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Investment Pancake
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My investment process is (1) own rock solid businesses with healthy earnings and that pay me dividends, (2) spend less than I earn, and (3) reinvest what I don't spend into similar businesses, at the lowest price available at the time. I avoid selling, or dipping into principal.
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  • How To Read A Brokerage Statement

    The water in Barrio Alto has gone out. I was about to wash out a glass so I could pour some wine, but all I heard was a dusty gurgle from the tap. As first I assumed that this was a result of yet another gaff brought on by our less than competent lawyers who attempted to activate our utilities some time ago. Fortunately, a quick conversation with the night watchman at our convent quickly brought me to the truth of the matter: this entire section of the city is currently without water.

    And so caps a week characterized by a string of failures, cancellations, and unanswered phone calls. Ordinarily, I would be frustrated and annoyed, but I have decided that frustration and annoyance are merely choices, and I choose not to make those choices. Nobody can make me frustrated or annoyed. Only I can make myself feel those things, and actually, I don't want to.

    It is similar with investing. You can choose to doubt yourself, or to have anxiety or even fear. Or you can choose to assume that you know what you are doing and that nobody can make you feel otherwise if you don't want them to.

    Now, you may hasten to point out that there is the question of objective evidence as to whether you are a competent investor or not. Some investors look at their brokerage statements as a source of this type of objective evidence, and conclude that they are either idiots or geniuses depending on whether there are little green arrows or little red arrows printed on the pages before them. In few aspects of life can a small arrow or collection of numbers have so profound an impact on a person's self esteem! How many people have ever flung themselves out a window because they opened an envelope and found a picture of a smiley face with some random numbers next to it? Not many, but somehow, red and green arrows do something to the human psyche that is more emotionally gripping than anything Da Vinci ever painted. I mean, toss Mona into the trash, and put up some green and red arrows.

    I have to ask my readers to perform a thought experiment. Go fetch a brokerage statement of yours, look at the shapes and squiggles and numbers on that statement, and then take careful stock of how you feel. Write down your feelings if you want.

    Finished? Okay, now look at this:

    **DS)AS* G

    How does the above graphic make you feel? Is it different from how your brokerage statement makes you feel? If so, why? Did you DO anything to make your brokerage statement look the way it does this month? I guarantee you didn't do anything to make me write **DS)AS*G. So really, why does the former make you feel any different from the latter?

    One possibility is that you think that what I wrote was simply incoherent nonsense, which is true, by the way. But you have a lingering doubt that maybe the stock market is not incoherent nonsense, and as such, what it says is more meaningful and important than **DS)AS*G. Perhaps this is because you think the stock market "knows" things you don't. Did you know that there are even people who think the stock market is "rational" and that the price of something is per se equal to it's value! If you fall into these camps, I really have to ask what on Earth could give you that idea? Did you sleep through the internet bubble? I watched a broadly traded index ETF sell off by 35% the other day, while the underlying assets were only down by about 2%. It snapped back up after a few moments, but if you can tell me how that is rational market behavior, I'd like to smoke whatever it is you happen to be smoking. Please. No, really. I could use some. I didn't get my glass of wine because our dishes are dirty because we have no running water.

    Ok, so maybe the next reason why your brokerage statement makes you feel differently than the expression **DS(AS*G is because you feel that your brokerage statement reflects your net worth, and maybe that is down from last month. If so, let me make you an offer. I would like to buy your house for $1. I am offering that to anyone who reads my blog. Sell me your house for $1, and I will buy it. I mean it, too.

    Now, as a result of my $1 offer, have you just lost 99% of the value of your home equity, simply because the $1 I offered you is dramatically less than what you bought your house for? Obviously not. Why? Because you aren't going to sell it to me. Why won't you? Because I am a maniac.

    So, if I (or some other drooling maniac) were to offer to buy your shares of IBM (or some other company or fund you own) for 50% off, and some other idiot shareholder actually sold those shares to me, would that mean the company is now worth 50% less than it was before the transaction? Have you just lost 50% of your investment based on what some OTHER morons and maniacs are up to?

    If you were to only look at the ticker tape, the answer is (incredibly) yes. The value of any public company is reported as the last sale price (and that sale could be for 1 share of 1 million shares) multiplied by the total shares outstanding. All it takes is one maniac buyer plus one moronic seller, and you can remove 50% or more of the value of any security with no more than a single trade costing a few dollars.

