The • Frost • Report

Buy Apple or Sell it?

2012-11-25T10:46:00.001-08:00

The new iPhone 5 is out, the iPad mini is selling well (I want one!) and Apple is rated one of the best brands in the world for simplicity. So, why has Apple stock been floundering?

In One Up On Wall Street, published back in 1989, mutual fund master Peter Lynch explains that the average person, using information available to everyone (but not available as a statistic to Wall Street), can beat the Street at its own game. It’s a strategy that’s worked well for me.

A few months ago my nephew, who has an iPhone4S and uses it constantly, visited me. I asked him how he liked it, and if he would be getting the iPhone5. He told me that his next phone would be an Android phone. Why? Bigger screens, “cooler” features, and that it’s far more customizable than the iPhone. The iPhone just isn’t hip anymore.

A few weeks ago, a small business banker I know – who is a huge Apple fan – received his new iPhone5. Last week he sent it back to Apple (the company graciously gave him his money back) and replaced it with a Samsung Galaxy running Android software. And he loves it. “It’s faster, it’s bigger: it’s more reliable. Even with Wi-Fi it’s very fast and never crashes.” Note that he means faster than the latest iPhone5.

And now, of course, the iPad is facing competition from both sub-$300 Android devices as well as the new Microsoft Surface, which is receiving rave reviews.

I always hesitate to sell an innovative, great company that makes reliable products. But, I believe that the competition has – for the time being at least – caught up.

Apple stock has dropped from it's heady peak of $705 in Sept 2012 to $571 today, giving it a decent P/E of 12.9x. It seems like a big price drop - and maybe a bargain - until one remembers that before Steve Jobs came back on board, Apple was selling at $89. The risk/reward balance just isn't there.

It’s time to sell Apple, if you haven't already.

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"Although it's easy to forget sometimes, a share is not a lottery ticket...it's part ownership of a business."

Peter Lynch

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Why the GOP Lost the Election

2012-11-10T01:54:00.001-08:00

These days there is a lot of soul-searching going on within the Republican Party. Most analysts talk about how the GOP should have worked harder to get female or Hispanics votes, or those of minorities. They say that Romney should have been tougher against Obama's economic record. These analysts have it all wrong. The thing that killed the GOP is their acceptance of gonzo madness.

It’s hard to believe, but when Mitt Romney was Governor of Massachusetts he signed a cap-and-trade program to reduce carbon emissions. At the time, he touted the program as contributing to the future health of our children and the “stewardship of this Earth.” He also supported abortion rights. Not any more.

Over the last 20 years, the GOP has altered its platform to appeal to powerful splinter groups such as the Tea Party, the Libertarian Party, civilian militia groups and survivalists. And in becoming the lunatic sponge, the GOP has lost the nation -- and the world.

In today’s GOP, it is common to believe that Barack Obama is a Satan-worshipper, that he is the Anti-Christ, that he is a secret Muslim extremist intent on wiping out Israel, that he is a secret Communist agent sent to destroy the US economy, or any combination of the above.

In October of 2012, Mitt Romney visited Reverend Billy Graham at his home in North Carolina. Following Romney’s electoral defeat, Graham warned voters that God’s punishment is coming because the Lord “brings bedlam when countries turn their back on him.” Just prior to the election, Pastor Robert Jeffress of First Baptist Texas assured his followers that he doesn’t believe Obama is the Anti-Christ, but merely “paving the way for the future reign of the Anti-Christ.” To many Americans (and most of the world), opinions such as these are bat-shit crazy.

It is well known that most GOP members deny the existence of global warning (and who knows, they may be right). However, few GOP supporters mention their reasons for not believing in global warming. One is that global warming is a Communist plot. Donald Trump summed it up nicely on his Twitter account on Nov. 6th, just before the election: “The concept of global warming was created by and for the Chinese in order to make U.S. manufacturing non-competitive.” It’s a bizarre idea, especially since most climate change scientists are Westerners. The second (and more popular) belief is that God created the Earth and that he would never have made it fragile; therefore, global warming cannot exist.

You’ll never hear a GOP candidate talk openly about Communist conspiracies, God's wrath or Satanism, because that would be political suicide. Instead, they let talking heads like Donald Trump, Wayne Allen Root, Glenn Beck, Rush Limbaugh and others do it for them.

During the campaign, when Donald Trump attempted to extort the President by offering a charitable donation in return for the President’s college records (so that he could “look them over”), Trump looked and acted just like an evil character from an Austin Powers movie. GOP insanity was suddenly vaulted to the forefront of the public mind. With that weird conspiracy-theory speech, Trump probably helped Obama’s re-election more than any single person except campaign leader David Axelrod.

Finally, there is the GOP and Tea Party’s religion: Founding Fatherism. Sarah Palin can hardly get through an interview without mentioning the founding fathers as if they were omniscient gods.

The GOP didn’t lose the election because they lost the female or Hispanic vote. They lost the election because too many GOP members have boarded the crazy train.

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"He is purposely overwhelming the U.S. economy to create systemic failure, economic crisis, and social chaos- thereby destroying capitalism and our country from within."

Professional gambler and former Libertarian Party Vice-Presidential Nominee Wayne Allen Root, describing President Barack Obama.

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Bad for Banks, Good for You

2012-10-11T20:01:00.001-07:00

People hate banks. Especially US banks.

In 2008, when President George W. Bush signed into law the biggest corporate bailouts in history, banks became the enemy. They are retirement killers, staffed by toga-party heathens. They are social pariahs. Few mutual fund managers dare to buy them. And this is what makes them great.

The Frost Report has been recommending bank stocks during every dip in the market since 2008 (which has been a great strategy), and things only look better for the future.

As of Oct 3, 2012, the six largest US lenders - including Bank of America, Citigroup, and JP Morgan - earned a combined $63 billion in profits. In Q2, Wells Fargo had its most profitable quarter in 160 years. Despite this, many bank shares are still trading at below book value, and at single-digit PE ratios. In other words, despite sustained earnings, US banks remain ridiculously cheap.

Enter the complainers.

