Justice Litle's Instablog

To Be Rich as Rockefeller, Embrace Dividends

Wed, 18 Nov 2009 11:16:51 -0500

“Do you know the only thing that gives me pleasure? It's to see my dividends coming in.”

– John D. Rockefeller

Hi, it’s Kent again – filling in for Justice for another day. Let’s slightly shift gears today. Yesterday I gave examples of how to take a “sector-based” approach to finding stocks.

Today I want to talk about dividends.

The Safe Haven Investor Focus

When you think about protecting and growing your wealth over the long term, one of the first things that comes to mind, or should come to mind, is dividends.

I believe dividends and dividend-paying stocks should be a core foundation of any diversified long-term investment portfolio... especially one focusing on safely building wealth and retirement assets.

My goal for Safe Haven Investor readers (and with Taipan Daily too) is to provide ideas and insights for long-term wealth creation (i.e. for your retirement), with a conservative or safer approach – that is, a priority of minimizing downside risk.

A Dividend Refresher Course

First, as a refresher, you probably know that dividends are a means of paying shareholders excess cash. Dividends are not a requirement and can be cut at any time (as we witnessed in record amounts this past year). For this reason, a company’s dividend policy sends important messages (i.e. signals) to the investment community. Starting, raising or cutting dividends are a very important part of corporate finance strategy.

For companies that are growing rapidly (like technology companies, for example), excess cash is used to fund projects, acquisitions, or research & development that will grow earnings. So, they don’t really have dividends.

In companies that have slower growth prospects, like utilities and tobacco companies, the company distributes a large portion of its excess cash to shareholders by way of the dividend.

And then there is everyone else in between – companies that pay a modest dividend amount, but still have opportunities to deploy cash to grow earnings. (There is a much deeper qualitative, quantitative and analytical foundation for dividend policy and theory that is quite fascinating, to me at least, but that discussion is for another day.)

It’s also good to think about the “payout ratio.” The payout ratio is an important metric to look at when analyzing dividend-paying stocks. It is a key measure of dividend sustainability.

The payout ratio is simply the dividend amount paid in dollars divided by the total earnings. If it gets too high, then watch out! Typical dividend-paying companies keep the payout ratio between 25% and 45%. Again, it can be lower if the company is using earnings and cash flow for other projects (e.g. 0% for technology companies) or higher if growth opportunities are more limited (e.g. utilities).

Why Dividends?

When it comes to protecting and growing your wealth, dividend-paying stocks are invaluable for so many reasons – especially in today’s environment. Let’s discuss a few.

Important Component to Total Return: Clearly, receiving a paycheck in the mail on a regular basis (typically quarterly) is a nice feeling! You can’t lose it in the market any more. In other words, “A bird in the hand is worth two in the bush”… especially when the bush is on shaky ground.

And that’s a return on your investment. When you talk about how much money you made in a stock, it’s the sum of the stock price appreciation plus any dividends you received over that time period. That’s called the total return. And since 1926, dividends have represented 30% of the total return of the S&P 500 index!

Power of Reinvesting: There’s a whole new world of benefit to dividends if you choose to reinvest your payments into more shares. By doing so, you are adding to your principal base, which then lets you earn BIGGER dividends in future.

It’s the amazing law of compounding. You’re no longer receiving your check in the mail with this strategy, but the good news is, that money is going back to work buying more dividend-earning shares, which provides the foundation for more upside and bigger returns. And that builds on itself, quarter after quarter, as long as you want it to. It’s a very powerful (and somewhat underutilized) strategy that I highly recommend, especially if you are saving for retirement.

Providing Stability and Support in a Flat, Frothy Market: If you believe, as I do, that the market is frothy and going to have a setback or correction sometime soon, then stocks with yields will provide income and help offset negative returns during such a period.

For example: If the market has a 10% correction and you own a stock that pays a 5% yield, then you only lose 5%, not 10% – that’s downside protection. And after the big run-up in the market, I like the odds of a correction... which is why I like even more having a defensive, dividend-paying portfolio.

And, too, what if we are in long, flat market environment, where the stock market basically doesn’t do much? That could happen in an economic environment of stagflation or deflation. Well, it would be good to know you are earning something even if stocks went nowhere, right? With this strategy, you’re getting a dividend cash payment while the market is flat. Being “paid to wait” is always nice.

A Unique Environment Today: Bond yields are very low right now, with no real change expected for the next few quarters (until unemployment and the economy show stronger signs of a turnaround). Right now the yield on the S&P 500 index is greater than bond yields! That’s rare.

So you can earn a dividend, just like a bond interest payment, but also pick up any upside in the stock price. The way the market is moving higher these days (and I’m not one to stand in the way of a high-speed train), you can make more than you do from Treasuries and benefit from Mr. Market’s ascent. This is not a long-term observation, but definitely one unique to these times and worth investigating closely.

Source: Bloomberg, Claymore Securities

In Search of… Dividend Ideas

Now that I’ve (hopefully) gotten you excited about dividends, where should you look? Well, my fellow Taipan editors and I are always presenting solid, well-researched ideas in our writings. And, of course, the Safe Haven Investor portfolio has several excellent, safe, high-yielding companies that are recommended as a “BUY” right now. So you’ve got some good places to start!

