Super-Hero Investments

Just thought I’d share an interesting email:

Jim Grant noted in his recent Interest Rate Observer that eight blue-chip companies now meet or exceed Ben Graham’s strictest criteria for defensive investors: Pfizer, Nucor, Cooper Industries, Cintas, Tiffany, Archer Daniels Midland, Molex, and RadioShack.

These are like superhero investments. Each has

  • 10 consecutive years of net profits
  • 20 consecutive years of uninterrupted dividend payments
  • earnings growth in the past decade of at least 33%
  • price-to-earnings and price-to-book multiples of less than 15

For perspective, Grant notes that at the bottom of the Nasdaq bust in 2003, only two stocks met all those criteria. At the bottom of the market in 1991, only six qualified. (Since 1991, those six produced average annual returns of almost 19%.) If you bought just these eight stocks and forgot about them for a decade, chances are better than 90% you’ll make a substantial return and beat the market. Usually, that’s a lot harder to do.

Note: These, are not my personal recommendations to buy. Do your own Due Diligence.

Will 2009 Be A Good Year For Stocks?

Prof. Jeremy Siegel, author of the excellent book The Future for Investors: Why the Tried and the True Triumph Over the Bold and the New, seems to think 2009 will be a good year for the stock market:

All of this means that, although the first quarter of 2009 will see negative growth, GDP should stabilize in the second quarter, earlier than most economists now anticipate. In real terms, housing prices have already retraced most of their gains from 2000, and by midyear prices should stabilize in this low-interest-rate environment. Year-over-year inflation should sink to zero, especially in the first half of 2009.

This year, as the economic slide abates and investors realize a catastrophe has been avoided, stock prices should enjoy a 20 percent or higher return. All equity sectors should recover.

The financial stocks will still be burdened by bad loans and government obligations. Nevertheless, new lending will prove extremely profitable to the banks whose cost of funds is now essentially zero. The Fed might find that it will be forced to raise rates during the summer, earlier than planned. And I believe long-term Treasuries are in a giant bubble and their prices will fall to earth once the economy improves.

All of this doesn’t mean there are no risks to stocks. The Fed must do more to encourage banks to lend to credit-worthy, non-delinquent customers. And the Obama administration must carefully structure its recovery plan so as not to bail out those that have been profligate and penalize those who have been thrifty.

Still, just as 2008 disappointed us on the downside, 2009 might surprise with better numbers than most are expecting.

Of course, just like everyone else, he didn’t exactly predict the worst bear market since the Great Depression! In fact, he thought the market would be led higher by financial stocks.

One of the few people who got it write was Nassim Nicholas Taleb or NNT for short. NNT was an options trader who achieved public fame after his awesome 2001 book Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets became a best-seller. His hedge fund actually did very well last year returning in excess of 50%.  Check out his video:

Also check out this great NYT article on how misunderstanding of risk management tools caused the financial mess.

Common Sense Advice For Investing In The Stock Market

Given the poor performance of the stock market in 2008, its time to go back to the investment basics and make sure you don’t forget the important stuff.

1. Only invest in companies that pay a decent dividend (at least 3%) and that have a long history of increasing their dividend.

You should consider share buybacks when measuring the dividend yield. This criteria achieves several goals. Its narrows your possible choices substantially, providing you an investment “universe” that’s more manageable.

It also automatically prevents you from buying stocks that are speculative or overpriced. If the company is cooking the books, it cannot maintain its dividend. Companies like AOL or MCI Worldcomm were reporting record profits during the Tech bubble (and so was Enron during a later period) when in fact, they were booking large losses. Since they weren’t paying out any dividends they were able to get away with the fraud for a lot longer than otherwise possible.

Investing in dividend-paying companies greatly reduces the odds that your account will ever show a loss. Earning 3% a year isn’t much, but it adds up, especially if the company continues to increase its dividend. After a year or two, even if the share price dips, you’ll probably still show a gain, thanks to the dividend.

2. Out of the companies that are paying a good dividend, only buy companies whose businesses you’re able to easily understand and that you judge to have a solid competitive advantage.

To increase your understanding, read the company’s 10K (annual report) filed with the SEC. You can get a copy online for free at the companies website or the SEC’s website. If you’re not willing to spend an hour or two reading a company’s 10K, are you really ready to invest 4%-6% of your life savings in its stock? It’s surprising that investors will readily pile money into companies that they don’t understand, and that they make no effort to understand.

Note, I’m not talking about trading here. I’m talking about investing – buying a position and keeping it for years.

