Estimates of economic costs of a flu pandemic

Estimates of economic costs of a flu pandemic

If the outbreak of swine flu in Mexico becomes a pandemic, the economic consequences could be great. Below are estimates of the costs of such a disaster:

Reuters
Last Updated: 10:25AM BST 27 Apr 2009

* The World Bank estimated in 2008 that a flu pandemic could cost $3 trillion (£2 trillion) and result in a nearly 5pc drop in world gross domestic product. The World Bank has estimated that more than 70m people could die worldwide in a severe pandemic.

* Australian independent think-tank Lowy Institute for International Policy estimated in 2006 that in the worst-case scenario, a flu pandemic could wipe $4.4 trillion off global economic output.

* Two reports in the United States in 2005 estimated that a flu pandemic could cause a serious recession of the US economy, with immediate costs of $500bn-$675bn.

* SARS in 2003 disrupted travel, trade and the workplace and cost the Asia Pacific region $40bn. It lasted for six months, killing 775 of the 8,000 people it infected in 25 countries.

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http://www.telegraph.co.uk/health/healthnews/5228878/Estimates-of-economic-costs-of-a-flu-pandemic.html

Asian markets retreat on swine flu fears

Asian markets retreat on swine flu fears
Asian stock markets retreated on Monday as investors worried the outbreak of swine flu in North America could grow into a worldwide pandemic that deepens the global recession.

Last Updated: 10:26AM BST 27 Apr 2009

Fears over a virus that has already made hundreds ill, and possibly killed more than 100 in Mexico, led investors to buy drug makers and dump airlines such as Qantas Airways (-4pc) and Cathay Pacific (-9pc).

In Asia, investors are painfully aware of the toll an epidemic can exact on companies and industries after SARS battered regional economies from Hong Kong to Singapore in 2003.

The markets were still more cautious than panicked, analysts said, yet mindful that the disease could derail what many believe are the beginnings of a recovery in a global economy reeling from its worst downturn in years. With the markets up sharply since March, the disease could cause more selling should it continue to spread.

"Investors are already sitting nervously looking for excuse to sell off and what better than swine flu," said Miles Remington, head of Asian sales trading at BNP Paribas Securities in Hong Kong.

In Hong Kong, the Hang Seng fell 413.63, or 2.7pc, to 14,845.22. Korea's Kospi lost 13.36 points, or 1pc, to 1,340.07, while Japan, the Nikkei 225 stock average dropped in early trading before edging up 18.3 points - or 0.2pc - to 8726.

Elsewhere, Australia's index shed 0.5pc, Shanghai's benchmark dropped 1.2pc and Taiwan's stock measure plummeted 3.2pc.

The outbreak offset optimism on Wall Street on Friday over the US Federal Reserve's announcement that 19 major banks won't be allowed to fail — even if they fared poorly on the government's 'stress tests' of banking health.

The Dow rose 119.23, or 1.5pc, to 8,076.29, after rising by as many as 170 points.

Oil prices slipped in Asian trade as investors mulled comments from OPEC suggesting the price was too low for companies to justify new investments in crude production. Benchmark crude for June delivery fell $1.28 to $50.25. The contract jumped $1.93 to settle at $51.55 last week.

Related Articles
Drugs companies prepare for epidemic
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Asian shares mostly higher but caution lingers
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'Nothing is an all-the-time good investment. Certainly not cash'

'Nothing is an all-the-time good investment. Certainly not cash'
People have been going back to risk and leaving the bomb shelters.

By James Bartholomew
Last Updated: 7:10AM BST 23 Apr 2009

I have to admit that I find the extreme ups and downs in the markets in recent months rather exciting. I am sorry that fortunes have been lost and people have suffered. I myself have lost a considerable amount.

But this has been exciting in a similar way, I imagine, as the view of London burning in the blitz was once thrilling for my mother when she recklessly went to the roof of Broadcasting House, where she was working, to have a look.

It is a jolly sight more fun, to be sure, when things are going well and they have certainly been a lot better since the rally started early last month.

I have had an extraordinary time with my shares in the pub-owning company, Enterprise Inns. Some readers may remember that 11 weeks ago, I wrote here, "I don't normally manage to lose money quite so quickly…"

I had bought shares in Enterprise at 69.75p. By the end of the week, they had halved. They reached a low of 32p.

Then they stabilised and eventually rose somewhat. But at the beginning of the week before last, I was still nursing a loss. Then, suddenly, whoosh! Up they went, leaping upward like a drug-enhanced mountain goat. A 15pc rise, then another 20pc. Out of the blue, I found myself in profit and still climbing.

The shares zoomed up to over 100p. They then fell back hard but got another lease of life. Having failed to buy more when they had been 32p, I found the courage to buy again when they were 93.5p.

There is human nature for you. As to whether this further purchase was wise, you can find out if you go to the business section of the main paper and look at the stock market prices under Travel and Leisure. They were trading at 117p on Monday.

The amazing downs and ups of Enterprise Inns reflect the abrupt return, since early March, of the appetite for risk. My defensive shares, such as Telecom Plus, a utility provider, have been shunned.

But shares that were heavily sold down because the companies are cyclical or heavily indebted, revived strongly. I also have shares in Tolent, a building company. It has performed like an investment Lazarus, leaving death's door at high speed.

Meanwhile, my investment in yen, through bonds, has done badly in the last couple of months. The yen has weakened precisely for the same reason as Enterprise Inns strengthened.

People have been going back to risk and leaving the bomb shelters. I have lightened my holdings in the yen, at least for the time being. This is because my view of what is going to happen in the economy and to investments has shifted a bit.

My rough idea, currently, of how things will pan out is this:

• first, the "quantitative easing" will work in ending the economic decline. The stock market will respond positively and go higher.
• Second, after a lag, inflation will pick up strongly. This will cause a flight to gold and inflation index-linked government stocks (and perhaps the yen).
• Third, in response to the inflation, interest rates will rise which will hurt shares somewhat – though it is difficult to tell how much.
• And finally, when inflation seems to be coming down and interest rates fall back again, there will be big rises in shares and property.

This forecast could easily be partly or completely wrong. But even if this guess/forecast of the future is right, the timing is uncertain. How long will the lag be before inflation? How much will people anticipate it and buy gold beforehand? It is hard to predict.

I have already bought some gold in the form of units in an exchange traded fund, ETFS Physical Gold and I have bought some Treasury 2.5pc 2024 inflation index-linked stock. But, at the time of writing, they have done nothing.

Yes, there is a risk of hyper-inflation, but a rush for inflation-protection investments may not really get going until the danger is clear and present. In the meantime, I suspect that shares are the investments that may do best.

That is why I bought extra shares in Enterprise Inns. I have also increased my holding in Home Products, a Thai company that runs DIY stores.

Its latest results were surprisingly good and the shares have risen by a third in the last two months but even at the price I paid, 4.59 baht, the shares have a historic dividend yield of 7.5pc.