Wall Street hates regulation. There is a natural tension between the motives of short-term profit and long-term sustainability. Without regulation (and sometimes despite it), the creative minds of Wall Street regularly devise new ways to make vast hordes of money before self-destructing. It is the loathsome job of government to prevent the latter by preventing the former.

When bankers are complaining about downsizing and frugal compensation, complaining about low leverage (which reduces risk, but also the opportunity to profit), complaining about high capital requirements and complaining about trading restrictions, you know that your money is both profitable and safe.

The greater the number of people who live in fear of bank stocks - while those banks continue to earn excellent profits - the better.

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"The future looks very dim."

Michael Greenberger, University of Maryland, regarding US Banks

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Absolut-ly Bad Trade

2012-10-11T18:24:00.000-07:00

Last week, the Financial Services Authority (FSA) finished a long investigation, and confirmed what Wall Street insiders already knew: that the large and unexpected jump in the price of oil on June 30th, 2009 was caused by a single trader.

Between the hours of 1:22 and 3:41 am, a highly intoxicated senior broker at PVM Oil Futures purchased 7 million barrels' worth of crude oil futures - equivalent to 69% of the global market for oil. The trader, Mr. Perkins, unfortunately has no recollection of the event as he subsequently experienced a blackout.

Shortly after waking up at 6:30 am, Perkins did what anyone would do under similar circumstances - he sent a text message to his supervisor, explaining that could not come into work as he had to care for a sick relative.

Unwinding the massive orders lost PVM 9.8 million USD.

As a result of his binge, Perkins was ordered to pay a fine of 72 thousand pounds, and had his license revoked for 5 years. In truth, not a bad penalty for momentarily changing the world, and for a great story to tell for the rest of your life.

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"Mr. Perkins poses an extreme risk to the market when drunk."

The Financial Services Authority

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US Housing Market strong for Softwood

2012-09-30T22:16:00.001-07:00

The US housing market has gone from disaster to doldrums. Although some areas have bounced back quickly (New York and San Francisco most notably), the overall market appears to be stagnant. But is it? To know the real story, take a look at the industry that supplies the hungry US market.

Major Canadian softwood manufacturers, whose precarious profitability depends upon accurate forecasting, are predicting US housing starts of 835-900,000 in 2013, up from an estimated 746,000 in 2012. By comparison, housing starts hit a low of 558,000 in 2008.

Already, the composite price of Random Lengths framing lumber (the most common wood used in homebuilding) has risen 27% in 2012, both from increased demand and the expectation of more.

The US housing recession is not over. Yet, with immigration and family development continuing faster than housing starts, a full recovery is only a matter of time.

Doubting the US housing recovery is a popular pastime at present - but it is not wise to bet against such obvious statistics.

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"The best thing about the future is that it comes one day at a time."

Abraham Lincoln

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Live Long

2012-09-30T21:53:00.000-07:00

After one has attained a significant degree of wealth, there is nothing better than the joy of a long and healthy life that allows one to take advantage of it.

A new study in the journal Current Biology suggests that there is a secret to extraordinary longevity in men: castration.

The study looked at historical data from ancient Korean aristocrats and the eunuchs (castrated servants) that worked in their households, and found that the eunuchs lived, on average, 19 years longer than their fully intact counterparts.

Testosterone, while making men strong and sexually potent, appears to also cause heart complications and weakened immune responses in later life.

Though the case for longevity through castration is strong, it is expected that few men will rush to take advantage of this new information.

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“We’re here for a good time, not a long time.”

70s rock band Trooper

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Stagnation in the Canadian Housing Market

2012-08-13T22:01:00.002-07:00

A LESSON IN TIMING, INCENTIVES, AND PSYCHOLOGY

The Aug 8^th 2012 edition of Canada’s Globe & Mail newspaper boldly stated that the country’s economists had reached a consensus: the bloated housing market will first slip 10-15%, and then “stagnate for years.”

The Frost Report has been warning prospective buyers about the coming decline of Canadian (and world) home prices since the first peak of February and March 2010 (see Spin City). So, why are economists lagging so far behind?

First, the news is coming out now because it can. The economists in the article -- who are employed by financial institutions -- have nothing left to lose since the market is “effectively exhausted” (their words). People who have already bought homes have given the banks and brokerages their business, and can no longer benefit from the advice. Those who don’t have homes after years of low interest rates either can’t afford them or don’t want them.

Secondly, economists have virtually no natural incentive to accurately predict slowdowns and price declines. Nasty predictions about the most popular investment in the country (real estate) are unpopular, unwanted, and of no benefit to the companies who employ economists.

And then there are the clients…

It’s dangerous to advise a client not to buy real estate. Contrary to what is taught in most investment psychology manuals, clients take declines in prices (“who could have known?”) far better than missed opportunities (“you said not to buy and prices went up 50%!”). Furthermore, a client who has already decided to buy (which is typically why they are speaking with a banker or real estate agent in the first place) will never, ever listen to advice anyway. If a client, who has already decided to buy, asks a banker if it’s a good time to do so and the banker replies, “I don’t believe it is,” that client will usually spend the next 15-20 minutes explaining to the banker why he is wrong.

The Cinderella party in Canadian housing is officially over. I sincerely hope that the moderate 10-15% decline predicted by the nation’s top economists is accurate – but I doubt it.

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Summer chill cools Toronto, Vancouver property markets

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Why would anyone Buy Bonds right now?

2012-08-06T01:18:00.000-07:00

Last week, bond manager Bill Gross (a man who should know better) made the curious statement that the stock market is sure to provide bleak returns for years to come. This is despite the fact that stocks have historically outperformed every major asset class, particularly after prolonged downturns.

Of course, it's not completely unexpected for Bill Gross to be dismissing stocks. As the manager of one of the world’s largest bond funds, he’s expected to be a bond pimp (though to be fair, he now says that bonds won't perform well either). So, how are bonds as an asset class?

When bonds are popular, long-term yields drop (there is no reason to offer a high interest rate if people will buy them with a lower one). And just how popular are bonds at the moment?

