The PE: On its way out? For the Intelligent Investor, the PE emerges as the perfect tool to evaluate the degree of disconnect between the herd and reality.

August 31st, 2010

The Wall Street Journal strikes again! This time it’s an article entitled “The Decline of the PE Ratio.” And once again, it was too hard to pass up as a topic for this blog.

The first sentence alleges that the PE ratio “is shrinking in size and importance.” And it points out that, in spite of the fact that U.S. companies announced record profits during the second quarter—beating forecasts by more than 10%—the market dropped 5% this month.

It goes on to connect the dots, making the point that “the market’s average price/earnings ratio…is in free fall, having plunged about 36% during the past year,” and claiming that, because PEs have declined while earnings have risen, that the PE ratio may no longer be a reasonable metric by which to value the market. They’re absolutely right…if the market is what you invest in!

I submit that this article simply puts the cart before the horse and lets the tail wag the dog! (How’s that for mixing a barnyard full of metaphors!)

If the exercise is to analyze the market for the purpose of forecasting where it’s going next—a waste of time for my money, but a preoccupation of the herd—then they’re right in saying the PE has little importance. It never really did! Technical analysis, the tool of the market analyst, never could be  bothered with earnings, or the other fundamentals.  The market is driven by anything but company performance, as the article correctly point out.

However, for the intelligent investor who has only a passing interest in the meanderings of the market, the PE emerges as the perfect tool to evaluate the degree of disconnect between the herd and reality. The lower the PE, especially in the face of growing corporate earnings, the more obvious it becomes that the herd doesn’t understand the nature of investing, and the wider the abyss between the herd and those who understand what investing really is.

And the easier it is to find bargains out there.

To understand the real value of the Price/Earnings ratio, read What’s a PE, and What’s it to Me?

http://www.financialiteracy.us/wordpress/2010/08/31/the-pe-on-its-way-out/#more-2331





Wall Street Journal

The Decline of the P/E Ratio

BY BEN LEVISOHN

As investors fixate on the global forces whipsawing the markets, one fundamental measure of stock-market value, the price/earnings ratio, is shrinking in size and importance.

And the diminution might not stop for a while.

The P/E ratio, thrust into prominence during the 1930s by value investors Benjamin Graham and David Dodd, measures the amount of money investors are paying for a company's earnings. Typically, companies that post strong earnings growth enjoy richer stock prices and fatter P/E ratios than those that don't.

But while U.S. companies announced record profits during the second quarter, and beat forecasts by a comfortable 10% ....

Warren Buffett - This is Always a Bad Investment

Uploaded by WarrenBuffettBlog on 1 Apr 2011

For the latest Warren Buffett, go to http://WarrenBuffettNews.com -

From 2008 to 2009 it was a once in a lifetime year. There was even more panic than the Great Depression because of how fast it came on. Congress came through into the end. We had the right people in Washington. We don't know what would have happened if other men were in that position.

This was a great opportunity to purchase a business that will be around for hundreds of years. It is the most inexpensive way for travel, and it is the best for the environment. Both of those things are going to be important in the future. There will be more people and more goods in America in the future.

If Charlie had agreed with this purchase, then it probably would have been the wrong answer. He just kin of grumbled, which is a good sign. The railroad business is highly controlled, and it is capital intensive. But it will be here, and if it provides reasonable returns, then that it good enough.

Coal is widely shipped by train. We will wean ourselves off of coal, and we will reduce our use of that over time. If someone wants to replicate a railroad company, it might take $100 million. Railroads have become far more efficient over the years. They move far more goods with fewer people.

Cash is always a bad investment. Cash has never produced anything, and its value will go down over time. We will always have cash around, but it's not good to have too much. You would much rather own a good business. Every currency will be worth less in the future. More money will be printed than there will be goods circulating in the economy.

Asians Are World's Biggest Risk Takers

In times like these of volatile markets, who's got the guts to get in the fray? Apparently, Asians do. A survey by Nielsen shows Asian consumers are more likely to stay invested. What's more - they are also more likely to put their cash in high-risk assets than their peers in Europe and the U.S.

Nielsen's Global Consumer Confidence Survey on investment attitudes shows 48 percent of consumers in the Asia Pacific region said they were invested in the markets or used investment services. That compares to just 27 percent in North America, 21 percent in the Middle East and Africa, 16 percent in Europe and 13 percent in Latin America.

Asia's appetite for risk is also seen in investors' ability to withstand market volatility. Oliver Rust, the Managing Director of Nielsen says Asian investors tend to trade more aggressively and more frequently than their European counterparts.

More than half (57 percent) of Asia Pacific consumers say they're willing to accept fluctuations of more than 10 percent. Only half of investors in the U.S. will stomach those swings and just 45 percent in Europe.

Rust says Asian investors tend to have a higher proportion of disposable income allowing them to take more risks.

Disposable incomes in Asia are higher because a growing working population has led to more households with singles, or couples without children in Asia, according to a report by Euromonitor. In fact, it says disposable income per household from 1995 to 2010 grew 13.2 percent in the U.S., while in China it surged 230 percent.

