Archive for March, 2011
Cutting Losses with Fisher’s 3 Golden Sell Rules
Returning readers to Investing Caffeine understand this is a location to cover a wide assortment of investing topics, ranging from electric cars and professional poker to taxes and globalization. Investing Caffeine is also a location that profiles great investors and their associated investment lessons.
Today we are going to revisit investing giant Phil Fisher, but rather than rehashing his accomplishments and overall philosophy, we will dig deeper into his selling discipline. For most investors, selling securities is much more difficult than buying them. The average investor often lacks emotional self-control and is unable to be honest with himself. Since most investors hate being wrong, their egos prevent taking losses on positions, even if it is the proper, rational decision. Often the end result is an inability to sell deteriorating stocks until capitulating near price bottoms.
Selling may be more difficult for most, but Fisher actually has a simpler and crisper number of sell rules as compared to his buy rules (3 vs. 15). Here are Fisher’s three sell rules:
1) Wrong Facts: There are times after a security is purchased that the investor realizes the facts do not support the supposed rosy reasons of the original purchase. If the purchase thesis was initially built on a shaky foundation, then the shares should be sold.
2) Changing Facts: The facts of the original purchase may have been deemed correct, but facts can change negatively over the passage of time. Management deterioration and/or the exhaustion of growth opportunities are a few reasons why a security should be sold according to Fisher.
3) Scarcity of Cash: If there is a shortage of cash available, and if a unique opportunity presents itself, then Fisher advises the sale of other securities to fund the purchase.
Reasons Not to Sell
Prognostications or gut feelings about a potential market decline are not reasons to sell in Fisher’s eyes. Selling out of fear generally is a poor and costly idea. Fisher explains:
“When a bear market has come, I have not seen one time in ten when the investor actually got back into the same shares before they had gone up above his selling price.”
In Fisher’s mind, another reason not to sell stocks is solely based on valuation. Longer-term earnings power and comparable company ratios should be considered before spontaneous sales. What appears expensive today may look cheap tomorrow.
There are many reasons to buy and sell a stock, but like most good long –term investors, Fisher has managed to explain his three-point sale plan in simplistic terms the masses can understand. If you are committed to cutting investment losses, I advise you to follow investment legend Phil Fisher – cutting losses will actually help prevent your portfolio from splitting apart.
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 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.
Reasoning with Investment Confusion
Some things never change, and in the world of investing many of the same principles instituted a century ago are just as important today. So while we are dealing with wars, military conflicts, civil unrest, and natural disasters, today’s process of filtering and discounting all these events into stock prices is very similar to the process that George Selden describes in his 1912 book, “Psychology of the Stock Market.”
Snub the Public
Investing in stocks is nowhere close to a risk-free endeavor, and 2008-2009 was a harsh reminder of that fact. Since a large part of the stock market is based on emotions and public opinion, stock prices can swing wildly. Public opinion may explain why the market is peaking or troughing, but Selden highlights the importance of the silent millionaires (today’s billionaires and institutional investors), and that the true measurement of the stock market is dollars (not opinions of the masses):
“Public opinion in a speculative market is measured in dollars, not in population. One man controlling one million dollars has double the weight of five hundred men with one thousand dollars each. Dollars are the horsepower of the markets–the mere number of men does not signify.”
When the overwhelming consensus of participants is bullish, by definition, the small inexperienced investors and speculators are supplied stock from someone else – the silent, wealthy millionaires.
The newspaper headlines that we get bombarded with on a daily basis are a mirror reflection of the general public’s attitudes and when the euphoria or despondency reaches extreme levels, these points in time have been shown to correlate with market tops and bottoms (see Back to the Future Magazine Covers).
In the short-run, professional traders understand this dynamic and will often take a contrarian approach to news flow. Or as Seldon explains:
“A market which repeatedly refuses to respond to good news after a considerable advance is likelely to be ‘full of stocks.’ Likewise a market which will not go down on bad news is usually ‘bare of stock.’”
This contrarian dynamic in the market makes it virtually impossible for the average investor to trade the market based on the news flow of headlines and commentator. Before the advent of the internet, 98 years ago, Selden prophetically noted that the increasing difficulty of responding to sentiment and tracking market information:
“Public opinion is becoming more volatile and changeable by the year, owing to the quicker spread of information and the rapid multiplication of the reading public.”