I had better add that, of course, I could be completely wrong. Many people think this is a bear market rally. We each must make our own judgements and arrange our investments accordingly.

But in these financially dangerous times, I believe that anyone with savings should be thinking hard about it. Nothing is an all-the-time good investment. Certainly not cash.

http://www.telegraph.co.uk/finance/personalfinance/investing/5202598/Nothing-is-an-all-the-time-good-investment.-Certainly-not-cash.html

Berkshire profit plunges 96% on stock market bets

Berkshire profit plunges 96% on stock market bets

Tags: Berkshire Buffett Omaha

Written by Bloomberg
Monday, 02 March 2009 10:32

NEW YORK: Warren Buffett’s Berkshire Hathaway Inc posted a fifth-straight profit drop, the longest streak of quarterly declines in at least 17 years, on losses from derivative bets tied to stock markets.

Fourth-quarter net income fell 96% to US$117 million (RM433 million), or US$76 a share, from US$2.95 billion, or US$1,904 a share, in the same period a year earlier, the Omaha, Nebraska-based firm said in its annual report. Book value per share, a measure of assets minus liabilities that Buffett highlights in his yearly letter to shareholders, slipped 9.6% for all of 2008, the worst performance since Buffett took control in 1965.

“The credit crisis, coupled with tumbling home and stock prices, had produced a paralysing fear that engulfed the country” at the end of 2008, Buffett in his letter to shareholders yesterday. “A freefall in business activity ensued, accelerating at a pace that I have never before witnessed.”

Berkshire, where Buffett serves as chairman, chief executive officer and head of investing, suffered as the benchmark Standard & Poor’s 500 Index turned in its worst year since 1937. Liabilities on derivatives linked to world equity markets widened by 49% to US$10 billion in the three months ended Dec 31, though the contracts don’t require Berkshire to pay out until at least 2019, if at all.

Berkshire shares have fallen 44% in the past year as the value of the firm’s top equity holdings dropped and losses increased on the derivatives. Nineteen of the top 20 stocks in Berkshire’s US portfolio declined last year.

Coca-Cola Co, Berkshire’s top holding, dropped 26%.American Express Co plunged 64%. Oil producer ConocoPhillips fell 41%, and Buffett said in his shareholder letter that he made a “major mistake” in buying shares when oil and gas prices were near their peak.

The decline in book value per share, a figure Buffett provides in a chart at the start of his annual report, still outperformed the S&P. Berkshire’s only other annual decrease in book value during Buffett’s tenure was a 6.2% drop in 2001; the company outperformed the S&P in 38 of the 44 years he’s run the firm. Book value has dropped by about US$8 billion this year, from US$109.3 billion on Dec 31, the report said.

“You can call it the worst year ever if you want, but the fact is, the results compared to the 30% to 50% declines in the world stock markets show just how defensive Berkshire is,” said Tom Russo, a partner at Gardner Russo & Gardner, whose largest holding is Berkshire shares. “In the face of the maelstrom, he did alright.”

In his “owner’s manual” for Berkshire shareholders, Buffett says he considers book value to be an objective substitute for the best, albeit subjective, measure of a firm’s success: a metric he calls intrinsic value. Buffett doesn’t provide a number for intrinsic value.

Net income fell 62% to US$4.99 billion for all of 2008, with storm claims from Hurricanes Ike and Gustav contributing to a decline at Berkshire’s insurance operations.

Industrywide, insurers faced US$25.2 billion in claims on natural disasters in 2008, the most since the record storm season of 2005, a trade group said last month.

Berkshire, which owns National Indemnity Co, General Re Corp and Geico Corp, said fourth-quarter profit from underwriting policies more than doubled to US$1.18 billion.

Pretax underwriting profit at Berkshire Hathaway Reinsurance Group jumped four-fold, in part because Buffett booked US$224 million after winning a bet with the state of Florida. Berkshire had pocketed the fee with the agreement that the company would buy bonds from the state if a hurricane forced the state to issue debt. No storms hit.

Profit from selling policies at car insurer Geico rose 18% to US$186 million before taxes as premium revenue increased. The unit added about 206,000 new policyholders in the quarter and 665,000 for the year.

Earnings from Berkshire’s energy and utilities unit, which includes MidAmerican Energy Holdings Co. and PacifiCorp, more than tripled to US$856 million in part from a breakup fee earned when Constellation Energy Group Inc backed out of a deal to be acquired by Berkshire.

Berkshire’s equity derivatives were sold to undisclosed buyers for US$4.85 billion as of Sept 30. The derivatives are tied to four indexes — the S&P, the UK’s FTSE 100 Index, the Dow Jones Euro Stoxx 50 Index and Japan’s Nikkei 225 Stock Average. The indexes would all have to fall to zero for Berkshire to be liable for the entire amount at risk, which was US$37.1 billion as of Dec 31 and can fluctuate with currency valuations. Buffett previously identified only the S&P.

Under the agreements, Berkshire must pay out if, on specific dates starting in 2019, the four benchmarks are below the point where they were when he made the agreements. Buffett, recognised as one of the world’s pre-eminent investors, gets to use the money in the interim. The liabilities on the derivatives are accounting losses that reflect the falling value of the stock indexes, not cash Berkshire has paid out.

“Derivatives are dangerous,” Buffett said in the annual letter.

“Our expectation, though it is far from a sure thing, is that we will do better than break even and that the substantial investment income we earn on the funds will be frosting on the cake.”

The worldwide recession and global contraction of the credit markets are giving Buffett, 78, opportunities to invest some of the firm’s cash hoard, which was about US$25.5 billion at yearend, down from US$33.4 billion three months earlier.

Berkshire agreed in the past six months to purchase preferred shares of General Electric Co. and Goldman Sachs Group Inc, and made deals to buy debt in firms including motorcycle-maker Harley-Davidson Inc, luxury jeweler Tiffany & Co and Sealed Air Corp, the maker of Bubble Wrap shipping products.

Berkshire is commanding yields as high as 15% at a time when potential rivals are no longer able to make such investments. In his letter, Buffett described the 10%yield on the Goldman and GE investments as “more than satisfactory”. — Bloomberg

The Ultimate Signal to Load Up on Stocks?

The Ultimate Signal to Load Up on Stocks?
By Brian Richards and Tim Hanson April 20, 2009 Comments (22)

Legendary fund manager Peter Lynch famously said that if investors spend 13 minutes thinking about the economy, they've wasted 10 minutes.

Granted, Lynch wasn't managing money during a mega-macroeconomic crisis of the sort we're facing today. Plus, Lynch was likely being funny and hyperbolic -- surely some thought to macroeconomic events is useful for investors. (Anyone thought about buying a bank stock lately?)

So when we read the other day that lipstick sales rose more than 4% in 2008, we nodded our heads. Here it was again: the leading lipstick indicator.

