It was announced Thursday that IMS Health (RX) was to be stolen from its shareholders for $4 billion or about $22 share; a private equity firm will buy them out. IMS Health should have free cash flows this year of over $340 million (the actual number should be higher than $400 million, but is benefited by a $60 million onetime tax benefit).

So this company, which has virtually no competition, has barriers to entry impossible for a new entrant to overcome, and a cash printing machine will be sold for about 12 times free cash flows. Over the past year we’ve seen much lower quality companies being sold for much higher valuations than this. Most recently, Burlington Northern Santa Fe (BNI), which has a significant competitive advantage but has far inferior return on capital and free cash flow generation than IMS, is to be purchased by Mr. Buffett for about 20 times earnings and 30 or more times free cash flows. IMS Health’s management and board have a history of making dumb capital allocation decisions, but this one may go down in history as their dumbest.

I originally wrote this list of recommended books last year; recently I updated it and added a few more. I hope to keep adding to it every year. It contains six sections: Selling, Think Like an Investor, Behavioral Investing, Economics, Stock Market History, and Books for the Soul. Due to its length, I divided it into two parts. You can read part 1 by clicking here

Here is part 2, I hope you enjoy it

I originally wrote this list of recommended books last year; recently I updated it and added a few more. I hope to keep adding to it every year. It contains six sections: Selling, Think Like an Investor, Behavioral Investing, Economics, Stock Market History, and Books for the Soul. Due to its length, I divided it into two parts (you can read part II here.) I hope you enjoy it.

In crazy times like today, all one could and actually should ask for is sanity. Yes, sanity – a clear mind free of noise to deal with the insanity that is thrust upon us by the volatile and noise-making machine also known as the stock market. We find ourselves glued to the computer screens or CNBC waiting to find out what the Dow’s next tick is going to be. Unfortunately, we are left with only a headache and wasted time. OK, what’s next? Here is my advice: read. Read books that will bring you sanity, the ones that will snap you back into the mode of an investor and out of the sorry shell of the nervous observer of the daily stock market melodrama. The following books are excellent choices and come with plenty of sanity and sage advice.

My writing is a byproduct of my investment process, I think through writing. I don’t do movie reviews and don’t watch Michael Moore’s movies. A Denver Post reporter invited me to a private showing of Moore’s latest flick last Monday Capitalism: a Love Story, it stirred up a lot of memories and I recently finished reading Atlas Shrugged which had a great impact on me. A combination of all those things motivated me to write this.

In the 1980s, in Soviet Russia, a few times a year, my class walked to a movie theater, where we were shown a documentary. Attendance was mandatory. The documentaries were different but the themes were the same: to the accompaniment of patriotic music, we learned about the righteousness of socialism, the greatness of Mother Russia, and the intelligence and foresight of our great leaders. To demonstrate how good we had it, we were shown images of “decaying” American capitalism. Of course, capitalism did not get the benefit of patriotic music as we were shown the poverty-stricken homeless, the KKK burning crosses and lynching blacks, and Russia-hating capitalists being poisoned by hamburgers (of course, later I learned this part about hamburgers was not a complete lie).

In investing, it’s important to think unconventionally and creatively while at the same time considering risks - no matter how remote or unmanageable they are. I keep thinking: What would drive our interest rates up in the US?

China is the obvious culprit as it’s the largest holder of our fine Treasury obligations. If China’s exports to the US don’t recover to the pre-Great Recession level then, considering its large overcapacity and bad-debt problems, it may quite suddenly find itself unable to buy as many of our bonds/bills. Or even worse, it may start selling them. But this scenario is one I’ve discussed in the past more than once.

Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.

- Warren Buffett

Financial stocks had a huge run up from their bottom. Many have doubled and tripled, but are they still cheap?

It’s almost impossible to value big financial institutions like Citigroup (C), Bank of America (BAC), or Goldman Sachs (GS) — they’re a lot like hot dogs — you don’t really know what’s inside of them; for the most part, they’re leveraged hedge funds.