Following what the so-called pundits are saying is fruitless, or as Gary Helms says, “If anybody really knew, they wouldn’t tell you.”
Selden’s Sage Advice
If trading was difficult in 1912, it must be more challenging today. Selden’s advice is fairly straightforward:
“Stick to common sense. Maintain a balanced, receptive mind and avoid abstruse deductions…After a prolonged advance, do not call inverted reasoning to your aid in order to prove that prices are going still higher; likewise after a big break do not let your bearish deductions become too complicated.”
The brain is a complex organ, but we humans are limited in the amount and difficulty of information we can assimilate.
“When it comes to so complicated a matter as the price of stocks, our haziness increases in proportion to the difficulty of the subject and our ignorance of it.”
The mental somersault that investors continually manage is due to the practice of “discounting.” Discounting is a process that adjusts today’s price based on future expected news. Handicapping sports “spreads” involves a very similar methodology as discounting stock prices (read What Happens in Vegas). But not all events can be discounted, for instance the recent earthquake and tsunami in Japan. When certain factors are over-discounted or under-discounted, these are the situations to profit from on a purchase or shorting basis.
The Dow Jones Industrial Average traded below a value of 100 versus more than 12,000 today, but over that period some things never change, like the emotional and mental aspects of investing. George Selden makes this point clear in his century old writings – it’s better to focus on the future rather than fall prey to the game of mental somersault we call the stock market.
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 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.
The Illusion of the Reverse Split
Source: Photobucket
“Citi is a fundamentally different company than it was three years ago. The reverse stock split and intention to reinstate a dividend are important steps as we anticipate returning capital to shareholders starting next year.”
Okay, so Citigroup is paying out a whopping 1/10 of one penny per your current share price (compared to $.49 per share before the financial crisis) and Vikram is telling me I should be excited. Maybe additional ecstasy should be kicking in once shareholders learn they will receive 1 pie with no slices, rather than 1 pie with 10 slices? These same share-slicing and re-piecing gimmicks were implemented in the pre and post dot-com era with no beneficial value. If this truly was such a novel idea, I wonder why smart people like Warren Buffett have chosen not put such amazing, whiz-bang ideas to use. The lauded 1-10 reverse split planned by Citigroup could also be used to raise Berkshire Hathaway’s share price from $127,766 per share to $1,277,660 per share. One share of post reverse-split BRKA could buy you 288,410 shares of Citigroup today.
Proponents of the reverse split cite the institutional benefits provided by the move. Not only will institutions previously prohibited from buying single digit equity securities now be able to buy Citigroup shares, but institutions will also be able to pay lower commissions because the current 29 billion shares outstanding will be reduced to a measly 2,900,000,000 shares. In reality, reducing share count through a reverse split may fool a few unknowledgeable speculators, but prudent investors understand a reverse split does not impact the value of the company one iota.
The fact of the matter is that earnings and cash flow growth will be the main drivers behind institutional shareholder buying of Citigroup’s stock.
Famous investor John Templeton simply stated, “In the long run, the stock market indexes fluctuate around the long-term upward trend of earnings per share.”
Peter Lynch appreciated the importance of earnings too: “People may bet on hourly wiggles of the market but it’s the earnings that waggle the wiggle long term.”
So while Citigroup may not be a horrible stock, the announcing of a 1 for 10 reverse stock split will not be a share price savior. So rather than let the illusion of capital structure gimmicks inform your decisions, investors would be better served by focusing on the sustainability and growth of earnings and cash flows.
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, C, 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.
Nuclear Knee-Jerk Reaction
It’s amazing how quickly the long-term secular growth winds can reverse themselves. Just a week ago, nuclear energy was thought of as a safe, clean, green technology that would assist the gasoline pump pain in our wallets and purses. Now, given the events occurring in Japan, “nuclear” has become a dirty word equated to a life-threatening game of Russian roulette.
Despite the spotty information filtering in from the Dai-Ichi plant in Japan, we are already absorbing knee-jerk responses out of industrial heavyweight countries like Germany and China. Germany has temporarily closed seven nuclear power centers generating about a quarter of its nuclear capacity, and China has instituted a moratorium on all new facilities being built. How big a deal is this? Well, China is one country, and it alone currently accounts for 44% of the 62 global nuclear reactor projects presently under construction (see chart below).