How lipstick explains the economy

The ... what?

The leading lipstick indicator, is a scientific measure of the sale of, well, lipstick. The theory goes as follows: When times are tough, women will purchase lipstick rather than purchasing new threads or splurging for a new necklace. During the Great Depression, lipstick sales reportedly rose 25%!

The term was introduced by Estee Lauder (NYSE: EL) Chairman Leonard Lauder, who created it with nothing more than years on the job and astute observation.

Of course, lipstick sales are a comically unreliable economic indicator and lipstick alone can't save Estee Lauder investors from a downturn in consumer discretionary spending. But the obvious absurdity of judging the state of the U.S. economy by sales of this single product should at least suggest that other market "indicators" that judge our economy by a single metric are equally dubious.

New home sales? New home starts? Jobless claims? Non-farm payroll numbers? Durable goods report? They all make for interesting morning segments on CNBC, but they're unreliable, subject to revision, and not worth much without loads and loads of context. That means they're nothing but obnoxious noise to the ears of long-term-focused investors.

Turning to Buffett -- who else?

So imagine our surprise when we read a Fortune piece a few weeks back with the following headline: "Buffett's Metric Says It's Time to Buy."

Would Warren Buffett -- the patron saint of fundamental-focused value investing -- really suggest broad market indicators are relevant to a buy decision?

As it turns out, it can be.

His signal looks at total stock market value compared to gross domestic product. In 2001, when the percentage was over 130%, Buffett said that "if the percentage falls to the 70% or 80% area, buying stocks is likely to work very well for you."

At the end of January, Fortune reported, the ratio was at 75%.

The ultimate signal to load up on stocks?

Not so fast. This is, after all, the same Warren Buffett who told Berkshire Hathaway shareholders that "We try to price, rather than time, purchases."

He went on to say:

In our view, it is folly to forego buying shares in an outstanding business whose long-term future is predictable, because of short-term worries about an economy or a stock market that we know to be unpredictable. Why scrap an informed decision because of an uninformed guess? ... We have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist.

In other words, it's foolish to abstain from buying because stocks in general appear "overheated," just as it's foolish to buy willy-nilly because stocks appear "cheap." Investing the Buffett way (which seems to have worked out pretty well for him) is about bottoms-up fundamental analysis with a focus on long-term competitive advantages.

Which brings us to an analogy

But look, it'd be daft to ignore the fact that it's better to go fishing at some times of the day than others and that that optimal time of day is determined by the weather and moon. If you go out at the wrong time with the best bait, your chances of hooking a fish are diminished; if you go out at the right time with nothing more than hook and a string, your chances are improved.

Similarly, in investing, you're more likely to earn great returns if you buy when stocks across the board are cheap than if you try to find the one or two bargains at a time when stocks across the board are expensive. And that's why some macroeconomic analysis can be useful: It tells you the best times to go fishing.

And today is one of those times. As we mentioned earlier, the market is broadly trading for just 75% of GDP, and on an individual level, many of the market's most impressive companies are trading at enormous discounts relative to their norms:

Company
Current P/E ..... 5-Year Average P/E

Google (Nasdaq: GOOG)
29.5 ..... 67.1
Johnson & Johnson (NYSE: JNJ)
11.6 ..... 17.8
Boeing (NYSE: BA)
10.5 ..... 20.9
Intuitive Surgical (Nasdaq: ISRG)
25.4 ..... 53.8
IBM (NYSE: IBM)
11.3 ..... 15.5
Disney (NYSE: DIS)
9.7 ..... 17.3
Data from Morningstar.

So, I buy those six stocks? Now, this doesn't mean that all of these stocks will beat the market from here on out, but it does mean that now is a great time to go fishing for top stocks in your portfolio.


Brian Richards does not own shares of any companies mentioned. Tim Hanson owns shares of Berkshire Hathaway. Google and Intuitive Surgical are Motley Fool Rule Breakers picks. Berkshire and Disney are Stock Advisor and Inside Value recommendations. Johnson & Johnson is an Income Investor selection. The Fool owns shares of Berkshire Hathaway. The Fool's disclosure policy says that if you're looking for fishing advice, try arkansasstripers.com -- but be careful when typing in the URL -- it learned the hard way and ended up having a talk with our IT department.

http://www.fool.com/investing/general/2009/04/20/the-ultimate-signal-to-load-up-on-stocks.aspx

Quality check to weed out company with an insatiable demand for capital.

Quality check to weed out company with an insatiable demand for capital.

Benjamin Graham and followers placed great emphasis on financial strength, liquidity, debt coverage and so on. It was the tune of the times.

Credit analysis today continue to check all manner of coverage (e.g. interest coverage) and debt ratios, but for most companies reporting a profit, it maybe overkill.

Here are a few checks to provide a margin of safety and a further test of whether the company has an insatiable demand for capital:

1. Are current assets (besides cash) rising faster than the business is growing?

This ties to the asset productivity and turnover measures but it is worth one last check to see whether a company is buying business by extending too much credit.

More receivables result from extending credit.

Losing channel structure and supply chain battles (customers and distributors won't carry inventory; suppliers are making them carry more inventory) result in increased inventories.

In a soft construction environment, distributors and retailers like Home Depot and Lowe's simply aren't taking as much inventory, pushing it back up the supply chain. The main supplier's risk is greater capital requirements and expensive impairments downstream.

2. Is debt growing faster than the business growth?

Over a sustained period, debt rising faster than business growth is a problem.

If the owners won't kick in to grow the business, and if retained earnings aren't sufficient to meet growth, what does that tell you? The business is forced to seek capital.

3. Repeated trips to the financial markets?

If the business continually has to approach the capital markets (other than in startup phases), that again is a sign that internally generated earnings and cash flows are not sufficient.

Once in a while it is okay, but again one is looking to weed out chronic capital consumers.

Two important things in the capital structure of the business

Capital Structure

When looking at capital structure, try to determine two things:

1. Is the business a consumer or producer of capital? Does it constantly require capital infusions to build growth or replace assets? Warren Buffett - and many other value investors - shun businesses that cannot generate sufficient capital on their own. In fact, one of the guiding principles behind Berkshire Hathaway is the generation of excess capital by subsidiary businesses that can be deployed elsewhere.

2. Is the business properly leveraged? Overleveraged businesses are at risk and additionally burden earnings with interest payments. Under-leveraged businesses, while better than overleveraged, may not be maximizing potential returns to shareholders.

Buy low, improve your chances

Buy low, improve your chances


Value investors buy cheap. Why? Two reasons:

1. Provide a margin of safety.
2. Allow for proportionally better returns on dollars invested.

The most common investing mistake is throwing good money after bad. (This refers to buying a lousy company.)

The second most common investing mistake is finding and buying a great company (with growth, intrinsic value, supporting fundamentals, and intangibles all there), but paying too much for it.

