.2	1.45
BMY	3.73%	5.00%	25.6	14.71	1.17
MRK	3.29%	4.19%	36.3	7.57	1

Putting it all together

The "weight" column in the table above indicates a dollar multiplier for each ticker. That means one should buy 2.36 times more Novartis (NVS) than Merck (MRK).

If one has a budget of $10,000 to allocate to this index, and rounding the number of shares to their nearest whole number, one should buy $1783.8 (36 shares) worth of NVS and only $762.3 (21 shares) of MRK.

The final portfolio worth approximately $10,000 in today's prices would look like this:

	Shares	Cost $
NVS	36	1783
JNJ	27	1634
LLY	38	1336
ABT	27	1296
PFE	86	1270
GSK	31	1080
BMY	34	870
MRK	21	762
	Total	$10,031

Of course, one should only follow this approach if one doesn't have time to do a thorough due-diligence fundamental analysis and after consulting with their financial advisor.

Disclosures: Long JNJ at the time of writing.

Preparing a Shopping List for Bad Times Ahead

2010-07-04T09:03:00.000-07:00

Several pundits online and on mainstream media are calling for another "leg down" or plain depression in the markets soon.

I don't react to predictions, forecasts, star readers or fortune tellers. I will see when it happens. However, it's always good to be prepared for anything -- up markets, down markets, neutral markets -- at all times. As such, I have my shopping list ready in case the forecasters turn out to be right.

Because it's a long shopping list and it's mostly still far from my entry prices, I will just pick those that have been approaching my entry price recently. Many of these are names I already own and am looking to buy more of. Some are new.

Shopping list for the next "leg down"

PAYX (Paychex) - Buy range: $25-21, Current: $25.47
COP (ConocoPhillips) - $47-38, Current: $48.82
PFE (Pfizer) - $13-11, Current: $14.14
RDS.A (Shell) - $48-42, Current: $50.01
CINF (Cincinnati Financial) - $23-21, Current: $25.53
ETR (Entergy) - $75-60, Current: $70.70

Note 1: These are all dividend payers that have been around for a while and paying dividends for a while.

Note 2: Entry prices were based on my model of discounted dividend analysis and a qualitative assessment of earning power. The entry prices typically entail a total return from dividend plus dividend appreciation to 11 to 12%. Any share price growth is extra icing on the cake (and was not factored in the price).

Note 3: There are two oil companies on the list. This is a good thing, because when governments in developed countries start to print money seriously, oil, gas and tanker and pipeline companies will benefit. It's best to own the companies behind these commodities than own the commodities outright for various reasons that are beyond this article's point right now.

Note 4: I started buying Shell a little ahead of my entry price and am looking into buying more significantly when it does enter the buy range.

Note 5: I haven't bought Entergy yet because I haven't had time to investigate their price drop and read their latest 10Qs. As soon as I find out they're still in as good a shape as when I first priced my buy range, I will pull the trigger.

Disclosures: I own shares of PAYX and RDS.A at the time of writing.

Return on salary

2010-05-07T22:42:00.000-07:00

In this blog, we've been talking about investing and getting a return on your investment. However, as most readers tell me, besides being investors, they are also salaried workers. Do the same principles of investment apply to salaried workers? But of course.

One should look objectively at compensation, with an investor's eye to it. The concept of return on salary should be routinely checked to make sure one is not working in vain.

Return on salary is simply the annualized rate of change in total compensation. For example, if one gets a pay raise on year 2 of 10% and then again on year 3, and no more raises until year 5, then over five years, this person has had a return on salary of about 3.8% (assuming salary of X at year 1, this person ends up with a salary of 1.21X on year 5 because a 10% raise applied twice is 1.1 x 1.1 = 1.21 and that annualized over five years is equivalent to 1.21^(1/5) = 3.8%).

So, this fellow would be in practice a little ahead of inflation, assuming inflation is 3% per year -- but not much more than that.

On the other hand, someone who gets a 20% raise twice would fare much better than inflation at the end of the same five-year period: 7.5% per year.

