Posts filed under ‘Stocks’
Taking Facebook and Twitter Public
Facebook CEO Mark Zuckerberg
Valuing high growth companies is similar to answering a typical open-ended question posed to me during business school interviews: “Wade, how many ping pong balls can you fit in an empty 747 airplane?” Obviously, the estimation process is not an exact science, but rather an artistic exercise in which various techniques and strategies may be implemented to form a more educated guess. The same estimation principles apply to the tricky challenge of valuing high growth companies like Facebook and Twitter.
Cash is King
Where does one start? Conceptually, one method used to determine a company’s value is by taking the present value of all future cash flows. For growth companies, earnings and cash flows can vary dramatically and small changes in assumptions (i.e., revenue growth rates, profit margins, discount rates, taxes, etc.) can lead to drastically different valuations. As I have mentioned in the past, cash flow analysis is a great way to value companies across a broad array of industries – excluding financial companies (see previous article on cash flow investing).
Mature companies operating in stable industries may be piling up cash because of limited revenue growth opportunities. Such companies may choose to pay out dividends, buyback stock, or possibly make acquisitions of target competitors. However, for hyper-growth companies earlier in their business life-cycles, (e.g., Facebook and Twitter), discretionary cash flow may be directly reinvested back into the company, and/or allocated towards numerous growth projects. If these growth companies are not generating a lot of excess free cash flow (cash flow from operations minus capital expenditures), then how does one value such companies? Typically, under a traditional DCF (discounted cash flow model), modest early year cash flows are forecasted until more substantial cash flows are generated in the future, at which point all cash flows are discounted back to today. This process is philosophically pure, but very imprecise and subject to the manipulation and bias of many inputs.
To combat the multi-year wiggle room of a subjective DCF, I choose to calculate what I call “adjusted free cash flow” (cash flow from operations minus depreciation and amortization). The adjusted free cash flow approach provides a perspective on how much cash a growth company theoretically can generate if it decides to not pursue incremental growth projects in excess of maintenance capital expenditures. In other words, I use depreciation and amortization as a proxy for maintenance CAPEX. I believe cash flow figures are much more reliable in valuing growth companies because such cash-based metrics are less subject to manipulation compared to traditional measures like earnings per share (EPS) and net income from the income statement.
Rationalizing Ratios
Other valuation methods to consider for growth companies*:
- PE Ratio: The price-earnings ratio indicates how expensive a stock is by comparing its share price to the company’s earnings.
- PEG Ratio (PE-to-Growth): This metric compares the PE ratio to the earnings growth rate percentage. As a rule of thumb, PEG ratios less than one are considered attractive to some investors, regardless of the absolute PE level.
- Price-to-Sales: This ratio is less precise in my mind because companies can’t pay investors dividends, buy back stock, or make acquisitions with “sales” – discretionary capital comes from earnings and cash flows.
- Price-to-Book: Compares the market capitalization (price) of the company with the book value (or equity) component on the balance sheet.
- EV/EBITDA: Enterprise value (EV) is the total value of the market capitalization plus the value of the debt, divided by EBITDA (Earnings Before Interest Taxes Depreciation and Amortization). Some investors use EBITDA as an income-based surrogate of cash flow.
- FCF Yield: One of my personal favorites – you can think of this percentage as an inverted PE ratio that substitutes free cash flow for earnings. Rather than a yield on a bond, this ratio effectively provides investors with a discretionary cash yield on a stock.
*All The ratios above should be reviewed both on an absolute basis and relative basis in conjunction with comparable companies in an industry. Faster growing industries, in general, should carry higher ratio metrics.
Taking Facebook and Twitter Public
Before we can even take a stab at some of these growth company valuations, we need to look at the historical financial statements (income statement, balance sheet, and cash flow statement). In the case of Facebook and Twitter, since these companies are private, there are no publically available financial statements to peruse. Private investors are generally left in the dark, limited to public news related to what other early investors have paid for ownership stakes. For example, in July, a Russian internet company paid $100 million for a stake in Facebook, implying a $6.5 billion valuation for the total company. Twitter recently obtained a $100 million investment from T. Rowe Price and Insight Venture Partners thereby valuing the total company at $1 billion.