Source: World Nuclear Association (URRE Presentation)
As a result of the damaged Fukushima reactors, coupled with various governmental announcements around the globe, Uranium prices have dropped a whopping -30% within a month – plunging from about $70 per pound to around $50 per pound today.
Where does U.S. Nuclear Go from Here?
As you can see from the chart below, the U.S. is the largest producer of nuclear energy in the world, but since our small population is such power hogs, this relatively large nuclear capability only accounts for roughly 20% of our country’s total electricity needs. France, on the other hand, manages about half the reactors as we do, but the French derive a whopping 75% of their total electricity needs from nuclear power. According to the Nuclear Energy Institute, Japanese reliance on nuclear power falls somewhere in between – 29% of their electricity demand is filled by nuclear energy. Like Japan, the U.S. imports most of its energy needs, so if nuclear development slows, guess what, other resources will need to make up the difference. OPEC and various other oil-rich, dictators in the Middle East are licking their chops over the future prospects for oil prices, if a cost-effective alternative like nuclear ends up getting kicked to the curb.
Source: The Economist
As I alluded to above, there is, however, a silver lining. As long as oil prices remain elevated, any void created by a knee-jerk nuclear backlash will only create heightened demand for alternative energy sources, including natural gas, solar, wind, biomass, clean coal, and other creative substitutes. While we Americans may be addicted to oil, we also are inventive, greedy capitalists that will continually look for more cost-efficient alternatives to solve our energy problems (see also Electrifying Profits). Unlike other countries around the world, it looks like the private sector will have to do the heavy lifting to solve these resources on their own dime. Limited subsidies have been introduced, but overall our government has lacked a cohesive energy plan to kick-start some of these innovative energy alternatives.
Déjà Vu All Over Again
We saw what happened on our soil in March 1979 when the Three Mile Island nuclear accident in Pennsylvania consumed the hearts and minds of the country. Pure unadulterated panic set in and new nuclear production ground to a virtual halt. When the subsequent Chernobyl incident happened in April 1986 insult was added to injury. As you can see from the chart below, nuclear reactor capacity has plateaued for some twenty years now.
Source: Wikipedia
The driving force behind the plateauing nuclear facilities is the NIMBY (Not In My Back Yard) phenomenon. The Three Mile Island incident is still fresh in people’s minds, which explains why only one nuclear plant is currently under construction in our country, on top of a base of 104 U.S. reactors in 31 states. I point this out as an ambivalent NIMBY-er since I work 30 miles away from one of the riskiest, 30-year-old nuclear plants in the country (San Onofre).
Unintended Consequences
The Sendai disaster is home to the worst Japanese earthquake in 140 years, by some estimates, but history will prove once again what unintended consequences can occur when impulsive knee-jerk decisions are made. Just consider what has happened to oil prices since the moratorium on offshore drilling (post-BP disaster) was instituted. Sure we have witnessed a dictator or two topple in the Middle East, and there currently is adequate supply to meet demand, but I would make the case that we should be increasing domestic oil supplies (along with alternative energy sources), not decreasing supplies because it is politically safe.
Time will tell if the Japanese earthquake/tsunami-induced nuclear disaster will create additional unintended consequences, but I am hopeful the recent events will at a minimum create a serious dialogue about a comprehensive energy policy. If the comfortable, knee-jerk reaction of significantly diminishing nuclear production is broadly adopted around the world, then an urgent alternative supply response needs to occur. Otherwise, you may just need to enjoy that bike ride to work in the morning, along with that nice, romantic candle-lit dinner at night.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and alternative energy securities, but at the time of publishing SCM had no direct position in BP, URRE, 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.
Shoring Up Your Investment Stool from Collapse
With March Madness just kicking into full gear, there’s a chance that your gluteal assets may be parked on a stool in the next two weeks. When leaning on a bar countertop, while seated on a stool, we often take for granted the vital support this device provides, so we can shovel our favorite beverage and pile of nachos into our pie holes. OK, maybe I speak for myself when it comes to my personal, gluttonous habits. But the fact remains, whether you are talking about your rump, or your investment portfolio, you require a firm foundation.
The main problem, when it comes to investments, is the lack of a tangible, visible stool to analyze. Sure, you are able to see the results of a portfolio collapse when there is no foundation to support it, or you may even be able to ignore the results when they remain above water. But many investors do not evenperform the basic due diligence to determine the quality of their investment stool. Before you place your life savings in the hands of some brokerage salesman, or in your personal investment account, you may want to make sure your stool has more than one or two legs.