As you may soon discover, there are plenty of dividend ideas exciting and compelling enough to talk about over cocktails with friends (or at the water cooler with co-workers). More importantly, dividends are a means of building back your retirement savings, sleeping better at night, and worrying less about short-term swings (unless you are trading them on purpose!).

Thanks again for reading my thoughts over the past two days. And again, please send any questions or comments you might have by way of justice@taipandaily.com, and he’ll forward them all on to me.

I really enjoyed writing to you about stocks, investing and, most importantly, protecting and growing your wealth!

Great Returns and Great Times,

Kent Lucas

Editor, Safe Haven Investor

Is the United States Playing Games With Oil Market Data?

Fri, 13 Nov 2009 09:40:51 -0500

Jim Morrison once sang about “Weird scenes inside the gold mine.” Perhaps it should have been weird scenes inside the energy agency.

The International Energy Agency, or IEA, is a 35-year-old quasi-political body headquartered in Paris, France. It was set up in 1974 in response to the budding energy crisis. The IEA’s main focus, as one might expect, is tracking the global oil market. Other energy markets are tracked and studied also.

Every year the IEA publishes its highly anticipated “World Energy Outlook,” or WEO, which runs hundreds of pages long. For the 2009 WEO, just recently released, the executive summary alone is 17 pages. (Your editor has printed up a copy to read at the poker table.)

The weirdness came earlier this week when the U.K. Guardian, a British newspaper, accused the IEA of inflating oil reserves in its projected forecasts.

“The world is much closer to running out of oil than official estimates admit,” The Guardian reports, “according to a whistleblower at the International Energy Agency who claims it has been deliberately underplaying a looming shortage for fear of triggering panic buying.” (Emphasis ours.)

The Guardian then went on to suggest that “serious questions” had been raised about the accuracy of the IEA’s forecasts. Of particular concern was the latest report, with the U.S. taking an “influential role” in “encouraging the watchdog to underplay the rate of decline... while overplaying the chances of finding new reserves.”

Were the IEA to be truly fudging the data, this would be major news, as a number of sovereign governments rely heavily on the IEA for stats. Indeed, for many facts and figures regarding global oil consumption, there is nowhere else to go.

Sharp Response, but a Yawn From Crude

The IEA’s response to the explosive allegations was swift and direct.

Nobuo Tanaka, the IEA’s executive director, said peevishly that “We have always been warning and warning,” and that it is no secret the world will need “45m more barrels per day” by 2030.

Fatih Birol, the IEA’s chief economist, declared himself “surprised and disappointed” at the charges, adding that he was “up to now criticized as being too alarmist.”

Biroh also pointed out that last year’s outlook was “a wake-up call to governments,” and that the IEA’s decline rate numbers “are the highest among our peers.”

And what of that ultimate judge, the oil market itself? Did the much-feared panic buying materialize upon word of a potential cover-up? No. Crude oil, locked in a mostly sideways trading range below $80 per barrel as of this writing, hardly responded at all to the news.

The above chart (courtesy of the WSJ) shows IEA projected oil demand heading out to 2030 for the big three – the United States, Europe and China. (The idea of seeing two decades into the future is absurd on its face, but we’ll leave that alone for now.)

Note that the green bar, representing oil demand for the United States, is the tallest by far (and remains so in 2030). The red bar, representing China demand, is taking off like a rocket, while blue Europe’s rate of oil consumption slowly drifts down.

Part of the reason the oil market yawned, in the short term, is lackluster American demand prospects. Because America is such a huge consumer of oil in the here and now, weakness on the home front is harder for oil to overcome. U.S. distillate stocks – seen as a good proxy for oil demand overall – are at a 26-year high, which means consumers and businesses are using less of the black stuff. Looking ahead a few quarters, U.S. oil demand is expected to fall in 2010 for the first time in decades.

Four Areas of Influence

One might say the oil market is responding to five areas of influence these days:

• Trends in the U.S. dollar (and other major paper currencies).

• The short-term supply and demand outlook (dominated by a weak U.S. economy).

• Long-term forecasts for rising emerging market demand (particularly China).

• “Peak oil” concerns and the potential dwindling of long-term energy reserves.

• Geopolitical concerns and the “fear” premium (dormant now, but with potential to surprise at any time).

Given these factors, the mix suggests downward pressure on oil in the near term (as the dollar shows sign of bottoming and the U.S. economy tails off), with renewed upward pressure in the mid to longer term.

The Oil Drum, a popular energy Web site, shows another reason for concern in the chart below (compiled from IEA data).

Roughly 40% of the world’s oil supply comes from OPEC members (Organization of the Petroleum Exporting Countries). The rest comes from non-OPEC members.

The chart above shows how non-OPEC supply actually peaked a number of years ago, with the high-water mark for production hitting some time in late 2003.

Others may disagree, but to your humble editor oil looks vulnerable here. That is very much a shorter-term observation, however. In the longer term, oil’s rise seems as assured as the dollar’s ultimate demise.