Valuing growth companies is quite different than assessing traditional value companies. Because of the earnings and cash flow volatility in growth companies, the short-term financial results can be distorted. I choose to find market leading franchises that can sustain above average growth for longer periods of time (i.e., companies with “long runways”). For a minority of companies that can grow earnings and cash flows sustainably at above-average rates, I will take advantage of the perception surrounding current short-term “expensive” metrics, because eventually growth will convert valuation perception to “cheap.” Google Inc. (GOOG) is a perfect example – what many investors thought was ridiculously expensive, at the $85 per share Initial Public Offering (IPO) price, ended up skyrocketing to over $700 per share and continues to trade near a very respectable level of $500 per share.
The IPO market is heating up and A123 Systems Inc (AONE) is a fresh example. Often these companies are volatile growth companies that require a deep dive into the financial statements. There is no silver bullet, so different valuation metrics and techniques need to be reviewed in order to come up with more reasonable valuation estimates. Valuation measuring is no cakewalk, but I’ll take this challenge over estimating the number of ping pong balls I can fit in an airplane, any day. Valuing growth companies just requires an understanding of how the essential earnings and cash flow metrics integrate with the fundamental dynamics surrounding a particular company and industry. Now that you have graduated with a degree in Growth Company Valuation 101, you are ready to open your boutique investment bank and advise Facebook and Twitter on their IPO price (the fees can be lucrative if you are not under TARP regulations).
DISCLOSURE: Sidoxia Capital Management and client accounts do not have direct long positions AONE, however some Sidoxia client accounts do hold GOOG securities at the time this article was published. 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.
How to Make Money in Stocks Using Cash Flows
There you are in front of your computer screen, and lo and behold you notice one of your top 10 positions is down -11% (let’s call it ticker: ABC). With sweaty palms and blood rushing from your head, you manage to click with trembling hands on the ticker symbol that will imminently deliver the dreadful news. A competitor (ticker: XYZ) just pre-announced negative quarterly earnings results, and an investment bank, Silverman Sax, has decided to downgrade ABC on fears of a negative spill-over effect. What do you do now? Sell immediately on the cockroach theory – seeing one piece of bad news may mean there are many more dreadful pieces of information lurking behind the scenes? Or, should you back up the truck to take advantage of a massive buying opportunity?
Thank goodness to our good friend, cash flow, which can help supply answers to these crucial questions. Without an ability to value the shares of stock, any decision to buy or sell will be purely based on gut-based emotions. Many Wall Street analysts follow this lemming based analysis when whipping around their ratings (see The Yuppie Bounce & the Lemming Leap). As I talk about in my book, How I Managed $20,000,000,000.00 by Age 32, I strongly believe successful investing requires a healthy balance between the art and the science. Using instinct to tap into critical experience acknowledges the importance of the artistic aspects of investing. Unfortunately, I know few (actually zero) investors that have successfully invested over the long-run by solely relying on their gut.
A winning investment strategy, I argue, includes a systematic, disciplined approach with objective quantitative measures to help guide decision making. For me, the science I depend on includes a substantial reliance on cash flow analysis (See Cash Flow Components Here). What I also like to call this tool is my cash register. Any business you look at will have cash coming into the register, and cash going out of it. Based on the capital needs, cash availability, and growth projects, money will furthermore be flowing in and out of the cash register. By studying these cash flow components, we gain a much clearer lens into the vitality of a business and can quickly identify the choke points.
ACCOUNTING GAMES
The other financial statements definitely shed additional light on the fitness of a company as well, but the income statement, in particular, is subject to a lot more potential manipulation. Since the management teams have more discretion in how GAAP (Generally Accepted Accounting Principles) is applied to the income statement, multiple levers can be pulled by the executives to make results look shinier than reality. For example, simply extending the useful life of an asset (e.g., a factory, building, computer, etc.) will have no impact on a company’s cash flow, yet it will instantaneously and magically raise a companies’ earnings out of thin air…voila!
“Stuffing the channel” is another manipulation strategy that can accelerate revenue recognition for a company. For example, let’s assume Company X ships goods to a distributor, Company Y, for the exclusive purpose of recognizing sales. Company X wins because they just increased their sales, Company Y wins because they have more inventory on hand (even if there is no immediate plan for the distributor to pay for that inventory), and the investor gets “hoodwinked” because they are presented artificially inflated sales and income results.