In the money management world, investors typically choose to buy the stool, rather than build it, which makes perfect common sense. Many people do not have the time or emotional make-up to manage their finances. If left to do it themselves, more often than not, investors usually do a less than stellar job. Unfortunately, when many investors do outsource the management of their investments, they neglect to adequately research the investment stool they buy. Usually the wobbly industry stool operates on the two legs of performance chasing and commission generation (see Fees, Exploitation, and Confusion). For most average investors, it doesn’t take long before that investment strategy teeters and collapses.
If the average investor does not have time to critically evaluate managers that take a long-term, low-cost, tax-efficient strategy to investing, those individuals would be best served by following Warren Buffet’s advice about passive investments, “A very low-cost index is going to beat a majority of the amateur-managed money or professionally-managed money.”
The Four Legs of the Investment Stool
For DIY-ers (Do-It-Yourself-ers), you do not need to buy a stool – you can build it. There are many ways to build a stool, but these are the four crucial legs of investing that have saved my hide over my career, and can be added as support for your investment stool:
1.) Valuation: I love sustainable growth as much as anything, just as much as I would like a shiny new Ferrari. But there needs to be a reasonable price paid for growth, and paying an attractive or fair price for a marquis asset will improve your odds for long-term success.
“Valuations do matter in the stock market, just as good pitching matters in baseball.”
-Fred Hickey (High Tech Strategist)
2.) Cash Flows: Cash flows, and more importantly free cash flows (cash left over after money is spent on capital expenditures), should be investors’ metric of choice. Companies do not pay for dividends, share buybacks, and capital expenditures with pro forma earnings, or non-GAAP earnings. Companies pay for these important outlays with cash.
“In looking for stocks to buy, why do you put so much emphasis on free cash flow? Because it makes the most sense to me. My first job was at a little corner grocery store, and it seemed pretty simple. Cash goes into the register; cash comes out.”
-Bruce Berkowitz (The Fairholme Fund)
3.) Interest Rates: Money goes where it is treated best, so capital will look at the competing yields paid on bonds. Intuitively, interest factors also come into play when calculating the net present value of a stock. Just look at the low Price-Earnings ratios of stocks in the early 1980s when the Fed Funds reached about 20% (versus effectively 0% today). In the long run, higher interest rates (and higher inflation) are bad for stocks, but worse for bonds.
“I don’t know any company that has rewarded any bondholder by raising interest rates [payments] – unlike companies raising dividends.”
-Peter Lynch (Former manager of the Fidelity Magellan Fund)
4.) Quality: This is a subjective factor, but this artistic assessment is as important, if not more important than any of the previous listed factors. In searching for quality, it is best to focus on companies with market share leading positions, strong management teams, and durable competitive advantages.
“If you sleep with dogs, you’re bound to get fleas.”
-Old Proverb
These four legs of the investment stool are essential factors in building a strong investment portfolio, so during the next March Madness party you attend at the local sports bar, make sure to check the sturdiness of your bar stool – you want to make sure your assets are supported with a sturdy foundation.
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 Fairholme, Ferrari, 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.
Killing Patients to Investment Prosperity
All investors are optimistic, every time they open up a position, but just like surgeons, sometimes the outcome doesn’t turn out as well as initially anticipated. When it comes to investing, I think this old Hindu proverb puts things into perspective:
“No physician is really good before he has killed one or two patients.”
So too, an investor does not become really good until he kills off some investment positions. But like surgeons, investors also have to understand the most important aspect of tragic events is learning from them. In many cases, unexpected outcomes are out of our control and cannot be prevented. This conclusion, in and of itself, can provide valuable insights. But on many occasions, there are procedures, processes, and facts that were missed or botched, and learning from those mistakes can prove invaluable when it comes to refining the process in the future – in order to further minimize the probability of a tragic outcome.
My Personal Killers
Professionally, I have killed some stocks in my career too, or they have killed me, depending on how you look at the situation. How did these heartrending incidents occur? There are several categories that my slaughtered stocks fell under:
- Roll-Up, Throw-Up: Several of my investment mistakes have been tied to roll-up or acquisition-reliant growth stories, where the allure of rapid growth shielded the underlying weak fundamentals of the core businesses. Buying growth is easier to create versus organically producing growth. Those companies addicted to growth by acquisition eventually experience the consequences firsthand when the game ends (i.e., the quality of deals usually deteriorates and/or the prices paid for the acquisitions become excessive).
