Doing Your Homework: Rule of thumb

Basic Financial Metrics

Sales per share
Rule of thumb: The higher the better.


Dividends per share
Rule of thumb: The higher the better.


Cash Flow per share
Rule of thumb: The higher the better.


Yield
Rule of thumb:  The higher the better.

Quick Ratio:
Rule of thumb:  Greater than 1 and the higher the quick ratio the better.  If the ratio is less than 1, you would want to assure yourself that the company is generating enough cash flow from operations to cover both its normal expenses and any short-term debt obligations that come due.

Valuation Ratios

Price-to-Sales ratio: 
Rule of thumb:  ratios less than 2 indicate good value

Price to Earnings ratio (P/E):
Rule of thumb:  Historically, stocks are a good value when the ratio or multiple is around 14.  We will consider stocks that have a P/E of less than 20 a decent value based on this ratio - the lower the ratio the better.

Dividend Ratios

Dividend Coverage ratio: 
Rule of thumb:  Minimum of 120%

Dividend Payout ratio:
Rule of thumb:  The higher the better, so long as the ratio does not exceed 100%.   By maintaining a conservative payout ratio of 30%, this allows management to consider increasing dividends as earnings increase.

Growth Ratios

One-year revenue growth rate:
Rule of thumb:  greater than 10% increase in revenue

One-year earnings growth rate:
Rule of thumb:  greater than 10% increase in earnings


Trend Analysis

All preceding ratios
Rule of thumb:  Look for positive trend with an increasing growth in sales, earnings, cash flow, and dividends per share.  The quick, leverage, value and dividend ratios are all positive or well within acceptable ranges.



Caution:  A parting word about a standard rule of thumb
Although convenient, rules of thumb should not be adhered to in isolation. 

For example, electric utilities normally have current liabilities that exceed their current assets, yielding a quick ratio of less than 1.  However, investors are not concerned because utilities have strong cash flow from operations and their accounts receivables are from electricity users who must pay their bills if they want to continue to receive electricity.  If your rule of thumb were rigid, a low quick ratio would be a signal for you to avoid the company and discard promising stocks individually or even across an entire industry.

Ultimately, by integrating these ratios into a single analysis for any given company, you should be able to confidently select dividend-paying stocks that will help you to accomplish your investment goals and to build your wealth slowly over time through compounding dividends and price appreciation.

Doing Your Homework: Trend Analysis

The information in the financial statements (BS, IS or RE statement), the basic (per-share) financial metrics and the various ratios are snapshots of the company's financial condition at a point in time, but there are trends in motion that need to be identified so you can understand if the company's position is improving or deteriorating.

For example: 

http://spreadsheets.google.com/pub?key=tdTJEsOwTqdvL-tOgwfeb9A&output=html

• Company ABC's year-over-year trend analysis indicates a generally positive trend with an increasing growth in sales, earnings, cash flow, and dividends per share. 
• The leverage, value, and dividend ratios are all positive or well within acceptable ranges, with the exception of the quick ratio. 
• Based on analysis, the dividend looks to be secure and Company ABC would be a good buy.

Doing Your Homework: Basic Financial Metrics and Ratios Analysis

Ratios Analysis

Ratios are widely used not only to evaluate a company, but to compare a company's financial position with other companies'.  The data used to calculate ratios are readily available in each company's annual and quarterly reports.  You can concentrate your analysis in the following two areas.


Building Block One:  Basic Financial Metrics

These are formulas that allow you to view any company's results on a per share basis.  Once financial data are reduced to the shareholder level you can easily compare companies that might be very different in size or in different industries.

For example, trying to compare the annual sales of General Motors with the annual sales of a much smaller car company like Porshe might not tell you much, but by comparing sales per share (divide each company's sales by the number of shares outstanding), you have a more meaningful measurement.  Generally, the company generating higher sales per share is going to be the better value. 

