Stock Market Economy
The Stock Exchange, “share market” or a “bourse” is a mutual organization for traders or “stock brokers” who trade in different company securities and stocks. Companies or businesses have to be “listed” in the bourses in order for any trading or exchange in their “shares” or equities to be carried out. Stock markets are also the place for trading in unit trusts and bonds issued by the government.
Like most other markets, the Stock market economy also depends on a number of factors with investor confidence being one of the keys. The amount of money that an investor will put on a share of a particular company depends on his perception of the company doing well in future or has been doing so for the past period. By putting in his money in the share of a company, the person becomes entitled to a share of the profit or loss the company makes. The initial offering of stocks and bonds is carried on at the primary market whereas trading of securities happens at the secondary market. Exchange of stocks, however, is the most important function of the Stock Market.
In the long run, as the shares are owned by the companies themselves, improved profits of the company are reflected in high stock prices also resulting in high stock indices. But the stock market is known as being one of the most volatile markets with ups and downs much difficult to comprehend than highs and lows in corporate profits. Swings in stock markets are known to be driven more by the speculative psychology of investors than actual economic analysis. Stock markets are sometimes said to be characterized by irrational exuberance rather than corporate performance being the real cause. Some analysts also point out that increased earnings on the part of investors will engage them more in speculative activities in the stock market.
Some of the most important stock indices reflecting the swings in the stock prices are:
Dow Jones Industrial Average
Standard and Poor 500 Index
NASDAQ
NYSE (New York Stock Exchange)
The major Indian Stock indices such as the Sensex and the Nifty have also shown huge increases from the early 1990’s and although Dalal Street experienced huge crashes in-between.
While stock market capitalization in India has increased by four times in the decade of 91’-92’ to 2001-02, capital formation in the country had barely increased over that decade. As a result, investment has also not risen commensurately which again suggests that the financial markets dance to a tune of their own. Upward swings in the stock market in early 90’s were mainly caused by a rise in Foreign Institutional Investment which only led to increase in the country’s foreign exchange reserves.
Although Stocks can mobilize savings into investment and can cause the growth of the company and increase its market share, it is not always a barometer of the economy in its true sense. Redistribution of wealth is not always indicated as fallout of a surge in the Stock indices. However, socio-political stability devoid of any recessionary effects can have a positive influence on the Stock Market Economy.
http://www.economywatch.com/market-economy/stock-market-economy.html
Monday, 1 December 2008
Is cash really king?
Buffett makes another prediction, but one that the world’s media did not pick up on. He said that “the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts”.
Buffett’s point is that the only way that the US – and other Anglo Saxon governments for that matter – is going to get itself out of its debt hole, is by inflating its way out.
In a best case scenario, this only entails sharply rising interest rates and substantial dollar depreciation.
In the worst case, a loss of confidence in banking systems and gold, assuming it is not outlawed, perhaps at $10,000 per ounce.
In both cases, holding cash would be a very bad idea.
In an inflationary environment, as Buffett says, it is best to hold stocks. Just make sure they are ones that will survive.
-----
Is cash really king?
By Hugh Young
19 November 2008
Holding cash in an inflationary environment is a very bad idea.
On October 17 Warren Buffett wrote in The New York Times that “equities will almost certainly outperform cash over the next decade, probably to a substantial degree”. Amid all the confusion, such a clear and bold prediction is jolting. Cash is king, right? How can Buffett be so sure that equities will mount a royal coup?
Buffett makes another prediction, but one that the world’s media did not pick up on. He said that “the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts”.
What! Inflation? Wasn’t that yesterday’s story? Oil prices have halved, as have the prices of many other commodities. And anyway, commodity prices never stayed high enough to trigger wage spirals. All they did was cause demand to fall.
Buffett’s point is that the printing presses have been turned on, following years of reckless monetary expansion, and that all the hundreds of billions of extra dollars recently created to prop up the banking system will ultimately feed through to rising prices (remember that inflation is really about money supply. Rising prices are the effect of inflation, not inflation itself).
Taking into account unfunded social security and Medicare obligations, the total US federal debt in 2006 was $49.4 trillion, equivalent to $160,000 for every American. Fast forward two years, during which there was an acceleration of government debt accumulation, and you get close to $300,000 for every working American. If Americans were to set aside, say, 3% of their average annual household income of around $48,000, it would take more than 200 years to pay off the debt.
The conjuring trick here required to create this debt mountain has been to convince people, Americans and foreigners alike, that the dollar, dollar deposits and federal debt are worth something. Spin is provided by implicit government guarantees, and continual reference to the dollar as the world’s de facto reserve currency. As long as there was confidence in the currency, debt (relative to economic activity) could rise forever.
We take for granted that bits of paper (bank notes) and electronic records in computer chips (bank deposits) have “value” to such an extent that it is impossible to imagine it any other way or, worse, the entire system collapsing. Article one, section 10, of the United States Constitution states that “no state shall…coin money; emit bills of credit; make any Thing but gold and silver Coin a Tender in Payment of Debts”.
Why were the founding fathers so against paper money (fiat currency)? Because they were aware that, throughout history, every single state-controlled fiat currency system had ultimately failed. The temptations to create money out of nothing could never be resisted, leading to the corruption of politicians and the elite and unsustainable wealth disparity between rich and poor.
George Washington had noted in 1787 that “paper money has had the effect to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice”. Later, in 1798, Thomas Jefferson wrote that the federal government has no power “of making paper money or anything else a legal tender”, and he advocated a constitutional amendment to enforce this principle by denying the federal government the power to borrow.
In days gone by money or, as it is also known, “IOUs”, developed naturally in the market. The best medium for these IOUs was gold coins as they were difficult to fake (gold is heavy, sufficiently scarce, expensive to extract and impossible to synthesise below its market value). But governments soon took control, often by guaranteeing the quality and purity of the coins. As governments outspent their revenues, they found ways to counterfeit the currency by reducing the amount of gold in the coins, hoping their subjects would not discover the fraud. But the people always did, and they tended to react badly.
What is happening today is no different. For money to be considered legal tender it must have a maker (person that will make the payment), a payee (person that will receive the payment), an amount to be paid, and a due date. Dollar bills used to state that the bearer would be paid on demand. In 1963 these words were removed.
By the same token the creation of bank deposits involves even less work than notes and coins, which at least require machines with moving parts. To create bank deposits, a bank simply needs to find someone to lend to, then punches a number into a computer. Boosh! A bank deposit! Even if the borrower spends the money such that it ends up in another bank, it’s still in the system.
When President Nixon closed the gold window in 1971, refusing, as promised under the Bretton Woods Agreement, to exchange dollars for one thirty fifth of an ounce of gold (there was not enough gold in the coffers), the stage was set for massive and unconstrained monetary expansion. Under Bretton Woods, credit as a percentage of GDP had been maintained at around 150%. From 1980 to 2007, it rose from 162% to 334%. The last 30 years have been one huge, credit-fuelled party. But the booze has now run out and the hangovers are just beginning.
Buffett’s point is that the only way that the US – and other Anglo Saxon governments for that matter – is going to get itself out of its debt hole, is by inflating its way out. In a best case scenario, this only entails sharply rising interest rates and substantial dollar depreciation. In the worst case, a loss of confidence in banking systems and gold, assuming it is not outlawed, perhaps at $10,000 per ounce. In both cases, holding cash would be a very bad idea. In an inflationary environment, as Buffett says, it is best to hold stocks. Just make sure they are ones that will survive.
Hugh Young is the Singapore-based managing director of Aberdeen Asset Management Asia.
© Haymarket Media Limited. All rights reserved.
http://www.asianinvestor.net/article.aspx?CIaNID=89287
Buffett’s point is that the only way that the US – and other Anglo Saxon governments for that matter – is going to get itself out of its debt hole, is by inflating its way out.
In a best case scenario, this only entails sharply rising interest rates and substantial dollar depreciation.
In the worst case, a loss of confidence in banking systems and gold, assuming it is not outlawed, perhaps at $10,000 per ounce.
In both cases, holding cash would be a very bad idea.
In an inflationary environment, as Buffett says, it is best to hold stocks. Just make sure they are ones that will survive.
-----
Is cash really king?
By Hugh Young
19 November 2008
Holding cash in an inflationary environment is a very bad idea.
On October 17 Warren Buffett wrote in The New York Times that “equities will almost certainly outperform cash over the next decade, probably to a substantial degree”. Amid all the confusion, such a clear and bold prediction is jolting. Cash is king, right? How can Buffett be so sure that equities will mount a royal coup?
Buffett makes another prediction, but one that the world’s media did not pick up on. He said that “the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts”.
What! Inflation? Wasn’t that yesterday’s story? Oil prices have halved, as have the prices of many other commodities. And anyway, commodity prices never stayed high enough to trigger wage spirals. All they did was cause demand to fall.
Buffett’s point is that the printing presses have been turned on, following years of reckless monetary expansion, and that all the hundreds of billions of extra dollars recently created to prop up the banking system will ultimately feed through to rising prices (remember that inflation is really about money supply. Rising prices are the effect of inflation, not inflation itself).
Taking into account unfunded social security and Medicare obligations, the total US federal debt in 2006 was $49.4 trillion, equivalent to $160,000 for every American. Fast forward two years, during which there was an acceleration of government debt accumulation, and you get close to $300,000 for every working American. If Americans were to set aside, say, 3% of their average annual household income of around $48,000, it would take more than 200 years to pay off the debt.
The conjuring trick here required to create this debt mountain has been to convince people, Americans and foreigners alike, that the dollar, dollar deposits and federal debt are worth something. Spin is provided by implicit government guarantees, and continual reference to the dollar as the world’s de facto reserve currency. As long as there was confidence in the currency, debt (relative to economic activity) could rise forever.
We take for granted that bits of paper (bank notes) and electronic records in computer chips (bank deposits) have “value” to such an extent that it is impossible to imagine it any other way or, worse, the entire system collapsing. Article one, section 10, of the United States Constitution states that “no state shall…coin money; emit bills of credit; make any Thing but gold and silver Coin a Tender in Payment of Debts”.
Why were the founding fathers so against paper money (fiat currency)? Because they were aware that, throughout history, every single state-controlled fiat currency system had ultimately failed. The temptations to create money out of nothing could never be resisted, leading to the corruption of politicians and the elite and unsustainable wealth disparity between rich and poor.
George Washington had noted in 1787 that “paper money has had the effect to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice”. Later, in 1798, Thomas Jefferson wrote that the federal government has no power “of making paper money or anything else a legal tender”, and he advocated a constitutional amendment to enforce this principle by denying the federal government the power to borrow.
In days gone by money or, as it is also known, “IOUs”, developed naturally in the market. The best medium for these IOUs was gold coins as they were difficult to fake (gold is heavy, sufficiently scarce, expensive to extract and impossible to synthesise below its market value). But governments soon took control, often by guaranteeing the quality and purity of the coins. As governments outspent their revenues, they found ways to counterfeit the currency by reducing the amount of gold in the coins, hoping their subjects would not discover the fraud. But the people always did, and they tended to react badly.