Mark Konyn, Chief Executive of Cathay Conning Asset Management says Asia's risk-taking also has to do with attitudes. "In a Western context, taking risk is often viewed as speculation, rather than investment. In Asia's high growth economies, investors typically look for higher return opportunities and tend to have shorter time horizons."

Shan Han, a sales trader at IND-X securities adds that inflation is another factor. He says "higher inflation has also meant that hoarding cash has not been a good strategy for savings because of negative real deposit rates," prompting Asian consumers to seek higher returns.

Han cites Hong Kong as an example. During most of the 1990s, annual inflation averaged 8.5 percent, while 12-month bank deposit rates averaged 6 percent. That means investors who stashed their cash in the banks were losing 2.5 percent of their savings each year.

Within Asia, Hong Kong consumers tend to be the biggest risk takers. 55 percent of Hong Kong consumers are financial investors, outweighing the global average of 33 percent.

Rust says that has to do with "new money". "First generation wealth holders tend to focus on capital growth, whereas second or third generation wealth holders tend to focus more on capital preservation," he says.

That explains why a larger number of Asian consumers pick stocks as opposed to other asset classes such as precious metals and bonds. Almost three-quarters of respondents in Asia picked equities, even though they're often seen as the riskiest assets class. In North America, only two-thirds picked stocks, and in Europe, less than half did.

Asians Are World's Biggest Risk Takers

Financial Planning The Right Way. Write down your goals, don't get emotional, and stay on course.

http://www.youtube.com/watch?feature=fvwp&v=e0G_ZKxbECM&NR=1

Malaysia National debt at RM257.2b in 2011

May 08, 2012

KUALA LUMPUR, May 8 — The country’s national debt at the end of last year stood at RM257.2 billion or 30.2 per cent of Gross Domestic Product (GDP), the Dewan Negara was told today.

Deputy Finance Minister Senator Datuk Donald Lim Siang Chai said the country’s national debt or external debt was debt borne by the country following loans obtained by the government and the private sector from overseas sources.

“It comprises the external debt of the federal government, non-financial public enterprises and private sector,” he said in reply to Senator Datuk Paul Kong Sing Chu and Senator Datuk Abdul Rahman Bakar.

Lim said the federal government’s total debt was RM456.1 billion or 53.5 per cent of GDP.

“Of the total, RM438 billion or 96 per cent was domestic debt while the balance RM18.1 billion or four per cent was external debt.

“The low external debt was in tandem with the government’s policy to give priority to domestic borrowing as the market had high liquidity, the cost of  borrowing was lower, and to minimise foreign exchange risk,” he said.

Lim said the federal government’s domestic debt sources were treasury bills, investment certificates, government securities, the Housing Loans Fund, issuance of Sukuk Simpanan Rakyat and Sukuk 1 Malaysia.

He said the holders of such instruments comprised financial institutions, insurance companies and institutions like Employees Provident Fund and Social Security Organisations.

He said sources of external debt were the international capital market through issuance of global sukuk, draw down of project loans from multilateral institutions like the World Bank, Asia Development Bank and Islamic Development Bank, and also bilateral borrowing in foreign currencies such as the US dollar, yen, euro, Canadian dollar and dinar.

“The government is committed to ensuring the debts are repaid according to schedule and so far, repayments are in order.

“This is the result of a prudent debt management approach. Last year, total debt service was RM17.7 billion or 9.7 per cent of the management expenditure,” said Lim.

In reply to Datuk Syed Ibrahim Kader, he said specifications for the new coins were in line with the finding of research conducted by Bank Negara Malaysia.

“The research was done between January and April 2009 covering discussions with the public, traders and other parties such as banking institutions and cash machine operators.

“The study’s crucial finding is that people prefer smaller and lighter coins compared with the previous ones,” he said.

He said the trend to reduce the size and weight of coins was among major strategies adopted by central banks in enhancing technical specifications when introducing new coins. — Bernama

Online Porn Is Huge. Like Really, Really Huge. Who Knew?

Online Porn Is Huge. Like Really, Really Huge. Who Knew?
By Ashlee Vance on April 05, 2012

The good folks at ExtremeTech took it upon themselves this week to get at one of the Internet’s crucial questions—just how big are porn sites these days? The answer? Ron Jeremy big. To study porn sites, ExtremeTech turned to the DoubleClick Ad Planner tool from Google (GOOG). It’s a useful website where you can peek at information gathered by ad-serving cookies about how much traffic a website gets, the age and income of visitors, and the amount of time people spend on a site.

According to this tool, the online porn kingpin Xvideos feeds up 4.4 billion page views per month. That’s about 10 times as many as the New York Times and three times as many as CNN.com. YouPorn—another site packed full of stimulating content—notches 2.1 billion page views per month. And while people spend a few minutes per day on news sites, they tend to spend 15 minutes or more on porn sites, which would seem to say something rather definitive about, er, male stamina.

“But it’s not just men on the sites,” you shout. True, although the top porn sites count men as about 75 percent of their visitors. Breaking the stats down further, about half of the visitors make between $25,000 and $50,000 per year, while only 2 percent earn more than $150,000 per year. According to Google, the other interests of Xvideos visitors include Latin American music and gangs and organized crime, while YouPorn visitors like networking equipment and family films, so it’s an eclectic bunch.