Some useful basic financial metrics you can use for your analysis are:

Sales per share
= Sales/Shares outstanding  (Source: IS; BS)

Earnings per share
=Earnings/Shares outstanding (Source: IS; BS)

Dividends per share
=Dividends/Shares outstanding (Source: RE; BS)

Cash flow per share
= (Net Income + Depreciation)/Shares (Source: IS, BS)

Yield
= Dividend per share/Price per share (Source: DPS; newspaper)



Building Block Two:  Ratio Analysis

Ratio analysis allow you to analyse a company's financial performance

• against other companies in the same industry,
• against all stocks in the market, or
• against industry standards, which are sometimes known as "rules of thumb." 

Although there are a great number of ratios that you can use to analyse a company, below is a short list of ratios that will give you the information you need to pick good dividend-paying stocks.

Liquidity Ratio
Quick Ratio
= (Current Assets - Inventory) / Current Liabilities (Source:  BS)

Debt Coverage Ratio
Short-term Debt Coverage Ratio
= Operating Income/Short-term debt (Current Liabilities)  (Source: IS; BS)

Valuation Ratios
Price-to-Sales ratio
 = Stock price/Sales per share (Source: Newspaper; Sales per share)
Price-to-Earnings ratio
= Stock price/Earnings per share (Source:  Newspaper; Earnings per share)

Dividend Ratios
Payout ratio =
Dividend per share/Earnings per share (Source:  Basic metric formulas)
Dividend coverage ratio =
Cash flow per share/Dividend per share (Source:  Basic metric formulas)

Growth Ratios:
Revenue growth rate ratio
= Year over Year percent change in revenues (Source: IS)
Earnings growth rate ratio
= Year over Year percent change in earnings (Source: IS)

Doing Your Homework: Analysing Financial Statements to pick Great Stocks

How do you pick great stocks?

If you don't have a crystal ball or inside information, then the best way you can tell a winning stock from a loser is by analysing a company's financial statements.

Before you dismiss this simple answer because you find financial statements confusing or boring, you should know that you don't have to become an accountant or financial analyst.  Just a nodding acquaintance with the fundamentals will allow you to make better decisions about

• which stocks you should investigate and
• which stocks you should own as part of your (e.g. dividend-focused or growth-focused) portfolio.

Financial statements are an important source of information regarding a company's profits or losses, assets and liabilities, and sources of funds used to operate its business.  You should concentrate on the basics: 

• the balance sheet,
• income statement, and
• statement of retained earnings.

The balance sheet
This gives you an overall picture of a company's assets, liabilities, and equity at the end of an accounting period (i.e. quarterly or year-end).

The Income statement and the statement of retained earnings
These tell you how much revenue, expense, and profit the firm generated over a specific period of time (e.g. its fiscal year).

Together, these statements provide you with all the financial data you need to perform a ratio analysis to determine if you would want to buy a stock.

Since financial transactions occur continuously, this information becomes rapidly dated.  Be sure you are looking at the most recent statements and continue to review the updated statements of those stocks you decide to hold.

Future expectations can be approached in two different ways: Qualitative or Quantitative approach

According to Benjamin Graham, the current price reflects both

• known facts and
• future expectations

was intended to emphasize the double basis for market valuations.

Corresponding with these two kinds of value elements are two basically different approaches to stock analysis. 

Every competent analyst looks forward to the future rather than backward to the past, and realizes that their work will prove good or bad depending on what will happen and not on what has happened.

The future expectation itself can be approached in two different ways, which may be called:

• 1.  the way of prediction (or projection) and
• 2.  the way of protection.

-----

1. The way of prediction (or projection)

Those who emphasize prediction will try to anticipate fairly accurately just what the company will accomplish in future years - in particular whether earnings will grow rapidly and consistently.  These conclusions may be based on a very careful study of such factors as

• supply and demand in the industry-
• or volume, price and costs -
• or else they may be derived from a rather naive extrapolation from past growth into the future. 

If these authorities are convinced that the fairly long-term prospects are unusually favourable, they will almost always recommend the stock for purchase without paying too much attention to its current price.

This first, or predictive approach, could also be called the qualitative approach, since it emphasizes prospects, management and other nonmeasurable, abeit highly important factors that go under the heading of quality.