JOINT STRATEGY
These are but just a few examples of why it’s important to use the cash flow statement in conjunction with the income statement to get a truer picture of a company’s valuation and “quality of earnings.” If you don’t believe me, then check out the work done by reputable academics (Konan Chan, Narasimhan Jegadeesh, Louis Chan, and Josef Lakonishok) that show negative differentials between accounting earnings and cash flow are significantly predictive of future stock price performance (Read more).
So the next time a holding craters (or sky-rockets), take an accounting on the state of the company’s cash flows before making any rash decisions to buy or sell. By doing a thorough cash flow analysis, you’ll be well on your way to racking up gains into your cash register.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
History Never Repeats Itself, But It Often Rhymes
As Mark Twain said, “History never repeats itself, but it often rhymes.” There are many bear markets with which to compare the current financial crisis we are working through. By studying the past we can understand the repeated mistakes of others (caused by fear and greed), and avoid making similar emotional errors.
Do you want an example? Here you go:
“Today there are thoughtful, experienced, respected economists, bankers, investors and businessmen who can give you well-reasoned, logical, documented arguments why this bear market is different; why this time the economic problems are different; why this time things are going to get worse — and hence, why this is not a good time to invest in common stocks, even though they may appear low.”– Jim Fullerton, former chairman of the Capital Group of the American Funds (written November 7, 1974)
Although the quote above seems appropriate for 2009, it actually is reflective of the bearish mood felt in most bear markets. We have been through wars, assassinations, banking crises, currency crises, terrorist attacks, mad-cow disease, swine flu, and yes, even recessions. And through it all, most have managed to survive in decent shape. Let’s take a deeper look.
1973-1974 Case Study:
For those of you familiar with this period, recall the prevailing circumstances:
- Exiting Vietnam War
- Undergoing a recession
- 9% unemployment
- Arab Oil Embargo
- Watergate: Presidential resignation
- Collapse of the Nifty Fifty stocks
- Rising inflation
Not too rosy a scenario, yet here’s what happened:
S&P 500 Price (12/1974): 69
S&P 500 Price (8/2009): 1,021
That is a whopping +1,380% increase, excluding dividends.
What Investors Should Do:
- Avoid Knee-Jerk Reactions to Media Reports: Whether it’s radio, television, newspapers, or now blogs, the headlines should not emotionally control your investment decisions. Historically, media venues are lousy at identifying changes in price direction. Reporters are excellent at telling you what is happening or what just happened – not what is going to happen.
- Save and Invest: Regardless of the market direction, entitlements like Medicare and social security are under stress, and life expectancies are increasing (despite the sad state of our healthcare system), therefore investing is even more important today than ever.
- Create a Systematic, Disciplined Investment Plan: I recommend a plan that takes advantage of passive, low-cost, tax-efficient investment strategies (e.g. exchange-traded and index funds) across a diversified portfolio. Rather than capitulating in response to market volatility, have a systematic process that can rebalance periodically to take advantage of these circumstances.
For DIY-ers (Do-It-Yourselfers), I suggest opening a low-cost discount brokerage account and research firms like Vanguard Group, iShares, or Select Sector SPDRs. If you choose to outsource to a professional advisor, I recommend interviewing several fee-only* advisers – focusing on experience, investment philosophy, and potential compensation conflicts of interest.
If you believe, like some economists, CEOs, and investors, we have suffered through the worst of the current “Great Recession” and you are sitting on the sidelines, then it might make sense to heed the following advice: “Some people say they want to wait for a clearer view of the future. But when the future is again clear, the present bargains will have vanished.” Dean Witter made those comments 77 years ago – a few weeks before the end of worst bear market in history. The market has bounced quite a bit since March of this year, but if history is on our side, there might be more room to go.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*For disclosure purposes: Wade W. Slome, CFA, CFP is President & Founder of Sidoxia Capital Management, LLC, a fee-only investment adviser based in Newport Beach, California.
