najdorf

Apple's AT&T Deal: Setting the Record Straight

To think that Apple is going to be able to extract the same amount of subsidy without offering exclusivity is insane. Apple made the deal they made with AT&T because it was the only way to get the price low enough to make the iPhone a mass-market product. Even if you're the world's #1 Apple fanboy, you know that the knock on Apple is that their products are overpriced. By handing AT&T a monopoly that will generate years of profits in exchange for up-front subsidies, Apple is able to handle that problem. If anyone can sell the iPhone, you will see a reduction in subsidy and eventual price cuts by Apple to get the phone into a mass-market-acceptable price range. They cut the deal with AT&T because the hotness of the phone and the limited initial production capacity allowed them to do so on favorable terms. If you think the price is going to go up/remain steady, please name one historical consumer electronic good the price of which has increased or remained the same as more people produce and sell it.

GE Is David Hartzell's Highest Conviction Holding - Here's Why

If you're not concerned about CRE you're not paying attention. Of course the big REITs are still okay - they've been able to raise capital at overvalued equity prices and no bank wants to cut off a commercial borrower who's sort of performing (that is, as long as you keep rolling their debt at low rates/easy terms and no more vacancies arise they can service the debt - under forseeable levels of moderately increased stress they can't) when they're nearly swamped with the residential real estate foreclosures.

The unfortunate reality of our current recession is that consumption hasn't yet shrunk enough - people are still spending like they used to in spite of being unemployed or losing chunks of their income (see the big WSJ article about this a couple weeks ago). That means that marginal retailers are still hanging on with only moderately decreased sales. There are plenty of retailers who cannot sustain any increased pressure from their lenders or any further drop in sales - everyone is counting on a big holiday season, which is why you see so much hype about it in media. You will see retail/commercial bankruptcies in the beginning of 2010 - the question is just how severe.

Even currently, as I walk around NYC I see lots of prime vacancies that in the boom times would have been snapped up. Anyone who hasn't been in NYC commercial real estate since the bad old days has no idea how cash-flow negative they can go. Neighborhoods that are beautiful and high-rent today were vacant wastelands before the 80s.

As to GE, if you assume that everything is going to be fine of course it's a great buy at trough valuations. But to pretend it's some kind of sure bet is to decieve yourself based on the name and history of the company. Cheap stocks are cheap for a reason. If you can analyze ALL the factors and feel that you can forsee a better future, they are the best opportunities. But when they're so dependent on the economic cycle and access to the credit markets, you can't guarantee yourself a good return the way you can with a less dependent investment. Even more importantly, with necessarily limited current knowledge there's no way to predict where GE will be a year from now. A smart investor would be willing to hold it for as long as it takes to reach fair value, knowing that in the meantime one is getting the cashflow at a cheap price and has the opportunity to reinvest it at a desirable rate of return.

Electronic Arts Will Lead the Gaming Industry When the Time Comes

Here's the thing about games - I love to play them too, and the games certainly make an impact in the culture and produce some impressive revenues - but where are the returns to shareholders? Why is it that with all the big hits and revenues these companies pay out nothing? On ERTS, the share count has grown over the past 10 years, so the money isn't going into repurchases. ATVI of course hasn't been around as long, but the last few years' earnings don't bode well. Both of these companies have been in business for years and have had recent huge hit games - if they're not yet profitable enough to pay a solid return, when will they reach this stage?

The only company I trust in the video game space is Nintendo. They only sell products that are directly, immediately profitable. They are committed to a dividend policy. I've enjoyed every console and marquee title they've released and they never seem to have the problems that other companies do. While Nintendo is going to go up and down based on console cycles and the vagaries of taste, at least the management is equipped to deliver profits to shareholders rather than just making a bunch of cool, unprofitable games and messing around with M&A to cloak how much the shareholders are getting hosed.

Hedge Funds Aren't All About Alpha - Just Mostly

I'm not sure Mr. G&D knows how to read this article. The point is nothing to do with justifying hedge funds. In fact, the message of the article is that to the extent your hedge funds offer beta, you should replace some of your exposure with cheap index funds.

However, to the extent that you look for alpha - which of course is in the title of the site and is central to Graham and Dodd value investing - hedge funds have done much better than mutual funds. I haven't read the underlying book, but I am surprised that the numbers for hedge funds are that good even with all the lousy hedge funds opened during the boom.