3. Only buy stocks when they are very attractively priced, i.e. when there’s a substantial margin of safety in the stock.

Benjamin Graham (The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel) was a huge proponent of Margin of Safety (Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor), which means you should buy a stock when it is worth more than its market price.

This step makes it nearly impossible for you to lose money investing and will ensure you garner the benefits of compounding, because your entry price will be small relative to the company’s assets and future earnings.

It’s very hard for anyone to beat the compound returns of high-quality common stocks held for the long term. If you will follow these three simple rules – good dividends, understandable businesses with competitive advantages, and buying only at very safe prices – you can achieve world-class investment results.

Now if I could only follow this advice!

Lessons From WCI’s Bankrupcy

I just found out from The Declining Market that Florida luxury Condo builder, WCI Communities filed Chapter 11.

Over a year ago I shorted the stock at $17. Then that jackass Carl Icahn went and put in a bid to buy the company at $22.50 a share, in order to “unlock the hidden value” of WCI’s assets. That’s when I closed my position at a loss. Apparently, there is no hidden value in the assets and WCI’s stock is now completely worthless!

Sadly, I didn’t have the fortitude or the conviction to hold my position and I cried uncle at the first sign of trouble. That same scenario was repeated when I shorted Countrywide last April. The stock went up 10% and I closed my short position. Then it went straight down!

Right now, I’m short Capital One Financial (COF). But instead of entering my position fully, I decided to venture in slowly and buy more if it goes up. I’ve entered a 50% position so far and I’m hoping it goes higher so I can short at a higher price.

I’m convinced that if people can’t pay their mortgages, then they’re sure not going to be paying the credit cards. However, there’s a chance I might be early, so I should be willing to set a wider stop-loss and be willing to hold my position for 6 months.

On my short positions, I usually set a 10% stop loss, because there is an inherent bullishness to stock prices. This bullishness does not come from my expectation of a continued rise the profitability of stocks, but rather due to inflation. Inflation causes price increases, which leads to slightly higher profits, which leads to slightly higher stocks prices!

One lesson we should all take from WCI’s bankruptcy is that even rich people make mistakes. Carl Icahn was wrong about WCI – there simply wasn’t an value to be had from its assets. Billionaire Jerry Lewis also made a mistake in buying a large chunk of Bear Stearns early this year at nearly $80/share. I was soon sold for only a couple of bucks a share to J P Morgan.

Don’t blindly buy a stock just because some famous investor is buying it!

Fannie Mae & Freddie Mac Collapse

About 5 weeks ago I suggested that both Fannie Mae and Freddie Mac were going bankrupt and their shares were going to hit single digits in 12 months. Well it looks like the market believed that too and their shares were punished. Instead of having to wait a year, the stocks dropped like bricks within the month!

According to Nouriel Roubini, renowned Professor of Economics & International Business at NYU’s Stern Business school, this is the worst financial crisis since the Great Depression and the worst U.S. Recession in the last few decades.

The FDIC that has already depleted 10% of its funds in the rescue of IndyMac alone will run out of funds and will have to be recapitalized by Congress as its insurance premia were woefully insufficient to cover the hole from the biggest banking crisis since the Great Depression

Fannie and Freddie are insolvent and the Treasury bailout plan (the mother of all moral hazard bailout) is socialism for the rich, the well connected and Wall Street; it is the continuation of a corrupt system where profits are privatized and losses are socialized. Instead of wiping out shareholders of the two GSEs, replacing corrupt and incompetent managers and forcing a haircut on the claims of the creditors/bondholders such a plan bails out shareholders, managers and creditors at a massive cost to U.S. taxpayers.

Wow, those are strong words! Practically every stock in the financial sector has jumped today, probably due of extreme oversold conditions and not because of any underlying change in the fundamental scenario.

Sadly, my beloved Oil & Gas stocks are down. It may be a sector rotation out of energy stocks and into the financials. But so long as my Canadian Income Trusts continue to provide me with dividends and passive income, I’ll continue to hold them.

But I might enter new short positions in the financials if the stocks rally significantly above these levels. Fed Chairman, Ben Bernanke announced today that FNM & FRE were “in no danger of failing”. I don’t know if I believe him – sounds just like a few months ago when the government telling us there’s no recession. Meanwhile everything (except housing) is getting more expensive and unemployment is rising. And as Jim Rogers says that “the only people Bernanke cares about are his buddies on Wall Street”!

There's Still No Recession!

Should You Believe Incompetent CEOs?