Paying too much simultaneously creates downside vulnerability and limits upside potential.

The mathematics of underperformance should be reason enough to buy cheap and provide oneself with that safety margin.

Deja Vu: 5 "New" Rules For Safe Investing

Deja Vu: 5 "New" Rules For Safe Investing
by James E. McWhinney (Contact Author Biography)


Investors were hammered by massive declines as a recession swept the globe in 2008 and 2009. In the midst of the chaos, experts began calling many decades-old investment practices into question.

Is it time to try a new approach?

Let's take a look at five trusted investment strategies to examine whether they still hold up in a post-credit crisis. (For background reading, see Recession-Proof Your Portfolio.)

1. Buy and Hold

By 2009, the global economic malaise had erased a decade's worth of gains. Buying and holding turned out to be a one-way ticket to massive losses. From 2007 to 2008, many investors who followed this strategy saw their investments lose at least 50%. So does a down market mean that buy and hold is done and gone? The answer is "no". In fact, history has repeatedly proved the market's ability to recover. The markets came back after the bear market of 2000-2002. They came back after the bear market of 1990, and the crash of 1987. The markets even came back after the Great Depression, just as they have after every market downturn in history, regardless of its severity. (To learn more, read A Review Of Past Recessions.)

Assuming you have a solid portfolio, waiting for recovery can be well worth your time. A down market may even present an excellent opportunity to add holdings to your positions, and accelerate your recovery through dollar-cost averaging. (For more insight, see DCA: It Gets You In At The Bottom.)

2. Know Your Risk Appetite

The aftermath of a recession is a good time to reevaluate your appetite for risk. Ask yourself this: When the markets crashed, did you buy, hold or sell your stocks and lock in losses? Your behavior says more about your tolerance for risk than any "advice" you received from that risk quiz you took when you enrolled in your 401(k) plan at work. (For more insight, see Risk Tolerance Only Tells Half The Story.)

Once you're over the shock of the market decline, it's time to assess the damage, take at look what you have left, and figure out how long you will need to continue investing to achieve your goals. Is it time to take on more risk to make up for lost ground? Or should you rethink your goals?

3. Diversify

Diversification failed in 2008 as stock markets around the world swooned. Hedge funds and commodities tumbled too. Bond markets didn't fare much better as only U.S. Treasuries and cash offered shelter. Even real estate declined. Diversification is dead … or is it? While markets generally moved in one direction, they didn't all make moves of similar magnitude. So, while a diversified portfolio may not have staved off losses altogether, it could have helped reduce the damage. (For more insight, see The Importance Of Diversification.)

Fixed annuities, on the other hand, had their day in the sun in 2009 - after all, a 3% guarantee sure beat holding a portfolio that fell by half. Holding a bit of cash, a few certificates of deposit or a fixed annuity can help take the traditional strategic asset allocation diversification models a step further.

4. Know When to Sell

Indefinite growth is not a realistic expectation, yet investors often expect rising stocks to gain forever. Putting a price on the upside and the downside can provide solid guidelines for getting out while the getting is good. Similarly, if a company or an industry appears to be headed for trouble, it may be time to take your gains off of the table. There's no harm in walking away when you are ahead of the game. (To learn more about when to get out of a stock, see To Sell Or Not To Sell.)

5. Use Caution When Using Leverage

The events that occurred following the subprime mortgage meltdown in 2007 had many investors running from the use of leverage. As the banks learned, making massive financial bets with money you don't have, buying and selling complex investments that you don't fully understand and making loans to people who can't afford to repay them are bad ideas. (For background reading, check out The Fuel That Fed The Subprime Meltdown.)

On the other hand, leverage isn't all bad if it's used to maximize returns, while avoiding potentially catastrophic losses. This is where options come into the picture. If used wisely as a hedging strategy and not as speculation, options can provide protection. (For more on this strategy, see Reducing Risk With Options.)

Everything Old Is New Again

In hindsight, not one of these concepts is new. They just make a lot more sense now that they've been put in a real-world context. In the early stages of the 2008-2009 U.S. economic downturn, experts argued that the Europe and Asia were "decoupled" from America and that the rest of the world could continue to grow while the U.S. shrank. They were wrong. When America sneezed, the rest of the world got the flu, just like always.

Now think back to the dotcom bubble of the late 1990s, when the pundits argued that technology offered unlimited promise and that companies like America Online (AOL) were the wave of the future, even when many of these companies had no profits and no hope of generating any, but still traded at hundreds of times their cash flows. When the bubble burst and the dust settled, nothing had changed. The markets worked the same way they always had.

It's Different This Time – Or Is It?

In 2009, the global economy fell into recession and international markets fell in lockstep. Diversification couldn't provide adequate downside protection. Once again, the "experts" proclaim that the old rules of investing have failed. "It's different this time," they say. Maybe … but don't bet on it. These tried and true principles of wealth creation have withstood the test of time.

by James E. McWhinney, (Contact Author Biography)

James McWhinney has been a professional writer for nearly two decades. He has worked for many of the nation's top mutual fund providers and banks in addition to numerous magazines, websites and other publications. He specializes in financial services and travel.

Book Value: Theory Vs. Reality

Book Value: Theory Vs. Reality
by Andrew Beattie (Contact Author Biography)

Earnings, debt and assets are the building blocks of any public company's financial statements. For the purpose of disclosure, companies break these three elements into more refined figures for investors to examine. Investors can calculate valuation ratios from these to make it easier to compare companies. Among these, the book value and the price-to-book ratio (P/B ratio) are staples for value investors. But does book value deserve all the fanfare? Read on to find out.

What Is Book Value?

Book value is a measure of all of a company's assets: stocks, bonds, inventory, manufacturing equipment, real estate, etc. In theory, book value should include everything down to the pencils and staples used by employees, but for simplicity's sake companies generally only include large assets that are easily quantified. (For more information, check out Value By The Book.)

Companies with lots of machinery, like railroads, or lots of financial instruments, like banks, tend to have large book values. In contrast, video game companies, fashion designers or trading firms may have little or no book value because they are only as good as the people who work there.

Book value is not very useful in the latter case, but for companies with solid assets it's often the No.1 figure for investors.

A simple calculation dividing the company's current stock price by its stated book value per share gives you the P/B ratio. If a P/B ratio is less than one, the shares are selling for less than the value of the company's assets assets. This means that, in the worst-case scenario of bankruptcy, the company's assets will be sold off and the investor will still make a profit. Failing bankruptcy, other investors would ideally see that the book value was worth more than the stock and also buy in, pushing the price up to match the book value. That said, this approach has many flaws that can trap a careless investor.

Value Play or Value Trap?