- Technology Kool-Aid: Another example is the Kool-Aid I drank, during the technology bubble days, related to a “story” stock – Webvan, a grocery delivery concept. How could mixing Domino’s pizza delivery (DZP) with Wal-Mart’s (WMT) low-priced goods not work? I’m just lazy enough to demand a service like that. Well, after spending hundreds of millions of dollars and never reaching the scale necessary to cover the razor thin profit margins, Webvan folded up shop and went bankrupt. But don’t give up hope yet, Amazon (AMZN) is refocusing its attention on the grocery space (mostly non-perishables now) and could become the dominant food delivery retailer.
- Penny Stocks = Dollars Lost: Almost every seasoned investor carries at least one “penny stock” horror story. Unfortunately for me, my biotech miracle stock, Saliva Diagnostics (SALV), did not take off to the moon and provide an early retirement opportunity as planned. On the surface it sounded brilliant. Spit in a cup and Saliva Diagnostic’s proprietary test would determine whether patients were infected with the HIV virus. With millions of HIV/AIDS patients spread around the world, the profit potential behind ‘Saliva’ seemed virtually limitless. The technology unfortunately did not quite pan out, and spit turned into tears.
The Misfortune Silver Lining
These stock tragedies are no fun, but I am not alone. Fortunately for me, and other professionals, there is a nine-lives feline element to investing. One does not need to be right all the time to outperform the indices. “If you’re terrific in this business you’re right 6 times out of 10 – I’ve had stocks go from $11 to 7 cents (American Intl Airways),” admitted investment guru Peter Lynch. Growth stock investing expert, Phil Fisher, added: “Fortunately the long-range profits earned from really good common stocks should more than balance the losses from a normal percentage of such mistakes.”
Warren Buffett takes a more light-hearted approach when he describes investment mistakes: “If you were a golfer and you had a hole in one on every hole, the game wouldn’t be any fun. At least that’s my explanation of why I keep hitting them in the rough.”
Some investors purposely forget traumatic investment experiences, but explicitly sweeping the event under the rug will do more harm than good. So the next time you suffer a horrendous stock price decline, do your best to log the event and learn from the situation. That way, when the patient (stock) has been killed (destroyed), you will become a better, more prosperous doctor (investor).
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, WMT, and AMZN but at the time of publishing SCM had no direct position in DZP, Webvan, Saliva Diagnostics, American intl Airways, 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.
Buffett on Gold Fondling and Elephant Hunting
Warren Buffett is kind enough to occasionally grace investors with his perspectives on a wide range of subjects. In his recently released annual letter to shareholders he covered everything from housing and leverage to liquidity and his optimistic outlook on America (read full letter here). Taking advice from the planet’s third wealthiest person (see rankings) is not a bad idea – just like getting basketball pointers from Hall of Famer Michael Jordan or football tips from Pro Bowler Tom Brady isn’t a bad idea either.
Besides being charitable with billions of his dollars, the “Oracle of Omaha” was charitable with his time, spending three hours on the CNBC set (a period equal to $12 million in Charlie Sheen dollars) answering questions, all at the expense of his usual money-making practice of reading through company annual reports and 10Qs.
Buffett’s interviews are always good for a few quotable treasures and he didn’t disappoint this time either with some “gold fondling” and “elephant hunting” quotes.
Buffett on Gold & Commodities
Buffett doesn’t hold back on his disdain for “fixed-dollar investments” and isn’t shy about his feelings for commodities when he says:
“The problem with commodities is that you are betting on what someone else would pay for them in six months. The commodity itself isn’t going to do anything for you….it is an entirely different game to buy a lump of something and hope that somebody else pays you more for that lump two years from now than it is to buy something that you expect to produce income for you over time.”
Here he equates gold demand to fear demand:
“Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn’t produce anything.”
Buffett goes on to say this about the giant gold cube:
“I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side…Now for that same cube of gold, it would be worth at today’s market prices about $7 trillion dollars – that’s probably about a third of the value of all the stocks in the United States…For $7 trillion dollars…you could have all the farmland in the United States, you could have about seven Exxon Mobils (XOM), and you could have a trillion dollars of walking-around money…And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally…Call me crazy, but I’ll take the farmland and the Exxon Mobils.”