This article and my comment are not defenses of lousy hedge funds. Just because the funds are under-regulated and have higher fees doesn't mean it should offer better returns - the opposite, in fact. But to think that long-only equity mutual funds with 1% fees and dullard, sheep-like managers can achieve better risk-adjusted returns than a quality hedge fund with reasonable fees that actually hedges (puts, CDS, shorting, etc.) is silly. There are idiots trading in our markets...of course smart people are going to profit by selling to them. It's impractical to think that even a very smart individual investor with a million-dollar portfolio is going to replicated a hedge fund portfolio on his own - it's still very hard for an individual to access cheap margin, shorts, and advanced options plays with decent commisions/spreads. Even bonds are hard to get decent pricing on if you're not a professional.

Utilities: Get Dividends Paid in Euros

The U.K. and U.S. have a special relationship on tax that doesn't exist between the U.S. and other European countries. All of the ones that I've looked at will withhold on dividends - Switzerland, Belgium, Netherlands, etc. I believe Germany is included as well.

Japan has a lower rate than the Europeans, around 8% I believe - I don't mind eating this on Nintendo or Toyota in an IRA.

There are two major problems that can arise for U.S. holders who hold international dividend stocks. First, in the IRA the issue is that the IRS doesn't care what happens inside the account - usually a benefit to the taxpayer but here a detriment because you can't take a credit against your U.S. taxes to make up for the foreign taxes. That is, international stocks in an IRA typically become taxable (internationally). As above, the only exception I know of among major nations is the U.K. Second, in a taxable account you may run into mismatches between the U.S. and international dividend tax that hurt returns or add hassles. As long as the U.S. and the foreign country have agreed on a 15% dividend tax rate (e.g. France above), the international stock acts similarly to a U.S. stock once you take the foreign tax credit on your 1040. If the other country automatically withholds at a higher rate, you have to apply to them for a refund which you may or may not be able to get and which may or may not be worth your time. The IRS is not in the business of making you whole on this transaction because they want you to do the legwork.

Alternate Business Models that Drive Retail Brand Value

Also remember that its tempting to juice same-store sales by opening for more hours or adding loss-leaders to the menu - lots of companies compensate based on SSS and lots of analysts look at it, but really we should be looking at whether growing same-store sales are leading to sustainable profit growth. What's the cost of turning the lights on and paying employees for another hour compared to the new sales created? What's the cost in management time spent pushing more hours and more products rather than focusing on profitable core business?

Buffett's Big Rail Buy: What It Means for Berkshire Shareholders

bottoms-up: It's hard to pump a dump a company by buying 100% of its shares with cash and your own shares. You can be sure that Buffett believes BNI is a good buy - whether he's right or not is of course debatable.

Also bear in mind that RRs transport over 40% of goods in the US, are more efficient than trucking/air, and are a primary mode of transportation in developed areas such as Europe, Japan, and the urban East Coast of the U.S. So we're not exactly talking Dr Quinn Medicine Woman stuff here.

Wells Fargo Is Doing Worse than It Seems

ebworthen: Your claim is the kind of idea for which really good data exist - don't use anecdotes. Most large banks are growing their deposit bases through acquisitions and many consumers preferring banks who can offer more services, more locations, clearer government backstop, etc. Read the SEC filings on WFC, BAC, JPM, etc. and you'll see that it's true.

The lesson of the crisis w/r/t deposit banking is that if you rate chase at small banks who have to pay high rates to attract funding, you face a significant risk of either rate cuts when they stabilize or having to deal with the vagaries of the FDIC takeover process. The FDIC or the banks they re-sell to can cut rates and terms, make you do a lot of extra paperwork and mailing, etc. People who want clarity and simplicity are often banking with the TBTF banks.

What Hedge Funds Are Buying and Selling Now

markfl: If you're not reading anything pro-CRE, doesn't that make you worry that bad news is priced in and good news will be rewarded with price gains? From a sentiment point-of-view, I'd always rather short something that people love with comical valuations.

That said, I'm sure that if you know CRE very well you can find some disasters. However, there's typically going to be a floor under the losses because real estate is worth something even under the worst of circumstances - you're going to do better shorting tech companies with no revenue or financials levered 30-1 than any of the CRE companies that have some revenue and less leverage.

Also, remember that America has such a love affair with entrepreneurship and real estate that no matter how bad things get, idiots will appear to hold up prices. People will open marginal businesses or buy up vacant space at 5% off right up until the collapse of our economic system. I could walk down my street and show you ten restaurants that will never be profitable and ten stores that couldn't pay the owner a decent salary even if they turned over their whole inventory every week, but hope springs eternal.