October. This is one of the peculiarly dangerous months to speculate in stocks in. The others are July, January, September, April, November, May, March, June, December, August, and February.

-Mark Twain

Electricity was not the only economic statistic not controlled / calculated by the Chinese government that showed that the 6% plus GDP growth in the first six months of 2009 (at a time when the global economy was sliding off the cliff) was an accounting miracle.

Guangshen Railway announced its results a few days ago for the first six months of 2009: “tonnage of freight transported by the Company amounted to 26.5406 million tonnes (2008 interim: 34.5508 million tonnes).” – a decline of 23%.

My previous article ended with a very insightful conclusion: “Need I say more?”. I received a dozen emails that said – you DO need to say more. So here I am saying more:

What do we take out of this? The Chinese ascent over the last decade has lowered the degree of separation between China and the global economy. What happens in China doesn’t stay in China (not anymore); it spills over to the rest of the world.

I know, I may sound like I’m beating a dead horse – how much printer cartridge can one spill over China? – but I have a very high burden of proof to overcome. Let me demonstrate it by this analogy: Let’s rewind 20 years. It is 1989 and I am writing that the Japanese economy is on the verge of severe decline. I’m facing a lot of skepticism. Most people are calling me crazy and throwing heavy objects at me. After all, the Japanese are on top of the world. Their economy has been a consistent grower for decades, with a rate of growth that trumps that of the US and Europe.

Japan has the manufacturing thing nailed – they are simply better and more efficient at it than us. Magazines and newspapers swarm with stories about Japan, how hard working they are, how unique their culture is (we of course, feel inferior, as lazy Americans). Japanese exports significantly exceed their imports, generating huge capital-account surpluses – they are swimming in dollars and buying up America. Every other restaurant in Hawaii serves sushi and menus are in English and Japanese (not Spanish). I may be exaggerating with the last part, a little, but not much.

Tired of the market's volatile swings? Sorry, but you need to get used to it.

For the next dozen years or so, the broad U.S. stock market will seem to be on a wild roller-coaster ride. The Dow Jones Industrial Average and the S&P 500 index will go up and down, often wildly, and in the process set more all-time highs and multi-year lows. But they will also be stagnant, trading in range without making much progress.

Given my usual warning, I don’t want to discuss politics in my writings for two reasons: it bores me to death and I’ll upset 55% of my readers. But an investor cannot ignore politics especially today. What happens in Washington doesn’t stay in Washington.

In his healthcare proposal President Obama is using a tactic described in behavioral finance as anchoring. Here’s a real life example from my married life. Let’s say I buy an expensive toy (usually a geeky one like an electronic gadget) for $300. My wife will ask me how much it is, and I’ll respond with $600. With a stunned look on her face, her reaction is typically “You paid $600 for this?” I then come back with, “What would you say if it was $300?”

Now we are learning how China has achieved its “miracle growth.” The country showed positive GDP growth while its electricity consumption declined in the beginning of 2009 – creative accounting that makes Enron’s accountants appear as dilettantes. A paper published by John Makin at American Enterprise Institute explains it well:

Once China had announced its 8 percent growth target, it began to disburse funds directed at a sharp increase in public works spending. It is important to understand that the disbursal of funds is recorded as GDP growth. So the government can easily control the pace of growth by the pace at which it releases funds that have already been allocated in the stimulus package to the creation of higher production or growth numbers. Funds disbursed for fixed-asset investment by state-owned enterprises or provincial governments are counted as having been spent when they are disbursed. In fact, the funds go out to the state-owned enterprises and provincial governments and may be held until actual projects are identified and undertaken.

I am not writing this under duress, neither my family nor I were kidnapped by the Chinese government; I simply made a mistake in my last note about China called, “Simple Math of Chinese ‘Staggering’ Growth” and would like to correct it. The Chinese non-export economy is not growing at a 23% rate. This figure would have been right if China only exported and did no imports, which is obviously not the case: imports are about 25% of GDP (exports are 35%, leaving net exports at about 10%).