As of August 1st 2012, the US 30-year treasury yield was 2.614%. For the first 6 months of 2012, the rate of inflation was 2.37%. Therefore, 30-year treasurys yield a Real Return of exactly 0.244%. At this rate of return, you will double your money every 298 years.

Canadian bond yields are excellent in comparison, though still dismal. The Canadian 30-year treasury yield on Aug 1^st was 2.297%, with inflation during the first 6 months of 2012 at 1.95%, for a Real Return of 0.347%. Far better than US treasuries, Canadian bonds allow you to double your money in slightly less than 200 years (198 years and 3 months).

The other problem with bonds is that when interest rates rise (as they are sure to do, well before 20 years from now), prices drop. If interest rates rise at all, there is an excellent chance that your .244% USD bond return will disappear completely.

If you have billions of dollars that absolutely needs to be in a guaranteed investment (for international real estate escrow, for example), there may not be anywhere else to put your money. I’m quite certain that most readers won’t fit into this category.

If your reason for buying Government bonds is, “I've heard that Government bonds are safe and I don’t want to lose my money,” then you should buy my book, The Intelligent Investors Mind, which clearly explains why this way of thinking is dangerous.

Normally, bonds -- especially Government bonds -- are one of the best and safest investments around; but in the world of investing, the exception proves the rule. At present, bonds are bad news.

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"The cult of equity is dying. Like a once bright green aspen turning to subtle shades of yellow then red in the Colorado fall, investors' impressions of 'stocks for the long run' or any run have mellowed as well."

Bill Gross

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The World has Changed

2012-07-28T21:31:00.001-07:00

There was an unprecedented delay since the last post in The Frost Report, as you may have noticed.

I could write volumes about the reasons for this, but simple explanations are always best: a new position at a global financial institution, followed by several high intensity 60-hour workweeks. For the moment, life is back to normal.

So, what has changed since the last post?

For one, the subject of the last post - the lawsuits expected against Baja Mining - have now begun.

On July 27th, a large shareholder initiated a class action lawsuit for over $250 million, claiming "misrepresentation" by Baja. Although the shares are now sure to be worth almost nothing (creating a loss for me) I am nevertheless satisfied by this development. As a speculative buy, I own just enough BAJ shares to be annoyed at their drop in value, but not enough to affect me in any material way whatsoever. In this case, justice is more interesting than profits.

In anticipation of the inevitable slowdown of the Chinese economy (something The Frost Report has been writing about since early 2011), the XME Metals and Mining Index has dropped more than 50%, exactly as expected. Interestingly, established mining companies were hit just as much as companies that own nothing more than a piece of land. And, those that produce gold were hit just as much as those that produce iron. One of these days I will remember that when a sector drops, even the best companies drop right along with it.

With many commodity-producing companies running at P/E Ratios of around 2.0, opportunities certainly abound. Long-term investors would be wise to consider making regular purchases of commodity index funds, such as XME. I say "regular purchases" because December of this year may mark the low point. In December, many investors will be doing year-end tax loss selling of the most battered stocks.

The global housing market slowdown (also something that The Frost Report has been anticipating since 2011) is now well underway.

In Israel prices have notably softened and they are preparing for a hard landing (i.e. a drop that they will not be able to control). In Canada, regional bank branches that were doing 6-10 mortgages a week in the spring of 2011 are now lucky if they do 2. And in China, home prices are officially stable and robust, signifying that the government is lying its pants off.

And finally, the thing that hasn't changed at all since the last post...

Retail Investors remain deathly afraid of stocks.

A Financial Planner a few days ago mentioned that in 2006 their company's best-selling mutual fund was composed of 80% stocks. Now, their best-selling mutual fund is composed of 80% bonds.

It seems that stocks are still, and for some time will continue to be, shunned by regular investors as a dangerous game. And so it is, if you don't know what you are doing.

If you are a long-term investor with a eye for value, the 2008-2012 (+) period will likely be the single greatest stock purchasing opportunity of your lifetime.

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"The day I went to work in 1932, steel mills were running at eight percent of capacity. I remember days when the trading was so slow people played ball on the floor of the exchange."

David Babson, as told to Adam Smith in Supermoney

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Baja Mining - Lies and Lawsuits?

2012-04-23T19:20:00.001-07:00

In an earlier article on The Frost Report, I wrote about a great mining company - Baja Mining.

What makes it great? Well, they have a huge, mostly finished mine with great expected cash flow in a known mining district with a low stock price!

Without taking sides, I wrote alot about one problem that was contributing to the low stock price: Mt. Kellett Capital Management, a hedge fund and major shareholder, said that Baja was not being governed properly, and so were attempting to place some new members on the board of directors. Mt. Kellett lost this battle on April 3rd.

It now seems that Mt. Kellett was right all along- Baja's management is indeed incompetent, or at the very least hopelessly confused.

Baja stock sank 40% (!!!) today, after Baja issued a press release saying that, contrary to everything they have ever said before, the project is NOT funded through to completion, and will require substantial new funding ($246 million) - from somewhere.

The issue of funding is especially interesting to me, since in my interview with Baja representative Alex Macdougall in February, I specifically asked him if there was any chance whatsoever of Baja needing to raise capital. Macdougall's answer was: "There is no chance of them [Baja] raising monies before they complete construction." About two months later, Baja issued a subtle press release saying that they were feeling "inflationary pressure," but that they were implementing cost-cutting measures to help offset these. Looking back, I feel like I was sucker-punched.

Today's latest press releases also included a short "by-the-way" statement, which was that three more directors quit because (their words), "In light of recent developments...we are no longer confident that we can ensure the level of good governance and oversight that the Shareholders of Baja have a right to expect from us." Tellingly, this quote only made the follow-up press release. The first release had no mention of this quote, despite the fact that the exiting directors had specifically asked that it be included. Shady.

The big question is...is Baja still a good investment? The answer is that at $0.57 per share, now more than ever, it is a fantastic investment - for someone. Just maybe not for you, the shareholder.

Whoever provides the funding to completion will find Baja an excellent investment. Mt. Kellett, I'm sure, is wetting their pants with excitement at taking over this flopping fish of a company and its incredible mining assets (either that, or today's drop was because they finally said "**ck it" and sold out!)