Eskin: Since gold and silver as investments have essentially no fundamentals (no earnings, no fixed rate of exchange for other goods, no risk of short supply relative to actual demand), the pricing of them is arbitrary and entirely sentiment-driven. We could easily decide that gold is worth 5x silver, 10x silver, 100x silver, or 1000x silver. It doesn't matter which one we choose, except that it would obviously affect how miners invest their capital. Trying to guess whether gold or silver is a better "value" is a mug's game.

I would also assess that investing in something which produces no cashflow (metals) is pretty foolish, but I suppose that there are two possible perspectives:

1. You think that the world as we know it will collapse and paper money will end. In that case, you probably want to steer away from anything other than physical gold. You'd also probably derive more benefit from guns, canned food, and a secure, stable place to live, but maybe once you have all these things some gold bars buried in a safe might be better than the alternatives.

2. You think that paper money will continue, but people will continue to place a higher and higher value on gold based on fear/greed. You are a Beanie Baby investor. Good luck with that.

Five North American Natural Gas Buys

It's funny that companies with years and years of reserves in the ground get valued exuberantly when NG is at 13 and pitifully when NG is at 3, almost within a year of one another. NG is a better fuel than oil in terms of pollution, accessibility and now cost. Do you really think NG demand isn't going to be up again next year or the year after? Companies would have to be crazy not to be developing ways to better store and use $3 NG while oil is at $70. It's not like there's going to be a magical point when NG sells at $1 and ECA stock is also at $1 and you can buy it with no risk...everyone else is looking for the cheap entry point too and it won't be there. You're not going to get better deals than March's for a long, long time. Try to look at DCF or PE/10 rather than the next year's earnings.

Specifically on ECA, the one I know, debt is under control and the company is good at hedging. Pretty solid investment here although I'd prefer to add in the 40s.

Dividends vs. Stock Buybacks

The GE example in the article is right on - surely this company, with huge liabilities matching tons of risky assets, could have seen the need for more reserves or debt repayment rather than continuing buybacks at prices where the return couldn't possibly be that great.

IBM and MSFT are different cases because they don't have GE's debt load or risky assets. Their cash flows are about as stable and predictable as they get outside of utilities, their debt is low-rate and manageable, and their reserves are adequate. There's no good reason they shouldn't repurchase shares. IBM has done a great job generating positive returns since 1998 when many tech companies have destroyed shareholder value with poor acquisitions and strategies. They also have seriously increased the dividend in recent years. MSFT has been somewhat less successful, I think because they haven't found the right way to enter new markets and drop unprofitable businesses (example: MSFT continuing to burn money online while IBM exits a weak laptop business to focus on software). But even still, many many stocks have done worse than MSFT, and the share price has been on a decent run of late. You have to remember that good buybacks increase real returns (you hold a larger share of a profitable company) while share prices reflect lots of speculative factors (people would pay ridiculous multiples of earnings in the late 90s - the bursting of the bubble was due to a shift in this perception rather than MSFT or IBM management errors).

Lightway: Please explain how IBM and MSFT could have grown larger than their current size by reinvesting more cash in their business (remembering that both carry large cash balances even as it is). I would argue that MSFT in particular currently is in too many businesses with lower margins than their home and office software - internet search, gaming, etc. I would rather see the company run as a cash-flow generator that investors can direct to their own investments in independent tech smallcaps than see MSFT make a bunch of overpriced acquisitions or internal growth initiatives that get lost in a huge corporate culture.

The Economy Is So Bad, Even Pawn Shops Are Suffering

In all of this talk about oil market manipulation, people tend to forget that futures transactions are real transactions that have two sides. No one can profit off storing oil unless there is a real buyer who wants to pay a higher price for future oil. There are plenty of rational reasons a buyer might want to do so - expected inflation, expected increase in demand, need to hedge exposure to oil prices in order to reduce cost risk, etc. The oil will eventually be bought by a consumer and used at a price driven primarily by supply and demand - the dickering about what it costs along the way mostly affects market participants.

Doug Kass's Killer Shorts - Barron's

About a year later, I'd say Kass's calls look pretty far off the mark. He seems like the kind of guy who's more interested in being contrarian and looking smart than making the maximum amount of money. All of his shorts were atypical calls and few are down more than the SPY (down ~35% since his article) while many have outperformed the SPY significantly.