What is happening today is no different. For money to be considered legal tender it must have a maker (person that will make the payment), a payee (person that will receive the payment), an amount to be paid, and a due date. Dollar bills used to state that the bearer would be paid on demand. In 1963 these words were removed.
By the same token the creation of bank deposits involves even less work than notes and coins, which at least require machines with moving parts. To create bank deposits, a bank simply needs to find someone to lend to, then punches a number into a computer. Boosh! A bank deposit! Even if the borrower spends the money such that it ends up in another bank, it’s still in the system.
When President Nixon closed the gold window in 1971, refusing, as promised under the Bretton Woods Agreement, to exchange dollars for one thirty fifth of an ounce of gold (there was not enough gold in the coffers), the stage was set for massive and unconstrained monetary expansion. Under Bretton Woods, credit as a percentage of GDP had been maintained at around 150%. From 1980 to 2007, it rose from 162% to 334%. The last 30 years have been one huge, credit-fuelled party. But the booze has now run out and the hangovers are just beginning.
Buffett’s point is that the only way that the US – and other Anglo Saxon governments for that matter – is going to get itself out of its debt hole, is by inflating its way out. In a best case scenario, this only entails sharply rising interest rates and substantial dollar depreciation. In the worst case, a loss of confidence in banking systems and gold, assuming it is not outlawed, perhaps at $10,000 per ounce. In both cases, holding cash would be a very bad idea. In an inflationary environment, as Buffett says, it is best to hold stocks. Just make sure they are ones that will survive.
Hugh Young is the Singapore-based managing director of Aberdeen Asset Management Asia.
© Haymarket Media Limited. All rights reserved.
http://www.asianinvestor.net/article.aspx?CIaNID=89287
Sunday, 30 November 2008
US Subprime: History of the Credit Crunch and Credit Crisis
US Subprime: History of the Credit Crunch and Credit Crisis
Geneva, 3 nov 2008.
In this multi-part series, we uncover the events that led to the subprime credit crunch, and analyze future financial prospects.
Part 1: INFLATING THE BUBBLE
Part 2: BURSTING THE BUBBLE
Part 3: CONFIDENCE
Part 4: UNWINDING
http://www.economywatch.com/us-subprime/History_of_subprime_credit_crunch_part_4.html
What now?
Well, this is difficult to predict as we are in uncharted territory. It has taken time for the severity of the situation to sink in with most governments. If they have been to slow to react, the IMF has given them a shake up this weekend by saying that we could see a major melt down in the world financial system if governments do not take strong action. As I write, more and more governments are coming out to support their banks.
We can be sure we are not at the end yet. There is more bad debt on the books of the banks that has not been fully written off yet. A change in accounting rules may stave off some of this, but there is still a problem. The equity markets are badly shaken and will undoubtedly be very volatile for some time to come.
The shock of it all has triggered a lack of confidence which takes time to be restored and will affect us all. The removal of the credit mountain will cause an economic slowdown, but the worry that ensues will filter down to the consumer, who will stop spending - even if he has the money to spend - and this will push the slowdown into recession. There is much pessimism around and many comparisons to the great depression of the 1930s. You have to remember when assimilating the news that bad news sells papers and keeps people glued to the news channels, far more than good news. Gloomy predictions sell better than optimistic ones. The news channels know this.
America is likely to bear the worst brunt of this, with UK close behind and then Europe. It is harder to predict the effect on the emerging markets. They will undoubtedly slow down as their export markets dry up, but the larger emerging countries have started to develop a domestic market and a new middle class and they do not carry the bad debt of the western banks. China is sitting on over $500 billion of US Treasury Bills. However, China has already started to feel the impact of a slow down with some 20 million jobs being lost already this year, according to the Sunday Times. This sounds a lot, but you have to remember they have population of over 1.3 billion, - more than 4.3 times that of USA.
Geneva, 3 nov 2008.
In this multi-part series, we uncover the events that led to the subprime credit crunch, and analyze future financial prospects.
Part 1: INFLATING THE BUBBLE
Part 2: BURSTING THE BUBBLE
Part 3: CONFIDENCE
Part 4: UNWINDING
http://www.economywatch.com/us-subprime/History_of_subprime_credit_crunch_part_4.html
What now?
Well, this is difficult to predict as we are in uncharted territory. It has taken time for the severity of the situation to sink in with most governments. If they have been to slow to react, the IMF has given them a shake up this weekend by saying that we could see a major melt down in the world financial system if governments do not take strong action. As I write, more and more governments are coming out to support their banks.
We can be sure we are not at the end yet. There is more bad debt on the books of the banks that has not been fully written off yet. A change in accounting rules may stave off some of this, but there is still a problem. The equity markets are badly shaken and will undoubtedly be very volatile for some time to come.
The shock of it all has triggered a lack of confidence which takes time to be restored and will affect us all. The removal of the credit mountain will cause an economic slowdown, but the worry that ensues will filter down to the consumer, who will stop spending - even if he has the money to spend - and this will push the slowdown into recession. There is much pessimism around and many comparisons to the great depression of the 1930s. You have to remember when assimilating the news that bad news sells papers and keeps people glued to the news channels, far more than good news. Gloomy predictions sell better than optimistic ones. The news channels know this.
America is likely to bear the worst brunt of this, with UK close behind and then Europe. It is harder to predict the effect on the emerging markets. They will undoubtedly slow down as their export markets dry up, but the larger emerging countries have started to develop a domestic market and a new middle class and they do not carry the bad debt of the western banks. China is sitting on over $500 billion of US Treasury Bills. However, China has already started to feel the impact of a slow down with some 20 million jobs being lost already this year, according to the Sunday Times. This sounds a lot, but you have to remember they have population of over 1.3 billion, - more than 4.3 times that of USA.
Recession, but we are nowhere near a depression
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click here to view the post.
The Master: Warren Buffett 9 (9/9)
For more on Buffett
Entire books have been written on Buffett, his personality, humor, lifestyle, experiences and teachings. One can enjoy the rich material available in other books devoted to him as a topic.
Another interesting place to get information from and about Buffett and Berkshire Hathaway is the corporate website, easily accessed at www.berkshirehathaway.com. Buffett's letteres to shareholders are particularly worthwhile and exemplify his deep understanding and sense of humour.
To find out what stocks your favourite guru is holding, buying, or selling, you can visit Web sites that track this sort of thing - but they come and go.
The best bet is to Google "Berkshire Hathaway Stock Holdings" or something similar (for example, George Soros Stock Holdings"). Better yet, keep up with the changes by reviewing the SEC 13F filings - do that search on "Berkshire Hathaway's 13F filings" or "George Soros 13F filings" instead.
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
Entire books have been written on Buffett, his personality, humor, lifestyle, experiences and teachings. One can enjoy the rich material available in other books devoted to him as a topic.
Another interesting place to get information from and about Buffett and Berkshire Hathaway is the corporate website, easily accessed at www.berkshirehathaway.com. Buffett's letteres to shareholders are particularly worthwhile and exemplify his deep understanding and sense of humour.
To find out what stocks your favourite guru is holding, buying, or selling, you can visit Web sites that track this sort of thing - but they come and go.
The best bet is to Google "Berkshire Hathaway Stock Holdings" or something similar (for example, George Soros Stock Holdings"). Better yet, keep up with the changes by reviewing the SEC 13F filings - do that search on "Berkshire Hathaway's 13F filings" or "George Soros 13F filings" instead.
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
The Master: Warren Buffett 8
Smaller Slices
Buffett doesn't always buy the whole company,
Buffett doesn't always buy the whole company,
- for either it is too big, or
- he simply wants to take a position without a complete commitment.
Needless to say, the list of 42 holdings in publicly traded companies as of March 2007 is instructive.
Buffett Public Company Holdings
Company--Business/Sector--Estimated 2007 P/E
Ameriprise Financial--Financial services--14.1
American Standard--Building products--10.6
USG Corporation--Building products--24.7
Norfolk Southern--Railroad--12.8
Comcast Corporation--Cable, communications--32.7
PetroChina ADRs--International energy-- ..
Gannett Corp--Newspapers--10.0
Burlington Northern--Railroad--15.0
Tyco International--Diversified--21.7
Ingersoll-Rand--Industrial--13.9
ConocoPhillips--Energy--8.2
SunTrustBanks--Financial services--13.0
H&R Block--Financial services--14.8
Home Depot--Retail--14.7
UnitedHealthGroup--Healthcare--13.4
American Express--Financial services--16.9
Nike Inc.--Consumer apparel--16.2
Torchmark Corp--Financial services--11.1
Moody's Corp--Financial services--20.8
M&T Bank--Financial services--13.6
Pier 1 Imports--Retail--..
Union Pacific--Railroad--16.8
USBancorp--Financial services--11.2
Lowe's Corp--Retail--13.9
WellPoint Inc--Healthcare--13.7
General Electric--Diversified--17.3
First Data Corp--Info services--24.4
Sanofi-Aventis ADR--Pharmaceuticals--11.3
Comdisco Holdings--Industrial--..
Wal-Mart Stores--Retail--14.5
Western Unin--Technology services--18.1
Anheuser-Busch--Consumer beverages--17.2
Wells-Fargo--Financial services--12.6
Wesco Financial--Financial services--78.8
Johnson & Johnson--Healthcare--15.1
United Parcel Service--Logistics--18.5
Costco Wholesale--Retail--24.8
Washington Post--Newspapers--26.7
Coca-Cola Co.--Consumer beverages--21.1
Procter & Gamble--Diversified consumer--18.9
Iron Mountain--Technology security--40.1
Check this out:
SEC 13F filings contain the disclosures as statements of change of ownership. You can find these 13 Fs yourself simply by doing a search on Berkshire Hathaway 13F and the year you're interested in.
http://www.hoovers.com/free/co/secdoc.xhtml?ID=10206&ipage=6253178
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
The Master: Warren Buffett 7
Berkshire Hathaway Manufacturing, Retail and Services Subsidiaries
Beyond insurance, the manufacturing, retail and service group now consists of some 70 companies large and small, all successful in their own arena.
Subsidiary Name----Subsidiary Business
Acme Brick----Face brick and other building materials
Applied Underwriters ----Worker's compensation solutions
Ben Bridge Jeweler----Retail fine jewelry
Benjamin Moore----Architectural and industrial coatings - paint
Berkshire Hathaway Homestates Companies----Specialty property/casualty insurance
Borsheim Fine Jewelry----Retail fine jewelry
Buffalo News----Newspaper
Business Wire----Business news and information services
Central States Indemnity Company----Consumer credit insurance
Clayton Homes----Modular and manufactured homes
CORT Business Services----Rental furniture
CTB, Inc.----Agricultural equipment
Fechheimber Brothers----Safety equipment
Flight Safety International----Training for aircraft and ship operators
Forest River----Towable RVs and trailers
Fruit of the Loom----Textiles
Garan Incorporated----Children's clothing
Gateway Underwriters----Property and casualty insurance
GEICO----Property and casualty insurance
General Re----Reinsurance
H.H.Browne Shoe Co.----Work shoes, boots, casual footwear
Helzberg's Diamond Shops----Retail fine jewelry
Home Services of America----Residential real estate
International Dairy Queen----Licensing and servicing D.Q. stores
Iscar Metalworking Companies----Machine tools
Johns Manville----Insulation, roofing
Jordan's Furniture----Retail home furnishings
Justin Brands----Western boots, hats
Larson-Juhl----Custom picture frames
McClane Company----Food distribution, logistics
Medical Protective----Healthcare provider insurance
MidAmerica Energy----Production, supply, distribution of energy
MiTek Inc.----Engineered building products and services
National Indemnity Co.----Property/casualty insurance
Nebraska Furniture Mart----Retail home furnishings
NetJets----Fractinal jet ownership
The Pampered Chef----Direct marketer, kitchen products
Precision Steel Products----Steel service center
RC Willey Home Furnishings----Retail home furnishings
Scott Fetzer Companies----Subsidiary group includes Kirby Vacuums, Campbell Hausfeld, World Book
See's Candies----Boxed candies, confectionary
Shaw Industries----Flooring, carpet
Star Furniture Company----Retail home furnishings
TTI, Inc----Transportation equipment components
United States Liability Insurance Group----Specialty insurance products
Wesco Financial----Holding company
XTRA Corporation----Transport equipment leasing
What do all Berkshire Hathaway companies have in common?