Although not offered up in this particular interview, here is another classic quote by Buffett on gold:
“[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”
For the most part I agree with Buffett on his gold commentary, but when he says commodities “don’t do anything for you,” I draw the line there. Many commodities, outside of gold, can do a lot for you. Steel is building skyscrapers, copper is wiring cities, uranium is fueling nuclear facilities, and corn is feeding the masses. Buffett believes in buying farms, but without the commodities harvested on that farm, the land would not be producing the income he so emphatically cherishes. Gold on the other hand, while providing some limited utility, has very few applications…other than looking shiny and pretty.
Buffett on Elephant Hunting
Another subject that Buffett addresses in his annual shareholder letter, and again in this interview, is his appetite to complete large “elephant” acquisitions. Since Berkshire Hathaway (BRKA/B) is so large now (total assets over $372 billion), it takes a sizeable elephant deal to be big enough to move the materiality needle for Berkshire.
“We’re looking for elephants. For one thing, there aren’t many elephants out there, and all the elephants don’t want to go in our zoo…It’s going to be rare that we are going find something selling in the tens of billions of dollars; where I understand the business; where the management wants to join up with Berkshire; where the price makes the deal feasible; but it will happen from time to time.”
Buffett’s target universe is actually fairly narrow, if you consider his estimate of about 50 targets that meet his true elephant definition. He has been quite open about the challenges of managing such a gigantic portfolio of assets. The ability to outperform the indexes becomes more difficult as the company swells because size becomes an impediment – “gravity always wins.”
With experience and age comes quote-ability, and Warren Buffett has no shortage in this skill department. The fact that Buffett’s investment track record is virtually untouchable is reason enough to hang upon his every word, but his uncanny aptitude to craft stories and analogies – such as gold fondling and elephant hunting – guarantees I will continue waiting with bated breath for his next sage nuggets of wisdom.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds (including commodities) and commodity related equities, but at the time of publishing SCM had no direct position in BRKA/B, XOM 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.
Share Buybacks and Bathroom Violators
We all have our own unique pet peeves that drive us crazy, and I am no exception. More grating than fingernails scraping down the chalkboard or rude drivers who refuse to let you merge lanes are those citizens that unabashedly exercise poor public bathroom etiquette. The only thing worse than listening to the loud-mouth cell phone talker in the neighboring stall is watching a restroom participant move straight from zipper closure (if they remember), immediately to the bathroom exit. I mean really, would it kill you at a minimum to pay a visit to the sink and feign a phantom hand-swipe under some running water? Don’t those people understand that I have to grab the same handle they use to exit the facility after they conduct their bathroom business? OK, now that I have gotten this issue off my chest, I feel better and I can get off my soapbox (no pun intended).
Something Stinks in Share Buyback Land
Beyond potty etiquette, there is another maddening pet peeve that drives me nuts in the realm of corporate capital allocation. I like to call this particular scheme the “empty share buyback.” Those companies that announce the empty share buyback do it with the intention of either getting a quick, short-term jump in stock price, or use the ploy as a way to indirectly line their pockets with future stock and option grants.
Here are a few ways on how the ruse works:
Scheme #1 – The Empty Pump-Fake: In one form or another, here is what the CEO basically says, “We plan to buyback zillions of shares from time to time, based on market conditions, and do not have any set expiration date for the plan.” In other words, the company executives are committing to absolutely nothing, but are hoping to confuse traders into buying shares to temporarily increase the stock price, so management can unload their shares for a swift profit. In actuality the management team is not obligated to purchase one share and may keep the pseudo-share buyback plan in place for years with no benefit to shareholders.
Scheme #2 – The Pocket Swap: Another one of my favorites, I like to call the pocket swap. Management effectively exchanges money from one pocket to the other. Typically management starts off by stating, “We treasure investor feedback, so we have initiated a new program to return capital to our valued shareholders in the form of a share buyback.” What they usually don’t tell investors is that the shares are being purchased (with shareholder money), so the executives can give more shares back to themselves (and a few other fortunate employees). That’s great for them, but what about me?!