After leading the company’s stock price down 60% in a year, Freddie Mac‘s CEO, Richard Syron, is doing the rounds trying to prop up the stock with feel-good stories. He tried to reassure investors that the worst is in the past and that the future will be brighter than ever.

According to Forbes,

Syron reiterated previous expectations, saying the company expects revenue growth of 15 percent to 20 percent this year, but expects to see losses from bad mortgages rise to as much as $6 billion this year.

“Weakening housing prices and housing activity have led to a punishing deterioration of credit which has hurt our results, along with those of other market participants,” Syron said.

However, the company is well-suited to ride out the housing bust because the home loans that Freddie Mac holds or guarantees are far less risky than those held by other lenders, he said.

Forgive my skepticism, but isn’t this exactly what Countrywide’s CEO Angelo Mozillo said in the beginning of last year when he was dumping stock hand over fist while claiming that CFC would be taking market share from the other lenders that were going out of business.

Anyway, I think its a good omen – I shorted Freddie Mac (FRE) and Fannie Mae (FNM) today at the open. So far I’m pretty happy with the result. FNM was down ~8% and FRE was down ~2.5%. Like I said yesterday, I wouldn’t be surprized to see these stocks in the low single digits in a year. [Note: this is not a stock recommendation – always do your own due diligence]

Omaha Here I Come!

The Annual Shareholder Meeting for Berkshire Hathaway is this Saturday on May 3rd in Omaha, Nebraska. I finally got my meeting credentials from the company. I had been waiting to book my tickets until I got them. It seems I could’ve gotten them in Omaha itself, but I didn’t want to take that risk. It would be pretty stupid if I showed up and they didn’t grant me admission!

Anyway, I’ve been following the online airline prices for flights to Omaha. Two weeks ago, the flights cost around $350 round-trip to Omaha from San Diego. Last Friday and Saturday the cheapest tickets on Orbitz were going for $505. Today, however, the price dropped down to $240! That’s half-price from just two days ago. Now of course, the next challenge is getting accomodation.

Apparently, hotels in the entire city of Omaha are sold out. The nearest hotel room is about 50 miles away in Lincoln, Nebraska! Luckily I found a couch at a friend of a friend’s place that’s only 3 miles away from the Qwest Center (which is where the shareholder meeting is going to take place).

I’m really excited to be going. I’m pretty keen on hearing what Buffett has to say about the bid for Wrigley’s. I also expect to meet a lot of other investors and make some new friends.

If any of you are going to be there, drop me a line and maybe we can meet up.

Investing In AeroGrow’s Gourmet Herb Gardens

The Economist.com had a very interesting article on a company called AeroGrow that makes Kitchen Crop Appliances, based on a technology invented by NASA called aeroponics. In aeroponics, plants grow at an accelerated speed because nutrients are sprinkled directly onto their roots, which dangle in the air instead of being planted in soil.

According to the Economist, these systems have been widely used by commercial pot growers but this is the first time it is being adapted from home use to grow tomatoes, lettuce and herbs.

AeroGrow’s Aeroponic AeroGarden Herb Garden KitI checked out AeroGrow’s Herb Garden on Amazon. For around $150 you get a really neat little garden. The picture doesn’t actually do it justice. Check out the AeroGarden Video. The kit allows you to grow herbs superfast all year round. Quite a phenomenal product!

The Economist article mentions that the company has spent 4 years developing this product. It’s almost idiot-proof and they claim a 99.9% success rate for the herbs, which is pretty spectacular considering I’ve killed mint, which is a pretty hardy weed and tough to get rid of. There are also sites that have “sprung up” detailing how to modify to for a different type of weed too. While the company doesn’t endorse that usage, they do have a pretty nice range of salads, herbs and even roses.

The first thing that came to mind was whether I could make any money of this idea. The stock price of AeroGrow [AERO] has plummeted from around $9 in October 2007 to about $3.30 today. That’s a pretty steep 65% drop in less than 6 months. However at this price the company is trading for just over 1 times sales, which seems pretty low for a small cap growth company, and a forward PE of 15. It also looks like the insiders are nibbling at the shares too. The CEO, Bissonette, thinks aeroponics will become a $1.5 Billion industry. So far in the last quarter of 2007, AeroGrow had $14 million in sales ( a 300% increase from the year before) and is close to profitability. Definitely seems worth looking into.

Maybe it’s time to invest in this stock? Or instead I should put my money where my mouth is and buy an actual AeroGarden Kit! What would you guys choose?