If it's obvious that a company is trading for less than its book value, you have to ask yourself why other investors haven't noticed and pushed the price back to book value or even higher. The P/B ratio is an easy calculation, and it's published in stock summaries on any major stock research website. The answer could be that the market is unfairly battering the company, but it's equally probable that the stated book value does not represent the real value of the assets. Companies account for their assets in different ways in different industries, and sometimes even within the same industry. This muddles book value, creating as many value traps as value opportunities. (Find out how to avoid getting sucked in by a deceiving bargain stock in Value Traps: Bargain Hunters Beware!)

Deceptive Depreciation

You need to know how aggressively a company has been depreciating its assets. This involves going back through several years of financial statements. If quality assets have been depreciated faster than the drop in their true market value, you've found a hidden value that may help hold up the stock price in the future. If assets are being depreciated slower than the drop in market value, then the book value will be above the true value, creating a value trap for investors who only glance at the P/B ratio. (Appreciate the different methods used to describe how book value is "used up"; read Valuing Depreciation With Straight-Line Or Double-Declining Methods.)

Manufacturing companies offer a good example of how depreciation can affect book value. These companies have to pay huge amounts of money for their equipment, but the resale value for equipment usually goes down faster than a company is required to depreciate it under accounting rules. As the equipment becomes outdated, it moves closer to being worthless. With book value, it doesn't matter what companies paid for the equipment - it matters what they can sell it for. If the book value is based largely on equipment rather than something that doesn't rapidly depreciate (oil, land, etc), it's vital that you look beyond the ratio and into the components. Even when the assets are financial in nature and not prone to depreciation manipulation, the mark-to-market (MTM) rules can lead to overstated book values in bull markets and understated values in bear markets. (Read more about this accounting rule in Mark-To-Market Mayhem.)

Loans, Liens and Lies

An investor looking to make a book value play has to be aware of any claims on the assets, especially if the company is a bankruptcy candidate. Usually, links between assets and debts are clear, but this information can sometimes be played down or hidden in the footnotes. Like a person securing a car loan using his house as collateral, a company might use valuable assets to secure loans when it is struggling financially. In this case, the value of the assets should be reduced by the size of any secured loans tied to them. This is especially important in bankruptcy candidates because the book value may be the only thing going for the company, so you can't expect strong earnings to bail out the stock price when the book value turns out to be inflated. (Footnotes to the financial statements contain very important information, but reading them takes skill. Check out An Investor's Checklist To Financial Footnotes for more insight.)

Huge, Old and Ugly

Critics of book value are quick to point out that finding genuine book value plays has become difficult in the heavily analyzed U.S. stock market. Oddly enough, this has been a constant refrain heard since the 1950s, yet value investors still continue to find book value plays. The companies that have hidden values share some characteristics:

• They are old. Old companies have usually had enough time for assets like real estate to appreciate substantially.
  
• They are big. Big companies with international operations, and thus with international assets, can create book value through growth in overseas land prices or other foreign assets.
  
• They are ugly. A third class of book value buys are the ugly companies that do something dirty or boring. The value of wood, gravel and oil go up with inflation, but many investors overlook these asset plays because the companies don't have the dazzle and flash of growth stocks.

Cashing In

Even if you've found a company that has true hidden value without any claims on it, you have to wait for the market to come to the same conclusion before you can sell for a profit. Corporate raiders or activist shareholders with large holdings can speed up the process, but an investor can't always depend on inside help. For this reason, buying purely on book value can actually result in a loss - even when you're right. If a company is selling 15% below book value, but it takes several years for the price to catch up, then you might have been better off with a 5% bond. The lower-risk bond would have similar results over the same period of time. Ideally, the price difference will be noticed much more quickly, but there is too much uncertainty in guessing the time it will take the market to realize a book value mistake, and that has to be factored in as a risk. (Learn more in Could Your Company Be A Target For Activist Investors? Or read about activist shareholder Carl Icahn in Can You Invest Like Carl Icahn?)

The Good News

Book value shopping is no easier than other types of investing, it just involves a different type of research. The best strategy is to make book value one part of what you look for. You shouldn't judge a book by its cover and you shouldn't judge a company by the cover it puts on its book value. In theory, a low price-to-book-value ratio means you have a cushion against poor performance. In practice it is much less certain. Outdated equipment may still add to book value, whereas appreciation in property may not be included. If you are going to invest based on book value, you have to find out the real state of those assets.

That said, looking deeper into book value will give you a better understanding of the company. In some cases, a company will use excess earnings to update equipment rather than pay out dividends or expand operations. While this dip in earnings may drop the value of the company in the short term, it creates long-term book value because the company's equipment is worth more and the costs have already been discounted. On the other hand, if a company with outdated equipment has consistently put off repairs, those repairs will eat into profits at some future date. This tells you something about book value as well as the character of the company and its management. You won't get this information from the P/B ratio, but it is one of the main benefits from digging into book value numbers, and is well worth the time. (For more information, check out Investment Valuation Ratios: Price/Book Value Ratio.)

by Andrew Beattie, (Contact Author Biography)

Andrew Beattie is a freelance writer and self-educated investor. He worked for Investopedia as an editor and staff writer before moving to Japan in 2003. Andrew still lives in Japan with his wife, Rie. Since leaving Investopedia, he has continued to study and write about the financial world's tics and charms. Although his interests have been necessarily broad while learning and writing at the same time, perennial favorites include economic history, index funds, Warren Buffett and personal finance. He may also be the only financial writer who can claim to have read "The Encyclopedia of Business and Finance" cover to cover.



http://www.investopedia.com/articles/fundamental-analysis/09/book-value-basics.asp


Also read: Nets and net net

Five Things To Know About Asset Allocation

Five Things To Know About Asset Allocation
by Investopedia Staff, (Investopedia.com)

With literally thousands of stocks, bonds and mutual funds to choose from, picking the right investments can confuse even the most seasoned investor. However, starting to build a portfolio with stock picking might be the wrong approach. Instead, you should start by deciding what mix of stocks, bonds and mutual funds you want to hold - this is referred to as your asset allocation.


What is Asset Allocation?

Asset allocation is an investment portfolio technique that aims to balance risk and create diversification by dividing assets among major categories such as cash, bonds, stocks, real estate and derivatives.

Each asset class has different levels of return and risk, so each will behave differently over time. For instance, while one asset category increases in value, another may be decreasing or not increasing as much. Some critics see this balance as a settlement for mediocrity, but for most investors it's the best protection against major loss should things ever go amiss in one investment class or sub-class. The consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make. In other words, your selection of stocks or bonds is secondary to the way you allocate your assets to high and low-risk stocks, to short and long-term bonds, and to cash on the sidelines. We must emphasize that there is no simple formula that can find the right asset allocation for every individual - if there were, we certainly wouldn't be able to explain it in one article. We can, however, outline five points that we feel are important when thinking about asset allocation:

Risk vs. Return

The risk-return tradeoff is at the core of what asset allocation is all about. It's easy for everyone to say that they want the highest possible return, but simply choosing the assets with the highest "potential" (stocks and derivatives) isn't the answer.