At the end of the day, if the management team is truly working for the shareholder, the game is all about reducing the outstanding share count, which thereby increases earnings per share (and better yet free cash flow per share). Despite the recent climb in interest rates, yields are still near multi-decade lows. Corporations are flush with cash after cutting expenses to the bone, delaying hiring, and riding the global recovery wave. For those real investors not trading a position for a few days, weeks, or months, it behooves you to hold management’s feet to the fire to make sure “empty pump-fakes” or “pocket swap” share buybacks are not occurring.
If you have difficulty gauging the integrity of those management teams announcing share buybacks, I have a litmus test that can be used to judge the executive’s true intentions. It’s quite simple – just follow the CEO into the bathroom (same gender required) and see whether they honorably follow bathroom etiquette by washing their hands after completing their duty. Sleuth work can be tricky, but failure in determining the genuine purpose of management’s capital allocation decisions can lead to a share buyback program that will get flushed down the toilet.
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 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.
Spreading the Seeds of Democracy
Excerpt from Free March Sidoxia Monthly Newsletter (Subscribe on right-side of page)
As we bathe ourselves in petroleum products, it is moments like these that highlight our deeply engrained addiction to oil. The flames of fundamental human rights, freedom, and democracy are spreading like wildfire throughout the Middle East and North Africa, and as a result, the cost of living and doing business has gone up. What started as a random plea by a Tunisian fruit merchant in response to insidious corruption (26 year old Mohammed Bouazizi burned himself to death in revolt to continuous crooked government bribes) has resulted in a broad wave of protesters removing two authoritarian, autocratic Arab leaders. Egyptian President Hosni Mubarak and Tunisian President Zine al-Abidine Ben Ali have been swiftly cast out by energized protesters, and other repressive leaders are likely bound to topple as well.
Who’s next and when? You’ll have to stay tuned, but Colonel Muammar Gaddafi, the Libyan leader, is on the short list. Leaders in Yemen, Bahrain, Jordan, and Algeria are among the other countries that are feeling the heat too. Even though Egypt, Libya, Tunisia, and other aforementioned countries remain relative oil lightweights, fear over a political contagion spreading to more substantive countries like Saudi Arabia has gotten speculators frothing at the mouth, which pushed oil prices above $100 per barrel and gasoline prices to an average of $3.37 per gallon (about $3.60 in California according to AAA motor club).
Source: FT.com - The U.S. population is a fraction of the size of China and India, but we continue guzzling dramatically more crude.
While the bloodshed on the streets has created fodder for great sensationalist headlines for the media outlets, the fact of the matter is that the spread of democracy is nothing new, and the innate desire for basic human rights has never died. Going back to 1900 the world housed about 10 practicing democracies, and today there are arguably more than 100 democratic (and quasi-democratic) countries (see blue line in chart below).
Source: The Financial Times.com
In the U.S., our standard of living has exploded for more than a generation. The internet – and applications like Facebook and Twitter – have flattened the planet and connected the rest of the world to the pleasures available to free, transparent, and open societies. As we have experienced firsthand in Iraq, however, regime changes and moves towards democracy can be messy and costly. Ultimately, the native populations must spearhead the drive toward democratic, political change. Regime change solely rammed through by the U.S. will only create temporary change, and with our fiscal wallets empty, we frankly cannot afford it (see Global Babysitter).
Embracing Alternatives
We didn’t run out of stones in the Stone Age, and we did not run out of steel in the Industrial Revolution. When it comes to oil, the same principle applies. As globalization accelerates the expansion of democratic, emerging middle classes around the world, other oil-rich countries, like Saudi Arabia, understand the havoc that $100-$125 dollar a barrel has on demand destruction. Just like a drug dealer does not want to scare its addicted users, so too oil producers do not want to price consumers out of the market with high prices. Oil may be the lubricant for global commerce, but unlike the empty promises offered by the Jimmy Carter era in the 1970s, technology advancements in the alternative energy industry have reached critical mass. If you don’t believe me, just take a gander at the $17 billion the Chinese are pouring into electric vehicle technology (see Electrifying Profits), or the 20% total energy mandate from renewable sources being instituted in Europe by 2020. Even if we choose to watch from the sidelines and pick our noses, our foreign competitors will wave with delight as they embrace alternative energy resources and race past us. Even if political turmoil temporarily worsens in the Middle East, any additional oil price increases will only make alternative energy resources more economical, and thereby accelerate adoption and make disciples of alternative energy less dependent on some of these oil-rich, corrupt regimes.
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 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.
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