After Sub-prime, Is Commercial Property Next?

Based on my own experiences of being allowed to borrow 40 times my annual income to purchase investment property, I knew the real estate party was going to end badly for many borrowers, banks and eventually tax-payers. I had tried  shorting Countrywide, which was the largest lender of mortgages, last year when the stock was trading at around $36. Unfortunately, I was a little early and closing my position at $39 incurring a substantial loss. If I had held on to my position, with Countrywide currently trading in $6-$7 range, I would’ve have been handsomely rewarded.

Hopefully, I’ll have the fortitude to hold onto my positions next time. Right now I think the Commercial real estate is the next bubble to burst.

Easy liquidity and the willingness of investors to settle for low rates of return have squeezed the margins on commercial properties over the past few years. Commercial construction has been on  tear and new malls have sprung up all over the place. There’s also been a contraction in commercial liquidity owing to the sub-prime fiasco. Added to that is the slow-down in consumer spending which will affect the bottom line of retailers and the amount their willing to spend on employees and rent.

I’m currently short Simon Properties (SPG), which gets 25% of its income from retail malls in California and Florida and the Dow Jones Real Estate Index (IYR). Lets see if I can hold on to these positions during the coming few months which will probably be quite volatile.

Are Stocks Better Than Other Investments?

There’s always someone at a party who’s claiming their investment asset of choices is the best. In 1999, it was stocks. In 2005, it was real estate. Right now, I’m claiming its Canadian Income Funds and commodities like gold. But is there an investment that’s actually better than something else?

Many proponents of the stock market have claimed that it is better than real estate. It’s more liquid and there’s never been a 10 year cycle where the S&P 500 had a down year. Of course, that’s rubbish. Ever try selling your stocks when the market is tanking? You’ll get taken to the cleaners. According to CNN Money, stocks follow a 16 year cycle. They go up for 16 years and then they’re roughly flat for the next 16 or so years.



Right now the Dow Jones Index is almost where it was back in early 2000. Adjusting for inflation, you’re still underwater. There’s also an often quoted comment about the stock market returning 11.5% a year over the long run. According to Ben Stein, this is factually incorrect. Over a rolling 20 year period since 1900, the stock market has on average returned just under 8%. Real estate also has had similar cycles. In Southern California, where I live, the market was down from 1991 to 1996, after booming for several years. Then in 1997 until 2005 it boomed again. Right now its falling again. Similarly in Salt Lake City, another market I follow and invest in, real estate boomed from 1991 until 1997 and then was stagnant until the end of 2004. Since 2005, its been in on the upswing again.NAR, the National Association of Real Estate, often cite the fact that nationwide, real estate has never gone down. That’s a useless fact unless you’re going to be buying a house in every major city in every state. Locally, real estate does follow periodic and somewhat predictable cycles. Between 2000 and 2005, when the stock market was tanking, real estate performed wonderfully.

And like stocks and real estate, commodities also have their own cycles. Chuck Butler , President of Everbank.com just sent me this email, “… the current Bull Market for commodities is at about 7 years and running… History shows us that (going back 200 years) that Bull Markets in Commodities have trends that last 17-22 years”. If you had bought gold in 1971 for $35/oz, you would’ve done extremely well by selling it in 1980-81 for nearly $800/oz. However, between 1982 and 2000 it languished and you might have given up and sold everything in 1999 after seeing the tremendous returns of the stock market. After all, nothing beats the stock market, right!

But $800/oz gold is here again. I’ve been investing since 2005 when it was around $500/oz. Gold has tripled since its lows of 2000 and is probably set to rally even further as the US Dollar continues its slide.

Even businesses are not free from cycles. There are times when businesses are cheap to buy (if you have the money) and are great money makers, and there are times when they are expensive (although easy with cheap money and easy liquidity) and tough to sustain at a profit.

So essentially there is no ideal investment. No single investment will yield substantial returns, year after year, for extended periods of time. Either you have to be on top of the economic factors that affect the various cycles, and keep switching in and out every few years or decades, or you need to diversify your assets so you have equal exposure to various different asset classes.

So unless you have exposure you US & foreign stocks and bonds, global real estate, currencies, commodities like oil & gas, precious metals, building materials like steel, lumber and copper, and even your own businesses, your investment portfolio is incomplete.

Claiming that one investment is better than another is just the result of ignorance. (Unless you decide to get a job as a day-trader, in which case trading indexed futures is probably the best vehicle, although the toughest to succeed at. But thats not an investment, its more like a job!)