Also read:
What do all Berkshire Hathaway companies have in common?
Berkshire Hathaway's Acquisition Criteria: Telling it like it is
Take a look at the following set of "acquisition criteria," straight from the 2006 Berkshire Hathaway Annual report. Straight, clear, to the point - and never before have we seen anything like this - including the commentary - in a shareholder report.
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
Beyond insurance, the manufacturing, retail and service group now consists of some 70 companies large and small, all successful in their own arena.
Subsidiary Name----Subsidiary Business
Acme Brick----Face brick and other building materials
Applied Underwriters ----Worker's compensation solutions
Ben Bridge Jeweler----Retail fine jewelry
Benjamin Moore----Architectural and industrial coatings - paint
Berkshire Hathaway Homestates Companies----Specialty property/casualty insurance
Borsheim Fine Jewelry----Retail fine jewelry
Buffalo News----Newspaper
Business Wire----Business news and information services
Central States Indemnity Company----Consumer credit insurance
Clayton Homes----Modular and manufactured homes
CORT Business Services----Rental furniture
CTB, Inc.----Agricultural equipment
Fechheimber Brothers----Safety equipment
Flight Safety International----Training for aircraft and ship operators
Forest River----Towable RVs and trailers
Fruit of the Loom----Textiles
Garan Incorporated----Children's clothing
Gateway Underwriters----Property and casualty insurance
GEICO----Property and casualty insurance
General Re----Reinsurance
H.H.Browne Shoe Co.----Work shoes, boots, casual footwear
Helzberg's Diamond Shops----Retail fine jewelry
Home Services of America----Residential real estate
International Dairy Queen----Licensing and servicing D.Q. stores
Iscar Metalworking Companies----Machine tools
Johns Manville----Insulation, roofing
Jordan's Furniture----Retail home furnishings
Justin Brands----Western boots, hats
Larson-Juhl----Custom picture frames
McClane Company----Food distribution, logistics
Medical Protective----Healthcare provider insurance
MidAmerica Energy----Production, supply, distribution of energy
MiTek Inc.----Engineered building products and services
National Indemnity Co.----Property/casualty insurance
Nebraska Furniture Mart----Retail home furnishings
NetJets----Fractinal jet ownership
The Pampered Chef----Direct marketer, kitchen products
Precision Steel Products----Steel service center
RC Willey Home Furnishings----Retail home furnishings
Scott Fetzer Companies----Subsidiary group includes Kirby Vacuums, Campbell Hausfeld, World Book
See's Candies----Boxed candies, confectionary
Shaw Industries----Flooring, carpet
Star Furniture Company----Retail home furnishings
TTI, Inc----Transportation equipment components
United States Liability Insurance Group----Specialty insurance products
Wesco Financial----Holding company
XTRA Corporation----Transport equipment leasing
What do all Berkshire Hathaway companies have in common?
- They are profitable, safe and solid.
- They are easy to understand with simple business models.
- They produce plenty of cash flow to reinvest.
- They are unique businesses with strong market positions and franchises.
- They have solid, trustworthy management.
- They were bought at reasonable prices.
Also read:
What do all Berkshire Hathaway companies have in common?
Berkshire Hathaway's Acquisition Criteria: Telling it like it is
Take a look at the following set of "acquisition criteria," straight from the 2006 Berkshire Hathaway Annual report. Straight, clear, to the point - and never before have we seen anything like this - including the commentary - in a shareholder report.
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
The Master: Warren Buffett 6
Shares? Why not the whole company?
Acquiring shares certainly works over time and is what we ordinary value investors should be focused on. But Berkshire went beyond this strategy - way beyond - to buy whole companies for its portfolio.
Why? Two reasons, mainly.
The insurance group has grown substantially and is anchored by consumer favourite GEICO, (originally bought by Ben Graham in the 1950s), and by General Re, in the lucrative reinsurance (wholesale insurance) market. The companies play in different insurance segments, and combine to produce $81 billion in revenue in 2006, with almost $13 billion in pretax income and an amazing $50 billion in "float" - cash taken in but not paid out on claims and used for investments.
Beyond insurance, the manufacturing, retail, and service group now consists of some 70 companies, large and small, all successful in their own arena.
An obvious favourite is Borsheim's, a chain of high-end jewelry stores. Dairy Queen, RC Willey Pampered Chef, and See's Candies are strong consumer names.
Applied Underwriters (worker's comp), NetJets (company jet leasing), FlightSafety International and MiTek, are for the business-to-business world.
Some companies are large and others are small, including the Nebraska Furniture Mart, which Buffett bought one morning as a $60 million birthday present to himself.
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
Acquiring shares certainly works over time and is what we ordinary value investors should be focused on. But Berkshire went beyond this strategy - way beyond - to buy whole companies for its portfolio.
Why? Two reasons, mainly.
- If you own the whole company, you're entitled to its cash and cash flow and can reinvest it as you wish.
- You don't have to compete with other shareholders, and management and reporting relationships are simpler.
The insurance group has grown substantially and is anchored by consumer favourite GEICO, (originally bought by Ben Graham in the 1950s), and by General Re, in the lucrative reinsurance (wholesale insurance) market. The companies play in different insurance segments, and combine to produce $81 billion in revenue in 2006, with almost $13 billion in pretax income and an amazing $50 billion in "float" - cash taken in but not paid out on claims and used for investments.
Beyond insurance, the manufacturing, retail, and service group now consists of some 70 companies, large and small, all successful in their own arena.
An obvious favourite is Borsheim's, a chain of high-end jewelry stores. Dairy Queen, RC Willey Pampered Chef, and See's Candies are strong consumer names.
Applied Underwriters (worker's comp), NetJets (company jet leasing), FlightSafety International and MiTek, are for the business-to-business world.
Some companies are large and others are small, including the Nebraska Furniture Mart, which Buffett bought one morning as a $60 million birthday present to himself.
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
The Master: Warren Buffett 5
Things go better with Coke
Berkshire put together a world-class portfolio of high visibility, blue chip growth stocks, including such household names as Coca-Cola, Gillette, American Express, and Wells Fargo.
Buffett could not resist the low price of Coca-Cola in the mid-1980s as the company seemed to struggle for reinvention with new Coke and other twists and turns in corporate strategy (most of which turned out to be unnecessary). Coca-Cola had the balance sheet and certainly the stability of earnings that one would expect of the world's leading purveyor of sugar water. Buffett saw not only the intrinsic value but also the franchise or marketplace value. Coke is arguably the world's most recognized brand, and that brand was and still is the closest thing to a guarantee against dips and significant competitive inroads. It's what Buffett calls a moat around the business.
Intrinsic value on the balance sheet, solid earnings with at least some growth and growth potential, and solid value in the franchise are what Buffett looked for in all his investments. And always -repeat, always - at a good price. Berkshire Hathaway acquired 200 million shares of Coke in the mid-1980s at around $6 to $6.50 per share (split adjusted). Coke generally sells at over $50 today. The Berkshire before-tax profit is in the $10 billion range.
Wanna know what Berkshire buys?
It isn't easy to find out. Berkshire keeps its puchases a secret (to avoid market overreaction, among other reasons). But as much as it tries to avoid disclosure, investmens of certain size and that constitue a certain proportion of ownership must be disclosed. SEC 13F filings contain the disclosures as statements of change of ownership. You can watch these directly or just watch the news. Any time a 13F surfaces, the financial news media is quick to pounce.
The most recent 13F filing, released in mid-May 2007 for the close of business on March 31, uncovered four new purchases, three of them in railroad companies (Union Pacific, Norfolk Southern, Burlington Northern Santa Fe) and a new position in health provider, Wellpoint. Buffett increased positions in Comcast, Iron Mountain, Wells Fargo, Johnson & Johnson, and Sanofi-Adventis, while reducing holdings in financials Ameriprise and H&R Block, brewer Anheuser-Busch and Western Union.
We know now, but hardly soon enough to have made a market killing from the knowledge. That said, knowing where Buffett has been and where he is going never hurts. By the way, you can find these 13Fs yourself simply by doing a search on Berkshire Hathaway 13F and the year you're interested in.
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
Berkshire put together a world-class portfolio of high visibility, blue chip growth stocks, including such household names as Coca-Cola, Gillette, American Express, and Wells Fargo.
Buffett could not resist the low price of Coca-Cola in the mid-1980s as the company seemed to struggle for reinvention with new Coke and other twists and turns in corporate strategy (most of which turned out to be unnecessary). Coca-Cola had the balance sheet and certainly the stability of earnings that one would expect of the world's leading purveyor of sugar water. Buffett saw not only the intrinsic value but also the franchise or marketplace value. Coke is arguably the world's most recognized brand, and that brand was and still is the closest thing to a guarantee against dips and significant competitive inroads. It's what Buffett calls a moat around the business.
Intrinsic value on the balance sheet, solid earnings with at least some growth and growth potential, and solid value in the franchise are what Buffett looked for in all his investments. And always -repeat, always - at a good price. Berkshire Hathaway acquired 200 million shares of Coke in the mid-1980s at around $6 to $6.50 per share (split adjusted). Coke generally sells at over $50 today. The Berkshire before-tax profit is in the $10 billion range.
Wanna know what Berkshire buys?
It isn't easy to find out. Berkshire keeps its puchases a secret (to avoid market overreaction, among other reasons). But as much as it tries to avoid disclosure, investmens of certain size and that constitue a certain proportion of ownership must be disclosed. SEC 13F filings contain the disclosures as statements of change of ownership. You can watch these directly or just watch the news. Any time a 13F surfaces, the financial news media is quick to pounce.
The most recent 13F filing, released in mid-May 2007 for the close of business on March 31, uncovered four new purchases, three of them in railroad companies (Union Pacific, Norfolk Southern, Burlington Northern Santa Fe) and a new position in health provider, Wellpoint. Buffett increased positions in Comcast, Iron Mountain, Wells Fargo, Johnson & Johnson, and Sanofi-Adventis, while reducing holdings in financials Ameriprise and H&R Block, brewer Anheuser-Busch and Western Union.