What’s the Motive?

If the Guardian allegations are true, why would the United States be pressuring the IEA behind the scenes? Perhaps because weakness in the U.S. economy is the Achilles’ heel of the whole “V-shaped recovery meme” that has whipped investors into a frenzy.

The bulls have managed to fix their gaze on the über-stimulated Chinese economy – somehow overlooking the major red flags – while averting their eyes from the unfolding horror that is the U.S. economy. Were the price of oil to rise too far, too fast, it would become all the harder for Washington and Wall Street to ignore the intense pain of Main Street.

In that light, a few gentle nudges in the IEA’s ribs would not be a surprise. As Morrisey sang in “The Lazy Sunbathers,” the bulls are now “too jaded to question stagnation”... and the powers that be want to keep it that way.

Warm Regards,

Planet Real Versus Planet Paper – My Biggest Lesson of 2009

Wed, 28 Oct 2009 16:52:19 -0400

Market models can be helpful when it comes to trading and investing decisions. For Justice, the year 2009 served up a major insight... Planet Real and Planet Paper are different worlds.

“Essentially, all models are wrong – but some are useful.” That noted quote comes from Dr. George E.P. Box, a grand old man of science and statistics.

It can be disconcerting to embrace the idea that “all models are wrong.” Especially when the insight comes from a legendary statistician!

It makes sense, though, because useful models are simple by definition. Think of a map. What you really need from a good city map is the layout of intersections and streets. A certain level of detail is okay, and even useful. But the more detail that gets added, the more cluttered the map becomes. A map that tried to do too much would cease to become useful at all.

In this sense, the map is “wrong” because it doesn’t give a 100% accurate picture. But, oddly, it is wrong on purpose. It has a very specific purpose and intent, and intentionally leaves things out.

Market models – that is to say, different analogies, metaphors, and ways of observing or thinking about the market – are similar. Like a good city map, the right market model can be extremely useful in terms of aiding trading and investing decisions.

In the spirit of continuous improvement, your editor is always seeking to refine, improve and upgrade his market models. Sometimes this means a small change. Sometimes it means a big change. Sometimes it means discarding a model entirely, or coming up with something entirely new.

In that context, here is one of your editor’s most important lessons learned in 2009...

“Real” and “Paper” Are Different Worlds

Let’s break down the insight in market model terms.

To begin, when it comes to trading and investing, there is the “real” economy and the “paper” economy. The real economy represents what is really and truly happening – the cut and thrust of Main Street, of jobs and wages, of boots on the ground and day-to-day life. The paper economy, in contrast, tracks what’s happening on Wall Street (as reflected in equities, bonds, commodities and currencies).

One can break out the two as follows:

Key Drivers for the “Real” Economy	Key Drivers for the “Paper” Economy
• Jobs, Wages and Unemployment • Debt Loads/Balance Sheet Quality • Trade Balances • Main Street (small business and consumers) • Realistic Long-Term Outlook • Negative Government Impact	• Liquidity Levels • Investor Sentiment • The “Expectations Game” • Wall Street (megabanks, connected interests) • Idealized Short-Term Outlook • Positive Government Impact

Looking at the factors listed in the table above, it is easy to say, “Duh.” None of these factors are especially new. In fact we’ve talked about them all at one time or another.

But sometimes major realizations are subtle. The market model shift is not always dramatic. Sometimes a small adjustment leads to a game-changing insight.

It is a further irony that big breakthroughs often have a whiff of “duh” to them. This is because a truly useful insight is, more often than not, simple. And sometimes the gain is in reweighting priorities – changing the recipe without changing the ingredients, so to speak.

In this case, the gist could be summed up like this: The real economy and the paper economy are not just “different,” they are different worlds... and thus should be thought about separately and distinctly.

Back to the mental model thing again...

Think of two planets, one slightly larger than the other. These two planets have a relationship. Each holds the other within a mutual gravitational pull.

But, because the relationship is not stable, the distance between the planets changes over time. When there is convergence, the planets move closer to each other. When there is divergence, they move apart.

One of these is “Planet Real.” The other is “Planet Paper.” And thus, if it sometimes seems that the “Real” folks are living on a different planet than the “Paper” folks... that’s because it is more or less true.

A Sharp Disagreement

This market model – seeing “real” and “paper” as distinct worlds to be analyzed separately – is controversial for a number of reasons. Those who embrace standard economic theory, for one, would reject such a model entirely.

Standard theory says that the real economy and the paper economy are very closely linked... that the stock market is both a barometer of health for the real economy and a leading indicator for the real economy’s future direction... and that the main purpose of the market is to allocate capital, i.e. to funnel cash to worthy enterprises and thus aid the real economy.

Your editor has always been skeptical of academic types. As a result of all that’s happened in 2009, his skepticism has morphed into full-on rejection of these common assertions put forth in grad school finance classes. In other words:

• Equity markets are NOT reliable leading indicators as to the health or future direction of the real economy. This would be far more true in an unmanipulated, ungamed free market system, but that is not what we have.