    Simply put, when it comes to showing what something is worth, price quotes can LIE. Your house, and your shares of IBM (or any other company or fund, for that matter) are worth something OTHER than what one, two or even a billion maniacs and morons have to offer you. Regardless of what the morons and idiots are selling IBM shares for, you, as a shareholder, still own the company and all the company's profits - just like you still own your house and all the future rents it could generate for you, EVEN though the drooling pancake maniac freak is waving a $1 bill in front of you howling "BUY BUY BUY." If you aren't selling your house, why on Earth would you pay me any attention anyhow! And if you aren't selling stocks, for goodness sake, why pay any mind at all to what the maniac drooling freaks on the floor of the NYSE are doing? Believe me, IBM's earnings and the number of shares you own aren't going to change either way REGARDLESS of what is going down on the floor of the NYSE.

    The big takeaway from this blog posting is that you are not making money or loosing money based on what OTHER people are selling stocks (or houses) for. You are making money and losing money based on what percentage of companies you own, and what those companies are earning. Period.

    And here is where it starts to get interesting. Your brokerage statement DOES NOT EVEN REPORT what you actually own or what you are actually earning!!!!! Seriously! What percent of IBM do I own? I don't see it on my brokerage statement. How many dollars of IBM's earnings belong to me this quarter? Nope, I don't see that on my statement either. All I see are numbers and arrows that have something to do with what other freaks and buying and selling the shares for, which says nothing about how much money I have made or lost, and is useless besides since I'm not selling IBM anyway. I actually have to dig on the internet to figure out what I own and how much money I'm earning because no brokerage account I have shows me that information.

    But I bet if you open up that brokerage statement again, you will feel crummy. Even after completely acknowledging everything I wrote above. So on to another thought experiment.

    I am going to tell you something. What I am about to say is completely true, and please assume that what I am about to tell you is 100% guaranteed. And you are not going to like it.

    You are DOWN by *&#&@((@(!!!!!!!!!!

    How does that make you? Lousy, right? You should! You just LOST *&#%@*&!!!!! And here is some more bad news for you. If you don't act now, you are going to lose another (*&SGDIS%&^#^!!!!!!! And the bad news doesn't stop there. Had you done something different, you would have earned &*(S&DHHS@%#%@, but NO. You blew it. The key here is you are DOWN, and you don't need to understand how or by what.

    Okay, hold it. I suppose you might be wondering what #(*&$^@@# precisely is, actually, but frankly, you and I both know it doesn't matter. Because in fact, nobody really knows why the prices of stocks or commodities or bonds or currencies do exactly what they do either. If anyone did know this, they would be able to predict prices and earn an arbitrary amount of money within nanoseconds and to keep doing so in perpetuity. Nobody does this, and the reason why is because nobody can. When it comes to understanding what makes a stock price do one thing or another on any given second, hour, day, even year, our understanding is precisely equal to your understanding of what I mean when I tell you that you just lost $^&*#*&SS.

    So what follows from all this? It's simple: there is no practical or logical difference between the arrows and numbers on your brokerage statement and the bad news I just gave you that you lost !^&*@*S. And that statement is completely free from any argument to the contrary if you aren't even in the market to sell anything to begin with.

    I admit, this is a big reason why I never sell stocks after I buy them. That said, I do listen attentively to the wild eyed maniacs when it comes time to BUY. It is like the singing of angels to hear the wild-eyed maniacs when they are willing to SELL me IBM shares for a $1, and in fact, I take them up on all sorts of crazy offers whenever I get the chance.

    I don't really look at my brokerage statements - except to track how many dividends came in. I produce my own statements that show what percentage of what companies I own, and what my earnings per share are. I update it annually. Mostly I just make sure my dividends are higher than my spending, and forget the rest. I used to track my dividend growth against the S&P500, but stopped. Why should I care if other people are growing dividends faster or slower than me, as long as my bills are paid, and I have a little morsel left over to buy bargain priced stocks from the maniacs at the end of the month.

    Which brings me back to how I am coping with my life here in Lisbon, where the water is shut off and where my useless attorney won't return my phone call to answer my very basic questions about what I need to bring in order to obtain my residency permit next week. remember that I made a choice not to be frustrated or annoyed. Some years ago I made a similar choice to only look at what I actually own, and to ignore colorful shapes or arrows or numbers on pieces of paper that do not tell me anything about what it is that I actually own or how much I actually earn. I decided to see those green and red arrows with same emotional import as smiley faces, random numbers, and squiggles. Then I decided to put the painting of the Mona Lisa back up on the wall, take down the painting of the green and red arrows and toss it in the trash.