If we were to assume that exports and imports are declining at the same pace of 20%, then the impact of declining net exports on the growth of the total economy would be about -2% a much lower number than the -7% I used in my misguided note. Also, the non-net-export economy (about 90% of the total) would have to grow at about 11% (not 23%) to offset declining net exports and for the total economy to grow 8%. Here I am assuming that exports and imports declined at the same rate. Chinese imports declined at a slower rate than exports in June and were dropping at about the same rate as exports in May.

Chinese non-export economy grew 23% in June! Before you start googling for that number, let me warn you. You won’t find it. I’ve computed it using fifth grade math.

Here is what we know: exports constitute about 35% of the Chinese economy and they dropped over 20% in June, while the Chinese economy (GDP) grew 8%. So the “X” is the growth rate of 65% of Chinese non-export economy.

IMS Health (RX) did not have a spectacular quarter, to put it mildly. Revenue decline (on constant currency basis) accelerated to 4% from a 2% decline last quarter. Pharmaceutical companies are becoming more stingy and thus RX’s business got pinched. However, most of the revenue damage is taking place on the consulting side of the business which accounted for about 20% of total revenues and less than that on a net income basis. Note that consulting is a lower profit margin business, and the revenues in that segment fell 17% for the quarter.

The company lowered earnings guidance for the year by 10 cents, though this is not uncommon in today’s environment, but the management was pounding the table only last month that $1.70 was a set-in-stone number. As of Friday, the set-in-stone number is $1.60 (lower side of the guidance). Wall Street obviously did not like that and took down the stock.

Financial commentators are obsessively debating whether the recent rise in the Chinese stock market means there’s a bubble — and if so, when it’s going to burst. My take? Who cares! What happens to the broader Chinese economy is what we should really be watching. It will have a far-reaching impact on the rest of the world — much more far-reaching than a decline in stocks.

Despite everything, the Chinese economy has shown incredible resilience recently. Although its biggest customers — the United States and Europe — are struggling (to say the least) and its exports are down more than 20 percent, China is still spitting out economic growth numbers as if there weren’t a worry in the world. The most recent estimate put annual growth at nearly 8 percent.

I’ve received a few emails asking my thoughts on Microsoft’s (MSFT) quarter. Here is my take: This is probably the least meaningful quarter in the company’s recent history. MSFT is about to introduce Windows 7 (and a slew of other products.) If I were a corporate customer, I wouldn’t be buying Windows Vista now if I could buy Windows Vista FIXED (or also known as Windows 7) in four months.

There is also news that it is difficult to upgrade from Windows XP to 7, but this difficulty will only impact consumers and very small businesses. Corporations upgrade using a very different procedure. They create a master disk, an image that has all programs installed and preconfigured, and then rollout this image to all computers. So in other words, corporate IT guys don’t go from one workstation to another with a Windows 7 disk and upgrade one computer at a time.

It is interesting to observe the excitement the Street has with Caterpillar’s (CAT) earnings. They were better than the company thought last quarter, but sales were still down 41%. I have to give CAT credit for cutting costs as much as they did. But here is what caught my attention in the quarter: the area that was doing less bad was Asia/Pacific, mainly China. Its sales were down only in the 20% range as opposed to other regions like the US and Europe where sales fell 40-50%.

Here is what management said about China: “Fixed asset investment in May was 38 percent above a year earlier. Our dealers reported significantly higher deliveries of machines in June of this year than a year ago.” So the company is doing less bad than expected because China is doing well. But we know that all of Chinese growth was driven by government consumption and tremendous liquidity growth. China’s largest consumers - the US and Europe - are struggling. Its exports are down 21% in June, while its economy posted almost 8% growth and money supply is up 28.5% in June.