• The primary function of equity markets is NOT efficient allocation of capital (getting investment dollars to businesses that need them). Again, this is the market’s hypothetical function in a free market system. But to the degree that the system is gamed, subject to intervention and coercion, this assertion is not true.

• Efficient market theory has little basis in empirical observation. Why “should” the markets be efficient? Just because academia says they are? Just because we want them to be? Why “should” the markets be rational allocators of capital, when strong influences make them otherwise?

• The “manipulated market” charge is easily supported by visible evidence, and does not require an embrace of conspiracy theory to be shown true. The evidence for efficient markets doesn’t really exist. But the evidence for manipulated markets is plain as day. We see it in the government’s actions. We see it in central bank officials’ openly stated intent. We see it in the actions and disclosures of the major Wall Street players. In other words, we observe evidence of legally sanctioned manipulation most everywhere we look.

• The major benefactors of the “paper” economy are incentivized to make large short-term profits... NOT to sustain logical market valuations. What are equities truly worth? What should they be worth? What is a sober and rational valuation for the market? The streetwise answer is, “Who cares???” That isn’t what the game is about. Economics is supposed to be all about incentives, and yet economists refuse to make the obvious connection. It seems plain that the mutually overlapping incentives of Washington and Wall Street favor markets going as high as the gamers can take them. This has nothing to do with rational valuation. When it comes to incentives for the paper crowd, the real economy is a restraint rather than a guide.

Where the Rubber Meets the Road

So what is the point of all the above in terms of hard-nosed trading and investing? How does this distinction between “real” and “paper” apply to protecting and building wealth?

First, thinking about the “real” economy and the “paper” economy separately can help avoid a number of future pitfalls. If one recognizes that there is a direct correlation between government intervention and market distortion, then one will be more likely to take positive “paper” results with a grain of salt (being aware of how quickly such gains can be spirited away). This realization could lead to better hedging techniques or other methods of protecting near-term capital gains.

What’s more, we are set up to see a LOT of government intervention in the coming years. Not just in the United States, but in Europe, China and elsewhere. 2009 may have only been a preview in that respect.

So the sooner one realizes that such intervention will lead to ever greater market distorting effects, the better... especially when tempted by the analysis of those who present the goings on of the real economy and the paper economy as if they are the same (or otherwise more tightly coupled than they really are).

On the flip side – and this is where your humble editor eats a plateful of crow – distinguishing between the two worlds can also help one avoid the trap of being prematurely gloomy in regard to the nominal direction of asset prices. The moneyed interests driving the paper economy can be extremely powerful... so powerful that they can present the illusion of stocks going up, even as the real (inflation-adjusted) value goes down.

Those who were bearish and cynical from the March lows (including yours truly) were, ironically, not cynical enough.

Opportunity and Turmoil

For many of us, it is a game that must be played (and a game that can still be quite fun, albeit dirty). When Wall Street and Washington have the ability to majorly impact your nest egg for the worse – and when most every central banker in the world is playing some version of the same game – there is no real way to opt out.

The alternative, then, is to “game the gamers” and set about making as much money as possible (what trading and investing is all about). In that respect, the “two worlds” model represents the presence of both opportunity and turmoil.

Think about the convergence and divergence idea again. Sometimes the planets (paper versus real) are rapidly increasing their distance from each other. But then gravity’s pull reasserts itself, causing the planets to reverse course and converge with frightening speed.

This is analogous to the swings between inflationary and deflationary sentiment we can expect moving forward, perhaps for a number of years. Government intervention and Nash-Equilibrium-style market movements will lead to euphoria, i.e., divergence, as Planet Paper moves away from Planet Real. But then the artificial boosters will run out of gas (as happened time and again with Japan), and the two planets will violently recouple.

For your editor, there will be many trickle-down impacts from this adjustment. Not least will be the conviction to never again confuse the natures of “Planet Real” and “Planet Paper”... sometimes converging but never the same, with distinct and separate drivers for each.

Link to original article: www.taipanpublishinggroup.com/taipan-dai...

The Two Essentials of Trading and Investing Success

Tue, 27 Oct 2009 15:35:21 -0400

What if the path to trading and investing success could be boiled down to just two things? Is there a way to do it – to ensure success almost no matter what?

How does one guarantee investing and trading success? Is there a way to do it – to ensure attainment of the goal no matter what?

There are few iron-clad guarantees in life, other than death and taxes. If we look hard, though, we can find reliable principles and truths here and there. Laws of nature, so to speak, that can be made to work powerfully in our favor.

When it comes to succeeding in markets – or succeeding in most anything, really – there are a lot of subtleties. Lists of do’s and don’ts... things to remember... things to recognize.

But what if the path to success could be boiled down to just two things? Two “meta-rules,” let’s say, that don’t cancel out or replace all the important little things, but instead, preside above them all?

There is virtue in simplicity. (That’s why Einstein said, “Things should be made as simple as possible, but not simpler.”) The closer you get to the root of things, the more powerful the insights become. One or two powerful rules can have an impact in countless situations, and act as a guideline for many follow-on decisions – like a ruler’s edge on a piece of drafting paper, making it easier to draw a straight line.