If one had a short bias as of last May, one could have done much better shorting just about any financial other than BRK/WFC/AXP - look at BAC, C, WM, AIG, FNM, FRE, WB, etc over the year. I know all about hindsight, but if your thesis is that financials are s**t why would you short the strongest and ignore much weaker companies still trading at decent prices? Why not short people who are in the same business as BRK with more leverage and less competence?

Likewise in consumerland: if the consumer is weak, why would you short toothpaste and cereal instead of cars and luxury goods? You could have done much better shorting GM or most clothing retailers. Auto sales can fall a lot faster than cereal sales and GM has been obviously over-levered and unprofitable for years, yet the shares were over 20 a year ago (I was surprised too).

He also totally missed the fact that commodities were in a bubble last spring/summer. Short CHK, FCX, etc.

Overall it seems that Kass overlooked the fact that the best shorts are companies with broken business models, over-exuberant speculative action, or excessive leverage - you want some chance that the stock explodes completely if you're going to take the risk of shorting. While you might make 10-20% shorting companies that will experience moderate but survivable business declines in the worst economic conditions in decades, this is a pretty terrible short list given the shorts that were available last year. It would seriously take you a while to find worse shorts than these - even MCD, WMT, and most utilities are down over 1 year. I didn't make any short calls last year, but I'd like to think that even I would have stumbled across one true disaster in a list of 10 shorts a year ago. None of his picks have even come close to blowing up.

Where Have All the Buybacks Gone?

There's really no reason to conflate the issues of excessive stock option issuance and stock buybacks (football frank, others). Let's imagine what would happen to a company that issued a ton of options, paid big dividends, and didn't buy back any shares. For a while this company would look great to the high-yield crowd. Then they'd hit a point where all the issuance diluted the free cash flow to the point where it was difficult to continue to pay the dividend and continue to invest in the business. Because most people never learn from the past, they'd keep paying the dividend, a few smart investors would head for the exits, and the share price would start to erode. Then the high-yield crowd would back up the truck for the even higher yield. Eventually you hit a crisis where they really can't pay the dividend any more, cut it radically, and watch the share price crash. All without the dreaded buybacks...

You should only hate options if your management is moronic and corrupt, and you shouldn't invest in companies for which you believe the management to be moronic and corrupt. Paying a great manager in long-term, slow-vesting options at the current market price with a holding requirement is just like paying him in cash, except you motivate him or her even more to make the company perform. If your manager isn't worth it, advocate your point of view to your board. If your board is cutting corrupt deals or looking the other way while management cashs out millions in options while running the business into the ground, fire them. If you can't make action happen, sell the stock to a greater fool and look for a decent investment instead.

The problem is not the buybacks; it's the dilution from overcompensation of poor executives. Buybacks are fantastic if the purpose is to increase the amount of FCF available to continuing shareholders, which can support either further profitable business expansion for a more concentrated group or greater dividends. However, in order for the buyback to work the shares of the company have to be cheaper than those of other companies and cheaper than the immediate direct capital investment options.

For instance, imagine a great business that trades for 5x FCF - unless you can find an expansion plan that yields greater than 20% immediate safe returns, why wouldn't you buy back some shares with the available cash? Why would you pay a dividend to shareholders so they have to pay tax and then go through the hassle of finding a new investment or paying a commission on more shares of something they already own?

Now, there may not be many companies that actually fit the criteria for buybacks - many of the best companies are regularly over-priced in the market and would do better with internal expansion or dividends to income-oriented shareholders. But there's no sound reason to philosophically object to buybacks of all kinds.

Must-Know Criteria for Picking Inflation Proof, High Dividend Stocks

The thing about T and VZ is that they have huge moats on an essential service. The cash flows are pretty predictable and they have access to new capital/debt whenever they need it. They could run a little more conservative on debt and payout ratios and totally eliminate financing risk, but they're still building out the wireless infrastructure that's going to generate cash flows for years to come and even in this crisis people are willing to own the debt at low yields and continue to pay the monthly bills. In a worse crisis during which people stop paying their phone bills or won't lend to companies with 70 million near-captive customers, what stock market investment is going to have a safe yield?

I wouldn't expect a lot of dividend growth out of T and VZ until they finish dividing up the country, grinding out weaker competition, and building infrastructure to support good nationwide access. But the current yield is pretty nice and there's not much risk of a cut.