Gold Market Lunacy Kicking Into Gear
So wait a second, let me get this right. A company pays billions of dollars to buy insurance, and then decides to sell $3.5 billion in dilutive ownership rights (current stockholders losing more than 10% of their ownership) so that they can pay somebody else another $5.6 billion to take that same insurance they previously loved away. In my book, I call that lunacy. This madness is exactly what Barrick Gold (ABX) just decided to do. The world’s largest gold miner issued approximately 95 million common shares at $37 per share to remove gold price hedges (used to lock in gold prices at a certain level), so if gold prices spike Barrick will now be able to participate fully without the drag of the hedges.
Effectively, management has decided to turn the mining company into a Vegas casino, where shareholders can now freely speculate in the price of gold without the volatility reducing hedges in place. Does this outlandish behavior signal a top in gold prices (now hovering around $1,000 per ounce)? I’m not stupid enough to call the end of frothing, speculative behavior – just witness Alan Greenspan’s “irrational exuberance” speech in 1996 when the NASDAQ traded at 1,300 (then went on to peak above 5,000). But what I am bold enough to do is call a spade a spade and to point out how ridiculous this reverse hedging activity is.
Other signs of speculation beyond the 4x price increase over the last 8 years or so, is the fact that gold prices have risen in the face of incredibly weak gold jewelry demand, -22% year-over-year globally in Q2 according to the Gold Demand Trends. This leaves the remaining demand coming largely from speculators and global central banks. If you need more evidence for the gold speculation, just turn on your local AM radio station and listen for the endless number of get-rich-quick on gold advertisements – some stations need to fill the gaping hole once held by those advertisers hawking mortgages.
From a gold investors’ perspective, I would say I fall more into Warren Buffett camp of thinking. Unlike other commodities (some of which I believe will be driven upwards by my emerging market demand and other forces) , gold is something dug up from the dirt in South Africa, melted, transported to another hole, buried in the ground (central bank), and then storage costs are incurred to guard the shiny metal. Sure, jewelry and small commercial applications are drivers for real demand, but the majority of demand is derived from intangible desires. Other commodities, for example oil, copper, uranium, and natural gas offer a lot more utility.
So what’s next when it comes to the price of gold? Peter Schiff an uber-gold bull broker at Euro Pacific Capital believes Armageddon is coming for the U.S. economy and hyper-inflation will drive gold upwards to the $4,000 per ounce price range (See How Peter Schiff’s Other Forecasts Have Performed). Another possibility to consider is a complete collapse in gold prices (and surge in the dollar) like we saw in the early 1980s after Paul Volcker raised interest rates and gold prices did not appreciate for a 25 year period. Hmmm, I wonder what direction interest rates are going next with the Federal Funds rate currently at effectively 0%? Could we see a repeat of the early ‘80s? Seems like a possibility to me. Certainly if you fall into the civil unrest, soup kitchen, and bread line camp, like Schiff and other U.S. bears, then piling into the diluted Barrick Gold shares may not be a bad strategy.
Inflation
Given the massive stimulus, debt loads, money supply growth and legislative agendas currently in place, inflation is a major medium and long-term concern. My remedy is government guaranteed Treasury Inflated Protection Securities (TIPS) that not only compensates investors with interest payments (unlike gold), but will also see principal values increase in tandem with principal if inflation indeed rears its ugly head. For those conspiracy theorists that believe the Consumer Price Index (CPI) is rigged, there are alternative international flavors of TIPs that reset according to other inflation benchmarks. As a kicker, some of these particular securities offer a hedge against a sliding U.S. dollar, which may or may not continue.
So as I lie in my recliner with my popcorn and TIPs, I’ll watch Barrick and other speculators continue the gold buying frenzy, wondering when and how ugly the gold finale will be?
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management and client accounts do not have direct long or short positions in ABX or gold related securities or BRKA/B at the time the article was published. Sidoxia Capital Management and its clients do have long exposure to TIP shares. 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.
Goldman Sachs in Talks to Acquire Treasury Department
Andy Borowitz from the Borowitz Report published an article a few months ago satirizing the ever increasing conspiracy theories being spread regarding Goldman Sachs’ (GS) role in the global financial crisis. Spearheading the scapegoating Goldman Sachs brigade is Matt Taibbi of Rolling Stone who wrote Inside The Great American Bubble Machine. Megan McArdle at The Atlantic has a detailed critique of Taibbi’s loose facts and outlandish generalizations.