--

2. The way of protection.

By contrast, those analyst who emphasize protection are always especially concerned with the price of the stocks at the time of study.  Their main effort is to assure themselves of a substantial margin of present value above the market price - a margin large enough to absorb any unfavourable developments in the future.  Generally speaking, therefore, it is not so necessary for them to be enthusiastic over the company's long-run prospects as it is to be reasonably confident that the enterprise will get along.

The second or protective approach may be called the quantitative or statistical approach, since it emphasizes the measurable relationships between selling price and earnings, assets, dividends and so forth. 

Incidentally, the quantitative method is really an extention into the field of common stocks of the viewpoint that security analysis has found to be sound in the selection of bonds and preferred stocks for investment.

----

Choosing the "best" stocks is a controversial one.

In Benjamin Graham's own attitude and professional work was always committed to the quantitative approach. 

• From the first he wanted to make sure that he was getting ample value for his money in concrete, demonstrable terms. 
• He was not willing to accept the prospects and promises of the future as compensation for a lack of sufficient value in hand.

This has by no means been the standard viewpoint among investment authorities; in fact, the majority would probably subscribe to the view that prospects, the quality of management, other tangibles, and the "human factor" far outweigh the past performance records, the balance sheet and all other cold figures.

Thus this matter of choosing the "best" stocks is a controversial one.

Buffett gambles £27bn on rail to get back on track

Buffett gambles £27bn on rail to get back on track
Warren Buffett has placed the largest single wager of his investing career, gambling on "the economic future of the United States" by taking control of the American rail giant Burlington Northern Santa Fe in a $44bn (£27bn) deal.

By James Quinn
Published: 8:53PM GMT 03 Nov 2009

Warren Buffett has bought Burlington Northern Santa Fe, the rail operator, in a $44bn deal. Burlington is America's largest railway by revenue, operating freight across large swathes of the west and mid-west. Its tracks are also used by a variety of passenger services.

Mr Buffett believes that Burlington will benefit as the US economy recovers.

The septuagenarian billionaire argues that railway operators cannot do well unless the businesses and consumers who use the products they transport are beginning to spend again. "It's an all-in wager on the economic future of the United States," said Mr Buffett. "I love these bets."

In typical Buffett style, the cash-and-shares deal was struck in a 15-minute conversation with Matthew Rose, Burlington's chief executive.

It is the largest single investment Mr Buffett has made since taking control of Berkshire Hathaway, the investment conglomerate he has run since 1965.

It contrasts with his more recent deals, which have been big bets on the financial services sector including multi-billion dollar gambles on the recovery of shares in General Electric and Goldman Sachs, both of which have repaid him handsomely.

However, not all of his financial gambles have paid off, with 2008 going down as Berkshire's worst financial year since Mr Buffett took the helm, following a 62pc fall in profits and a drop in net worth of 9.6pc.

Berkshire is offering $26bn for the 77.4pc of Burlington it did not already own, 40pc in shares and the balance – $16bn – in cash, drawn equally from existing reserves and a bank syndicate. Berkshire will still have $20bn of cash.

Including Berkshire's previous investment and the assumption of $10bn of debt, the deal is worth $44bn.


http://www.telegraph.co.uk/finance/businesslatestnews/6496667/Buffett-gambles-27bn-on-rail-to-get-back-on-track.html

US to reduce Quantitative Easing as rates kept low

US to reduce Quantitative Easing as rates kept low
The Federal Reserve reiterated its desire to keep American interest rates “exceptionally low” for an extended period, but gradually reduce some of its quantitative easing as the US economy begins to recover.

By James Quinn, US Business Editor
Published: 8:51PM GMT 04 Nov 2009

America’s central bank, holding interest rates in a range of 0 to 0.25pc, did not signal when borrowing rates might rise, as it remains wary of knocking the US’s nascent recovery off course just a week after productivity figures signalled the country emerged from recession in the third quarter.

The decision comes ahead of the results of the Bank of England’s Monetary Policy Committee meeting, which is due to report its views on interest rates and quantitative easing on Thursday.