As the title of today’s piece suggests, some recent reading inspired your editor to come up with “the two essentials” of trading and investing success. If you remember these two “meta-rules” (to be revealed below), you will greatly achieve your odds of success in any endeavor.

The Exponential Curve

A few years ago, I had the opportunity to chat with one of the original “turtles.”

The turtles, if you haven’t heard of them, were a group of market neophytes (rank beginners) trained from scratch by the legendary trend-following trader Richard Dennis. (Dennis himself is known for starting with $400 and parlaying it into $200 million.)

Richard Dennis and his partner had a gentleman’s disagreement over whether trading skills were innate – i.e. something you were born with – or something that could be taught. Dennis believed that trading skills could be taught. His partner was skeptical.

To test the hypothesis, Dennis and his partner decided to take on a group of trainees, teach them a set of rules, and give them money to trade. The “turtles” moniker came from a trip Dennis took to Singapore. He saw turtles being grown in vats there and mused that he was going to grow traders the same way.

The experiment was an astonishing success. A handful of the turtle trainees went on to make tens or even hundreds of millions of dollars for themselves and their clients, using modified versions of the Dennis trend-following technique. At least one or two of the original turtles (if not more – they are a secretive bunch) have $1 billion or more under management today.

Going back to the discussion of a few years back, there was one thing said in particular that stuck in your editor’s head.

“Justice,” the taciturn turtle said, “the exponential curve that is trading returns cares more about your ability to stay alive than the absolute rate of the return. If you are good, and stay in this game long enough, everything takes care of itself.”

Sitting by the River

That old exchange came to mind by way of insight from another market sage, Howard Marks of Oaktree Capital Management.

Howard Marks is the founder of a $60 billion fund (that’s billion with a “b”) focused on the high yield and distressed debt markets. He has been a keen observer of markets since 1969. As a result of his longevity, Marks is known in the fund management world for his uncommon wisdom and insight, which he often shares with clients.

In a recent interview, Marks reflected on the concept of survival and its natural tie-in to success:

Sun Tzu said if you sit by the river long enough, you’ll see the bodies of your enemies float by. The key is “long enough.” If you live long enough, you have to be the survivor. When I was a kid, we didn’t have the video games you have today, so we used to listen to comedy records. One of the greatest ones was Mel Brooks doing the 2000 year old man. Carl Reiner says to him, “how did you get to be the world’s oldest man?” And he says, “Simple. Don’t die.” How do you get to be the world’s oldest investor? The answer is don’t crap out.

So if you look at distressed debt where we started in 1988, I could tell you who our number one competitor was in every year through 1995 and not one is a main competitor today. And it’s not because of what we did; all we did is perform consistently. They crapped out. It sounds simplistic to say, but the first requirement for success is survival...

The Two Essentials

And so, to put it in less than poetic terms, one could say the two “meta-rules” for trading and investing success are as follows:

1. Strive for continuous improvement (shun perfection; embrace iteration).

2. Survive at all costs (don’t “crap out”).

It sounds so simple. If you manage to survive, and not just survive but continuously improve, you dramatically increase the odds of getting where you want to go.

The surprising thing about these two rules is not how deep or profound they are, but how widely they are neglected!

When it comes to pursuit of a challenging goal, human nature seems to favor the W.C. Fields approach: “Try, try again – and then quit. There’s no sense making a damned fool of yourself.”

Take dieting habits for example. Statistics suggest that the percentage of successful dieters – those who manage to lose weight and keep it off – is on par with the percentage of successful traders and successful entrepreneurs.

Your editor finds that fascinating. Starting a successful business is hard. Becoming a successful trader is hard. And yet, for those who attempt either of these noble and worthy goals, the hit rate is (roughly) on par with the relatively simple goal of “eat less and exercise!”

What does that say about us? That dieting is a lot harder than looks? That a little self discipline, consistently applied, goes farther than we realize? Or both?

Getting the Tution’s Worth

Besides survival (staying in the game and not crapping out), the other “meta-rule” for success is a commitment to constant and ongoing improvement. There has to be a desire to get a little bit better, a little bit wiser, a little bit smarter or stronger or more efficient, with each passing day.

In poker and in markets, many survivors forget the importance of continuous improvement. They come to the table with the same attitude and skill level, content not to grow – and then they grouse about how their results never get better.

Your editor has witnessed this phenomenon many times. In the poker room in particular, you can find grizzled old hands caught in a permanent time warp. “I’ve been playing hold ‘em for twenty years,” these battle-scarred survivors will tell you. The only problem is, they still play as if they had two years’ experience... repeated 10 times in a row!

Experience is by far the best teacher. But if life is a classroom, we have to be paying attention to benefit from the lessons. Those who seek to continuously improve – to always and everywhere find ways to get smarter, wiser, better – are making the most of the “tuition” that the game extracts as we play. Those who fail to pay attention in the game of life are like the lazy college student killing time at an Ivy League school. Someone is shelling out the big bucks, but the money is being wasted.