On a lighter note, here’s what Mr. Borowitz has to say about the Goldman Sachs/Treasury Department merger, with tongue firmly in cheek:
According to Goldman spokesperson Jonathan Hestron, the merger between Goldman and the Treasury Department is “a good fit” because “they’re in the business of printing money and so are we.” The Goldman spokesman said that the merger would create efficiencies for both entities: “We already have so many employees and so much money flowing back and forth, this would just streamline things.” Mr. Hestron said the only challenge facing Goldman in completing the merger “is trying to figure out which parts of the Treasury Dept. we don’t already own.” Goldman recently celebrated record earnings by roasting a suckling pig over a bonfire of hundred-dollar bills.
If Matt Taibbi is having difficulty coming up with some fresh new material, perhaps he could target some of these hotly debated areas of contention:
- The 40 year anniversary of NASA faking the moon landing.
- The CIA assassination of John F. Kennedy and the 4th shot from the “grassy knoll.”
- Crashed UFO aircraft remains stored at Area 51, Air Force base in Nevada.
- Elvis still alive.
- Paul McCartney actually dead.
- 9/11 terrorist attacks government cover-up.
- The creation of HIV/AIDS by the CIA.
If Bill Clinton can’t suppress sexual relations with Monica Lewinsky and Dick Cheney can’t hide the fact he shot someone in the face with a shotgun, I guess the Goldman crew is just better at pulling the wool over the eyes of 6.5 billion people…less one smart cookie, Matt Taibbi.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management and client accounts do not have direct positions in GS at the time the article was published. 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.
From Pond Scum to the Pump
The “Green” movement got a shot in the arm recently when a $600 million joint venture between Craig Venter, the critical man behind mapping the human genome, and ExxonMobil the oil company (XOM) was formed to engineer oil from green algae. More than half of the money will be directed to Dr. Venter’s La Jolla, California-based biotech firm Synthetic Genomics.
On the surface the announcement is very appealing because it marries the biggest brains in genetic engineering (Venter) with the biggest brains in energy/oil (ExxonMobil). Add hundreds of millions of dollars to this powerhouse dream team and perhaps something miraculous can be commercialized in the next 5 – 10 years. Environmentalists appear to be on board too, if the hype turns to reality, because not only will cleaner fuels be created but the algae production will reduce harmful CO2 (carbon dioxide) emissions from the air. ExxonMobil’s grand scheme is to build algae farms near power plants and other major CO2 emitters –the farms will feed the algae and by doing so will help curb long-term fuel costs for the businesses.
ExxonMobil and Craig Venter are not the only game in town. A scientific article written by Molika Ashford claims there are more than 50 companies trying to affordably squeeze oil from slime, including a creative way of squeezing oil from algae-eating fish.
Although the “Greenies” seem to buy into the algae-oil process, the environmentalists are not the only constituency the genetic engineers must appease. The ethical debate over manipulating life forms is already percolating – just think, Frankenstein meets algae. In a newer Bloomberg article, Alison Smith, a professor of plant sciences at the University of Cambridge in England commented on the state-of-the-art research: “It is an untested technology, and there needs to be extensive debate about the ethics and environmental consequences of generating these new organisms.”
More recently, Dr. Venter performed a pioneering ‘gene swap’ on a simple species of bacteria called Mycoplasma mycoides, which raised optimism levels even higher that a green, bio-engineered fuel solution is indeed possible. Dr. Venter effectively created a new form of bacteria by swapping DNA from one form of bacteria into another. Researchers and scientists around the globe are searching for solutions to our worsening global energy problems, however time is required. I will anxiously watch from the sidelines to see if big brains and big oil can come together to make “green gold.”
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
Sidoxia Capital Management and its clients did not have any direct position in XOM at the time the article was published. 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 Yuppie Bounce & the Lemming Leap
Source: Gary Larson – Where’s Your Preserver?
Making money in the stock market is a tough game, and most people don’t beat the market because like lemmings the average investor follows the herd mentality to underperformance. So, should Wall Street analysts and the media be crucified for their analysis? The short answer is yes. Certainly there are some exceptional analysts and journalists, however most of them merely report what is happening or are looking in the rear-view mirror. Beyond that, the vast majority of commentators prey on emotions of the public and masses by pushing them into knee-jerk selling panics at the bottom and also getting them frothing at the mouth to buy at market peaks. Can I understand why they offer such bad advice? Yes. Quite simply, the incentive structures are wrong.