In a more upbeat assessment of the state of the US economy, the Federal Open Markets Committee (FOMC) said that it would begin to pull back on some of the extraordinary capital injections it made into the US economy during the crisis.

The Fed has completed its $300bn (£181bn) US Treasuries purchase programme, and reduced the fund for buying agency debt through the first quarter of next year from $200bn to $175bn. But it will continue with its $1.25 trillion purchase programme of agency mortgage-backed securities.

The FOMC’s unanimous decision to hold rates came as it noted that “activity in the housing sector has increased over recent months” and that businesses are beginning to slow the rate of cutbacks.

New data from the FOMC included the latest ADP payroll survey, which showed that the US private sector lost 203,000 jobs last month, ahead of tomorrow’s government unemployment figures, which could show the US unemployment rate hit 10pc in October.

Dividend incomes do not depend on the kindness of strangers

The vast majority of stock transactions are simply investors selling the same stocks back and forth among themselves.  Prices change as their opinions change about what each share is worth to them.  They rise as a buyer tries to entice an owner to sell, and they fall as sellers try to attract a buyer.

Assuming that your stock has risen in price since the day you bought it, how do you benefit from this increase in your wealth? 

• You could borrow against your shares, but then you're really using someone else's money, and the stock is just collateral.  You still have to repay the loan, plus interest, somehow.
• If you ever want to spend the money, you have to sell the stock.  In order to sell your shares, you have to find someone to buy them.

Dividend incomes, on the other hand, does not depend on the kindness of strangers in the same way that appreciation does.  Dividends are driven primarily by the ability and willingness of the company to share its profits with its shareholder owners.  They are tied more closely to the business itself and are less subject to the emotional response of investors to world or market events. 

Investors holding stocks for the income they provide, on the other hand, enjoy an ongoing advantage that "pure growth" investors don't  - they get to keep their shares.  Obviously, once you've sold your shares, it's somebody else's stock.  You no longer have a stake in the fortunes of the company.  The benefits and profits that may follow - as well as the future appreciation in share price - are of no further value to you.  Of course, you don't necessarily have to sell all your stock at once and can therefore continue to enjoy some of the good fortune that may continue to visit the company whose shares you're selling. 

The simple fact remains, though, that as you sell your shares, you have less of an ownership interest than you did before.  By periodically liquidating your holdings, you are systematically reducing your ownership in the very thing that is your store of investment wealth.  Appreciation has its advantages too, and fortunately, dividend investors can enjoy the appreciation in the value of their shares while they continue to collect the ongoing income from their holdings.

When the time eventually comes to take income from your portfolio to support your lifestyle, either in retirement or to help defray major expenses such as education costs, the investments do not have to be sold to create cash flow.  The dividends are already flowing cash to you.  You simply have to adjust how much of it you're reinvesting and how much of it you can afford to spend.

What is Predictable? Market Cycles

You can count on Performance Bursts

Years
Percentage Change*---- Cycle

1901-1903 
-30.55%  Correction
1904-1905   
95.89% Burst
1906 -1907 
-38.93%  Correction
1908-1909
68.60%  Burst
1913-1914
-37.89%  Correction
1915
81.66%  Burst
1916-1917
-24.98%  Correction
1918-1919
44.17% Burst
1920
-32.98% Correction
1921-1922
37.22% Burst
1929-1932
-80.02%  Correction
1933-1936
200.18%  Burst
1937
-32.82%  Correction
1938
28.06%  Burst
1939-1941
-28.30%  Correction
1942-1945
73.86%  Burst
1973-1974
-39.59%  Correction
1975-1976
63.03%  Burst

*Year over year percent change in DJIA Index, excluding dividends.

What most investors don't know is that market cycles are fairly predicatable (see above).  This is good news! 

The above exhibit shows the powerful performance bursts that have followed each market decline of 20% or more as measured by the year over year change in the DJIA Index. It's as if the markets understand Newton's law of physics, that for every action there is an equal and opposite reaction. Over the past 100 years there have been 9 year over year market corrections of 20% or more and after each correction a performance burst has helped to salvage investors' fortunes.