We know now, but hardly soon enough to have made a market killing from the knowledge. That said, knowing where Buffett has been and where he is going never hurts. By the way, you can find these 13Fs yourself simply by doing a search on Berkshire Hathaway 13F and the year you're interested in.
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
The Master: Warren Buffett 4
To insurance and beyond
Neither Berkshire nor Buffett made it very far in the textile business. No "Buffett" line of designer towels ever made it to the shelves at Nordstrom's (although they's be worth a lot today, too, if they had!). Instead, Berkshire is now the world's largest investing pool.
The Berkshire's formula is as follows:
From socks to stocks
Gradually, Buffett shifted his emphasis from small, opportunistic, turnaround situations, often of a short-term nature, to longer-term, large cap investments - he even acquired whole companies when the numbers were right. He did this with a clear eye on tapping the growth potential of the major companies and major brands that are abundant in American life. No more buying "cigar butts with one puff left in them," such as trading stamp companies, as he often did in the mid-1950s.
Berkshire Hathaway was off to the races with a winning portfolio of value investments, a world-class pit crew, and high-octane fuel provided by the insurance business.
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
Neither Berkshire nor Buffett made it very far in the textile business. No "Buffett" line of designer towels ever made it to the shelves at Nordstrom's (although they's be worth a lot today, too, if they had!). Instead, Berkshire is now the world's largest investing pool.
The Berkshire's formula is as follows:
- Employ cash flows from businesses owned within the holding company.
- Buy stocks and bonds in the open market.
- Use the cash flow to buy businesses outright - preferably cash rich and cash generating - to build the investment pool and increase book value.
- Acquire solid insurance companies to provide cash flow and further build investing float and to insulate from downturns.
From socks to stocks
Gradually, Buffett shifted his emphasis from small, opportunistic, turnaround situations, often of a short-term nature, to longer-term, large cap investments - he even acquired whole companies when the numbers were right. He did this with a clear eye on tapping the growth potential of the major companies and major brands that are abundant in American life. No more buying "cigar butts with one puff left in them," such as trading stamp companies, as he often did in the mid-1950s.
Berkshire Hathaway was off to the races with a winning portfolio of value investments, a world-class pit crew, and high-octane fuel provided by the insurance business.
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
The Master: Warren Buffett 3
The start of Berkshire Hathaway
Buffett spied a faltering Massachusetts textile company known as Berkshire Hathaway. He saw potential value in a very depressed stock and began buying shares cheaply for his partnership. These shares traded at less than half of working capital (remember Ben Graham's net current asset value model). If the stock price would just grow to reflect the balance sheet value, a 100 percent gain was in store, at the very least. Buffett continued to accumulate shares until the partnership owned 49 percent of the company by 1965. He effectively controlled the company.
Originally, Buffett planned to righ some of the wrongs and capture quick gains by selling or merging the company. But he saw a tempting opportunity to use Berkshire as an investment conduit to build worth by buying other businesses. The opportunity owes its origin to favourable tax treatments for companies owning other companies. The ability to defer taxes is very important in value investing as a way to keep capital deployed and continuously earning returns.
When Buffett distributed the partnership in 1969, he offered a choice of cash or Bershire shares as part of the distribution. For his portion, Buffett took shares. He offered to buy the shares of other partners for himself.
Suppose you had invested with Buffett. Your modest investment in the partnership resulted in getting offered 200 shares of Berkshire Hathaway or $8,400 cash (equivalent to two new cars, or maybe a third of a new house in 1969). What would you have done? We all know the answer NOW: At a current share price of $111,600, your investment would be worth over $22 million! A small group of wealthy folks made the choice to stick with Buffett. Many of them still make the annual pilgrimage to Omaha to enjoy those juicy steaks and count their blessings.
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
Buffett spied a faltering Massachusetts textile company known as Berkshire Hathaway. He saw potential value in a very depressed stock and began buying shares cheaply for his partnership. These shares traded at less than half of working capital (remember Ben Graham's net current asset value model). If the stock price would just grow to reflect the balance sheet value, a 100 percent gain was in store, at the very least. Buffett continued to accumulate shares until the partnership owned 49 percent of the company by 1965. He effectively controlled the company.
Originally, Buffett planned to righ some of the wrongs and capture quick gains by selling or merging the company. But he saw a tempting opportunity to use Berkshire as an investment conduit to build worth by buying other businesses. The opportunity owes its origin to favourable tax treatments for companies owning other companies. The ability to defer taxes is very important in value investing as a way to keep capital deployed and continuously earning returns.
When Buffett distributed the partnership in 1969, he offered a choice of cash or Bershire shares as part of the distribution. For his portion, Buffett took shares. He offered to buy the shares of other partners for himself.
Suppose you had invested with Buffett. Your modest investment in the partnership resulted in getting offered 200 shares of Berkshire Hathaway or $8,400 cash (equivalent to two new cars, or maybe a third of a new house in 1969). What would you have done? We all know the answer NOW: At a current share price of $111,600, your investment would be worth over $22 million! A small group of wealthy folks made the choice to stick with Buffett. Many of them still make the annual pilgrimage to Omaha to enjoy those juicy steaks and count their blessings.
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
The Master: Warren Buffett 2
Taking charge
Like most investors, Buffett evolved his investing style, trying different things along the way.
Often, Buffett would simply buy shares, hold them, and wait for growth prospects to materialize.
Sometimes his objective was a little more short term in nature, buying to capture arbitrage - small differences between price and value that often emerge in merger, acquisition, and liquidation situations. (Capturing arbitrage is value investing, too; it's very short term in nature and you had better be good. You're going up against other professionals who have access to a lot of information and are betting for something different to happen.)
Sometimes, Buffett would buy a large stake in an undervalued company, large enough to be noticed and reported to the SEC, usually 5 percent or more. He then would get himself installed on the company's board of directors. Many of these companies were having financial problems or problems translating company value into shareholder value. Many welcomed his presence. Buffett would help right these problems and, if necessary, assist in selling or finding a merger partner for the company. Of course, most ordinary investors can't do this, bu the thought process is important.
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
Like most investors, Buffett evolved his investing style, trying different things along the way.
Often, Buffett would simply buy shares, hold them, and wait for growth prospects to materialize.
Sometimes his objective was a little more short term in nature, buying to capture arbitrage - small differences between price and value that often emerge in merger, acquisition, and liquidation situations. (Capturing arbitrage is value investing, too; it's very short term in nature and you had better be good. You're going up against other professionals who have access to a lot of information and are betting for something different to happen.)
Sometimes, Buffett would buy a large stake in an undervalued company, large enough to be noticed and reported to the SEC, usually 5 percent or more. He then would get himself installed on the company's board of directors. Many of these companies were having financial problems or problems translating company value into shareholder value. Many welcomed his presence. Buffett would help right these problems and, if necessary, assist in selling or finding a merger partner for the company. Of course, most ordinary investors can't do this, bu the thought process is important.
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
The Master: Warren Buffett 1
Warren Buffett was born on September 30, 1930. He has turned his steady devotion to value investing principles into some $52 billion in net worth. He is the second wealthiest person in the world (depending on the price of Microsoft stock). His on-court record cannot be touched. His off-court demeanor, where his candor, clairvoyance and wit combine with his own enviably humble lifestyle, creates a model for investors to emulate.
In the beginning
The early stages of Buffett's career and lifestyle suggested investing success, although hardly on the scale he actually went on to achieve. Warren grew up in an investing environment. His father, Howard, ran an Omaha brokerage house in the 1930s that was known as Buffett, Sklenicka, & Co. In his late teens, Warren worked in the house posting stock quotes and doing odd jobs providing exposure to the trade. He learned about business through this experience and through a series of small business ventures in his high school days.
Like many other financial prodigies, Warren's aptitude did not go unnoticed by his parents, who urged him to atteend the revered Wharton School at the University of Pennsylvania. This didn't work out well. Warren soon became bored and dissatisfied, feeling that he knew as much or more than Penn's vaunted faculty. Perhaps he was homesick; perhaps he had a more practical view of matters than the pages and pages of portfolio theory he has no doubt exposed to. in any case, he retreated to more familiar territory at age 19 to finish his degree at the University of Nebraska.
Benjamin Graham's Intelligent Investor hit the shelves, and legent has it that Warren, with a newly rekindled interest in investing and the business world, decided to put the finishing touches on his business education by attending Harvard Business School. Again, a poor match. Warren was rejected, as the story goes, after a 10-minute interview. Perhaps the admissions department had already reached its quota of Nebraskans.
Warren bounced back quickly from this setback and applied to Columbia Business School. Then and there, Buffett hooked up with Benjamin Graham. The rest, as they say, is history.
Warren took to Graham's preachings. The two bantered in engaging dialogue from the opening bell to the end of class. Warren graduated in a year with a Master's in Economics. More important, he left with a philosophy of investing based on valuing companies and finding undervaluation in the market-place.
Buffett returned to work in his father's brokerage firm and later went to work for Ben at Graham's brokerage firm, Graham Newman. There, he learned to manage investment portfolios and use insurance assets as an effective investing vehicle.
From these beginnings Buffett started his own investment fund (with contributed capital from neighbours, relatives, coworkers, and the like) and later built the Taj Mahal of investment companies, Berkshire Hathaway.
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
In the beginning
The early stages of Buffett's career and lifestyle suggested investing success, although hardly on the scale he actually went on to achieve. Warren grew up in an investing environment. His father, Howard, ran an Omaha brokerage house in the 1930s that was known as Buffett, Sklenicka, & Co. In his late teens, Warren worked in the house posting stock quotes and doing odd jobs providing exposure to the trade. He learned about business through this experience and through a series of small business ventures in his high school days.
Like many other financial prodigies, Warren's aptitude did not go unnoticed by his parents, who urged him to atteend the revered Wharton School at the University of Pennsylvania. This didn't work out well. Warren soon became bored and dissatisfied, feeling that he knew as much or more than Penn's vaunted faculty. Perhaps he was homesick; perhaps he had a more practical view of matters than the pages and pages of portfolio theory he has no doubt exposed to. in any case, he retreated to more familiar territory at age 19 to finish his degree at the University of Nebraska.
Benjamin Graham's Intelligent Investor hit the shelves, and legent has it that Warren, with a newly rekindled interest in investing and the business world, decided to put the finishing touches on his business education by attending Harvard Business School. Again, a poor match. Warren was rejected, as the story goes, after a 10-minute interview. Perhaps the admissions department had already reached its quota of Nebraskans.
Warren bounced back quickly from this setback and applied to Columbia Business School. Then and there, Buffett hooked up with Benjamin Graham. The rest, as they say, is history.
Warren took to Graham's preachings. The two bantered in engaging dialogue from the opening bell to the end of class. Warren graduated in a year with a Master's in Economics. More important, he left with a philosophy of investing based on valuing companies and finding undervaluation in the market-place.
Buffett returned to work in his father's brokerage firm and later went to work for Ben at Graham's brokerage firm, Graham Newman. There, he learned to manage investment portfolios and use insurance assets as an effective investing vehicle.
From these beginnings Buffett started his own investment fund (with contributed capital from neighbours, relatives, coworkers, and the like) and later built the Taj Mahal of investment companies, Berkshire Hathaway.
