Archive for January, 2012
If you don’t pay close enough attention, you may miss the Facebook initial public offering (IPO) in the blink of an eye. Since computer programming or Botox has frozen Facebook CEO Mark Zuckerberg’s face into a wide-eyed, blink-free state, you may have bought yourself a little more time to buy shares in this imminent IPO, which is estimated to value the company at upwards of $100 billion.
We don’t know a lot of details about the financial health of Facebook right now, but what we do know is that this snot-nosed, 27-year-old Mark Zuckerberg has created one of the most powerful companies on this planet and his estimated net worth is currently around $17 billion. Not bad for a college drop-out who started Facebook in 2004 as a freshman at Harvard University. Hmmm, maybe I should have dropped out of college like Mark Zuckerberg, Steve Jobs, and Bill Gates, and I too could have become a billionaire? OK, maybe not, but sometimes living in dreamland can be fun.
Speaking of dreams, Zuckerberg has a dream of connecting the whole world, and with more than 800 million-plus Facebook users, he is well on his way. If Facebook users made their own own country, it would be #3 behind only China and India – I’ll check back in a few years to see if Facebook can climb to the top position.
The Pre-IPO Interview
Charlie Rose recently ditched the tie and headed to Silicon Valley to conduct an interview at Facebook headquarters with Mark Zuckerberg and his Chief Operating Officer Sheryl Sandberg. If you fast forward to MINUTE 9:30 you can listen to the official Facebook IPO response:
The Hype Machine
The hype surrounding the Facebook IPO is palpable and feels a lot like the Google Inc. (GOOG) IPO in 2004, but that capital raising event only resulted in proceeds of $1.9 billion for Google. The recent chatter surrounding the pending Facebook IPO places the value to be raised closer to $10 billion. Partial offerings seem to be the trend du jour in the social media IPO world, where companies like LinkedIn Corp. (LNKD), Groupon Inc. (GRPN), and Zillow Inc. (Z) all sold just a sliver of their shares to the public in order to create artificial scarcity, thereby pumping up short-term demand for their respective stocks. These companies trade at or above their initial offering price, but significantly below the early investor mouth-frothing spikes in share prices near the time of the IPOs. Facebook appears to be using the same playbook to build up hype for its eventual offering.
Even at an estimated value of $100 billion, Facebook still has some wood to chop if wants to pass Google (about $185 billion in value) and Apple Inc’s (AAPL) approximate $415 billion, but Zuckerberg is no stranger to ambition. When Facebook unveils its inevitable IPO prospectus in the not too distant future, we will have a better idea of whether Facebook and the 2010 Time magazine Person of the Year deserve all the mega-billion dollar accolades, or will an IPO feeding frenzy bring tears to those investors’ eyes that are not privileged enough to receive IPO allocated shares? Regardless of your faith or skepticism, we’re likely to find out the answer to these critical questions in a blink of an eye.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, AGN, AAPL, GOOG but at the time of publishing SCM had no direct position in Facebook, MSFT, LNKD, GRPN, Z, TWX, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
There are many ways to make money in the financial markets, but if this was such an easy endeavor, then everybody would be trading while drinking umbrella drinks on their private islands. I mean with all the bright blinking lights, talking baby day traders, and software bells and whistles, how difficult could it actually be?
Unfortunately, financial markets have a way of driving grown men (and women) to tears, usually when confidence is at or near a peak. The best investors leave their emotions at the door and follow a systematic disciplined process. Investing can be a meat grinder, but the good news is one does not need to have a 90% success rate to make it lucrative. Take it from Peter Lynch, who averaged a +29% return per year while managing the Magellan Fund at Fidelity Investments from 1977-1990. “If you’re terrific in this business you’re right six times out of 10,” says Lynch.
Sweating Way to Success
If investing is so tough, then what is the recipe for investment success? As the saying goes, money management requires 10% inspiration and 90% perspiration. Or as strategist and long-time investor Don Hays notes, “You are only right on your stock purchases and sales when you are sweating.” Buying what’s working and selling what’s not, doesn’t require a lot of thinking or sweating (see Riding the Wave), just basic pattern recognition. Universally loved stocks may enjoy the inertia of upward momentum, but when the music stops for the Wall Street darlings, investors rarely can hit the escape button fast enough. Cutting corners and taking short-cuts may work in the short-run, but usually ends badly.
Real profits are made through unique insights that have not been fully discovered by market participants, or in other words, distancing oneself from the herd. Typically this means investing in reasonably priced companies with significant growth prospects, or cheap out-of-favor investments. Like dieting, this is easy to understand, but difficult to execute. Pulling the trigger on unanimously hated investments or purchasing seemingly expensive growth stocks requires a lot of blood, sweat, and tears. Eating doughnuts won’t generate the conviction necessary to justify the valuation and excess expected return for analyzed securities.