In April of 2003, the markets had already started to reverse the bear trend.  Unfortunately, many investors are still sitting on the sidelines because they were burned by losses incurred in the Y2K bear market.  Most investors, retail and institutional alike, were surprised by the uptrend, but once again a good working knowledge of market history would have allowed them to anticipate a significant move to the upside.  After every major market decline, markets have snapped back with a performance burst to the upside.  These uptrends tend to be very powerful, lifting investors' account balances and spirits at the same time.  

****The most insidious risk of all - Investor Risk

Investors are justifiably wary of the various risks that can beset a portfolio.  In addition to the eroding effects of volatility, there's

• business risk,
• currency risk,
• market risk,
• interest rate risk, and
• inflation risk. 

Perhaps the most insidious risk of all, though, is the one that's the hardest to protect yourself from - investor risk.  Investor risk is the risk we face just by being human.

It is easy to understand the concept that to be successful as an investor you should buy low and sell high.  But if you invest over a long enough time period to see both rising and falling markets, you'll see just how hard it can be to actually bring yourself to do this. 

• Buying at highs and selling at lows is the opposite of success and can cause yur portfolio irreparable harm, but it's .  extraordinarily common
• Had you asked those investors who were rushing into Internet or other high-flying stocks in early 2000, after the Nasdaq had just jumped more than 85% in 1999, if they thought they were buying high, you probably would have heard all kinds of reasons why this time was different.  There was a "new paradigm"; the old rules of valuation no longer applied.  
• Had you asked many of these same investors in early 2003 if they felt they were selling low after three years of crushing stock market declines, you would likely have heard that the market was going to keep falling, the world had changed, and prospects looked bleak for as far as the eye could see.

Investors were once thought to be "rational," efficiently processing all known market data and making decisions on the basis of the logical pursuit of their own best interests.  A whole branch of study called behavioural finance has sprung up to study the question of how investors really behave, and the short answer is that it's rarely rational. 

• Nature has 'wired' us to react in certain ways so we can quickly process information, understand patterns (like those that occur in nature), and make good, quick survival decisions. 
• Unfortunately, many of the same ways of thinking that have proven so helpful to our survival as a species can get us killed as investors.

Emotional responses, uneven reactions to risk and reward, looking for patterns where none may exist, believing our recent experience will persist, and overconfidence in our initial judgements are just some of the natural tendencies that can lead us astray.  Rather than trying to overcome our nature - to overcome the thinking processes and habits that have been woven into our very beings for millennia - we can try to invest in such a way as to reduce this investor risk and increase our odds of financial survival.

The markets will continue to rise and fall, but if your account doesn't fall so much that it triggers your primal urge to sell, you'll still be invested for the rebound. 

• Even the most robust market recovery doesn't help the investor who has already sold everything before it starts. 
• To reap the long-term performance advantages of being an investor, you have to find a way to stay invested for the long term. 

To the extent a lower volatility, dividend-based portfolio provides you with an investment experience you can live with in all kinds of markets, your portfolio is more likely to evolve into a fortune - and less likely to face extinction.

The Performance Illusion: Higher returns have long been associated with higher risks.

Which would you rather have, a portfolio with an average annual return of almost 34%, or one with an average annual return of just 5%?  Let's llok at a couple of examples that show why sometimes less is more.

Exhihit 1
The  Performance Illusion:  High Average Return

Year 1
Starting Value $100,000  Return 100%  Gain or (Loss) $100,000
Ending Value $200,000

Year 2
Starting Value $200,000  Return -99.00%  Gain or (Loss) ($198,000)
Ending Value $2,000

Year 3
Starting Value $2,000  Return 100%  Gain or (Loss) $2,000
Ending Value $4,000

Average Annual Return: 33.67%
Change in Value: ($96,000)
Percentage of Initial Investment Gained or (Lost) after 3 years: -96%



Exhihit 2
The  Performance Illusion:  Low Average Return

Year 1
Starting Value $100,000  Return 15%  Gain or (Loss) $15,000
Ending Value $115,000

Year 2
Starting Value $200,000  Return -15%  Gain or (Loss) ($17,250)Ending Value $97,750

Year 3
Starting Value $97,750  Return 15%  Gain or (Loss) $14,662.50
Ending Value $112,412.50

Average Annual Return: 5%
Change in Value: $12,412.50
Percentage of Initial Investment Gained or (Lost) after 3 years: 12.41%


Which return would you rather have? Of course, to illustrate the dangers of a high-volatility approach to investing, these two examples include an extreme case. Surely no one would ever face the kind of volatility shown in the 100 percent up and 99 percent down example ... but they might come close.