Also visit:
The Master: Warren Buffett 9 (9/9)
The Master: Warren Buffett 8
The Master: Warren Buffett 7
The Master: Warren Buffett 6
The Master: Warren Buffett 5
The Master: Warren Buffett 4
The Master: Warren Buffett 3
The Master: Warren Buffett 2
The Master: Warren Buffett 1
Saturday, 29 November 2008
Stock Market Investment
Stock Market Investment
Stock Market Investment refers to the investment in the market; where exchange of company stocks or collective shares of the companies and other kinds of securities and derivatives takes place. Stocks are traded in Stock Market by the help of Stock Exchange.
The Stock Exchange brings the sellers and buyers of stocks and securities under same roof. The available stocks are listed and traded in the Stock Exchange among the buyers and the sellers. Proper investment in Stock Market essentially requires detailed knowledge of Stock Market, its’ participants, knowledge about the functioning, behavior and contribution of the stock market.
Main Participants of the Stock market
The main participants of Stock Market are the individual investors, banks, insurance companies, mutual funds and pension funds. Since, markets of today have turned more “institutionalized”, the largest share of the market participation comes from the large institutions rather than individual rich investors.
Functioning of the Stock Market
The stock market functions through the Stock Exchanges. Stock Exchanges can be a physical entity and sometimes a virtual entity. In physical stock exchanges, transactions are made by auctioning. In this case, a buyer offers a specific price for a stock by verbal bid and the seller asks a specific price for the stock. When the buyer’s bid price and seller’s price match, exchange of stock takes place. In the presence of multiple buyers and sellers market operations are carried on a first come first served basis.
Contribution of Stock Market
Stock Market is the best medium of raising funds. Businesses which need financing for expansion or improvement can easily raise required capital by participating in Stock Market. On the other hand, for the investors; investing in stocks is a better option than investing in property or real estate as the stocks contain more liquidity than any other property. This means, stocks can be sold more easily and quickly than any other property and so, the investors can get their money back by selling the stocks anytime they need.
The prices of stocks or shares in the Stock
Market have strong effects on the economy in various ways. Prices of stock influence business investment, individual household consumption and wealth of individual households. For this deepening effect, Central banks of each country keep a track of the Stock Market activities. A proper functioning of Stock Market in a country can result in low costs, increased production of goods and services and increased level of employment. In this way, an efficient Stock Market can contribute to economic growth of the country.
Behavior of the Stock Market
The behavior of Stock Market and the prices of stocks depend greatly on the speculation of the investors. So, over- reactions and wrong speculation can give rise to irrational behavior of the Stock Market. Excessive optimistic speculation of future prospects can raise the prices of stocks to an extreme high and excessive pessimism on the part of the investors can result in extremely low prices. Stock Market behavior is also affected by the psychology of “Group Thinking”. The thinking of a majority group of people many times influences others to think in the same line and the Stock Market behavior gets naturally affected.
Sometimes the Stock Market behavior is affected by rumors and mass panic. The prices of the stocks fluctuate tremendously by the economic use even if it has nothing to do with values of stocks and securities.
So, it is extremely difficult to make predictions about the Stock Market and the inexperienced investors who are not that much interested in financial analysis of stocks; rarely get the financial assistance from the Stock Market at the time of need.
Stock Market Investment refers to the investment in the market; where exchange of company stocks or collective shares of the companies and other kinds of securities and derivatives takes place. Stocks are traded in Stock Market by the help of Stock Exchange.
The Stock Exchange brings the sellers and buyers of stocks and securities under same roof. The available stocks are listed and traded in the Stock Exchange among the buyers and the sellers. Proper investment in Stock Market essentially requires detailed knowledge of Stock Market, its’ participants, knowledge about the functioning, behavior and contribution of the stock market.
Main Participants of the Stock market
The main participants of Stock Market are the individual investors, banks, insurance companies, mutual funds and pension funds. Since, markets of today have turned more “institutionalized”, the largest share of the market participation comes from the large institutions rather than individual rich investors.
Functioning of the Stock Market
The stock market functions through the Stock Exchanges. Stock Exchanges can be a physical entity and sometimes a virtual entity. In physical stock exchanges, transactions are made by auctioning. In this case, a buyer offers a specific price for a stock by verbal bid and the seller asks a specific price for the stock. When the buyer’s bid price and seller’s price match, exchange of stock takes place. In the presence of multiple buyers and sellers market operations are carried on a first come first served basis.
Contribution of Stock Market
Stock Market is the best medium of raising funds. Businesses which need financing for expansion or improvement can easily raise required capital by participating in Stock Market. On the other hand, for the investors; investing in stocks is a better option than investing in property or real estate as the stocks contain more liquidity than any other property. This means, stocks can be sold more easily and quickly than any other property and so, the investors can get their money back by selling the stocks anytime they need.
The prices of stocks or shares in the Stock
Market have strong effects on the economy in various ways. Prices of stock influence business investment, individual household consumption and wealth of individual households. For this deepening effect, Central banks of each country keep a track of the Stock Market activities. A proper functioning of Stock Market in a country can result in low costs, increased production of goods and services and increased level of employment. In this way, an efficient Stock Market can contribute to economic growth of the country.
Behavior of the Stock Market
The behavior of Stock Market and the prices of stocks depend greatly on the speculation of the investors. So, over- reactions and wrong speculation can give rise to irrational behavior of the Stock Market. Excessive optimistic speculation of future prospects can raise the prices of stocks to an extreme high and excessive pessimism on the part of the investors can result in extremely low prices. Stock Market behavior is also affected by the psychology of “Group Thinking”. The thinking of a majority group of people many times influences others to think in the same line and the Stock Market behavior gets naturally affected.
Sometimes the Stock Market behavior is affected by rumors and mass panic. The prices of the stocks fluctuate tremendously by the economic use even if it has nothing to do with values of stocks and securities.
So, it is extremely difficult to make predictions about the Stock Market and the inexperienced investors who are not that much interested in financial analysis of stocks; rarely get the financial assistance from the Stock Market at the time of need.
Source:
http://www.economywatch.com/stock-markets-in-world/stock-market-investment.html
Behavioural Finance
Behavioral Finance
By Albert Phung
Whether it's mental accounting, irrelevant anchoring or just following the herd, chances are we've all been guilty of at least some of the biases and irrational behavior highlighted in this tutorial. Now that you can identify some of the biases, it's time to apply that knowledge to your own investing and if need be take corrective action. Hopefully, your future financial decisions will be a bit more rational and lot more lucrative as well.
Here is a summary:
Table of Contents
1) Behavioral Finance: Introduction
2) Behavioral Finance: Background
3) Behavioral Finance: Anomalies
4) Behavioral Finance: Key Concepts - Anchoring
5) Behavioral Finance: Key Concepts - Mental Accounting
6) Behavioral Finance: Key Concepts - Confirmation and Hindsight Bias
7) Behavioral Finance: Key Concepts - Gambler's Fallacy
8) Behavioral Finance: Key Concepts - Herd Behavior
9) Behavioral Finance: Key Concepts - Overconfidence
10) Behavioral Finance: Key Concepts - Overreaction and Availability Bias
11) Behavioral Finance: Key Concepts - Prospect Theory
12) Behavioral Finance: Conclusion
By Albert Phung
Whether it's mental accounting, irrelevant anchoring or just following the herd, chances are we've all been guilty of at least some of the biases and irrational behavior highlighted in this tutorial. Now that you can identify some of the biases, it's time to apply that knowledge to your own investing and if need be take corrective action. Hopefully, your future financial decisions will be a bit more rational and lot more lucrative as well.
Here is a summary:
- Conventional finance is based on the theories which describe people for the most part behave logically and rationally. People started to question this point of view as there have been anomalies, which are events that conventional finance has a difficult time in explaining.
- Three of the biggest contributors to the field are psychologists, Drs. Daniel Kahneman and Amos Tversky, and economist, Richard Thaler.
- The concept of anchoring draws upon the tendency for us to attach or "anchor" our thoughts around a reference point despite the fact that it may not have any logical relevance to the decision at hand.
- Mental accounting refers to the tendency for people to divide their money into separate accounts based on criteria like the source and intent for the money. Furthermore, the importance of the funds in each account also varies depending upon the money's source and intent.
- Seeing is not necessarily believing as we also have confirmation and hindsight biases. Confirmation bias refers to how people tend to more attentive towards new information that confirms their own preconceived options about a subject. The hindsight bias represents how people believe that after the fact, the occurrence of an event was completely obvious.
- The gambler's fallacy refers to an incorrect interpretation of statistics where someone believes that the occurrence of a random independent event would somehow cause another random independent event less likely to happen.
- Herd behavior represents the preference for individuals to mimic the behaviors or actions of a larger sized group.
- Overconfidence represents the tendency for an investor to overestimate his or her ability in performing some action/task.
- Overreaction occurs when one reacts to a piece of news in a way that is greater than actual impact of the news.
- Prospect theory refers to an idea created by Drs. Kahneman and Tversky that essentially determined that people do not encode equal levels of joy and pain to the same effect. The average individuals tend to be more loss sensitive (in the sense that a he/she will feel more pain in receiving a loss compared to the amount of joy felt from receiving an equal amount of gain).
Table of Contents
1) Behavioral Finance: Introduction
2) Behavioral Finance: Background
3) Behavioral Finance: Anomalies
4) Behavioral Finance: Key Concepts - Anchoring
5) Behavioral Finance: Key Concepts - Mental Accounting
6) Behavioral Finance: Key Concepts - Confirmation and Hindsight Bias
7) Behavioral Finance: Key Concepts - Gambler's Fallacy
8) Behavioral Finance: Key Concepts - Herd Behavior
9) Behavioral Finance: Key Concepts - Overconfidence
10) Behavioral Finance: Key Concepts - Overreaction and Availability Bias
11) Behavioral Finance: Key Concepts - Prospect Theory
12) Behavioral Finance: Conclusion
Technical Forces That Move Stock Prices
Technical Factors
Things would be easier if only fundamental factors set stock prices! Technical factors are the mix of external conditions that alter the supply of and demand for a company's stock. Some of these indirectly affect fundamentals. (For example, economic growth indirectly contributes to earnings growth.)
Technical factors include the following:
Inflation - We mentioned inflation as an input into the valuation multiple, but inflation is a huge driver from a technical perspective as well. Historically, low inflation has had a strong inverse correlation with valuations (low inflation drives high multiples and high inflation drives low multiples). Deflation, on the other hand, is generally bad for stocks because it signifies a loss in pricing power for companies. (To learn more, read All About Inflation.)
Economic Strength of Market and Peers - Company stocks tend to track with the market and with their sector or industry peers. Some prominent investment firms argue that the combination of overall market and sector movements - as opposed to a company's individual performance - determines a majority of a stock's movement. (There has been research cited that suggests the economic/market factors account for 90%!) For example, a suddenly negative outlook for one retail stock often hurts other retail stocks as "guilt by association" drags down demand for the whole sector.
Substitutes - Companies compete for investment dollars with other asset classes on a global stage. These include corporate bonds, government bonds, commodities, real estate and foreign equities. The relation between demand for U.S. equities and their substitutes is hard to figure, but it plays an important role.
