The market has been great the past three years for those of us with large US stock investments. Since the lows of March 2009 until now in March of 2012, the DOW has increased greatly.
I plan on continuing to be heavily invested in stocks because the US economy is finally starting to hit on all cylinders. Technology and manufacturing are really starting to percolate.
There are some areas and companies that concern me. First is the insurance industry. Basically the trend has become very scary. Violent events have plagued the world over the last few years at a much higher rate and causing great devastation. Catastrophic events are occurring frequently and are seen on the newspaper headlines daily, including flooding, hurricanes, tidal waves, earthquakes, volcanoes, tornadoes, fires, nuclear disasters, crop failures, etc. These unfortunate events have greatly hurt the insurance industry that has had to pay off claims on all these calamitous events. These insurance claim payoffs have been destroying the industry's bottom line and capital reserves.
Munich Re (MURGY.PK), a German multinational that insures insurance companies, reports that the first six months of 2011 set record losses for the industry, "For the United States, 98 events (storms, flooding, fires and earthquakes) left $27 billion in economic losses, more than double the 10-year average of $11.8 billion." The question for the future is will the insurance industry recover; what will the future bring as far as future payouts by this industry? While predicting the future is difficult, one thing has changed. The facts of global warming have been accepted. Experts all agree that global increases in temperature are accompanied by a much more energetic weather system. And unfortunately more energetic weather means more disasters and more insurance company payouts. Companies that provide insurance will try to raise rates to consumers but they likely will be met by resistance that will lower their revenues. The big factor is about the statistics the rates are based on - these are no longer valid due to larger and more frequent claims and this effect could have an extremely bad outcome for companies like the Munich Re Group. This big unknown about the future is why calamity insurance sector investments should be avoided. I would also avoid buying property in coastal regions due to a possible rise in ocean sea levels and a resulting valuation decrease of the property becoming both literally and financially underwater.
As an investor I look at the bottom line balance sheets, cash flow and income statements. I also look at stock prices and tend to invest in companies and sectors that have a positive trend. Two of those company trends that look really good are Caterpillar (CAT) and General Electric (GE). First we will examine Caterpillar which has shown a very real annual stock price increase of 70% over the last three years. Looking at their profits and revenue sales this looks very justified. What worries me is the balance sheet. Good will and intangible assets jumped a whopping amount, going from 3.4 billion in June of 2012 to 11.4 billion in December. This past year the tangible assets dropped by 7 billion dollars despite incredible revenues and profits. I did not look into the details of why this is happening. But any big swings of this nature are scary and unless I have total knowledge of why it is occurring, I avoid the stock. I am avoiding Caterpillar.
Another great-looking stock is General Electric. It has done fantastic in the past three years with the stock showing substantial gains. Over the past three years the stock has grown annually at 42%. On the surface the future looks pretty bright for GE. Cash flow, balance sheet, income statements all look acceptable. The financial sector seems to be recovering so that is a positive for GE. But two things worry me about GE. First is the huge capital costs GE paid to Buffett a few years ago. Part of the cost of that bail-out was stock options; GE in effect gave away a large part of the future to get cash in the past. Buffett has a large amount of stock options. These options become actionable when the price of the stock goes above $22.25 per share. Berkshire Hathaway (BRK.A) has the option to buy $3 billion worth of G.E. common until late 2013. This future dilution of the stocks will dampen the appreciation of GE over the next couple of years and is a reason to invest elsewhere. A second area of concern is goodwill. GE is known for its light bulbs. However, I noticed a few years ago that other companies' light bulbs seemed to last longer and seemed to have higher quality than GEs. Often companies that are dominant in a product will decrease quality to improve the bottom line. Perhaps a decrease in longevity can increase sales. This can help the bottom line in the short term but in the long term it can cause a loss of good will. Another important factor for GE is the major industry change from incandescent bulbs to florescent bulbs and other long lasting brighter lighting; will GE be able to hold onto its dominant market position? These concerns dim my appreciation of GE and explain why I am avoiding GE stock investments until at least early 2014.