If you are an analyst or journalist, the number one priority (incentive) is not to be wrong, because if they are mistaken, then job loss becomes a bona fide risk. However, if they throw in some fancy language and mix it in with a lot of caveats, there virtually is no risk of being wrong. If factors happen to change, no worries, their opinions can change too. Therefore, most analysts huddle together in tight packs reporting the same news du jour as everyone else, while mixing in a fair dosage of fear and greed to drum up more interest. These incentives align well for the journalists/analysts but unfortunately not for the average investor.
Joshua Brown over at the Reformed Broker recently wrote an excellent piece highlighting his so-called “Yuppie Bounce” example. Last winter, as all the discretionary consumer stocks (Joshua Brown calls them “waster stocks”) were getting pasted, the pundits were advising investors to pile into defensive stocks. Lo and behold, this was the absolute worst time to follow that advice. Mr. Brown gives a superb Starbucks (SBUX) versus Wal-Mart (WMT) example showing how SBUX has effectively doubled over the last nine months just as WMT flat-lined.
Source: The Reformed Broker (Joshua M. Brown)
Investing is like a game of chess, so although a current move may sound logical, it’s more important to think about decisions multiple steps into the future. Most successful long-term investors don’t follow the conventional lines of thinking, and they are generally swimming against the tide. Therefore, if you are going to jump in with the other lemmings, make sure you have your life preserver with you.
DISCLOSURE: Some Sidoxia Capital Management and client accounts HAVE direct positions in WMT at the time the article was published. 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.
Coke Targets Cows
Coca-Cola (KO) has come up with a new product idea: fizzy milk. Sound strange? From my perspective, I prefer my milk with cereal and chocolate chip cookies. I never received a marketing degree, so somebody please explain to me what the heck Coke is thinking?
What’s next? Coca-Cola anchovy and liver protein shakes. Or perhaps fizzy gravy? What better than a little carbonation to liven up your mash potatoes on Thanksgiving?!
The name of Coke’s new carbonated milk product is Vio, and the creation is being test-marketed throughout New York (primarily in delis and health food stores) to gauge acceptance. The fizzy milk product comes in various fruit flavors, including Tropical Colada, Very Berry, Citrus Burst, and Peach Mango. Peculiarly, the product is stocked on shelves at room temperature. Mmm, nothing like lukewarm milk, it just sounds so delightful (I don’t think so).
Coke also has grander ambitions of rolling Vio out globally, if the U.S. launch proves successful. According to the TimesOnline article, perhaps natural food stores should not be targeted since Vio contains similar levels of sugar as Coca-Cola’s main non-diet drinks. Some believe Coke’s introduction of Vio is merely a crafty exploitation of a technicality in school beverage rules. A recent article written on creativematch states, “The American Beverage Association’s School Beverage Guidelines prohibits sugar-sweetened carbonated soft drinks from being sold in elementary, middle, and high schools. However, the guidelines still allow some milk-based products to be sold.” Perhaps Vio is Coke’s Trojan Cow for getting new drinks onto schools’ menus.
Time will tell whether Coke is successful in this beverage niche, but I will not hold my breath for its triumph. No matter the level of Vio achievement, at a minimum, dairy cows have found a new revenue stream to keep them employed in a tough economic environment.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management and its clients do not have direct investment exposure in Coca Cola Co. (KO) at the time the article was published. 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.
Technology Does Not Sleep in a Recession
Our economy may be coming out of a long economic hibernation; however technology does not sleep through a recession. Gordon Moore, co-founder of Intel Corporation, has proven this trend true through his groundbreaking piece written in the April 1965 issue of Electronics Magazine. In the article Mr. Moore predicted transistor densities would double about every two years (“Moore’s Law”). Transistors can be thought of as the brains of electronics devices, and the industry (Intel and other semiconductor manufacturers) has been boosting the brain power of electronics for decades. How far has the industry come? The number of transistors contained on a chip has gone from 16 in 1960s to over 600 million today – now that’s what I call progress!