Exhihit 3
Nasdaq Composite Index

Year 1999
Starting Index Value 2192.69; Return 85.59%; Point Gain or(Loss) 1876.62
Ending Value 4069.31

Year 2000
Starting Index Value 4069.31; Return -39.29%; Point Gain or(Loss)(1598.79)
Ending Index Value 2470.52

Year 2001
Starting Index Value 2470.52; Return -21.05%; Point Gain or(Loss)(520.12)
Ending Index Value 1950.40

Year 2002
Starting Index Value 1950.40; Return -31.53%; Point Gain or(Loss)(614.89)
Ending Index Value 1335.51

Year 2003
Starting Index Value 1335.51; Return 50.01%; Point Gain or(Loss)667.86
Ending Index Value 2003.37

Average Annual Return: 8.74%
Change in Index: -189.32
Percentage of Initial Investment Gained or (Lost) after 5 years: -8.63%


Exhibit 3 shows the actual results of the Nasdaq Composite Index (Nasdaq) over five years beginning in 1999 and ending on December 31, 2003.

The truly remarkable 86% return posted by the Nasdaq in 1999 was followed by a truly gruesome bear market mauling over the three years. From the start of 2000 to the end of 2002, the Nasdaq shed an amazing 2,733 points - more than 67% of its value. The year 2003 brought welcome relief, but even after a 50% rise, the Nasdaq was still more than 8.6% below where it had stood five years earlier.

An investor unlucky enough to have missed out on the gains over this time span - either by coming late to the party or bailing out before the rebound - would have suffered a massive financial setback. As of the end of 2003, the Nasdaq remains more than 3,000 points, or 60%, below its all time closing high.


Exhibit 4
The Y2K Bear Market

Nasdaq
Index Closing High 5048.62
Date Hit 03/10/2000
Index (On 12/31/2003) 2003.37
Decline -60.32%
Points from High 3045.25
Gain Needed to Recover 152.01%

S&P 500
Index Closing High 1527.45
Date Hit 03/24/2000
Index (On 12/31/2003) 1111.92
Decline -27.20%
Points from High 415.53
Gain Needed to Recover 37.37%

DJIA
Index Closing High 11722.98
Date Hit 01/14/2000
Index (On 12/31/2003) 10453.92
Decline -10.83%
Points from High 1269.06
Gain Needed to Recover 12.14%


The Exhibit 4 shows the damage the Y2K bear market has visited on three major U.S. stock market indexes. The S&P 500 and DJIA did not soar nearly as high as the Nasdaq during the technology/telecom/Internet boom of the 1990s, and they suffered much less damage during the bust that followed.

The scenarios above are to illustrate, that there are consequences to taking risks. The easy success of the late 1990s bull market lulled many investgors, including many professional investors, into believing risk had lost its bite. Why not shoot for a 30 percent return? If you don't get it, you'll probably just have to settle for 20%. But that's not how it works in the real world - at least not in the long run. The experience of the Nasdaq versus the DJIA during the Y2K Bear Market wasn't a fluke. Higher returns have long been associated with higher risks.

Dividend stocks for Growth Investors

Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. 

If it don't go up, don't by it. 

Will Rogers

For many investors, current income is not an important consideration in building their portfolios. They may have sufficient income from other sources, including employment. For them, building and growing the overall value of their portfolios may be the primary focus of their efforts. Should these “growth investors” concern themselves at all with a strategy built around investing in dividend paying securities?

One of the classic advantages of dividends is their large contribution to the long-term performance that has made stocks so attractive to investors. (About 50% of the returns of your stocks are contributed by dividends.) Reinvesting those dividends can compound the growth of a portfolio. The attraction dividend-paying stocks hold for investors looking for a steady and rising stream of income to support their lifestyles is pretty clear.