For the average shareholder, it is far too early to load up on shares of a company that has proven so opaque and -- as of today -- almost ungoverned. I bought a few hundred more shares just to be crazy, fully recognizing that Baja has turned from an investment into what is essentially an asset-backed gamble.

Bad governance is almost as bad as "unexpected accounting irregularities." When the rules keep changing, you can't play the game.

I have no high expectations.

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The Earlier Article (including interviews): Stocks I Like - Baja Mining

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Boy Broker: Investment Classic Returns

2012-04-21T20:12:00.001-07:00

The Frost Report is proud to announce the re-release of the 1888 investment classic, The Boy Broker: Among the Kings of Wall Street.

Though The Boy Broker has been available as a re-print for some time, the quality of these earlier reproductions was very low. One version, for instance, actually includes an apology for the poor quality of the printing. Another version (obviously edited by non-English speakers) boasts that is was “restored by human beings.”

We felt compelled to do it right.

From the Amazon.com description:

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In 1888, one of the richest men in America published his masterpiece on becoming successful. More than a century later, the wit and wisdom of Frank A. Munsey's "Boy Broker" still shines through.

This edition maintains all the integrity of the 1888 edition, while adding valuable new features including "Notes for the Modern Reader," which provide information and context to the 21st Century reader.

- Edited for Clarity
- Now includes Historical Biographies and Information
- Contains New Illustrations

From his own experience, Frank Munsey noted that when young people are given lectures or advice, it often proves valueless (they ignore it). Instead, he reasoned, people are influenced by their friends and peers, and also their heros. Munsey therefore wrote this book as a story with a hero, where the subconscious mind is the recipient of its advice.

The story follows the adventures of young Herbert Randolph, in his quest for independence and achievement in the great city of New York.

We hope that you will find this updated edition far more readable than the original, while enjoying all its 19th century wit and character.

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Thanks again to all the readers of The Frost Report!

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BlackBerry's Bold Move

2012-04-19T20:00:00.001-07:00

Reuters news agency this week released an article with the hopelessly biased title, “RIM’s BlackBerry May Have New Hope in One Market.” Within that article, however, Research in Motion outlines a great new sub-strategy to further increase sales in emerging market countries.

When I was in India just a few years ago, it was impossible not to notice how everyone – no matter how poor - has a mobile phone.

That bicycle-rickshaw driver may live in a hut made of dried cow dung and tin, yet he owns a mobile phone. The street vendor who sells curried rice for $0.20, then washes the plates in a pothole filled with rainwater and cow piss…she has a mobile phone too. The young call centre employee, who lives in his parents “condo” (three rooms and almost no furniture), owns both a mobile phone and a laptop: he is middle class.

RIM’s strategy is to capture the lucrative “trade up” market: the billions of people who currently own older mobile phones capable of talk and text but little else. These people could never realistically afford an iPhone 4S, yet are willing to spend a few months’ salary to get a simple, reliable smartphone like RIM’s new BlackBerry Curve 9220.

The Curve 9220 is a sleeker version of the 8520, with improved Web browsing, Facebook and Twitter apps, FM radio, long battery life, and $48 US worth of free application downloads – including both business applications and games like "Ultimate Cricket." In other words, the features are simple, but are the most important ones for the customer base RIM is trying to capture. Monthly plan fees start at as little as $5!

The Curve 9220 will sell for about $210 US (without contract), which compares nicely to the older iPhone 3GS which sells for $350 or more and has higher monthly plan fees.

Earlier this year, RIM made a great move by upgrading its Playbook tablet operating system, and slashing prices down to $199 to compare positively to the Kindle Fire.

RIM has been struggling of late, and no one yet knows if these and other strategies will give RIM its profitability back.

I’m not willing to make a huge investment in RIM – but I am willing to throw a few investment dollars their way. I think RIM has been written off far too easily.

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"Asia is not going to be civilized after the methods of the West. There is too much Asia and she is too old."

Rudyard Kipling

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Disclosure

Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.
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Terrorism Doesn't Pay

2012-04-15T20:26:00.002-07:00

At least, not as well as it used to.

OJSC Izhmash, maker of the legendary Kalashnikov assault rifles (favorites of terrorists and rebels worldwide for their remarkable reliability) filed for bankruptcy last week.

Though OJSC’s product line remains extremely popular, the AK-47 and other famous rifles have been relentlessly copied and sold by foreign manufacturers. These mostly inferior copies – for which OJSC receives no royalties – have long been biting into the company’s bottom line.

Similar to a US Chapter 11 filing, OJSC Izhmash has proposed a restructuring plan that will allow it to maintain regular business operations until the restructuring takes hold. To help out the iconic brand, it’s widely expected that the Russian government will place large, unnecessary orders for new weapons (how do you say “bailout” in Russian?).

OJSC Izhmash’s long-term strategy is to develop a new family of automatic weapons to retrieve its falling market share.

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"I'm proud of my invention, but I'm sad that it is used by terrorists. I would prefer to have invented a machine that people could use and that would help farmers with their work - for example a lawnmower."

Mikhail Kalashnikov, age 82

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I Hate Banks but I love JP Morgan

2012-04-04T23:05:00.000-07:00

Contrarian investing is, in concept, one of the simplest things in the world. It says that the masses are idiots and are always wrong; therefore, doing exactly the opposite of the masses is the correct thing to do.

The problem with contrarian investing is that the masses are sometimes right.

In 1985, faced with high interest rates, the masses said that interest rates could still go higher (and long-term bond prices lower) – and they were right. In 2009, despite falling markets and great valuations, the masses said that stocks would still go lower – and they were right. Doing the opposite of what the crowd recommends isn’t always the best course of action.

And yet, contrarian investing works, largely because people make investment decisions based on emotions rather than logic. Case in point: CEO Jamie Dimon's annual newsletter, released Wednesday.

In the newsletter, Dimon pointed out that JP Morgan Chase had record earnings of $19 billion last year (that’s the best year ever). He added that the earnings would have been even better if it had not been for still-high mortgage related losses. As time has gone forward, these losses have been declining.