Perfection Versus Iteration

When you combine these two things – a commitment to survive and a commitment to keep on improving, no matter what – a sort of alchemy happens.

With the “survive and improve” mindset, short-term setbacks become less grating; instead, they are seen more as learning experiences. When a trading or investing decision is viewed as just one of a thousand decisions, there is less pressure to be “perfect.” When the trading and investing journey is seen as a path many miles and many years long, a gnawing sense of urgency is replaced by more of a zen-like calm.

The market is a good teacher, too, in that it demands the abandonment of perfectionism. There is no such thing as a “perfect” investment or a “perfect” trade. The entry could have always been a little bit better. The exit could have always been a little bit sooner (or later). Or, if the entry and exit were nailed dead-bang on, the position itself should have been larger, and so on.

There is no perfection in trading, only iteration... repeated performance with an eye for subtle improvement in each repeat. Over and over, again and again.

Last but not least, a commitment to survival and improvement above all ensures two things. It ensures you will be back tomorrow – because the markets will always be there, there will always be another day, and you are committed to seeing that day. And it ensures you give yourself permission to experiment, to learn and to make mistakes (because mistakes are invariably the best lessons, as administered by the teacher called Experience).

Put it all together, and you get the eighth wonder of the world working in your favor – compound interest. In this case, it is the compound interest of accumulated knowledge and experience, continuously built on and refined over time.

It is by that means that the turtle’s final words prove true: “If you are good, and stay in this game long enough, everything takes care of itself.”

Invest in Open Source Leader

Wed, 14 Oct 2009 13:30:52 -0400

Red Hat, Inc. – Growth at Any Price
By Zach Scheidt, Editor, Taipan Publishing Group

Investors are buying up shares of technology companies quickly as fears of an economic collapse begin to dissipate and margins for many companies are quite attractive. Red Hat, Inc. (RHT:NYSE), the provider of open source operating systems for enterprises has seen its stock rocket 268% from the low set last November. Investors are now willing to pay a hefty premium for the stock due to its stable track record of sales and earnings growth.

Recently, the company announced results for its fiscal second quarter (Red Hat operates with a February fiscal year end). The results came in ahead of expectations with the company posting earnings of $0.20 per share from revenue of $184 million. Sales were up 12% above the same quarter last year, which indicates that businesses are willing to invest in technology even while the purse strings are held tight for many other expenditures.

These purchases are often made with the assumption that stronger technology will help companies operate more efficiently as many are looking for ways to maintain business levels while laying off employees. This helps to explain why productivity levels have increased on a macro scale even while unemployment rises to new levels. Red Hat is capitalizing on this trend and offering significant value to customers.

Merrill Lynch (MER:NYSE) had spent the last quarter with Red Hat at a “hold” ranking, but after the quarterly release the brokerage firm raised it’s price objective and once again recommended clients buy this well-known technology stock. Last quarter, Merrill had become concerned with a declining level of billings, but with year-over-year billings now increasing to 8% from a low 3% last quarter the picture appears a bit brighter. Merrill cited three primary reasons for it’s positive assessment of Red Hat:

Forward Metrics Strengthening – A growing backlog of business appears to ensure that the company will be able to maintain revenue growth for quite some time.
Upsell Thesis Playing Out – The company is seeing its premium products (with higher margins) move off the shelf with 23 of the top 30 renewals opting for higher margin products
Share Gain Potential – There are quite a few high profile competitor renewal contracts that will come up over the next three years. Merrill estimates $240 million of potential new business from these contracts.

So as far as the business is concerned, it looks like Red Hat is firing on all cylinders and growing profit at a steady clip. This is just what we want to see as growth stock investors – but there is just one problem. The price of the stock more than accounts for this attractive growth. In fact, it appears investors are completely ignoring the economics of what they are paying for this cash generating company.

Consider this: Analysts are expecting the company to book $0.67 of revenue in fiscal 2011. The following year, the company is expected to grow earnings by 12% as the economy theoretically continues its recovery from the economic turbulence. So that puts next year’s earnings at about $0.75 if you believe that these analysts are accurate in determining future earnings.

Now look at the stock price: Investors are currently paying roughly $27.50 for this company at the time of this article, that means that you are paying 37 bucks for every dollar that the company generates. Now I don’t mind paying that kind of multiple for a small company with the potential to grow by 30% to 50% annually for several years. Small companies offset the risk of buying too high with the potential for very aggressive earnings growth.

But Red Hat is a $5 billion dollar company. It’s not the young hot technology company it was in 2000 when the stock price hit a high of $150. We’re also not in the same environment where investors are likely to go nuts and pay triple digit multiples for technology stocks. The tech bubble of 2000 and the financial crisis of 2008 is still fresh on investors minds and I believe we are approaching the upper limits for what investors are willing to pay for a maturing technology stock with estimated 12% growth.

Now shorting Red Hat today could be extremely risky. Just a few days ago, the stock made a new 52 week high which is not the kind of pattern you want to have when betting for lower prices. But the stock is running up against what should be very strong resistance in the $28 to $32 area. If the stock begins to falter running into this region, it may be worthwhile to slowly begin building a short position, and then add to your trade once you start to see unrealized gains. It may also be worthwhile to develop an options strategy that will minimize risk but still allow you to participate if and when the stock begins to decline.