    Tags: IBM
    Sep 17 6:02 PM | Link | 5 Comments
  • Asia

    I spent some time this morning reviewing potential investment targets for the end of the month. MMM. Valspar. Doctor Pepper. Emerson Electric. Royal Canadian Bank. Dupont. Praxair. Tomkins Financial. Kinder Morgan. Stanley Black and Decker. These are all dividend growth engines that are priced at levels that I am willing to pay. Each has rock solid businesses that have stood the test of time, and an excellent history of raising dividends (I never cease to be amazed by Stanley Black and Decker, which has over a century of consistent dividend increases under it's belt). While I have no clue what the stock prices for these businesses will be by the end of the month (or the end of the next decade), I have a pretty good idea that their businesses should be thriving for the foreseen future. One of the reasons I invest in companies that make hammers or bottles of compressed air, instead of the latest internet fad companies, is that I have an easier time assuming that the hammer business will look pretty similar in 20 years to how it looks today. Will people be using Facebook in a year? Not only do I not know, I don't care.

    My general investment approach is to buy individual shares of companies, and to hold them permanently in a hand-picked portfolio. I own a small enough allocation to any given business that I am comfortable taking a 100% loss on any given investment. In fact, when a business that I own falls onto hard times, that is most likely the time when I will buy more stock. Hard times come and go, and enduring lean years is part of what every long-term investor must face. But the big consolation prize is that stock prices tend to overreact when a company has a few years of soft earnings or managerial difficulties. "Enduring" lean years equates to an opportunity to buy shares at very appealing prices. It's like having to endure a winning lottery ticket.

    A good example is Kinder Morgan. Kinder is a pipeline company, and has leased out their pipelines to various oil companies under very, very long term lease agreements that provide Kinder with a base of fairly stable, locked-in income. As the price of oil has come down, so too has the profitability of firms that produce oil, which doesn't affect Kinder directly since all Kinder does is to move the oil from point A to point B. Still, no business (including Kinder) can truly thrive if it's primary customers are suffering economically, and the CEO of Kinder has even said as much.

    Year over year, Kinder's net income has dropped by 6%, and there is a widely reported fear that income could drop even further. Investors are selling shares briskly. However, on closer inspection, you will see that year over year, the company's gross profit is actually up 16% - it's only an increased depreciation expense that accounts for the lower paper profits. It's true that depreciation is a real expense for sure, but pipelines don't actually depreciate anywhere near as quickly as the tax code permits company's to write off the depreciation expense on its income statement. In fact, the higher depreciation expense really overstates the company's true economic costs of moving oil from here to there. Put it all together, and you find that if anything, it seems Kinder is doing BETTER today with lower oil prices than before the price of oil fell - possibly since they are actually moving MORE oil and thereby collecting MORE rents.

    But the stock price has fallen 20%. Some investors would suggest that the reason for the lower stock price is because the stock market knows something we don't. In my view, the idea that the stock market is some sort of omnipotent diety is just plain silly. If stock prices are down, it could be due to no other reason than glitchy trading algorythms, or depressed, terrified investors selling simply because prices are dropping. Either way, I don't care. The value of a business doesn't generally change much on any given day, even though the stock price can and often does. That's the only reason I need to dismiss the notion that the stock market is a rational, all knowing diety. From my perspective, if the market wants to sell me something for less money today than it would have cost me yesterday, count me in. I don't even need to know or guess why the price is lower as long as I can guess that the business is more or less the same business today it was yesterday, and will continue to be for the foreseen future.

    To be honest, I generally don't even pay much attention to annual profits. When I value a company, I look at the past five to ten years worth of earnings, adjust for inflation, and average them out. To my viewpoint, a company is worth how ever many years of earnings, on average, it will take for the investment to completely pay for itself. If I can buy a company that will pay me back for my investment within 10 years, I'm happy. I'd even go out as far as 14 or possibly 15 years if I really like the business. When I find a stable, predictable business that I think on average could pay me back with earnings in 7 or 8 years, and if the share price is down hard and still falling, I become very interested. I'm then content to hold the business and allow the earnings to pay back my investment over and over again as the years pass, interupting this chain of events with sell orders as few times as I can muster.