Times Have Changed
Investing in stocks is difficult enough with equity fund flows hemorrhaging out of investor accounts like the asset class is going out of style (See ICI data via The Reformed Broker). Stocks’ popularity haven’t been helped by the heightened volatility, as evidenced by the multi-year trend in the schizophrenic volatility index (VIX) - escalated by the “Flash Crash,” U.S. debt ceiling debate, and European financial crisis. Globalization, which has been accelerated by technology, has only increased correlations between domestic market and international markets. As we have recently experienced, the European tail can wag the U.S. dog for long periods of time. In decades past, concerns over economic activity in Iceland, Dubai, and Greece may not even make the back pages of The Wall Street Journal. Today, news travels at the speed of a “Tweet” for every Angela Merkel – Nicolas Sarkozy breakfast meeting or Chinese currency adjustment, and eventually results in a sprawling front page headline.
The equity investing game may be more difficult today, but investing for retirement has never been more important. Stuffing money under the mattress in Treasuries, money market accounts, CDs, or other conservative investments may feel good in the short run, but will likely not cover inflation associated with rising fuel, food, healthcare, and leisure costs. Regardless of your investment strategy, if your goal is to earn excess returns, you may want to check the moistness of your armpits – successful long-term investing requires a lot of sweat.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in ETFC, VXX, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Simon had Garfunkel, Batman had Robin, Hall had Oates, Dr. Evil had Mini Me, Sonny had Cher, and Malone had Stockton. In the investing world, Buffett has Munger. Charlie Munger is one of the most successful and famous wingmen of all-time - evidenced by Berkshire Hathaway Corporation’s (BRKA/B) outperformance of the S&P 500 index by approximately +624% from 1977 – 2009, according to MarketWatch. Munger not only provides critical insights to his legendary billionaire boss, Warren Buffett, but he also is Chairman of Berkshire’s insurance subsidiary, Wesco Financial Corporation. The magic of this dynamic duo began when they met at a dinner party during 1959.
In an article he published in 2006, the magnificent Munger describes the “Art of Stock Picking” in a thorough review about the secrets of equity investing. We’ll now explore some of the 88-year-old’s sage advice and wisdom.
Charlie Munger believes an individual needs a solid general education before becoming a successful investor, and in order to do that one needs to study and understand multiple “models.”
“You’ve got to have models in your head. And you’ve got to array your experience both vicarious and direct on this latticework of models. You may have noticed students who just try to remember and pound back what is remembered. Well, they fail in school and in life. You’ve got to hang experience on a latticework of models in your head.”
Although Munger indicates there are 80 or 90 important models, the examples he provides include mathematics, accounting, biology, physiology, psychology, and microeconomics.
Advantages of Scale
Great businesses in many cases enjoy the benefits of scale, and Munger devotes a good amount of time to this subject. Scale advantages can be realized through advertising, information, psychological “social proofing,” and structural factors.
The newspaper industry is an example of a structural scale business in which a “winner takes all” phenomenon applies. Munger aptly points out, “There’s practically no city left in the U.S., aside from a few very big ones, where there’s more than one daily newspaper.”
General Electric Co. (GE) is another example of a company that uses scale to its advantage. Jack Welch, the former General Electric CEO, learned an early lesson. If the GE division is not large enough to be a leader in a particular industry, then they should exit. Or as Welch put it, “To hell with it. We’re either going to be # 1 or #2 in every field we’re in or we’re going to be out. I don’t care how many people I have to fire and what I have to sell. We’re going to be #I or #2 or out.”
Bigger Not Always Better
Scale comes with its advantages, but if not managed correctly, size can weigh on a company like an anchor. Munger highlights the tendency of large corporations to become “big, fat, dumb, unmotivated bureaucracies.” An implicit corruption also leads to “layers of management and associated costs that nobody needs. Then, while people are justifying all these layers, it takes forever to get anything done. They’re too slow to make decisions and nimbler people run circles around them.”
Becoming too large can also create group-think, or what Munger calls “Pavlovian Association.” Munger goes onto add, “If people tell you what you really don’t want to hear what’s unpleasant there’s an almost automatic reaction of antipathy…You can get severe malfunction in the high ranks of business. And of course, if you’re investing, it can make a lot of difference.”
Technology: Benefit or Burden?
Munger recognizes that technology lowers costs for companies, but the important question that many managers fail to ask themselves is whether the benefits from technology investments accrue to the company or to the customer? Munger summed it up here:
“There are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that’s still going to be lousy. The money still won’t come to you. All of the advantages from great improvements are going to flow through to the customers.”
Buffett and Munger realized this lesson early on when productivity improvements gained from technology investments in the textile business all went to the buyers.