The crashes of 1929, 1981, 1987, and the more recent declines of 2000-2002 are all examples of times when investing in only stocks with the highest potential return was not the most prudent plan of action. It's time to face the truth: every year your returns are going to be beaten by another investor, mutual fund, pension plan, etc.

What separates greedy and return-hungry investors from successful ones is the ability to weigh the difference between risk and return. Yes, investors with a higher risk tolerance should allocate more money into stocks. But if you can't keep invested through the short-term fluctuations of a bear market, you should cut your exposure to equities. (To learn more about bond investing, see Bond Basics Tutorial.

Don't Rely Solely on Financial Software or Planner Sheets

Financial planning software and survey sheets designed by financial advisors or investment firms can be beneficial, but never rely solely on software or some pre-determined plan.

For example, one rule of thumb that many advisors use to determine the proportion a person should allocate to stocks is to subtract the person's age from 100. In other words, if you're 35, you should put 65% of your money into stock and the remaining 35% into bonds, real estate and cash.

But standard worksheets sometimes don't take into account other important information such as whether or not you are a parent, retiree or spouse. Other times, these worksheets are based on a set of simple questions that don't capture your financial goals. Remember, financial institutions love to peg you into a standard plan not because it's best for you, but because it's easy for them.

Rules of thumb and planner sheets can give people a rough guideline, but don't get boxed into what they tell you.

Determine your Long and Short-Term Goals

We all have our goals. Whether you aspire to own a yacht or vacation home, to pay for your child's education, or simply to save up for a new car, you should consider it in your asset allocation plan. All of these goals need to be considered when determining the right mix.

For example, if you're planning to own a retirement condo on the beach in 20 years, you need not worry about short-term fluctuations in the stock market. But if you have a child who will be entering college in five to six years, you may need to tilt your asset allocation to safer fixed-income investments.

Time is your Best Friend

The U.S. Department of Labor has said that for every 10 years you delay saving for retirement (or some other long-term goal), you will have to save three times as much each month to catch up.

Having time not only allows you to take advantage of compounding and the time value of money, it also means you can put more of your portfolio into higher risk/return investments, namely stocks. A bad couple of years in the stock market will likely show up as nothing more than an insignificant blip 30 years from now.

Just Do It!

Once you've determined the right mix of stocks, bonds and other investments, it's time to implement it.

The first step is to find out how your current portfolio breaks down. It's fairly straightforward to see the percentage of assets in stocks vs. bonds, but don't forget to categorize what type of stocks you own (small, mid, or large cap).

You should also categorize your bonds according to their maturity (short, mid, long-term). Mutual funds can be more problematic. Fund names don't always tell the entire story. You have to dig deeper in the prospectus to figure out where fund assets are invested.

There is no one standardized solution for allocating your assets. Individual investors require individual solutions.

Furthermore, if a long-term horizon is something you don't have, don't worry. It's never too late to get started.

It's also never too late to give your existing portfolio a face-lift: asset allocation is not a one-time event, it's a life-long process of progression and fine-tuning.

by Investopedia Staff, (Contact Author Biography)

Investopedia.com believes that individuals can excel at managing their financial affairs. As such, we strive to provide free educational content and tools to empower individual investors, including thousands of original and objective articles and tutorials on a wide variety of financial topics.

http://www.investopedia.com/articles/03/032603.asp

Latest Articles
Five Things To Know About Asset Allocation
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http://business.timesonline.co.uk/tol/business/industry_sectors/need_to_know/

Warren Buffett's Bear Market Maneuvers

Warren Buffett's Bear Market Maneuvers
by Dan Barufaldi (Contact Author Biography)

In times of economic decline, many investors ask themselves, "What strategies does the Oracle of Omaha employ to keep Berkshire Hathaway on target?" The answer is that the esteemed Warren Buffett, the most successful known investor of all time, rarely changes his long-term value investment strategy and regards down markets as an opportunity to buy good companies at reasonable prices. In this article, we will cover the Buffett investment philosophy and stock-selection criteria with specific emphasis on their application in a down market and a slowing economy. (For more on Warren Buffett and his current holdings, sign up for our Coattail Investor newsletter.)


The Buffett Investment Philosophy

Buffett has a set of definitive assumptions about what constitutes a "good investment". These focus on the quality of the business rather than the short-term or near-future share price or market moves. He takes a long-term, large scale, business value-based investment approach that concentrates on good fundamentals and intrinsic business value, rather than the share price. (For further reading, see Warren Buffett: The Road To Riches and What Is Warren Buffett's Investing Style?)

Buffett looks for businesses with "a durable competitive advantage." What he means by this is that the company has a market position, market share, branding or other long-lasting edge over its competitors that either prevents easy access by competitors or controls a scarce raw-material source. (For more insight, see Competitive Advantage Counts, 3 Secrets Of Successful Companies and Economic Moats Keep Competitors At Bay.)

Buffett employs a selective contrarian investment strategy: using his investment criteria to identify and select good companies, he can then make large investments (millions of shares) when the market and the share price are depressed and when other investors may be selling.

In addition, he assumes the following points to be true:
The global economy is complex and unpredictable.
The economy and the stock market do not move in sync.
The market discount mechanism moves instantly to incorporate news into the share price.
The returns of long-term equities cannot be matched anywhere else.

Buffett Investment Activity

Berkshire Hathaway investment industries over the years have included:
Insurance
Soft drinks
Private jet aircraft
Chocolates
Shoes
Jewelry
Publishing
Furniture
Steel
Energy
Home building

The industries listed above vary widely, so what are the common criteria used to separate the good investments from the bad?

Buffett Investment Criteria

Berkshire Hathaway relies on an extensive research-and-analysis team that goes through reams of data to guide their investment decisions. While all the details of the specific techniques used are not made public, the following 10 requirements are all common among Berkshire Hathaway investments:
The candidate company has to be in a good and growing economy or industry.
It must enjoy a consumer monopoly or have a loyalty-commanding brand.
It cannot be vulnerable to competition from anyone with abundant resources.
Its earnings have to be on an upward trend with good and consistent profit margins.
The company must enjoy a low debt/equity ratio or a high earnings/debt ratio.
It must have high and consistent returns on invested capital.
The company must have a history of retaining earnings for growth.
It cannot have high maintenance costs of operations, high capital expenditure or investment cash flow.
The company must demonstrate a history of reinvesting earnings in good business opportunities, and its management needs a good track record of profiting from these investments.
The company must be free to adjust prices for inflation.

The Buffett Investment Strategy

Buffett makes concentrated purchases. In a downturn, he buys millions of shares of solid businesses at reasonable prices. Buffett does not buy tech shares because he doesn't understand their business or industry; during the dotcom boom, he avoided investing in tech companies because he felt they hadn't been around long enough to provide sufficient performance history for his purposes.