Incidental Transactions - Incidental transactions are purchases or sales of a stock that are motivated by something other than belief in the intrinsic value of the stock. These transactions include executive insider transactions, which are often prescheduled or driven by portfolio objectives. Another example is an institution buying or shorting a stock to hedge some other investment. Although these transactions may not represent official "votes cast" for or against the stock, they do impact supply and demand and therefore can move the price.
Demographics - Some important research has been done about the demographics of investors. Much of it concerns these two dynamics: 1) middle-aged investors, who are peak earners that tend to invest in the stock market, and 2) older investors who tend to pull out of the market in order to meet the demands of retirement. The hypothesis is that the greater the proportion of middle-aged investors among the investing population, the greater the demand for equities and the higher the valuation multiples. (For more on this, see Demographic Trends And The Implications For Investment.)
Trends - Often a stock simply moves according to a short-term trend. On the one hand, a stock that is moving up can gather momentum, as "success breeds success" and popularity buoys the stock higher. On the other hand, a stock sometimes behaves the opposite way in a trend and does what is called reverting to the mean. Unfortunately, because trends cut both ways and are more obvious in hindsight, knowing that stocks are "trendy" does not help us predict the future. (Note: trends could also be classified under market sentiment.) (For more insight, check out Short-, Intermediate- and Long-Term Trends.)
Liquidity - Liquidity is an important and sometimes under-appreciated factor. It refers to how much investor interest and attention a specific stock has. Wal-Mart's stock is highly liquid and therefore highly responsive to material news; the average small-cap company is less so. Trading volume is not only a proxy for liquidity, but it is also a function of corporate communications (that is, the degree to which the company is getting attention from the investor community). Large-cap stocks have high liquidity: they are well followed and heavily transacted. Many small-cap stocks suffer from an almost permanent "liquidity discount" because they simply are not on investors' radar screens. (To learn more, read Diving In To Financial Liquidity.)
http://www.investopedia.com/articles/basics/04/100804.asp?viewall=1
Things would be easier if only fundamental factors set stock prices! Technical factors are the mix of external conditions that alter the supply of and demand for a company's stock. Some of these indirectly affect fundamentals. (For example, economic growth indirectly contributes to earnings growth.)
Technical factors include the following:
Inflation - We mentioned inflation as an input into the valuation multiple, but inflation is a huge driver from a technical perspective as well. Historically, low inflation has had a strong inverse correlation with valuations (low inflation drives high multiples and high inflation drives low multiples). Deflation, on the other hand, is generally bad for stocks because it signifies a loss in pricing power for companies. (To learn more, read All About Inflation.)
Economic Strength of Market and Peers - Company stocks tend to track with the market and with their sector or industry peers. Some prominent investment firms argue that the combination of overall market and sector movements - as opposed to a company's individual performance - determines a majority of a stock's movement. (There has been research cited that suggests the economic/market factors account for 90%!) For example, a suddenly negative outlook for one retail stock often hurts other retail stocks as "guilt by association" drags down demand for the whole sector.
Substitutes - Companies compete for investment dollars with other asset classes on a global stage. These include corporate bonds, government bonds, commodities, real estate and foreign equities. The relation between demand for U.S. equities and their substitutes is hard to figure, but it plays an important role.
Incidental Transactions - Incidental transactions are purchases or sales of a stock that are motivated by something other than belief in the intrinsic value of the stock. These transactions include executive insider transactions, which are often prescheduled or driven by portfolio objectives. Another example is an institution buying or shorting a stock to hedge some other investment. Although these transactions may not represent official "votes cast" for or against the stock, they do impact supply and demand and therefore can move the price.
Demographics - Some important research has been done about the demographics of investors. Much of it concerns these two dynamics: 1) middle-aged investors, who are peak earners that tend to invest in the stock market, and 2) older investors who tend to pull out of the market in order to meet the demands of retirement. The hypothesis is that the greater the proportion of middle-aged investors among the investing population, the greater the demand for equities and the higher the valuation multiples. (For more on this, see Demographic Trends And The Implications For Investment.)
Trends - Often a stock simply moves according to a short-term trend. On the one hand, a stock that is moving up can gather momentum, as "success breeds success" and popularity buoys the stock higher. On the other hand, a stock sometimes behaves the opposite way in a trend and does what is called reverting to the mean. Unfortunately, because trends cut both ways and are more obvious in hindsight, knowing that stocks are "trendy" does not help us predict the future. (Note: trends could also be classified under market sentiment.) (For more insight, check out Short-, Intermediate- and Long-Term Trends.)
Liquidity - Liquidity is an important and sometimes under-appreciated factor. It refers to how much investor interest and attention a specific stock has. Wal-Mart's stock is highly liquid and therefore highly responsive to material news; the average small-cap company is less so. Trading volume is not only a proxy for liquidity, but it is also a function of corporate communications (that is, the degree to which the company is getting attention from the investor community). Large-cap stocks have high liquidity: they are well followed and heavily transacted. Many small-cap stocks suffer from an almost permanent "liquidity discount" because they simply are not on investors' radar screens. (To learn more, read Diving In To Financial Liquidity.)
http://www.investopedia.com/articles/basics/04/100804.asp?viewall=1
Impairment Charges: The Good, The Bad and The Ugly
Impairment Charges: The Good, The Bad and The Ugly
by Rick Wayman
"Impairment charge" is the new term for writing off worthless goodwill. These charges started making headlines in 2002 as companies adopted new accounting rules and disclosed huge goodwill write-offs (for example, AOL - $54 billion, SBC - $1.8 billion, and McDonald's - $99 million). While impairment charges have since then gone relatively unnoticed, they will get more attention as the weak economy and faltering stock market force more goodwill charge-offs and increase concerns about corporate balance sheets. This article will define the impairment charge and look at its good, bad and ugly effects.
Impairment Defined
As with most generally accepted accounting principles, the definition of "impairment" is in the eye of the beholder. The regulations are complex, but the fundamentals are relatively easy to understand. Under the new rules, all goodwill is to be assigned to the company's reporting units that are expected to benefit from that goodwill. Then the goodwill must be tested (at least annually) to determine if the recorded value of the goodwill is greater than the fair value. If the fair value is less than the carrying value, the goodwill is deemed "impaired" and must be charged off. This charge reduces the value of goodwill to the fair market value and represents a "mark-to-market" charge.
The Good
If done correctly, this will provide investors with more valuable information. Balance sheets are bloated with goodwill that resulted from acquisitions during the bubble years, when companies overpaid for assets by using overpriced stock. Over-inflated financial statements distort not only the analysis of a company but also what investors should pay for that stock. The new rules force companies to revalue these bad investments, much like what the stock market has done to individual stocks.
The impairment charge also provides investors with a way to evaluate corporate management and its decision-making track record. Companies that have to write off billions of dollars due to impairment have not made good investment decisions. Managements that bite the bullet and take an honest all-encompassing charge should be viewed more favorably than those who slowly bleed a company to death by deciding to take a series of recurring impairment charges, thereby manipulating reality.
The Bad
The accounting rules (FAS 141 and FAS 142) allow companies a great deal of discretion in allocating goodwill and determining its value. Determining fair value has always been as much an art as a science and different experts can arrive honestly at different valuations. In addition, it is possible for the allocation process to be manipulated for the purpose of avoiding flunking the impairment test. As managements attempt to avoid these charge-offs, more accounting shenanigans will undoubtedly result.
It's doubtful that very many corporate managements will face reality and take their medicine. Compensation packages will incite managers to delay the inevitable as they hope for a stock market rebound that will boost fair value.
A delay, however, could backfire and adversely impact EPS in 2003. According to the rules, impairment charges that occur within the first year of adopting the new accounting rules (calendar 2002 for most corporations) are accounted for as a charge to equity. After the first year, impairment charges hit the income statement. Consequently, postponing may help results in 2002 but could reduce EPS in 2003.
The other bad thing is that investors will have a hard time evaluating how management is handling this issue. The process of allocating goodwill to business units and the valuation process will be hidden from investors, which will provide ample opportunity for manipulation. Companies are also not required to disclose what is determined to be the fair value of goodwill, even though this information would help investors make a more informed investment decision.
The Ugly
Things could get ugly if increased impairment charges reduce equity to levels that trigger technical loan defaults. Most lenders require companies who have borrowed money to promise to maintain certain operating ratios. If a company does not meet these obligations (also called loan covenants), it can be deemed in default of the loan agreement. This could have a detrimental effect on the company's ability to refinance its debt, especially if it has a large amount of debt and in need of more financing.
An Example
Assume that NetcoDOA (a pretend company) has equity of $3.45 billion, intangibles of $3.17 billion and total debt of $3.96 billion. This means that NetcoDOA's tangible net worth is $28 million ($3.45 billion of equity less debt of $3.17 billion).
Let's also assume that NetcoDOA took out a bank loan in late 2000 that will mature in 2005. The loan requires that NetcoDOA maintain a capitalization ratio no greater than 70%. A typical capitalization ratio is defined as debt represented as a percent of capital (debt plus equity). This means that NetcoDOA's capitalization ratio is 53.4%: debt of $3.96 billion divided by capital of $7.41 billion (equity of $3.45 billion plus debt of $3.96 billion).
Now assume that NetcoDOA is faced with an impairment charge that will wipe out half of its goodwill ($1.725 billion), which will also reduce equity by the same amount. This will cause the capitalization ratio to rise to 70%, which is the limit established by the bank. Also assume that, in the most recent quarter, the company posted an operating loss that further reduced equity and caused the capitalization ratio to exceed the maximum 70%.
In this situation, NetcoDOA is in technical default of its loan. The bank has the right to either demand it be repaid immediately (by declaring that NetcoDOA is in default) or, more likely, require NetcoDOA to renegotiate the loan. The bank holds all the cards and can require a higher interest rate or ask NetcoDOA to find another lender. In the current economic climate, this is not an easy thing to do.
(Note: The numbers used above are based upon real data. They represent the average values for the 61 stocks in Baseline's integrated telco industry list.)
Conclusion
New accounting regulations that require companies to mark their goodwill to market will be a painful way to resolve the misallocation of assets that occurred during the dotcom bubble (1995-2000). In several ways, it will help investors by providing more relevant financial information, but it also gives companies a way to manipulate reality and postpone the inevitable. If the economy and stock markets remain weak, many companies could face loan defaults.
Individuals need to be aware of these risks and factor them into their investing decision-making process. There are no easy ways to evaluate impairment risk, but there are a few generalizations that should serve as red flags indicating which companies are at risk:
1. Company made large acquisitions in the late 1990s (notably the telco and AOL).
2. Company has high (greater than 70%) leverage ratios and negative operating cash flows.
3. Company's stock price has declined significantly since 2000.
Unfortunately, the above can be said about most companies.
by Rick Wayman, (Contact Author Biography)
http://www.investopedia.com/articles/analyst/110502.asp?viewed=1
by Rick Wayman
"Impairment charge" is the new term for writing off worthless goodwill. These charges started making headlines in 2002 as companies adopted new accounting rules and disclosed huge goodwill write-offs (for example, AOL - $54 billion, SBC - $1.8 billion, and McDonald's - $99 million). While impairment charges have since then gone relatively unnoticed, they will get more attention as the weak economy and faltering stock market force more goodwill charge-offs and increase concerns about corporate balance sheets. This article will define the impairment charge and look at its good, bad and ugly effects.