Surfing the Wave
When looking for good businesses, Munger and Buffett are looking to “surf” waves or trends that will generate healthy returns for an extended period of time. “When a surfer gets up and catches the wave and just stays there, he can go a long, long time. But if he gets off the wave, he becomes mired in shallows,” states Munger. He notes that it’s the “early bird,” or company that identifies a big trend before others that enjoys the spoils. Examples Munger uses to illustrate this point are Microsoft Corp. (MSFT), Intel Corp. (INTC), and National Cash Register from the old days.
Large profits will be collected by those investors that can identify and surf those rare large waves. Unfortunately, taking advantage of these rare circumstances becomes tougher and tougher for larger investors like Berkshire. If you’re an elephant trying to surf a wave, you need to find larger and larger waves, and even then, due to your size, you will be unable to surf as long as small investors.
Circle of Competence
Circle of competence is not a new subject discussed by Buffett and Munger, but it is always worth reviewing. Here’s how Munger describes the concept:
“You have to figure out what your own aptitudes are. If you play games where other people have the aptitudes and you don’t, you’re going to lose. And that’s as close to certain as any prediction that you can make. You have to figure out where you’ve got an edge. And you’ve got to play within your own circle of competence.”
For Munger and Buffett, sticking to their circle of competence means staying away from high-technology companies, although more recently they have expanded this view to include International Business Machines (IBM), which they invested in late last year.
Market Efficiency or Lack Thereof
Munger acknowledges that financial markets are quite difficult to beat. Since the markets are “partly efficient and partly inefficient,” he believes there is a minority of individuals who can outperform the markets. To expand on this idea, he compares stock investing to the pari-mutuel system at the racetrack, which despite the odds stacked against the bettor (17% in fees going to the racetrack), there are a few individuals who can still make decent money.
The transactional costs are much lower for stocks, but success for an investor still requires discipline and patience. As Munger declares, “The way to win is to work, work, work, work and hope to have a few insights.”
Winning the Game – 10 Insights / 20 Punches
As the previous section implies, outperformance requires patience and a discriminating eye, which has allowed Berkshire to create the bulk of its wealth from a relatively small number of investment insights. Here’s Munger’s explanation on this matter:
“How many insights do you need? Well, I’d argue: that you don’t need many in a lifetime. If you look at Berkshire Hathaway and all of its accumulated billions, the top ten insights account for most of it….I don’t mean to say that [Warren] only had ten insights. I’m just saying, that most of the money came from ten insights.”
Chasing performance, trading too much, being too timid, and paying too high a price are not recipes for success. Independent thought accompanied with selective, bold decisions is the way to go. Munger’s solution to these problems is to provide investors with a Buffett 20-punch ticket:
“I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had 20 punches ‑ representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.”
The great thing about Munger and Buffett’s advice is that it is digestible by the masses. Like dieting, investing can be very simple to understand, but difficult to execute, and legends like these always remind us of the important investing basics. Even though Charlie Munger may be slowing down a tad at 88-years-old, Warren Buffett and investors everywhere are blessed to have this wingman around spreading his knowledge about investing and the art of stock picking.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in BRKA/B, GE, MSFT, INTC, National Cash Register, IBM, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
As it turns out, 2011 can be characterized as the year of the pancake…the flat pancake. While the Dow Jones Industrial Average (Dow) rose about 6% this year (its third consecutive annual gain), the S&P 500 ended the year flat at 1257.6 (-0.003%), the smallest yearly move in more than four decades. Along the way in 2011, there was plenty of violent beating and whipping of the lumpy pancake batter before the flat cake was cooked for the year. With respect to the financial markets, the 2011 lumps came in the form of various unsavory events:
* Never-Ending Eurozone Financial Saga: After Ireland and Portugal sought bailouts, Greece added its negligent financial storyline to the financial soap opera. Whether European government leaders can manage out-of-control deficits and debt loads will determine if Greece and other peripheral countries will topple larger countries like Italy and Spain.
* Credit Rating Downgrade: Standard & Poor’s, the highest profile credit rating agency, downgraded the U.S.’s long-term debt rating to AA+ from AAA due to high debt levels and Congressional legislators inability to hammer out a deficit-reduction plan during the debt ceiling negotiations.
* Japanese Earthquake and Tsunami: Japan and the global economy were rocked by a magnitude 9.0 earthquake and tsunami on March 11, 2011, which resulted in 15,844 people dead and 3,451 people missing. The ripple effects are still being felt through large industries like the automobile and electronics industries.