And even in a bear market, although Buffett had billions of dollars in cash to make investments, in his 2009 letter to Berkshire Hathaway shareholders, he declared that cash held beyond the bottom would be eroded by inflation in the recovery.

Buffett deals only with large companies because he needs to make massive investments to garner the returns required to post excellent results for the huge size to which his company, Berkshire Hathaway, has grown. (To learn about the disadvantage of being confined to blue chip stocks, read Why Warren Buffett Envies You.)

Buffett's selective contrarian style in a bear market includes making some large investments in blue chip stocks when their stock price is very low. And Buffett might get an even better deal than the average investor: His ability to supply billions of dollars in cash infusion investments earns him special conditions and opportunities not available to others. His investments often are in a class of secured stock with its dividends assured and future stock warrants available at below-market prices.

Conclusion

Buffett's strategy for coping with a down market is to approach it as an opportunity to buy good companies at reasonable prices. Buffett has developed an investment model that has worked for him and the Berkshire Hathaway shareholders over a long period of time. His investment strategy is long term and selective, incorporating a stringent set of requirements prior to an investment decision being made. Buffett also benefits from a huge cash "war chest" that can be used to buy millions of shares at a time, providing an ever-ready opportunity to earn huge returns.

For further reading, see Think Like Warren Buffett and Warren Buffett's Best Buys.
by Dan Barufaldi , (Contact Author Biography)

Dan Barufaldi is an Independent Consultant associated with the management consulting and global business development firm, Globe Lynx Group, located in Lewiston, NY. He has a Bachelors degree in economics from Cornell University. Barufaldi has authored business articles and columns in four newspapers and several Chamber of Commerce publications.

http://www.investopedia.com/articles/stocks/09/buffett-bear-market-strategies.asp?partner=wbw4

Interesting questions in a survey

Took the survey in Investopedia today. Here are some of the interesting questions asked.

What investments currently interest you? (Check as many as apply)

Stocks

Mutual Funds

ETF

IRA/Retirement

FOREX

Options

Cash and Cash Equivalents

Futures/Commodities

Real Estate

Precious Metals

Bonds/Debt

CD/Notes/Bills

Money Market/Bank Account

None of the Above


What investments do you currently own?

Stocks

Mutual Funds

ETF

IRA/Retirement

FOREX

Options

Cash and Cash Equivalents

Futures/Commodities

Real Estate

Precious Metals

Bonds/Debt

CD/Notes/Bills

Money Market/Bank Account

None of the Above


There are many features on Investopedia. Which of the following features do you read or use? (Check as many as apply)


Latest Articles

Recent Stock Analysis

Tutorials

Exam Prep

Stock Simulator

Get Current Rates (Savings, Home Equity, Mortgate, etc.)

Other (Please Specify)



Which of the following types of method do you use to trade? (Check only one)

I trade online

I use a traditional broker

Both



On average, how often do you trade?

Several times per day

Daily

2-6 times a week

Once a week

2-3 times a month

Once a month

Less than once a month

I currently do not trade

I do not trade


On average, how many trades per month do you make?

None

1-5

6-10

11-50

51-99

100+

Don't Know


How often do you check your investments?


Everyday

2-6 times a week

Once a week

2-3 times a month

Once a month

Less often than once a month

Never check my investments


Which of the following best describes your portfolio size?


Less than $49,999

$50,000-$74,999

$75,000-$99,999

$100,000-$199,999

$200,000-$299,000

$300,000-$399,000

$400,000-499,000

$500,000-$999,999

$1,000,000+

Don't Know


Which of the following websites do you visit on a regular basis? (Check as many as apply)

Investopedia.com

WSJ.com

BW.com

NYtimes.com

FT.com

Forbes.com

Bloomberg.com

CNNmoney.com

Yahoofinance.com

Economist.com

USnews.com

Other


Which of the following best describes your age?


Under 18

18-24

25-34

35-44

45-54

55-64

65+


In the past 12 months, have you attended any school, classes, or workshops on
investing or finance related?

Yes

No

Not sure


Which of the following best describes your status?

Working full-time

Working part-time

Homemaker/Stay home parent

Student/working part or full-time

Student Only

Retired

Not Employed


Which of the following best describes the industry that you work in?


Investment Banking

Commercial Banking

Accounting

Real Estate

Mortgage Industry

Media

Retail

Telecommunications

Healthcare

Insurance

Manufacturing

Education

Other


Which of the following best describes your title?

C-Level (President, CEO, COO, CFO, CMO, CIO, etc.)

Owner/Partner

SVP/EVP

Director/GM

Manager

Consultant

Accountant

Financial Planner

Financial Adviser

Sales

Other


Which of the following best describes your total household income in 2008 before taxes?

Under $24,999

$25,000-$49,999

$50,000-$74,999

$75,000-$99,999

$100,000-$149,999

$150,000-$199,999

$200,000-$249,999

$250,000-$299,999

$300,000+

Don't Know

Halal Forum expected to generate million-ringgit deals

Halal Forum expected to generate million-ringgit deals
By Hamisah Hamid

Published: 2009/04/24


THIS year's World Halal Forum (WHF 2009) will continue its tradition of generating several hundred million- ringgit worth of deals, its organisers said yesterday.

The previous three forums resulted in about RM500 million investments from international companies, KasehDia Sdn Bhd executive director Nordin Abdullah said.

Last year's event witnessed several hundred million-ringgit worth of deals signed, and this year's instalment should see similar performance, he added.

"And this is a conservative estimate," said Nordin, who is also WHF deputy chairman.

Earlier, KasehDia managing director Jumaatun Azmi said there will be a series of memoranda of understanding (MOUs), matchmaking and joint-venture deals signed during WHF 2009 and World Halal Research Summit 2009 (WHR 2009) next month.

"You can expect a very big announcement on the first day of WHF, involving a large public-listed company," she said at a news conference yesterday, but declined to elaborate.

Halal Industry Development Corp Sdn Bhd (HDC) chief executive officer Datuk Jamil Bidin said during the event, HDC will sign an MOU with a Muslim European country to develop halal industry there.

Areas covered in the deal include halal standards, training and halal parks. He said the collaboration provides an opportunity for Malaysian companies to penetrate the European market.

Themed, "Achieving Global Halal Integrity", WHF 2009 will take place on May 4 and 5, and host two concurrent parallel sessions - one on International Halal Integrity Alliance (IHI Alliance) standards and another on business and trade.

The first draft of 10 modules for the Global Halal Standard, which is expected to be endorsed by the Organisation of Islamic Conference (OIC) standards committee in the next few days, will be presented for public comment at WHF 2009.

Besides delegates from OIC countries, other international participants will come from the US, the UK, China, India, Thailand, New Zealand and Australia.

Meanwhile, WHR 2009, a conference on new research findings, emerging technologies and trends in halal industry, will be held on May 7 and 8.

Both events will be held in conjunction with Halal Malaysia Week, which will also feature the 6th Malaysia International Halal Showcase (Mihas 2009).