    I mainly avoid buying ETFs and mutual funds (although I already own many) because fund managers typically buy and sell shares of the companies that the fund owns. It isn't possible to be a buy-and-hold investor if you own funds that turn over a meaningful percentage of their assets every single year, and as far as I'm concerned, every single transaction on Wall Street is nothing more than yet another opportunity to mess up. I aim for my portfolio to have zero turnover, and the only transactions I seek to execute are buy orders from the dividends I save each month. There are no funds I am aware of that have anything close to the level of inaction I aspire towards. Just imagine you work on Wall Street as a fund manager and you have to report to your investors that what you did all month was read quarterly statements and research, and that you devoted a grand total of 2.5 minutes to actually executing transactions. Imagine that the net asset value of your fund was down 10% for the year, and you brightly quip to your concerned investors "good news!!! Now that your investments are down 10%, it means you can buy more shares in your businesses for less money!" If the fund price is down by $100 per share, but the dividends per share the fund owns are up by $5, I can be almost certain that the fund shareholders will not be pleased in the least. In sum, fund managers do not have the luxury of investing the way I prefer to invest: slowly accumulating shares and growing portfolio income exponentially over the space of decades. That's one big reason I eschew funds.

    That said, I still look carefully at the universe of funds available anyway - particularly passive index ETFs. My interest is always trained on areas of the market that are widely reviled by Wall Street. Energy has been a very appealing area to find bargains over the past year, as well as other commodities sensitive industries like shipping and transportation. Increasingly, though, it seems that Asia, as a region, is now becoming relatively cheap again. But lacking any familiarity with the region or any understanding of local accounting rules, I simply lack the expertise to buy individual shares of, let's say, a Korean company.

    That is why I have started to look at Asian focused ETFs. Today, I noticed that the Ishares Asia ex-Japan ETF (ticker EPP) has a yield of close to 7%, a fairly consistent dividend track record, and most of all, a very very low turnover rate relative to other passive ETFs (according to Morningstar, EPP has an asset turnover rate of only 8%).

    While I don't anticipate allocating the bulk of our savings towards EPP or any other ETF or fund, I've put the fund onto our shopping list, and will initiate a small position once our month end dividends come through.

    (click to enlarge)Another day

    Sep 16 5:07 AM | Link | 2 Comments
  • Basquiat Paintings?

    We are developing new routines. Most days, we pack our son off to school, and then spend the morning preparing for our Portuguese lessons, which start at 9:00am. After our two hour lessons are through, we run errands, do chores, eat lunch, and I then head off to the gym. Typically after that, I do a last minute shopping to get whatever fresh ingredients we need for dinner (bread, fish, veggies), and then pick up our son at the bus stop. There is maybe an hour to relax, and then we take our son to his martial arts lessons, come home, eat dinner, do homework and prepare for school the next day, and then, once everyone is in bed and it's slow and quiet, I spend a couple of hours reading financial news and digesting whatever reports I find interesting or useful.

    Today, though, I decided to take a break from the routine, and walked down into Chiado for the specific reason of obtaining a 60 cup of espresso at my favorite cafe, The Brasiliero. What I love about this cafe is, above all, the coffee, but also the artwork that hangs on the wall. One of the paintings bears an eeri resemblance to Jean Michel Basquiat, although when I asked the bartender about it, he'd never heard of Basquiat. If it were a genuine Basquiat, then I assume it would be worth roughly 50 times the value of the entire Cafe Brasiliero, and I'd also have to assume that the bartender would be keenly aware of that fact. Still, you learn to let nothing surprise you in Lisbon.

    In about a week, we will go in for our interview to obtain a residency permit - which is distinct from a Visa. The permit is the official document that says we are allowed to remain in Portugal for the next year, whereas the Visa expires after three months. We don't fit into any obvious category, though. We are not specialized employees since we don't work, and we are not pensioners, per se, since we (like most Americans) do not actually have any pensions whatsoever. From what I can see, the requirements for a residency permit are entirely ad hoc, which can have benefits as well as detriments. The bottom line is that if the country wants people like you, you'll find a way in, and if not, you won't. It's very useful to hire an attorney to help with this aspect of immigrating to Portugal, but given the flexibility of the permitting process, I suspect no attorney can actually give you assurances that if you do XYZ or provide ABC documentation, you're guaranteed to get your permit. So, with fingers crossed, we boldly move forward.

    (click to enlarge)Brasiliero

    Sep 14 6:19 AM | Link | 14 Comments
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