Red Hat is a name that I would like to own at the right price. Buying the stock at 20 times earnings (or roughly $15) might be a bit aggressive but out of respect for the franchise the company has built I think this would be a relatively attractive spot to own RHT. But for now, the risk seems significant and any surprises will likely cause selling and not additional buying.

Link to original article: http://www.taipanpublishinggroup.com/invest-open-source-leader.html

Revisiting the Carter Thesis

Wed, 14 Oct 2009 10:24:12 -0400

Back in May of this year, Taipan Daily posed the question, “Is Barack Obama the next Jimmy Carter?” (You can find part one of that discussion here and part two here.)

The question is not meant as political bait. To Democrats and Republicans alike we say, “A pox on both your houses.”

The question matters because if the answer is yes – if President Obama is, in fact, channeling President Carter – then the inflationary malaise of the 1970s looks set to repeat. The darker aspects of the disco era could become as much a part of the future as the mostly forgotten past. And that, in turn, leads to some pretty clear investing and trading implications for the years ahead.

Norway’s Exploding Cigar

As if you hadn’t heard, a committee of Norwegians has bestowed upon Barack Obama the Nobel Peace Prize. They might as well have given him an exploding cigar.

(As The Onion put it, "Oh, to be honored among such towering presidents as Woodrow Wilson and Jimmy Carter.")

The sentiment behind the prize was silly and unserious. Given how far in advance these things are decided, the POTUS was in office for a scant 12 days before the committee deemed him worthy. He barely had time to find the Oval Office bathroom, let alone do anything peace-worthy.

This matters because many of President Obama’s tasks will be harder now. One could argue that countries like Russia and Iran will take the White House less seriously, knowing that the U.S. Commander in Chief has a dovish reputation to live up to. On the other side of the coin, if the president makes a distinctly “non-peaceful” military decision – of the sort that looms large, re, Iran and Afghanistan – the subject of the prize could surface again as an object of mockery.

It’s almost as if the Norwegian committee wanted to hog-tie Mr. Obama – to mold him into the vessel of hope and salvation they craved, subtly seeking to limit his options with a deliberate preemptive gesture. “If we give him the prize, he’ll be that much less tempted,” they may have reasoned. Or maybe they were thinking something else entirely.

Either way, an attempt on the part of Europe to influence American foreign policy simply looks bad. The act in itself feels mildly insulting. It comes off as unfortunate no matter how you slice it.

Of course, it is not the president’s fault he got nominated. But he could have said no.

North Vietnam’s Le Duc Tho was awarded the Nobel Peace Prize jointly with U.S. Foreign Secretary Henry Kissinger in 1973. But Tho declined to accept it, on the grounds that a true Vietnam peace agreement had not yet been secured.

Le Duc Tho, in other words, recognized the importance of being a worthy recipient. President Obama could have graciously declined too, making the point that no shortage of compelling nominees existed.

This would have been a wise thing to do sheerly on political grounds. It might have even bolstered Mr. Obama’s standing as a leader, distancing him from the baggage of utopian expectations and starry-eyed rhetoric.

Instead, the POTUS accepted the award... and let the cigar explode in his face. Why?

Tennis Courts and Swimming Pools

Perhaps because, like President Carter before him, our current president is just too damn distracted.

Jimmy Carter was known for being a micro-manager, caught up in such a vast array of little things that the truly big things were left untended. For example: Legend has it that, in his first six months in office, President Carter personally reviewed all requests to use the White House tennis court. (Carter later denied this, but various insiders confirmed it. As James Fallows writes in The Atlantic, “I always provided spaces where he could check Yes or No; Carter would make his decision and send the note back...”)

Your editor was reminded of this anecdote on reading a recent Washington Post piece, “A Vigorous Push From Federal Regulators.” According to the Post, “The Obama administration is taking on Cheerios. And popular cold remedies and swimming pool drains and rhinestones on children's clothing.”

In a move designed as much for symbolism as effect, the new chairman of the Consumer Product Safety Commission dispatched all 100 agency inspectors across the country last month to enforce a law that requires special drains on swimming pools to prevent children from entrapment. The agency shut down more than 200 pools.

“Symbolism” indeed. The frightening message we are getting is that swimming pools, Nobel Prizes and Olympic bids (witness the recent mad dash to Copenhagen on behalf of the city of Chicago) have more mindshare in the president’s head than things like the rapidly deteriorating job situation, the unfinished business in Iraq and Afghanistan, and the quiet coup that has taken place on Wall Street.

And then there is healthcare...

Neither the Time nor the Place

Whether you stand adamantly in favor of universal healthcare coverage or adamantly against it, at least one thing has become clear. Efforts at healthcare “reform” have become a giant boondoggle.

According to fund manager Jeff Matthews, who took a keen look at the Senate Finance Committee’s efforts, the bill as it stands would still leave 25 million Americans uninsured in the year 2019. (So much for “universal.” What was the point again?) An additional 29 million “nonelderly” Americans would be insured under the bill at a theoretical cost of $829 billion.