Of course, we are not advocating that people focus on a salaried job to get rich. Very few people manage to do that. But if that's your biggest source of income, then watching your return on salary every so often is important to make sure you're not losing to inflation or effectively staying behind on pay given your added responsibilities as you progress in the job.

If you're only getting raises that match inflation or you're only getting promoted every so many years, you may effectively be making no progress on the financial aspect of the job.

How bad is "excessive" debt?

2010-04-30T22:03:00.000-07:00

Investing and accounting books everywhere say that too much debt is bad. One can resonate with this mantra. After all, debt holders are the real owners. They are the ones who dictate the terms of the loan and how the loan will be paid back. Many loans even have special clauses that force payback if certain ratios exceed given thresholds -- that is, exactly when the situation is bad for the company. In other words, debt holders are those who lend you an umbrella when it's shining but demand it back the moment the rain shows up on the horizon.

There is no hard and fast rule about how much debt is bad. Certainly, a debt-to-equity ratio of 100 to 1 is pretty bad, no matter how one tries to spin it. But then there are those who think that 2:1 is already pretty bad. These are the likes of Warren Buffett and similar conservative investors. "The least the best" they say. I don't recriminate them. After all, I too don't appreciate gratuitous debt or companies that must take on debt because they have heavy fixed expenses or need too much reinvestment into fixed assets just to stay afloat (case in point: airlines, car manufacturing and some mining companies).

But there's a subtle kind of debt that is not at all bad. That is private debt with the owners.

A common way to fund a startup is by giving it equity -- owners put in cash in exchange for shares. Another common way to do it is to lend money to the company. In many ways, an owner lending money to his or her company is a smart way to fund it and yet keep first dibs on any cash left over in case the company goes under.

I currently hold a tiny cap company that has a 4:1 debt-to-equity ratio and is about to take on more debt. And yet, I'm not at all worried about it because the only reason this debt load is high is because of accounting reasons -- the owners prefer to fund the company that way, but are otherwise convicted of its success and so am I.

So, there you have it. There's bad debt and there's just accounting debt. Differentiating them can provide investing opportunities that are typically overlooked by even the deepest of the value investors.

Final Update on Real Estate Investment

2010-03-19T17:58:00.000-07:00

This is my last update on my much discussed foreign real estate investment. The final return on this investment is now about 33%.

We started with an expected return range from 40 to 98% in mind. We assumed something in the middle of the range was doable. There were unforeseen costs and a surge in supply in the area, which made the sale difficult and thus brought the price down. In the end, 33% over about a year is still a very strong return (construction started this time last year, but the land had been purchased six months prior -- the land, though, was cheaper than the construction itself).

The lesson here is to have a margin of safety, as we did, and to watch out for hidden costs, which eat into the profit margins.

All told, this was a successful investment in two fronts: a successful learning opportunity for three first-time real estate developers and a nice return to go along and set the bar high from here on.

Now I'm preparing for the next one. Or two or three.

Invest in ethics

2010-03-07T18:11:00.000-08:00

It seems like an obvious thing to say "be ethical, be honest" and yet there are so many people and so many companies out there that are not. Some make money, some don't. But in the long run, there is no other way to run a sustainable business without these qualities.

While a simple comparison between the returns of the FTSE KLD social index ETF with those of the S&P 1500 over 1, 3 and 5 years shows a small advantage to the socially responsible group, the jury is still out on who ultimately wins. There are academic studies that both support this theory and some that show no difference in returns.

Regardless of who wins, there's no doubt in my mind that there is one major pre-requisite to being in business and that is being honest, transparent and ethical (socially responsible is just a part of these qualities).

Instead of engaging in over analyzing why people and companies behave unethically, a much better question is "why would anyone invest in companies or people who behave unethically?".

A few stories to illustrate

I know this small business owner who operates in the service industry. He hires service providers to deliver services to a third party, the third party pays him, he pays the service providers the bulk of the earnings and takes out a small percentage, for coordinating the team and assuming all liabilities for the services rendered. His percentage goes down as his team grows.