* Arab Spring Protests: Protesters throughout the Middle East and North Africa provided additional uncertainty to the global political map as demonstrators demanded regime change and more political freedoms. In the long-run, removing oppressive leaders like Hosni Mubarak (Egypt’s leader for 30 years), Muammar Gadaffi (Libya’s leader for 42 years), and Zine al-Abidine Ben Ali (Tunisia’s president for 23 years) should be beneficial for global stability, but in the short-run, how the new leadership vacuum will be filled remains ambiguous.
* Occupy Movement Voices Disapproval: The Occupy Wall Street movement began on September 17, 2011 in Liberty Square in Manhattan’s Financial District, and spread to over 100 cities in the U.S. There has not been a cohesive articulated agenda, but a common thread underlying all the Occupy movements is a sense that 99% of the population is being treated unfairly due to a flawed corrupt system controlled by Wall Street that is feeding the richest 1%.
All these lumps experienced in 2011 were not settling to investors’ stomachs. As a result individuals continued the trend of piling into bonds, in hopes of soothing their investment tummies. Long-term Treasury prices spiked upwards in 2011 (+29% as measured by TLT Treasury ETF) and soaring 10-year Treasury note prices pushed yields (1.87%) below yields on S&P 500 equities (2.1%). Despite a more than 3,400 point increase in the Dow (+39%) since the end of 2008, investors have still poured $774 billion into bonds versus $33 billion yanked from equities, according to EPFR Global. Over-weighting bonds makes sense for some, including retirees on fixed budgets, but many investors should brace for an inevitable reversal in bond prices. Eventually, the sweet taste of safety achieved from bond appreciation will turn to heartburn, once interest rates reverse their 30 year trend of declines.
Although the aforementioned factors lead to historically high volatility and flat flavors in 2011, there are also some countering sweet reasons that make equities look more palatable for 2012. Here are some of the factors:
* Record Corporate Profits: Even with the constant barrage of fear, uncertainty, and doubt distributed via the media channels, corporations posted record profits in 2011, with an estimated increase of +16% over last year (and another forecasted +10% rise in 2012 – Source: S&P).
* Historic Levels of Cash: Record profits mean record cash, and all those riches have been piling up on non-financial corporate balance sheets at historic levels. At the beginning of Q4 the figure stood at $2.12 trillion. Companies have generally been stingy, but as the recovery progresses, they have increasingly been spending on technology, equipment, international expansion, and even the beginnings of hiring.
* Interest Rates at 60 Year Lows: Interest rates are at record lows and home affordability has never been better with 30-year fixed rate mortgages hovering below 4%. Housing may not come screaming back, but the foundation for a recovery is being laid.
* Improving Economic Variables: Whether you’re looking at broader economic activity (Gross Domestic Product up for nine consecutive quarters); employment growth (declining unemployment rate and 21 consecutive months of private job creation), or consumer spending (consumer confidence approaching multi-year highs), all major signs are currently pointing to an improving outlook.
* Near Record Exports: While the U.S. dollar has made some recent gains against foreign currencies because of the financial crisis in Europe, the relative value of the dollar remains historically low versus the major global currencies. The longer-term depreciation of the dollar has buoyed exports of U.S. goods to near record levels despite the global uncertainty.
* Unprecedented Central Bank Support Globally: Ben Bernanke and the U.S. Federal Reserve is committed to keeping exceptionally low levels of lending interest rates at least through mid-2013, while also implementing “Operation Twist” and potential further quantitative easing (QE3). Translation: Ben Bernanke is going to do everything in his power to keep interest rates low in order to stimulate economic growth. The European Central Bank (ECB) has pulled out its lending fire trucks too, with an unparalleled three-year lending program to extinguish liquidity fires in the European banking sector.
* Improving Mergers & Acquisitions Environment: We may not be back to the 2006 buyout “hay-days,” but U.S. mergers and acquisitions activity increased +24% in 2011. What’s more, high profile potential IPOs like an estimated $100 billion Facebook offering may help kick-start the new equity issuance market in 2012.
* Tasty Fat Dividends: Rarely have S&P 500 dividend yields (currently 2.1%) outpaced the interest rates earned on 10-year Treasury note yields, but now happens to be one of those times. Typically S&P 500 stock dividends have averaged about 40% of the yield on 10-year Treasury notes, and now it is 112%. In Q3 of 2011, dividend increases rose +17% and expectations are for nearly a +11% increase in 2012, said Howard Silverblatt, senior index analyst at S&P.
Any way you cut it (or beat the batter), 2011 was a volatile year. And despite all the fear, uncertainty, and doubt, profits continue to grow and sovereign nations are being forced to deal with their fiscal problems. Unforeseen risks always exist, but if Europe can contain its financial crisis and the U.S. recovery can continue into this new election year, then opportunities in the 2012 attractively priced equity markets should sweeten the flat equity pancake we ate in 2011.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, including a short position in TLT, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.