The word “theoretical” deserves strong emphasis there because the present bill 1) assumes large Medicare cuts that will never happen, 2) anticipates heavy taxation of “Cadillac” private insurance plans, and 3) surely underestimates the added fraud, abuse and gaming of the system that would take place under an expanded government mandate.

As if all this weren’t headache enough, the massively powerful health insurance lobby known as America’s Health Insurance Plans, or AHP, appears to have thrown a spanner into the works at the last minute. AHP has released a study saying premiums could rise sharply for all privately insured Americans were the present bill to pass. The White House angrily cried “sabotage.”

All of this leads your editor to ask in strident tone: Why the heck are we getting so caught up in this now?

Healthcare reform is the political equivalent of cleaning out the Augean Stables. Hercules had to reroute two rivers to wash the mountain of horse crap away. Given the intense emotional stakes, the deeply entrenched corporate interests, and the sheer degree of complexity involved, tackling healthcare head-on might rank as one of the most ambitious political endeavors of all time.

In other words, draining the healthcare swamp would be a challenging enough task during flush economic times with nothing but blue skies on the horizon – let alone in the midst of an epic financial crisis/jobs crisis/energy crisis punctuated by wars past, present and future!

It’s the Economy, Stupid

In your editor’s humble opinion, the president should have a Clinton-era campaign phrase affixed to his desk: “IT’S THE ECONOMY, STUPID.” (The prez is far from stupid, of course. He may well be a genius. But then, so was Carter.)

Even the most vocal and loyal Obama supporters, like columnist Bob Herbert of The New York Times, are wondering if the president “gets it” when it comes to jobs. As Herbert wrote on Oct. 6,

The Obama administration seems hamstrung by the unemployment crisis. No big ideas have emerged. No dramatically creative initiatives. While devoting enormous amounts of energy to health care, and trying now to decide what to do about Afghanistan, the president has not even conveyed the sense of urgency that the crisis in employment warrants.

...The word now, in the wake of last week’s demoralizing jobless numbers, is that the administration is looking more closely at its job creation options. Whether anything dramatic emerges remains to be seen.

We’re being set up for something “dramatic” all right – just not the type of drama that Herbert is hoping for.

On the home economic front, the news keeps going from bad to worse. Wall Street is throwing a stimulus party while “Main Street” America – i.e. regional banks, small business, and U.S. taxpayers – is headed to Davy Jones’ locker. As a certified news junkie, your humble editor reads the equivalent of five or six newspapers most every day. Here is just a smattering of recent headlines:

• Foreclosures grow in housing market’s top tiers (WSJ)

• Credit Vise Tightens for Small and Midsize Businesses (NYT)

• Steep Losses Pose Crisis for Pensions (WPost)

• Failures of Small Banks Grow, Straining FDIC (NYT)

• Small firms face credit squeeze as crisis drags (Reuters)

• Banks cutting back on loans to businesses (MarketWatch)

What the White House refuses to acknowledge is that the jobs crisis ties directly back to Wall Street. The trillions of dollars pumped into the U.S. economy by way of various alphabet soup programs and government guarantees have directly enriched the megabanks and top Wall Street firms, while potentially making things even worse for the average man in the street.

The way this game is played, if you have the U.S. Treasury Secretary on speed dial, you win. Virtually everyone else loses. The list of Wall Street players banking huge profits off the crisis looks uncannily similar to a “who’s who” list of Paulson and Geithner telephone contacts over the past 12 months.

It’s a losing game for America because Wall Street has become a one-way thoroughfare. Huge sums of taxpayer-funded bailout money get poured in, but nothing comes back out. The taxpayer ponies up vast sums to bail out the megabanks... the megabanks use the free funds to make fat profits on guaranteed government securities while bidding up paper assets... and the real economy continues to suffer as small banks go under and small businesses find no one willing to lend.

As Spengler (aka David P. Goldman) puts it in the Asia Times,

The parallels between America in 2009 and Japan in 1989 are uncanny. An asset price bubble has collapsed, just before a tsunami of prospective retirements that the asset bubble was supposed to fund. Demand for savings is bottomless, and the government satisfies demands for savings by running a huge deficit and issuing debt. The crippled banking system borrows at an interest rate of zero and buys government securities. And the economy shrivels up and dies.

The frustrating thing about our Carteresque president is that he shows no visible sign of giving a damn about any of this. (Perhaps he doesn’t see it happening? How could that be possible?)

As the economy contracts, a combination of rising unemployment and explosive government debt expenditure threatens to ignite a period of “inflationary malaise” like we haven’t seen in decades... maybe even surpassing the ‘70s this time around.

Unless the situation is somehow rectified – and the window seems to be closing fast – our president risks being remembered much like Carter: For a raft of lofty promises unfulfilled, crafted against a legacy of deep financial incompetence and a damning roster of big problems left unaddressed.

And what’s your opinion, particularly those of you who remember those dark days of inflationary malaise? Too harsh, or more or less on the money?