It just happened that over a short few months last year his team started to flock to a competitor who offered slightly higher rates. His business suffered. But he remained honest and insisted on paying his team fairly and timely as always while his competitor had to make up for the higher wages by delaying payment and "accidentally" misplacing people's paychecks.

So what happened? The honest small business owner soon saw his business flourish again as his competitor started to lose people due to dishonest and unethical behavior.

Moral of the story: honesty pays, dishonesty is not sustainable.

A personal story

I recently hired a team of contractors for a small project of mine. The candidates who seemed the best had done work in advance of being awarded the project. They had updates and demos for me even before I agreed to hire them. Their turnaround time was impressive, sometimes answering my concerns within a few hours. So I hired them, expecting nothing short of great results. I was promised a new update the next Monday.

So a few days went by and on Tuesday I decided to check on the status of the job. The contractor said the team was on holidays for a few days but that the next day, there would be updates. Another day went by and this time I was told that the team was actually busy working on another project, but that within a day or two they'd be taking on my job. They had lied to me. Of course, the next two days went by and the team was "getting started very soon now".

Had they told me upfront that they were busy, I might have taken my project to someone else or I might have chosen to go with them anyway. But now, not only I'll never hire them again, I won't let anyone I know hire them either. That's worse than losing one single job -- they lost a customer, possibly a repeat customer, and who knows how many more customers they've now lost.

Conclusion

These are just simple illustrations of why I believe that being ethical in the long run is the only way of operating. As such, I don't hire or invest in businesses that can't or won't operate in the most ethical way possible.

No investor should. Do your homework before investing (or hiring).

Disclosures: No interest in the above mentioned securities.

Beat Warren Buffett

2010-02-27T17:16:00.000-08:00

Warren Buffett likes to remind us that he likes easy one-foot hurdles he can step over rather than having to jump over the higher ones. He's referring to companies that are easy to understand and provide a lot of downside protection. It's easy to make money if we can find these easy-to-step-over hurdles!

However, for us non-Buffetts, finding these safe money-making investments is not that easy -- and Buffett admits it's getting tougher for him as well. Investment is about taking risks and, of course, managing them.

So how can you and I beat Warren Buffett at his own game? Not by doing better research than him on public companies. Nor by buying big, private ones either.

Be where Buffett cannot be

Both you and I have an advantage over Buffett: we live in different places, buy different products, surf different websites, have different tastes and most importantly, we come in contact with new, small, local businesses that Buffett cannot cover!

What does this mean? Should I be buying small start-ups?

Why not?

Be an angel to small businesses and start-ups

I'm not advocating you go door to door trying to buy your local landscaper or butcher shop. But you can be a small angel investor in small businesses if you simply ask them. Many business owners will be happy to take your money. All you have to do is find one that you believe in. And you have the tools for that, and Warren Buffett doesn't: you already buy their services or goods or know about their future products or services first-hand, by word-of-mouth and local publicity.

Angels don't have to be those who can offer multi-million dollar deals or even hundreds of thousands. I once read a short biography of a successful entrepreneur named David Portes, who started out by selling candy on the streets, with borrowed money -- ten dollars. By the time I read about him, he was already making more than a hundred thousand a month from teaching marketing seminars and his candy-selling business. Those ten bucks came from an angel -- who, given the circumstances, didn't think of himself as an angel. But he effectively was.

You too can be an angel investor to perhaps someone in your family or a friend. Yes, investing in start-ups and small businesses can be a huge risk. But if you do your due diligence as you would do on a big business(*), you have an edge over Buffett and over Wall Street that not very many people have.

Think about it, how many people knew about Bill Gates when he was just a kid with a computer? It's true that for each Bill Gates there are thousands of Broke Bobs and Bankrupt Sams out there. Your job is to find the ones that are competent, that have a great product or service, a lot of energy and integrity and most importantly, whom you trust.

Being an epic investor is about looking where others aren't.

* Remember, in this blog, we never recommend you invest blindly in anything, big or small, new or established -- you still need to do the scuttlebutt to find a suitable business that qualifies for your investment.

Disclosures: None.