Most interestingly, Dimon hinted that the price of JP Morgan stock was likely low because of “hostility” toward him and to the banking sector in general. Based on the comments seen after the newsletter was released, Dimon is right: he was called a “criminal,” “manipulator,” “slime ball,” etc.

By now, I’m sure Dimon is immune to such disparaging remarks. As a banker myself, I occasionally have clients tell me that they “hate banks,” which I consider a polite (weak?) way of saying, “I hate you.” Then again, I also have people tell me that I’m wonderful but that they hate bankers: is that a compliment or an insult??

Emotions aside, here are the facts that investors should be interested in:

- Record earnings of $17 billion, up from $12 billion in 2009.

- Return on equity of 15% (which Dimon thought was low).

- Market share growth in almost every area.

- Approved to implement stock buybacks.

- Opening 120 to 200 new branches a year.

There are many headwinds in banking, to be sure, including new regulations, housing weakness, and worldwide economic uncertainly. But none of these are reasons to not buy a company.

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“We all have a vested interest in getting this right.”

Jamie Dimon

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AIG gets its Pants Back On

2012-03-23T23:43:00.001-07:00

There are some companies that the average investor simply will not touch; American International Group is one of them. AIG is, after all, a poster-child for the excesses of the 2008 banking fiasco. While America burned, AIG executives dressed in togas and had grand parties – literally!

At The Frost Report, however, we recognize that companies the public hates are often good bargains. When the numbers make sense, we let bygones be bygones.

This Wednesday, AIG paid back the US Treasury an additional $1.5 billion in TARP money, eliminating the government’s preferred share stake. Tim Massad, the Treasury department’s assistant secretary for financial stability, had this to say about the event: “In the dark days of the financial crisis, when commitments to AIG totaled $182 billion, few would have believed that we'd already be able to reduce that amount by more than 75 percent, or that we may be able to recover every single dollar invested in the company.” And yet they have – ahead of schedule.

Consider these statistics: AIG has a book value of $55 per share, yet today’s closing price was only $28.27. In what always strikes me as one of the wonders of Wall Street, you can literally buy $55 worth of goods for $28.27. Of course, "book value" is useless if AIG is forced to have a fire sale on its goods and sell them for less than cost. So, is the company profitable?

AIG had annual sales of over 64 billion dollars in 2011, with profit of $15 billion on 1.9 billion shares outstanding. Return on equity also handily beat the market at 26%.

Like other companies in the pariah class, there is no big rush to buy AIG. The government will be selling its stake for some time, and the stock will not likely jump until that selling pressure is over. Having said that, the government has done a good job of letting other companies it owns (like Citi) rise steadily in value, selling them in a mellow and responsible manner.

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"I would suggest the first thing that would make me feel a little bit better toward them [AIG executives] is if they'd follow the Japanese example and come before the American people and take that deep bow and say, I'm sorry, and then either do one of two things: resign or go commit suicide."

Senator Charles Grassley, 2009

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A Tale of Trading Woe

2012-03-16T15:05:00.003-07:00

Last Friday, I was chatting on the phone with a friend of mine who is a talented and logical investor: one of the elite. He and I often trade views on economic trends or discuss companies and stock tips, and this was just such a day.

He mentioned having recently bought a company called “Viterra,” which has a virtual monopoly on grain storage and shipping in central Canada. He said that its price had dropped in recent quarters, and went through a short burst of statistics to back up his “great buy” claim, including earnings history, price to book value, and the nature of the industry. I told him I’d check it out, and we each hung up the phone.

It only took a couple of minutes for me to realize that Viterra was indeed a great company at a great price, so I put in a limit order well above the current bid (at $11.50), to make sure I’d get in. Then I hit the "enter" key and sat back. But strangely, it didn’t fill.

I looked at my screen in disbelief as I read that trading had been halted pending an announcement. The newswire then announced that “certain parties” had expressed interest in buying the company. When the stock resumed trading a few minutes later, Viterra stock had jumped 29.8% to over $14 a share. My order (at a now-measly $11.50) didn't fill. Dammit!

Needless to say, my friend called back a couple of minutes later to casually jab me about my lost opportunity (“I didn’t know this would happen. Honestly!”)

Shortly after that, I called him back to let him know that the transaction just made the cover story for the Globe and Mail’s online business section.

I completely missed out.

Lesson of the day: solid, undervalued companies do not stay that way forever. Don't wait to buy.

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“We didn’t lose the game; we just ran out of time.”

Vince Lombardi

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Canadian Government welcomes Crackheads to Banking

2012-03-05T23:32:00.001-08:00

The Canadian government this week announced upcoming changes to federal banking rules, designed to reduce "consumer irritants," and make banking more transparent and fair. Unfortunately, the new rules are also a dream for the nation's con-artists.

One set of changes, for instance, relates to holds on deposited cheques. Currently, people with bad credit may have a 5-7 day hold put on all non-cash deposits. According to the new rules, banks must provide access to the first $100 deposited by cheque into the bank, no matter what the credit score of the individual opening the account. And, for any cheque less than $1500, the maximum hold is 4 days, down from the previous 7 days. For the working man with spoiled credit, these changes are convenient. But, it's for con-artists that the new rules really shine.

Once the new rules are in place I can, as a con-artist, now open an account at a bank, deposit a $100 cheque (payable to myself) from my account at another institution (with no money in it), and then take out the $100 as cash! Awesome! Even better, I can write a cheque to myself for $1499 from my $0 balance Credit Union account in Toronto or Montreal, deposit it into a new account at a bank in Vancouver, and only 4 days later walk away with $1499 in cash, courtesy of the new 4-day hold maximum (cross-Canada cheques often take more than 4 days to be returned NSF).

Canada's crack addicts will be busy opening accounts at every bank in town, guaranteed a $100 minimum payday for each new account.

Among other changes, the new banking rules also ban unsolicited credit card "convenience cheques," which most banks have discontinued anyway since they tend to get stolen from the mail and used by 3rd parties. The ban was introduced because Canadians - like their American counterparts during the last housing boom - have shown a remarkable inability to delay gratification (Canada's personal debt levels are at record highs), and would presumably use the cheques if they received them.