Impairment Defined
As with most generally accepted accounting principles, the definition of "impairment" is in the eye of the beholder. The regulations are complex, but the fundamentals are relatively easy to understand. Under the new rules, all goodwill is to be assigned to the company's reporting units that are expected to benefit from that goodwill. Then the goodwill must be tested (at least annually) to determine if the recorded value of the goodwill is greater than the fair value. If the fair value is less than the carrying value, the goodwill is deemed "impaired" and must be charged off. This charge reduces the value of goodwill to the fair market value and represents a "mark-to-market" charge.
The Good
If done correctly, this will provide investors with more valuable information. Balance sheets are bloated with goodwill that resulted from acquisitions during the bubble years, when companies overpaid for assets by using overpriced stock. Over-inflated financial statements distort not only the analysis of a company but also what investors should pay for that stock. The new rules force companies to revalue these bad investments, much like what the stock market has done to individual stocks.
The impairment charge also provides investors with a way to evaluate corporate management and its decision-making track record. Companies that have to write off billions of dollars due to impairment have not made good investment decisions. Managements that bite the bullet and take an honest all-encompassing charge should be viewed more favorably than those who slowly bleed a company to death by deciding to take a series of recurring impairment charges, thereby manipulating reality.
The Bad
The accounting rules (FAS 141 and FAS 142) allow companies a great deal of discretion in allocating goodwill and determining its value. Determining fair value has always been as much an art as a science and different experts can arrive honestly at different valuations. In addition, it is possible for the allocation process to be manipulated for the purpose of avoiding flunking the impairment test. As managements attempt to avoid these charge-offs, more accounting shenanigans will undoubtedly result.
It's doubtful that very many corporate managements will face reality and take their medicine. Compensation packages will incite managers to delay the inevitable as they hope for a stock market rebound that will boost fair value.
A delay, however, could backfire and adversely impact EPS in 2003. According to the rules, impairment charges that occur within the first year of adopting the new accounting rules (calendar 2002 for most corporations) are accounted for as a charge to equity. After the first year, impairment charges hit the income statement. Consequently, postponing may help results in 2002 but could reduce EPS in 2003.
The other bad thing is that investors will have a hard time evaluating how management is handling this issue. The process of allocating goodwill to business units and the valuation process will be hidden from investors, which will provide ample opportunity for manipulation. Companies are also not required to disclose what is determined to be the fair value of goodwill, even though this information would help investors make a more informed investment decision.
The Ugly
Things could get ugly if increased impairment charges reduce equity to levels that trigger technical loan defaults. Most lenders require companies who have borrowed money to promise to maintain certain operating ratios. If a company does not meet these obligations (also called loan covenants), it can be deemed in default of the loan agreement. This could have a detrimental effect on the company's ability to refinance its debt, especially if it has a large amount of debt and in need of more financing.
An Example
Assume that NetcoDOA (a pretend company) has equity of $3.45 billion, intangibles of $3.17 billion and total debt of $3.96 billion. This means that NetcoDOA's tangible net worth is $28 million ($3.45 billion of equity less debt of $3.17 billion).
Let's also assume that NetcoDOA took out a bank loan in late 2000 that will mature in 2005. The loan requires that NetcoDOA maintain a capitalization ratio no greater than 70%. A typical capitalization ratio is defined as debt represented as a percent of capital (debt plus equity). This means that NetcoDOA's capitalization ratio is 53.4%: debt of $3.96 billion divided by capital of $7.41 billion (equity of $3.45 billion plus debt of $3.96 billion).
Now assume that NetcoDOA is faced with an impairment charge that will wipe out half of its goodwill ($1.725 billion), which will also reduce equity by the same amount. This will cause the capitalization ratio to rise to 70%, which is the limit established by the bank. Also assume that, in the most recent quarter, the company posted an operating loss that further reduced equity and caused the capitalization ratio to exceed the maximum 70%.
In this situation, NetcoDOA is in technical default of its loan. The bank has the right to either demand it be repaid immediately (by declaring that NetcoDOA is in default) or, more likely, require NetcoDOA to renegotiate the loan. The bank holds all the cards and can require a higher interest rate or ask NetcoDOA to find another lender. In the current economic climate, this is not an easy thing to do.
(Note: The numbers used above are based upon real data. They represent the average values for the 61 stocks in Baseline's integrated telco industry list.)
Conclusion
New accounting regulations that require companies to mark their goodwill to market will be a painful way to resolve the misallocation of assets that occurred during the dotcom bubble (1995-2000). In several ways, it will help investors by providing more relevant financial information, but it also gives companies a way to manipulate reality and postpone the inevitable. If the economy and stock markets remain weak, many companies could face loan defaults.
Individuals need to be aware of these risks and factor them into their investing decision-making process. There are no easy ways to evaluate impairment risk, but there are a few generalizations that should serve as red flags indicating which companies are at risk:
1. Company made large acquisitions in the late 1990s (notably the telco and AOL).
2. Company has high (greater than 70%) leverage ratios and negative operating cash flows.
3. Company's stock price has declined significantly since 2000.
Unfortunately, the above can be said about most companies.
by Rick Wayman, (Contact Author Biography)
http://www.investopedia.com/articles/analyst/110502.asp?viewed=1
Stock-Picking Strategies: Value Investing
Stock-Picking Strategies: Value Investing
Value investing is one of the best known stock-picking methods. In the 1930s, Benjamin Graham and David Dodd, finance professors at Columbia University, laid out what many consider to be the framework for value investing. The concept is actually very simple: find companies trading below their inherent worth.
The value investor looks for stocks with strong fundamentals - including earnings, dividends, book value, and cash flow - that are selling at a bargain price, given their quality. The value investor seeks companies that seem to be incorrectly valued (undervalued) by the market and therefore have the potential to increase in share price when the market corrects its error in valuation.
Can value companies be those that have just reached new lows? - Definitely, although we must re-emphasize that the "cheapness" of a company is relative to intrinsic value.
A company that has just hit a new 12-month low or is at half of a 12-month high may warrant further investigation.
Here is a breakdown of some of the numbers value investors use as rough guides for picking stocks. Keep in mind that these are guidelines, not hard-and-fast rules:
Value investing is one of the best known stock-picking methods. In the 1930s, Benjamin Graham and David Dodd, finance professors at Columbia University, laid out what many consider to be the framework for value investing. The concept is actually very simple: find companies trading below their inherent worth.
The value investor looks for stocks with strong fundamentals - including earnings, dividends, book value, and cash flow - that are selling at a bargain price, given their quality. The value investor seeks companies that seem to be incorrectly valued (undervalued) by the market and therefore have the potential to increase in share price when the market corrects its error in valuation.
Can value companies be those that have just reached new lows? - Definitely, although we must re-emphasize that the "cheapness" of a company is relative to intrinsic value.
A company that has just hit a new 12-month low or is at half of a 12-month high may warrant further investigation.
Here is a breakdown of some of the numbers value investors use as rough guides for picking stocks. Keep in mind that these are guidelines, not hard-and-fast rules:
- Share price should be no more than two-thirds of intrinsic worth.
- Look at companies with P/E ratios at the lowest 10% of all equity securities.
- PEG should be less than one.
- Stock price should be no more than tangible book value.
- There should be no more debt than equity (i.e. D/E ratio < 1).
- Current assets should be two times current liabilities.
- Dividend yield should be at least two-thirds of the long-term AAA bond yield.
- Earnings growth should be at least 7% per annum compounded over the last 10 years.
The Margin of Safety
A discussion of value investing would not be complete without mentioning the use of a margin of safety, a technique which is simple yet very effective. Consider a real-life example of a margin of safety. Say you're planning a pyrotechnics show, which will include flames and explosions. You have concluded with a high degree of certainty that it's perfectly safe to stand 100 feet from the center of the explosions. But to be absolutely sure no one gets hurt, you implement a margin of safety by setting up barriers 125 feet from the explosions.
This use of a margin of safety works similarly in value investing. It's simply the practice of leaving room for error in your calculations of intrinsic value. A value investor may be fairly confident that a company has an intrinsic value of $30 per share. But in case his or her calculations are a little too optimistic, he or she creates a margin of safety/error by using the $26 per share in their scenario analysis. The investor may find that at $15 the company is still an attractive investment, or he or she may find that at $24, the company is not attractive enough. If the stock's intrinsic value is lower than the investor estimated, the margin of safety would help prevent this investor from paying too much for the stock.
Conclusion
Value investing is not as sexy as some other styles of investing; it relies on a strict screening process. But just remember, there's nothing boring about outperforming the S&P by 13% over a 40-year span!
http://www.investopedia.com/university/stockpicking/stockpicking3.asp
Stock-Picking Strategies: Fundamental Analysis
Stock-Picking Strategies: Fundamental Analysis
Ever hear someone say that a company has "strong fundamentals"? The phrase is so overused that it's become somewhat of a cliché. Any analyst can refer to a company's fundamentals without actually saying anything meaningful. So here we define exactly what fundamentals are, how and why they are analyzed, and why fundamental analysis is often a great starting point to picking good companies.
The Theory
Doing basic fundamental valuation is quite straightforward; all it takes is a little time and energy. The goal of analyzing a company's fundamentals is to find a stock's intrinsic value, a fancy term for what you believe a stock is really worth - as opposed to the value at which it is being traded in the marketplace. If the intrinsic value is more than the current share price, your analysis is showing that the stock is worth more than its price and that it makes sense to buy the stock.
Although there are many different methods of finding the intrinsic value, the premise behind all the strategies is the same: a company is worth the sum of its discounted cash flows. In plain English, this means that a company is worth all of its future profits added together. And these future profits must be discounted to account for the time value of money, that is, the force by which the $1 you receive in a year's time is worth less than $1 you receive today. (For further reading, see Understanding the Time Value of Money).
The idea behind intrinsic value equaling future profits makes sense if you think about how a business provides value for its owner(s). If you have a small business, its worth is the money you can take from the company year after year (not the growth of the stock). And you can take something out of the company only if you have something left over after you pay for supplies and salaries, reinvest in new equipment, and so on. A business is all about profits, plain old revenue minus expenses - the basis of intrinsic value.
Greater Fool Theory
One of the assumptions of the discounted cash flow theory is that people are rational, that nobody would buy a business for more than its future discounted cash flows. Since a stock represents ownership in a company, this assumption applies to the stock market. But why, then, do stocks exhibit such volatile movements? It doesn't make sense for a stock's price to fluctuate so much when the intrinsic value isn't changing by the minute. The fact is that many people do not view stocks as a representation of discounted cash flows, but as trading vehicles. Who cares what the cash flows are if you can sell the stock to somebody else for more than what you paid for it? Cynics of this approach have labeled it the greater fool theory, since the profit on a trade is not determined by a company's value, but about speculating whether you can sell to some other investor (the fool). On the other hand, a trader would say that investors relying solely on fundamentals are leaving themselves at the mercy of the market instead of observing its trends and tendencies. This debate demonstrates the general difference between a technical and fundamental investor. A follower of technical analysis is guided not by value, but by the trends in the market often represented in charts. So, which is better: fundamental or technical? The answer is neither. As we mentioned in the introduction, every strategy has its own merits. In general, fundamental is thought of as a long-term strategy, while technical is used more for short-term strategies. (We'll talk more about technical analysis and how it works in a later section.)