Current Short Interest

2010-02-20T08:21:00.000-08:00

I thought it would be time to revisit the NYSE list of short interest. We've last talked about it in April 2009.

The NYSE table is interesting, but as it is it doesn't say much, because it's sorted by absolute number of shares sold short. But companies have different number of shares, so the sheer amounts correspond to vastly different percentages of their total shares.

To put things in perspective I like to look at the percentage of shares sold short, out of the total number of shares issued (column H in the spreadsheet). Too high and it means short sellers are aggressively shorting the stock and are probably very confident about it. Ignore numbers higher than 100%, these are ETFs for which the number of shares issued is simply a matter of market demand for the shares, which are created upon request.

Another interesting metric to look at is the number of days to cover (column G). This takes the number of shares sold short and divides by average daily volume. This tells us how long it would take for short sellers to unwind their positions. The larger the number the riskier it is for a short seller should a stock move against him/her. But it's also interesting from the perspective of a speculator trying to catch a short squeeze.

Finally, I like to combine both days-to-cover and percentage-short in one metric, where the product of the two gives us a number that "combines" both metrics equally. That is, the higher the number the highest the combination of both metrics together where both are equally important. Again, some numbers are skewed due to ETFs going above 100% shares sold short. Disregard those.

Here's the final table. Use it with care.

Disclosures: Long PG, BAC, GE, HD, EEM, KFT, SPY.

Bracing for Inflation

2010-02-12T20:39:00.000-08:00

I'm no economist. Neither I have a crystal ball. Nonetheless, all I hear is talk about inflation. I don't know where it is, but from all I've read and thought about, one thing is clear: the US dollar will continue to lose value (as has been the case in the last 40 years or so since coming off of the gold standard), and it is likely to lose value faster than in the last ten years.

Again, I'm no economist. I don't know that there isn't a perfectly acceptable magic way out of this. But economists too have predicted seven of the last three recessions...

Anyway, it doesn't take much understanding about money to figure out that the USD is toast. With 30% of GDP compromised as debt and with the Greenspan-Guidotti rule out-of-the-whack the picture doesn't look rosy for Uncle Sam.

So what's an investor to do?

Well, by and large, nothing much one wouldn't do in normal times: buy undervalued, dividend-paying stocks. In the long run, if anything is going to hold value, it's a well run company with valuable assets (physical or intellectual) with a strong franchise.

Ok, but there might be something else investors can do to tweak their portfolios a bit: they should move their cash away from the USD and bonds and into:

Diversified baskets of foreign currencies
Physical assets (commodities, oil, gold)
More stocks, favoring global companies with business presence in large foreign markets.

TIPS is not an unreasonable option, but being a taxable security and being tied to the official inflation rate (which is computed by those devaluing the currency), I tend to leave them as a distant fourth option.

Foreign currencies

I've discussed the role of foreign currencies before. So I'll just add that there's no reason to completely avoid emerging markets. The Brazilian Real is old news. But the Mexican Peso (FXM) pays a reasonable interest and I don't see it defaulting or going into hyper inflation anytime soon.

Physical assets

My beef with commodities and physical assets in general is their lack of dividends, lack of internal growth rate. Nonetheless, it doesn't hurt to have some as a backup plan.

My favorite commodity would be oil, given its importance as an industrial raw product and its finite production. Also, gold tends to do well in uncertain times like now.

But my favorite physical asset is really real estate. With real estate, one can obtain dividends (rent) and increase its value over time, through proper maintenance, and upgrades.

More stocks

As you may have guessed, investing in businesses is still my favorite option, be them your own business (assuming you're competent and are in a good industry) or someone else's, under the same assumptions, plus the condition that these companies trade for a discount and/or pay juicy, growing dividends.

However, there's no telling what will happen with the US or the USD. If the country defaults, we lose. If we go to war, we lose (as Phillip Fisher said in his book, "War is always bearish on money. To sell stock at the threatened or actual outbreak of hostilities so as to get into cash is extreme financial lunacy. Actually just the opposite should be done") and if do nothing, well, nothing will be resolved.

Disclosures: Long brazilian Real and global real estate.