The goal of a growth investor, is to increase the overall size of the portfolio so that it will be large enough to meet a future need. That need may be a lump sum to pay for college expenses, or a much larger account from which to draw retirement income. In either case, the object of the game is to make the pot of money bigger in the time available. The key to winning the game lies in understanding that total return is what counts.

Total return is made up of two parts: price appreciation and income. A security that goes up in price by 5% and pays 5% in income adds as much to the financial pot as one that goes up by 10% in value, but pays no income. Still, like the customer who insists on having his pizza cut into 6 slices because he doesn’t think he can eat eight, some investors want their returns delivered only as appreciation.

Stocks that pay dividends do tend to be more mature companies, with characteristically slower growth rates. This is sometimes taken to mean they have low total-return prospects. More accurately, they offer a different path to total return, and that path can lead to an excellent outcome. Flashy price gains are exciting; steady and reliable income can seem boring by comparison. To the extend those flashy gains come at the expense of increased volatility in annual returns, chasing them could lead you down the road to disaster.

Dubai bites the bullet on debt

Dubai bites the bullet on debt
Dubai has finally entered a treatment facility voluntarily.

By Una Galani, Breakingviews.com
Published: 6:12AM GMT 26 Nov 2009

Dubai World, one of the emirate’s biggest holding companies, has shocked creditors by asking for a standstill on the $60bn of debt attached to its entire portfolio, which includes ports operator Dubai Ports World, investment vehicle Istithmar and Nakheel – the property developer responsible for one of the Gulf’s most iconic sights: a series of man-made palm islands. If the emirate’s request is granted that would amount to a technical default.

Though Dubai’s troubles had been widely heralded, investors had been expecting a timely repayment of bonds. Sheikh Mohammed bin Rashid al-Maktoum even recently told critics of the emirate’s ability to meet its financial commitments to “shut up”. No surprise then that the request for a standstill from Dubai World until May 2010 sent the price of Dubai’s five year credit default swaps leaping to 420 basis points – up 100 basis points. That is still less than half the high Dubai’s CDS reached in February when confidence in the emirate was at an all time low.

Dubai has been smart to prove that it can still raise money. At the same time as asking creditors for more time, Dubai announced it had raised a further $5 billion tranche of its $20 billion emergency support bond from two government-owned banks in Abu Dhabi. Two weeks ago, the emirate also placed $2 billion worth of Islamic sukuk bonds with private investors, although those proceeds were not raised for distressed entities.

So why isn’t Dubai putting its hand in its pocket to help Dubai World meet its most pressing maturity, namely Nakheel’s $3.5 billion sukuk due mid-December? One reason could be because Dubai World faces at least a further $2.2 billion of maturities in the coming six months and more after that. Deloitte’s Aidan Birkett, who will lead the restructuring effort, will be one of the first outsiders to see the true scale of the problem that lies within.

Creditors might not like having to grant concessions, but anyone with a long term interest in Dubai should be pleased that the emirate is biting the bullet. Authorities last week took the decision to remove some of the key architects of modern Dubai from their positions. Now the debt laden emirate appears to have finally realised that it can’t pay off all of its debts without a serious financial restructuring. The first step to a cure is admitting there’s a problem.

Dubai: what the immediate future holds

Dubai: what the immediate future holds
Until last Wednesday, most investors saw Dubai as an attractive tourist destination, a regional financial centre and an example of what bold and visionary leadership can achieve.

By Mohamed A El-Erian
Published: 12:23AM GMT 29 Nov 2009

Some worried that Dubai's impressive achievements came with a debt burden that would prove difficult to sustain after last year's financial crisis.

This weekend, investors around the world are united in wondering "what does Dubai mean for me?"

Dubai has triggered local, national, regional and global forces that will play out in the weeks ahead.

At the local level, the standstill is an explicit recognition that the Emirate's debt and leverage levels cannot be sustained in what, at PIMCO, we have called the "new normal". The question for Dubai is now two-fold: can an orderly extension of debt payments be achieved; and how will this impact the risk premium that is attached to other economic and financial activities in the Emirate?