Canada's banks will no doubt fight the new legislation, since it leaves them exposed to millions of dollars' worth of preventable fraud.

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"It's easy to dodge our responsibilities, but we cannot dodge the consequences of dodging our responsibilities."

Josiah C. Stamp, economist

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See also:
Goodbye to three irritating bank practices

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Share Buybacks - Good or Bad?

2012-02-11T23:19:00.000-08:00

A recent article from Canada’s Globe and Mail ("Share Buybacks: The wrong way to reward shareholders") suggests that stock buybacks are - as a rule - useless.

The Globe article states that after a buyback program is announced a company's stock price usually declines anyway; that is, the buyback typically signifies a peak, and does not add any value to shareholders. But is this correct? How can buying back shares not add value to shareholders?

The Globe's simple look at the statistics ignores the rationale for doing buybacks. In fact, there are good stock buybacks and bad ones, and management’s reasoning makes all the difference.

Share buybacks can be the best way to reward shareholders. The fact that the market doesn't immediately recognize this and boost the stock price is irrelevant.

When a company's shares are trading at close to or below book value and at low P/Es, why would the company issue dividends or make acquisitions? Buying the stock of an underpriced company (their own) is the best choice. Every share bought back by the company means more earnings for remaining shareholders. For example, if a company has earnings per share of $.50 and you own 100 shares, your personal share of the earnings is $50.00. If the company buys back ¼ of its shares, your personal share of the same earnings is now $62.50. Eventually, more earnings per share = a higher stock price.

On the other hand, if a company's stock is overvalued either in terms of P/E or book value (or both), then share buybacks are clearly a waste of money: why buy back overpriced shares when the same money could be used to make valuable acquisitions or pay a dividend? In this case, a share buyback doesn't make sense.

When management does a share buyback for the right reasons, people notice. When Berkshire Hathaway, for example, announced in Sept of 2011 that it would buy back shares, BRK jumped 8% in a single day.

The Globe and Mail article notes that companies typically buy back stock when they are flush with cash but stock prices are high - which is the wrong time to buy back stock. At the moment, however, many companies are flush with cash at a time when their stock prices are low - the perfect time to buy back stock.

Good companies pay extra dividends or make acquisitions only when their stock is overvalued (or at least fairly valued). When their stock is undervalued, buybacks are the best choice.

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"When companies purchase their own stock [at a discount to fair value], they often find it easy to get $2 of present value for $1."

Warren Buffett

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Stocks I Like - Baja Mining

2012-02-04T21:52:00.000-08:00

IMPORTANT - See this important update as of April 23rd, 2012: Baja Mining.

Every once in a while, one notices a stock that seems to have all the qualities that allow the patient investor to make a windfall. Baja Mining Corp. of Canada is just such a company.

Baja Mining (TSX: BAJ) is developing one of the largest copper mines in the world in Baja, Mexico. Construction of the Boleo mine and associated port is well underway, and expected to start commercial operations in Q2-Q3 of 2013. A great time-lapse presentation of the construction is available on their website. The Boleo mine will have an initial 23+-year mine life.

So, what makes Baja such a great value?

First, unlike most companies that are still two years away from project completion, Baja is fully financed for construction, meaning it will not have to issue new shares to complete its project.

Once in production, the company is expected to have earnings of around $0.80 per share, which would give it a P/E of only 1.2 at today’s price of $0.92 per share. Using a reasonable P/E of 10, Baja’s future price should be around $8.00 per share.

Finally, the company has hedged 50% of its initial 2 years of production at between $2.40 and $3.97 per pound, which will allow the company to remain profitable even if copper prices drop.

By all measures, Baja seems drastically undervalued.

I spoke with Baja representative Alex Macdougall regarding the company on Feb 1^st, 2012. Following are some choice excerpts from that conversation.

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The Frost Report: “According to your corporate presentation, you are on track to start commercial operations in Q2 or Q3 2013. Is that still correct?”

Macdougall: “It should be Q2 2013.”

The Frost Report: “It says (in your presentation) that 50% of your production is hedged at between $2.40 and $3.97 per pound…where in that range does the majority of your hedging occur?”

Macdougall: “That I don’t know. That was done by (Louis) Dreyfus - a very large metal trader like Glencore (see The Frost Report’s article about Glencore). The hedging was required by the five commercial banks involved in the financing (Barclays, Standard Chartered Bank, HVB etc). I would suppose that Dreyfus has sold various amounts of the first year’s production at varying prices…each commercial bank put up 20 million dollars."

The Frost Report: “Now, you have somewhat of a battle going on right now with Mount Kellett Capital Management…” (Mount Kellett alleges, among other things, that the CEO’s daughter is employed by the company at an extravagant and unnecessary compensation).

Macdougall: “Can I give you the history on that?”

The Frost Report: “Please do.”

Macdougall: “Mount Kellett was formed by former Goldman Sachs people. The guy who really started it is McGoldrick (known as “Mark ‘Goldfinger’ McGoldrick”). He was working at Goldman Sachs, specializing in distressed companies. Goldman bought them and took them private, then brought them back out (took them public again). He earned GS multi-billions of dollars. He was offered a bonus of 70 million dollars, which he refused and said that he wanted 1.5 billion dollars. I call that greed.”

The Frost Report: “He’s pointing out things like…the corporate secretary’s pay.”

Macdougall: “That’s misrepresented, by the way.”

The Frost Report: “It is?”

Macdougall: “If you go to SEDAR…it reveals Kendra’s (corporate secretary’s) to be $140K CDN a year base pay.”

The Frost Report: “So where did he get the total compensation of $725K from?”

Macdougall: “Using the Black-Scholes calculation for options. But they are all out of the money. They are (currently) worth zero. It’s a red herring. The only issue they have left is nepotism…having a family member be assigned an important position in the company merely because they are a family member. But, John (Greenslade, CEO) did not hire Kendra. Kendra was hired by Bill Murray, former President and Director of Baja…”

Macdougall went on to explain how McGoldrick’s firm has bought close to 20% of Baja. He remarked that if one follows the history of Mount Kellett Capital Management, it seems reasonable to speculate that their plan for Baja is to take over this undervalued company at the undervalued price, keep it until mine completion, and then flip the shares back to the public at true value. Obviously, this plan would allow the vast majority of the jump in value [from under valuation to fair valuation] to go to Mount Kellett Capital Management instead of existing shareholders.