The global halal food sector grows 25 per cent annually, with increasing demand for value-added halal food products from Muslim population in developed countries such as halal sausages, pizza, microwaveable food and others.

There are currently about 1.8 billion Muslims worldwide, while the global halal industry is estimated to be worth US$1 trillion (RM3.64 trillion) a year.

http://www.btimes.com.my/Current_News/BTIMES/articles/23WHF/Article/

Assessing indebtedness. How much debt is too much?

Leverage

Leverage and debt assessments are perpetually subjective and are discussed continuously by financial and credit analysts. Some debt is usually regarded as a good thing, for it expands the size of the business and hence the return on owner capital/equity. But too much is too much. Where do you draw the line?

Guiding principles include comparative analysis and vulnerability to downturns. Debt must always be paid back, whether business is good or not - so debt stops being okay when it's too large to cover during a downturn or business strategy change.

Here are a couple of supporting metrics:

Debt to equity

This old standard is common used to get a feel for indebtedness, particularly in comparison with the rest of an industry.

D/E = Total long-term debt / Equity

A company with only $300,000 in long-term debt beyond the portion currently due, against $653 million in equity is virtually debt-free. Such a debt to equity ratio well below 1% is healthy, and so it is for most businesses too. But business analysts may wonder if the company could produce a greater return by borrowing and putting more assets in play. Evidently management has decided that it isn't worth it, so hasn't. That's a better decision than borrowing funds to make the wrong investments.

The investor is left to agree or disagree with management's judgment, but debt-free companies - just like debt-free consumers - come out ahead more often.


Interest coverage

Interest coverage is the ratio of earnings to annual interest, a rough indication of how solvent or burdened a company is by debt.

Interest coverage = Earnings / Annual interest

One way to look at whether a business has the right amount of debt is to look at how much of its earnings are consumed to pay interest on it. (Prudent to keep annual interest less than 20% of earnings.)

When looking at interest coverage, a good question to ask is this: What happens to coverage if, say, business (sales) drops 20%, as in a deep recession?

Capital-intensive and Capital-hungry companies

CAPITAL SUFFICIENCY

Capital-hungry companies are sometimes hard to detect, but there are a few obvious signs.

Companies in capital-intensive industries, such as manufacturing, transportation, or telecommunications, are likely suspects.

Here are a few indicators.

1. Share buybacks

The number of shares outstanding can be a real simple indicator of a capital hungry company. A company using cash to retire shares - if acting sensibly - is telling you that it generates more capital than it needs. On the other hand, if you look at a company like IBM, ROE has grown substantially, and massive share buybacks are a major reason.

Warning! : When evaluating share buybacks, make sure to look at actual shares outstanding. Relying on company news releases alone can be misleading. Companies also buy back shares to support employee incentive programs or to accumulate shares for an acquisition. Such repurchases may be okay but aren't the kind of repurchases that increase return on equity for remaining owners. (Comment: to take a look at HaiO share buyback.)

2. Cash flow ratio

Is cash flow from operations enough to meet investing requirements (capital assets being the main form of investment) and financing requirements (in this case, the repayment of debt)?

If not, it's back to the capital markets. This figure is pretty elusive unless you have - and study - statements of cash flow.

3. Lengthening asset cycles

If accounts receivable collection periods and inventory holding periods are lengthening (number of days' sales in accounts receivable and inventory), that forewarns the need for more capital.

4. Working capital

A company requiring steady increases in workng capital to support sales requires, naturally, capital. Working capital is capital.

ROE in Action

ROE in Action

Using Value Line as the source, IBM's ROE was a paltry 5% in the 1991-1993 timeframe. At that point, now-retired chairman and CEO Louis Gerstner took over. Through a balanced combination of profitability, productivity and capital structure initiatives, ROE rose quickly to the 20-25% range in 1995, and has been over 30% for most years since. Even maintaining ROE at a steady figure requires performance improvement, unless all returns are paid to shareholders.

Share buybacks have been one of the keys to ROE performance. When Gerstner took over, IBM had about 2.3 billion shares outstanding. Today, that figure hovers at about 1.5 billion - IBM has retired about a third of its shares. Meanwhile, per-share cash flow has risen from about $3 to over $10 per share.

Looking at IBM's track record, it's clear that Gertsner placed particular emphasis on managing ROE and its components. He managed the owner's bottom line - not just sales growth, earnings reports, and image. He took the concept of ROE to heart.

2008

-----

One of the best ways to understand a concept or approach to investing is by example. It's hard to find a "pure" example of strategic financial excellence culminating in a world-class ROE performance.

Companies may perform well and indeed have ROE in their sights, but difficult business conditions or changing markets make actual performance in all areas and "drivers" a mixed bag.

A search of typical "value" businesses, even in the Buffett/Berkshire portfolio, yields mostly mixed results.

Understanding the Importance of ROE

The importance of Return on Equity (ROE)

Profits and growth drive intrinsic value.

For any fairly priced asset to increase in value over time, the value of the returns must grow.

If it isn't easy to pin down growth and the value of growth, it gets a little easier to step back and identify business characteristics that drive growth.

Sustained return on equity (ROE) implies sustained growth and blare out, "well-managed company!"

The management can control the component drivers of ROE (profitability, productivity and capital structure) to achieve growth, ROE, and hence, intrinsic value.

Whether or not you indulge in intrinsic value calculations, be aware that earnings and growth do matter.

When you look at a business, you seek consistent, growing returns on a quality asset base - achieving reasonable returns without taking on unreasonable risk.

ROE Components and Strategic Profit Formula ("DuPont formula")

ROE Components and the Strategic Profit Formula ("DuPont formula")

Some years back, the finance department at DuPont originated the "strategic profit formula." In some circles, this is called the "DuPont formula."

Return on equity = [profits/sales] x [sales/assets] x [assets/equity]

It is easy to see the links in this chain: profitability, productivity and capital structure.

These strategic business fundamentals that directly influence ROE are controlled or influenced by management. Management can influence or control these business fundamentals to maintain or increase ROE. Good managers work on each one.

When all three are strong and tight, ROE outcome is destined for success. If there is a "weakest link" (a business fundamental that is poor, failing, or declining), it can weaken the entire chain and hamper ROE indefinitely.

For each of these business fundamentals in the formula, we observe its value,

• in what direction it's going (trend) and
• how it compares to others in the industry.

Benjamin Graham 113 wise words

Just reminding myself and this may also be useful for some who are following this blog:

"The true investor scarcely ever is forced to sell his shares, and at all times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more.* Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons' mistakes of judgement." - Benjamin Graham

In these 113 words Graham summarised his lifetime of experience.

If you keep them close at hand and let them guide you throughout your investing life, you will survive whatever the markets throw at you.

For those wishing to monitor the various stock market indices in the world, visit this site.
World Market Index http://www.indexq.org/