The key issue at the national level is how Abu Dhabi, the largest and richest of the seven UAE Emirates, will react. Here, it is a question of willingness. The leaders of Abu Dhabi must strike that delicate balance between using enormous wealth to support Dubai and ensuring appropriate burden sharing among those that repeatedly failed to heed Abu Dhabi's past warnings about the excesses in Dubai.

The regional dimension is captured by a word familiar to investors in emerging markets: "contagion". The immediate reaction of almost all markets (and too many commentators) is to lump together countries in the region that have very different characteristics. Witness how market measures of risk have surged for all the oil exporters in the region even though they share none of Dubai's debt and leverage characteristics.

At the global level, the Dubai announcement serves as a catalyst to take the froth off expensive financial markets. For the last few months, massive injections of liquidity (primarily by the US), aimed at limiting the adverse impact of the financial crisis on employment, have turbo-charged financial market valuations rather than make their way to the real economy. While many have worried about the generalised over-extension of equity markets, most have hesitated to take money off the table as there did not appear to be a catalyst to break the general "trend is your friend" mentality. Dubai is that catalyst.

So, what next?

First, it will take time to sort out the Dubai situation. Inevitably, this is an uncertain and protracted process that involves both on- and off-balance sheet exposures. It will cast a cloud not only on companies in the Emirate itself but also on institutions that have large exposures there, especially in the banking and real estate sectors.

Second, the immediate indiscriminate sell-off in regional (and emerging market) names will, over time, give way to greater differentiation based on economic and financial realities. Those with strong fundamentals will recover (including Abu Dhabi, Brazil, Kuwait, Qatar and Saudi Arabia) while others, including countries with large deficits and debt burdens in eastern/central/southern Europe, may come under more pressure.

Finally, and most importantly, Dubai serves as a warning to those that were quick to find comfort in the sharp market rally of the last few months. Since the summer, the appreciation of risk assets has been driven predominantly by artificial liquidity injections rather than fundamentals. The Dubai announcement is a reminder that a flood of government-induced liquidity cannot mask all excesses, all the time.

Investors should treat last Wednesday's announcement as an illustration of the lagged financial effects of the global financial crisis. The Dubai situation is no different than that facing commercial real estate in the US and UK.

Let Dubai be a reminder to all: last year's financial crisis was a consequential phenomenon whose lagged impact is yet to play out fully in the economic, financial, institutional and political arenas.

Mohamed A El-Erian is CEO and co-CIO of PIMCO, the investment management firm

http://www.telegraph.co.uk/finance/economics/6678194/Dubai-what-the-immediate-future-holds.html

Dubai: an emirate in crisis

DUBAI facts

Ruled by Sheikh Mohammed bin Rashid Al-Maktoum (above), who has embraced the extravagance of his emirate

16bn  Ruler's personal wealth – world's fourth-richest royal

1.7m Population

240,000 Oil production per day

State company is Dubai World, a property-focused investment group with a $59bn debt problem

Government holding companies bought large stakes in HSBC, Deutsche Bank and US retailer Barneys

Key London assets include the Adelphi, on the Strand, and the Grand Buildings in Trafalgar Square

The ruler's slogan is "Leader, equestrian, poet"



ABU DHABI facts

Ruled by Sheikh Khalifa bin Zayed al-Nahy (above), who has taken a reserved and anonymous stance in his
oil-rich state

$21bn Ruler's personal wealth – world's second-richest royal

1.3m Population

2.7m Oil production per day

State company is the Abu Dhabi Investment Authority, the world's largest sovereign wealth fund with assets worth more than $250bn

The company bought 4.9pc of Citigroup for £7.5bn in 2007 and is thought to be the world's second-largest institutional investor behind Bank of Japan

Key London assets include the ExCel exhibition centre in the Royal Docks and No1 Knightsbridge Green, close to Harrods

Its flagship project is the Gulf version of the Peggy Guggenheim Museum, which is set to open in 2011