As an aside to Frost Report readers, out-of-the-money stock options are a form of compensation - with a cash value - and are an expense to a company.

The Frost Report: “The company (Baja) is fully financed through to production. I have seen in the past - unfortunately from my own experience – companies…as soon as production starts, issue a bunch of new shares. What is the probability of issuing shares between now and production? And, would there be any reason for Baja to go after acquisitions by releasing (new) shares after production begins?”

Macdougall: “No to both. There is no chance of them raising monies before they complete construction. Because of the agencies that have financed them…they (ex. the US export agency) are very demanding. Every time they (Baja) approach the agency for an additional tranche (of financing), they have to prove exactly where all the money went, what was achieved, what the status of the program is, etc. I think the stock is very undervalued…”

The Frost Report: “Well, I kind of like that part (the undervaluation)!"

For the remainder of the conversation, we bitched about program trading causing unusual valuations in the market, and about how retail investors are spooked out of buying equities, making it hard for venture companies to finance.

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During a brief (7 minute) follow-up conversation with Steven Lehner of Mount Kellett, he assured me that they are not interested in taking control of Baja, but merely ensuring the company does not burn any money unnecessarily. If this is true, then we can expect Baja to reach its full intrinsic value in the hands of today's shareholders. If Mount Kellett is covertly setting up a takeover (as Macdougall fears), then today's shareholders will likely get a premium on today's price, but not realize the full potential of the stock.

Baja Mining is an undervalued company with excellent potential for appreciation. The fact that Baja is being stalked by an aggressive hedge fund shows how attractive Baja is at its current price. And, having Mount Kellett as a large shareholder has arguably helped keep management accountable.

Benjamin Graham would love BAJ.

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Berkshire Hathaway's Machine

2012-01-22T22:04:00.000-08:00

If you believe recent commentaries, Berkshire Hathaway’s Warren Buffett – once considered one of the greatest investors in the world – is now “too old” for investing and is washed up, tired, and has lost his touch. The people making these comments have clearly not taken the time to examine Berkshire’s financial statements!

In investing, timing is everything. An undervalued investment can sometimes take months or years to begin rising in price; and, while waiting, returns will be stagnant. Berkshire has found a way around this problem. Berkshire is now so synonymous with safety and stability (and for being a good business partner) that it obtains exclusive deals – unavailable to anyone else - where it is actually paid to wait.

Take, for example, Berkshire’s investment in Bank of America. BAC’s current share price is $7.07. Berkshire bought preferred shares of BAC that earn 6%. With this preferred share deal came warrants to purchase up to 700 million shares of BAC at $7.14 per share, and these warrants don’t expire until 2021. In other words, any time between now and 2021, Berkshire can purchase BAC shares at $7.14 per share, even if the stock doubles or triples (or more). While waiting, Berkshire earns 6% on the Preferred shares!

Berkshire has a similar deal with Dow Corporation. Berkshire currently earns 8.5% on Dow Preferred Shares. Berkshire can purchase up to 72.6 million shares of Dow at $41.32 per share with no expiry date, except the stipulation that Dow has the option to redeem the preferred shares when the stock attains stable prices of $53.72 or more! Put more simply, this means that Berkshire will earn 8.5% from its investment in Dow for months or years, and then make at least $12.40 per share ($52.72-$41.32) when the Preferred shares are converted to common shares, for an additional profit of 900 million dollars.

Berkshire Hathaway is an incredible moneymaking machine...especially for those who have the luxury of time, and the patience to wait.

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"The most important attribute for success in value investing is patience, patience, and more patience. The majority of investors do not possess this characteristic."

Peter Cundill

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Stocks I Like - Leucadia National Corp

2012-01-17T00:51:00.000-08:00

Leucadia National Corporation (stock symbol: LUK) may be the biggest, most successful company you've probably never heard of.

A quick look at Leucadia's website (www.leucadia.com) reveals that this company is different; the homepage looks like it was designed by a high-school student twenty years ago (and maybe it was). One would never guess that as of Q3 2011, the company had assets in excess of 9 billion dollars, and that in 2010 - Leucadia's last fully reported year - the company had $1.3 billion in revenues.

Virtually everyone these days has heard of Berkshire Hathaway and it's famous value investor, Warren Buffett. Yet, Leucadia National Corp. has managed to stay under the radar of the average investor: presumably where they want to be.

Like Berkshire Hathaway, Leucadia is a conglomerate, specializing in the purchase of undervalued, under priced assets. Also like Berkshire, their annual reports are easy to read, honest and straightforward. Unlike Berkshire, Leucadia loves to buy "turnarounds" - companies with bad management, shoddy business practices, or lack of funding. It then sticks with these companies - often for years - providing the management expertise and funding required until the moment of fruition.

At present, Leucadia owns investment banks, mines, timber companies, plastics manufacturers, wineries, energy companies, hotels , auto retailers and natural gas drillers. Leucadia also has a 50% stake in "Berkadia Commercial Mortgage Inc.," a joint venture with Berkshire Hathaway.

Leucadia frequently carries a massive cash and stock portfolio: as of Q3 2011, $306 million in cash and $811 million in investments. Due to this large stock portfolio (and the fact that Leucadia purposely invests in money-losing companies), the company's income tends to swing wildly; despite this, the company has averaged a stunning equity growth rate of 20.2% annually since 1978.

Knowing that Leucadia's investors are value investors, you can be fairly certain that their current investments are drastically undervalued.

Leucadia is currently trading at $25.45 per share.

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"We quickly changed the name from Goober Drilling to Keen Energy Services."

Ian Cumming and Joseph Steinberg of Leucadia National Corp, regarding their 2009 purchase of Goober Drilling of Stillwater, Oklahoma.