These achievements have been nothing short of revolutionary, and many people consider the introduction of the transistor as the greatest invention of the 20th century. According to many industry experts, Mr. Moore’s forecasts have been shockingly accurate and many believe “Moore’s Law” will hold true for years to come – despite challenging technological limitations.
Source: The Financial Times
We may curse at our computers (I absolutely despise Vista), but there is no arguing with the huge productivity and standard of living improvements we have experienced over the last forty years – since the introduction of the transistor. Many take their GPS, Tivo, WiFi laptop, iPhone, and HiDef TVs for granted, however I for one thank Gordon Moore and those diligent engineers for making my geeky tech dreams come true.
However the cost of further advancements is becoming pricier. As line widths (the ability to add more transistors) narrow, the costs of building fabrication plants (“fabs”) with the necessary equipment are running in the multi-billion range. The Financial Times (FT) article talking about semiconductor trends mentions a $4.2 billion state-of-the-art factory in upstate New York that is just beginning construction. The FT notes that only two players (Intel and Samsung) have firm plans to build 20 nanometer fabs. For comparison purposes, one nanometer is equal to one-billionth of a meter and a human hair is 100,000 nanometers wide. In other words, a nanometer is pretty darn tiny. To further illustrate the point, Intel has managed to fit up to 11 Intel Atom processors – each packed with 47 million transistors – on the face of an American penny.
Source: The Financial Times
As the chip making industry become more costly, fewer semiconductor manufacturers will be playing in the sandbox:
“Intel argues that only companies with about $9bn in annual revenues can afford to be in the business of building new fabs, given the costs of building and operating the factories and earning a decent 50 per cent margin. That leaves just Intel, Samsung, Toshiba, Texas Instruments and STMicroelectronics.”
The economy may still be in the doldrums, but the $60 trillion global economy (as measured by Gross Domestic Product) never sleeps – technologies created by Gordon Moore and others continue to propel amazing advancements.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
Buffett Sells Insurance: Weapons of ANTI-Destruction
Writing Options is the Opposite of Mass Destruction
Those same “Weapons of Mass Destruction” that Warren Buffett so ardently warned investors against are the same derivatives that catapulted Berkshire Hathaways (BRKA) Q2 earnings performance. Chris McKhann at OptionMonster summarized Buffet’s moves:
Buffett has sold a large number of puts on four major indexes starting in 2007: the S&P 500, the FTSE 100, the Euro Stoxx 50, and the Nikkei 225. He took in $4.9 billion, with a potential loss of more than $35 billion–but only if all four indexes were at zero come the expiration date (at which point we would be worrying about other things).
Derivatives are like a gun, if used responsibly for gaming or for self-defense, then they can be a useful tool. Unfortunately, like guns, these derivatives are used irresponsibly in many instances. This point is especially true in areas like Credit Default Swaps where there were inadequate regulations and capital requirements to prevent disastrous outcomes (e.g., AIG’s collapse). With proper transparency, capital requirements, and proper regulation, derivatives can be used to manage risk rather than create additional risk.
Although I wouldn’t categorize myself as a value investor like Warren, I would prefer to call myself a growth investor with a value conscience. With that said, if you incorporate valuation within your investment discipline, I believe writing (selling) options is a brilliant idea. I can make this assertion because I’ve used this strategy for myself and my hedge fund. Volatility has a direct impact on the amount of premiums collected; therefore the trading levels of the CBOE Volatility Index (VIX) will have a directly correlated impact on option writing profitability. For example, if I’m selling flood insurance, I’m going to collect much higher rates in the period right after Katrina occurred.
If you are willing to accept free money from speculators betting on short-term swings in prices (Warren sold long-term, multi-year options), while being forced to sell/buy stock at price levels you like, then why not?! However, buying and selling puts and calls is a different game in my book, and one I personally do NOT excel at. I’ll keep to utilizing “Weapons of Anti-Destruction” and collect premiums up-front, like Warren, from speculators and leave the rest of the options strategies to others.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management and client accounts do not have direct positions in AIG or BRKA/B at the time the article was published. Sidoxia Capital Management and its clients do have long exposure to TIP shares. 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.
Investing Caffeine 