Putting Theory into Practice
The idea of discounting cash flows seems okay in theory, but implementing it in real life is difficult. One of the most obvious challenges is determining how far into the future we should forecast cash flows. It's hard enough to predict next year's profits, so how can we predict the course of the next 10 years? What if a company goes out of business? What if a company survives for hundreds of years? All of these uncertainties and possibilities explain why there are many different models devised for discounting cash flows, but none completely escapes the complications posed by the uncertainty of the future.
Let's look at a sample of a model used to value a company. Because this is a generalized example, don't worry if some details aren't clear. The purpose is to demonstrate the bridging between theory and application. Take a look at how valuation based on fundamentals would look:
The problem with projecting far into the future is that we have to account for the different rates at which a company will grow as it enters different phases. To get around this problem, this model has two parts:
(1) determining the sum of the discounted future cash flows from each of the next five years (years one to five), and
(2) determining 'residual value', which is the sum of the future cash flows from the years starting six years from now.
In this particular example, the company is assumed to grow at 15% a year for the first five years and then 5% every year after that (year six and beyond). First, we add together all the first five yearly cash flows - each of which are discounted to year zero, the present - in order to determine the present value (PV). So once the present value of the company for the first five years is calculated, we must, in the second stage of the model, determine the value of the cash flows coming from the sixth year and all the following years, when the company's growth rate is assumed to be 5%. The cash flows from all these years are discounted back to year five and added together, then discounted to year zero, and finally combined with the PV of the cash flows from years one to five (which we calculated in the first part of the model). And voilà ! We have an estimate (given our assumptions) of the intrinsic value of the company. An estimate that is higher than the current market capitalization indicates that it may be a good buy. Below, we have gone through each component of the model with specific notes:
So far, we've been very general on what a cash flow comprises, and unfortunately, there is no easy way to measure it. The only natural cash flow from a public company to its shareholders is a dividend, and the dividend discount model (DDM) values a company based on its future dividends (see Digging Into The DDM.). However, a company doesn't pay out all of its profits in dividends, and many profitable companies don't pay dividends at all.
What happens in these situations? Other valuation options include analyzing net income, free cash flow, EBITDA and a series of other financial measures. There are advantages and disadvantages to using any of these metrics to get a glimpse into a company's intrinsic value. The point is that what represents cash flow depends on the situation. Regardless of what model is used, the theory behind all of them is the same.
Reference:
http://www.investopedia.com/university/stockpicking/stockpicking1.asp?partner=WBW
Next: Stock-Picking Strategies: Qualitative Analysis
Ever hear someone say that a company has "strong fundamentals"? The phrase is so overused that it's become somewhat of a cliché. Any analyst can refer to a company's fundamentals without actually saying anything meaningful. So here we define exactly what fundamentals are, how and why they are analyzed, and why fundamental analysis is often a great starting point to picking good companies.
The Theory
Doing basic fundamental valuation is quite straightforward; all it takes is a little time and energy. The goal of analyzing a company's fundamentals is to find a stock's intrinsic value, a fancy term for what you believe a stock is really worth - as opposed to the value at which it is being traded in the marketplace. If the intrinsic value is more than the current share price, your analysis is showing that the stock is worth more than its price and that it makes sense to buy the stock.
Although there are many different methods of finding the intrinsic value, the premise behind all the strategies is the same: a company is worth the sum of its discounted cash flows. In plain English, this means that a company is worth all of its future profits added together. And these future profits must be discounted to account for the time value of money, that is, the force by which the $1 you receive in a year's time is worth less than $1 you receive today. (For further reading, see Understanding the Time Value of Money).
The idea behind intrinsic value equaling future profits makes sense if you think about how a business provides value for its owner(s). If you have a small business, its worth is the money you can take from the company year after year (not the growth of the stock). And you can take something out of the company only if you have something left over after you pay for supplies and salaries, reinvest in new equipment, and so on. A business is all about profits, plain old revenue minus expenses - the basis of intrinsic value.
Greater Fool Theory
One of the assumptions of the discounted cash flow theory is that people are rational, that nobody would buy a business for more than its future discounted cash flows. Since a stock represents ownership in a company, this assumption applies to the stock market. But why, then, do stocks exhibit such volatile movements? It doesn't make sense for a stock's price to fluctuate so much when the intrinsic value isn't changing by the minute. The fact is that many people do not view stocks as a representation of discounted cash flows, but as trading vehicles. Who cares what the cash flows are if you can sell the stock to somebody else for more than what you paid for it? Cynics of this approach have labeled it the greater fool theory, since the profit on a trade is not determined by a company's value, but about speculating whether you can sell to some other investor (the fool). On the other hand, a trader would say that investors relying solely on fundamentals are leaving themselves at the mercy of the market instead of observing its trends and tendencies. This debate demonstrates the general difference between a technical and fundamental investor. A follower of technical analysis is guided not by value, but by the trends in the market often represented in charts. So, which is better: fundamental or technical? The answer is neither. As we mentioned in the introduction, every strategy has its own merits. In general, fundamental is thought of as a long-term strategy, while technical is used more for short-term strategies. (We'll talk more about technical analysis and how it works in a later section.)
Putting Theory into Practice
The idea of discounting cash flows seems okay in theory, but implementing it in real life is difficult. One of the most obvious challenges is determining how far into the future we should forecast cash flows. It's hard enough to predict next year's profits, so how can we predict the course of the next 10 years? What if a company goes out of business? What if a company survives for hundreds of years? All of these uncertainties and possibilities explain why there are many different models devised for discounting cash flows, but none completely escapes the complications posed by the uncertainty of the future.
Let's look at a sample of a model used to value a company. Because this is a generalized example, don't worry if some details aren't clear. The purpose is to demonstrate the bridging between theory and application. Take a look at how valuation based on fundamentals would look:
The problem with projecting far into the future is that we have to account for the different rates at which a company will grow as it enters different phases. To get around this problem, this model has two parts:
(1) determining the sum of the discounted future cash flows from each of the next five years (years one to five), and
(2) determining 'residual value', which is the sum of the future cash flows from the years starting six years from now.
In this particular example, the company is assumed to grow at 15% a year for the first five years and then 5% every year after that (year six and beyond). First, we add together all the first five yearly cash flows - each of which are discounted to year zero, the present - in order to determine the present value (PV). So once the present value of the company for the first five years is calculated, we must, in the second stage of the model, determine the value of the cash flows coming from the sixth year and all the following years, when the company's growth rate is assumed to be 5%. The cash flows from all these years are discounted back to year five and added together, then discounted to year zero, and finally combined with the PV of the cash flows from years one to five (which we calculated in the first part of the model). And voilà ! We have an estimate (given our assumptions) of the intrinsic value of the company. An estimate that is higher than the current market capitalization indicates that it may be a good buy. Below, we have gone through each component of the model with specific notes:
- Prior-year cash flow - The theoretical amount, or total profits, that the shareholders could take from the company the previous year.
- Growth rate - The rate at which owner's earnings are expected to grow for the next five years.
- Cash flow - The theoretical amount that shareholders would get if all the company's earnings, or profits, were distributed to them.
- Discount factor - The number that brings the future cash flows back to year zero. In other words, the factor used to determine the cash flows' present value (PV).
- Discount per year - The cash flow multiplied by the discount factor.
- Cash flow in year five - The amount the company could distribute to shareholders in year five.
- Growth rate - The growth rate from year six into perpetuity.
- Cash flow in year six - The amount available in year six to distribute to shareholders.
- Capitalization Rate - The discount rate (the denominator) in the formula for a constantly growing perpetuity.
- Value at the end of year five - The value of the company in five years.
- Discount factor at the end of year five - The discount factor that converts the value of the firm in year five into the present value.
- PV of residual value - The present value of the firm in year five.
So far, we've been very general on what a cash flow comprises, and unfortunately, there is no easy way to measure it. The only natural cash flow from a public company to its shareholders is a dividend, and the dividend discount model (DDM) values a company based on its future dividends (see Digging Into The DDM.). However, a company doesn't pay out all of its profits in dividends, and many profitable companies don't pay dividends at all.
What happens in these situations? Other valuation options include analyzing net income, free cash flow, EBITDA and a series of other financial measures. There are advantages and disadvantages to using any of these metrics to get a glimpse into a company's intrinsic value. The point is that what represents cash flow depends on the situation. Regardless of what model is used, the theory behind all of them is the same.
Reference:
http://www.investopedia.com/university/stockpicking/stockpicking1.asp?partner=WBW
Next: Stock-Picking Strategies: Qualitative Analysis
Greater Fool Theory
Greater Fool Theory
One of the assumptions of the discounted cash flow theory is that people are rational, that nobody would buy a business for more than its future discounted cash flows. Since a stock represents ownership in a company, this assumption applies to the stock market. But why, then, do stocks exhibit such volatile movements? It doesn't make sense for a stock's price to fluctuate so much when the intrinsic value isn't changing by the minute.
The fact is that many people do not view stocks as a representation of discounted cash flows, but as trading vehicles. Who cares what the cash flows are if you can sell the stock to somebody else for more than what you paid for it? Cynics of this approach have labeled it the greater fool theory, since the profit on a trade is not determined by a company's value, but about speculating whether you can sell to some other investor (the fool). On the other hand, a trader would say that investors relying solely on fundamentals are leaving themselves at the mercy of the market instead of observing its trends and tendencies.
This debate demonstrates the general difference between a technical and fundamental investor. A follower of technical analysis is guided not by value, but by the trends in the market often represented in charts. So, which is better: fundamental or technical? The answer is neither. Every strategy has its own merits.
In general, fundamental is thought of as a long-term strategy, while technical is used more for short-term strategies.
One of the assumptions of the discounted cash flow theory is that people are rational, that nobody would buy a business for more than its future discounted cash flows. Since a stock represents ownership in a company, this assumption applies to the stock market. But why, then, do stocks exhibit such volatile movements? It doesn't make sense for a stock's price to fluctuate so much when the intrinsic value isn't changing by the minute.
The fact is that many people do not view stocks as a representation of discounted cash flows, but as trading vehicles. Who cares what the cash flows are if you can sell the stock to somebody else for more than what you paid for it? Cynics of this approach have labeled it the greater fool theory, since the profit on a trade is not determined by a company's value, but about speculating whether you can sell to some other investor (the fool). On the other hand, a trader would say that investors relying solely on fundamentals are leaving themselves at the mercy of the market instead of observing its trends and tendencies.
This debate demonstrates the general difference between a technical and fundamental investor. A follower of technical analysis is guided not by value, but by the trends in the market often represented in charts. So, which is better: fundamental or technical? The answer is neither. Every strategy has its own merits.
In general, fundamental is thought of as a long-term strategy, while technical is used more for short-term strategies.
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