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Disclosure

Do not buy stocks, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

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Potash Corp shows its Strength

2012-01-06T20:33:00.000-08:00

Potash Corp of Saskatchewan, the company with the hippest stock symbol in the world (POT), announced today that it was halting production at its Allen mine for 4 weeks. The stated reason: world potash prices are too low, so the company is “adjusting supply.”

Though Potash Corp controls only 20% of global supply (according to its website), it is also one of the lowest cost producers. In addition, Potash Corp markets its product - along with local competitors Agrium and Mosaic - through a company called Canpotex, "an international marketing and distribution company wholly owned by the Saskatchewan potash producers."

If there was ever any doubt that Potash Corp and Canpotex have a virtual monopoly on potash prices, now there is none. By shutting down one plant (the Allen mine) that provides only 10% of Potash Corp’s total supply, the company believes it will be able to stabilize world prices. That is power.

Potash is currently trading at $42.94 CDN on the TSX exchange. It's a reasonable price, but with a forward P/E of 10 and slowing BRIC demand, not a screaming deal. If POT hits $35 or lower, consider loading up.

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"Money is power - and what can one accomplish without power?"

Cecil Rhodes

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Assess This

2012-01-06T19:57:00.000-08:00

In yet the latest reminder of the inevitable Canadian real estate apocalypse, B.C. Assessment announced this week that home prices in Vancouver rose between 10-25% during 2011. In the family-oriented West Side of Vancouver, prices “skyrocketed” (their words) as much as 20-40%.

In order to lessen the blow to existing homeowners, B.C. Assessment sent what it calls “extreme letters” to approx. 1500 households, letting them know in advance (as a matter of courtesy) that their property taxes will be increasing dramatically.

Since 2002, Vancouver real estate fairy tales have become so commonplace that many people now actually believe that their run-down house on an average size lot is worth $1.3 million dollars (1.26 million USD).

In the East Side of Vancouver (the city’s equivalent to New Jersey), an average single family home is now worth more than $800,000.

In a brilliant understatement earlier this week, the deputy assessor for the Vancouver Sea to Sky region stated: “It’s been a really strong market for Vancouver, a good one –a robust one."

Apparently, BC Assessment sees no downside risk to real estate prices rising at rates up to 37% faster than wages.

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"In our view, the housing market is one of the most vulnerable sectors to this weakening economic environment, showing classic signs of overvaluation, speculation and oversupply. We are not calling for an all-out rout in the market, but caution is now decidedly warranted."

Bank of America Merrill Lynch, regarding Canadian real estate, December 2011.

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Happy New Year

2012-01-06T19:25:00.000-08:00

Fresh off a nice holiday, and it's a new year.

Recognizing that there is no reason to start off the year too seriously, here's my favorite (repeatable) Inbox joke from the past couple of weeks. Enjoy!

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The American Investment Banker and the Greek Fisherman

An American investment banker was at the pier of a Greek coastal village when a small boat with just one fisherman docked. Inside the small boat were several large tuna.

The American complimented the Greek on the quality of his fish and asked, “How long does it take to catch them?”

The Greek replied, “Only a little while.”

The American then asked why he didn't stay out longer and catch more fish. The Greek replied that he had enough to support his family’s immediate needs, so there was no reason to. The American then asked, “But what do you do with the rest of your time?”

The Greek fisherman said, “I sleep late, fish a little, play with my children, take siesta with my wife, and stroll into the village each evening where I sip wine and play cards with my friends. I have a full and busy life.”

The American scoffed: “I am a Harvard MBA and could help you. You should spend more time fishing, and with the proceeds, buy a bigger boat. With the proceeds from the bigger boat you could buy several boats. Eventually you would have a fleet of fishing boats. Instead of selling your catch to a middleman you would sell directly to the processor, eventually opening your own cannery. You would control the product, processing and distribution. You would need to leave this small coastal fishing village and move to Athens, then London and eventually New York where you will run your expanding enterprise.”

The Greek fisherman asked, “But, how long will this all take?”

“15-25 years,” the American answered.

“But what then?” the fisherman asked.

The American laughed and said, "That’s the best part. When the time is right you would announce an IPO and sell your company stock to the public and become very rich. You would make millions.”

“Millions … then what?” the fisherman asked again.

The American said, “Then you would retire. You could move to a small coastal fishing village where you would sleep late, fish a little, play with your kids, take siesta with your wife, stroll to the village in the evenings where you could sip wine and play cards with your friends.”

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Riots in Russia

2011-12-12T21:44:00.000-08:00

OR WERE THERE?

Investors rely on news about companies, politics and economics to make informed investment decisions; it is therefore essential to obtain accurate news.

An easy way to seek truth in reporting is to compare stories from several different sources. By “several different sources,” I don’t mean several news sources from the US, which all use the same news wires to get their information. I mean getting news from the West’s traditional enemies as well as its allies, since the truth is usually found somewhere in the middle.

On December 7th, 2011, several US news stations carried footage of anti-government protests in Russia.

Some stations showed Russian protesters marching with flags. Another station showed protesters waving flags and burning red flares. Yet, Fox News had amazing clips showing protesters throwing Molotov cocktails, lighting bonfires, smashing windows, and fighting with police in riot gear.

The reason that Fox News had such exciting footage is because although they were describing protests in Moscow, they were actually showing footage of riots in Athens Greece!

Russian news agency Pravda - itself not known for the quality of its reporting - noted that the Moscow protests “appeared to be too boring and ordinary for Fox News producers. They wanted some action, which was obviously missing in the video reports from Moscow.”

Pravda later drolly added that “it is quite possible that American and European TV viewers will soon have a chance to see drunken Cossacks riding bears, playing balalaikas and terrorizing peaceful demonstrators in the streets of Russian cities somewhere in Egypt.”

Awesome!

When the truth is boring, why not just make it up?

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Note: The original Fox News link to this broadcast (Protester's Express Outrage Over Russian Elections) has been taken down.

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"There's absolutely no truth in this malicious rumor that I starting running mad cow disease stories simply because Angus Black, the great British beef baron, lost ten thousand pounds against me in a game of poker and refused to pay up.”

“Elliot Carver,” evil news baron in the James Bond film, Tomorrow Never Dies

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