While anyone can dig through these numbers, ExtremeTech did a nice job of adding some context to the incredible amount of data served up by porn sites. According to the Google estimates, Xvideos would record “29 petabytes of data transferred every month, or 50 gigabytes per second. That’s about 25,000 times more than your home Internet connection is probably capable of, which is a couple of megabytes per second.” Sliced another way, Xvideos will “serve up 50 gigabytes per second, or 400Gbps,” ExtremeTech writes. “Bear in mind this is an average data rate, too: At peak time, Xvideos might burst to 1,000Gbps (1Tbps) or more. To put this into perspective, there’s only about 15Tbps of connectivity between London and New York.”

Someone at YouPorn chatted with ExtremeTech and said the Google estimates are way below actual totals. YouPorn stores more than 100TB of porn and feeds up about 28 petabytes per month.

These types of figures put the top porn sites in a class that only Microsoft (MSFT), Google, and Facebook really surpass. My takeaway from this is that companies such as Dell (DELL) and Cisco Systems (CSCO) make a ton of money selling gear to the top porn sites and that these companies must have some very savvy engineers.

Vance is a technology writer for Bloomberg Businessweek.

The Signature PE

The signature PE is the somewhat unique price-earning ratio that is tied to a company.  Over time a company consistently attracts investors at a certain multiple of earnings.

Is this rational?

"Would your car's value change so much?"
Market price volatility is the friend of a value investor.

The Demand for Chocolate Slumps

European cocoa grindings-a key ingredient in the production of chocolate-fell by 18% in the second quarter of 2012, the largest quarterly drop for 12 years amid worsening consumer demand in Europe and Asia. Dow Jones's Neena Rai reports. 7/12/2012 8:06:52 AM2:36

Any price - and therefore P/E - movements that is not related to the company's earnings is transient.

The stock market is governed by a diverse set of influences.  And just as the sea is, it is predictable over the long term but not over the short term.

Probably the most widely watched reason for the long-term fluctuations of the price and P/E is the rise and fall of the stock market itself.  This can be a function of the economy's volatility.  The economy is battered by the rise and fall of interest rates, by inflation, and by a variety of factors that drive consumer confidence or buying power up or down.  Actual changes in the economy itself will cause longer-term changes in the market and the prices of its individual stocks.  Speculation about such changes has a shorter-term effect.

In the shorter term, there are the ripples and wavelets.  Every little utterance of a government official or company offer, insider buying or selling (which may or may not mean anything), rumour, gossip, and just about anything else can influence the whims of those on the street.  Many people will use these stories to try to make or break a market in the stock.

Over the life of a company, its fair P/E - the "normal" relationship between a company's earnings and its stock's price - is relatively constant.  It does tend to decline slowly as the company's earnings growth declines, which happens with all successful companies.  For all practical purposes, however, that relationship is remarkably stable.  And for that reason, it's also remarkably predictable.

When a company's earnings continue to grow, so will its stock price.  Conversely, when earnings flatten or go down, the price will follow.

The little fluctuations in the P/E ration above and below that constant (fair) value are not so predictable because they are all caused by investor perception and opinion.  Think of them as the winds that blow across the surface of the sea.

The broader moves above and below the norm are the undulations that are typically caused by the continuous rising and falling of analysts' expectations.  When a company first emerges into its explosive growth period, the analysts expect earnings to continue to skyrocket.  Earnings growth estimates in the 50% range or more are not uncommon.

As the company continues to meet these expectations, investor confidence booms along with it, and more investors pay a higher and higher price for the stock.  The P/E rises as a meteor right along with the price.  The faster the growth, the higher the P/E.  This does nothing to alter the value of the "reasonable or fair" P/E multiple.  It just means that investor confidence has risen well above that norm and that there will eventually be an adjustment.

Sure enough, one fine day when the analysts' consensus called for growth of 45%, the company turns in a "disappointing" earnings growth of only 38%.  The analysts start wringing their hands because the company has not met their expectations, and some fund manger sells.  Next, all of the lemmings on Wall Street follow suit.  And not long thereafter you get a call from your broker telling you that you've had a nice ride, you've made a lot of money on the stock, and it's time to take your profit and get out.  In the meantime, the broker has made a commission on your purchase and is hoping to make it on your sale as well.

After a while, after the price and the P/E have plummeted and then sat there for a while, some analyst wakes up to the fact that a 34% earning growth rate is still pretty darn good and jumps back in.   Soon the cycle is reversed.  The market starts showing the company some respect again.  And you get a call from your broker.

Of course, as a smart intelligent investor you didn't sell it in the first place!  Because you were watching the fine earnings growth all along, you knew better than to sell.  And you chose the opportunity to buy some more.  In the meantime, your brokers'; clients who were not so savvy has taken their profits (and, had paid the taxes on them, by the way) and are now wishing that they had stayed in with you.  By the time their broker called them again, the price had already climbed past the point where it made good sense for them to jump in again.

It is best to assume that any price - and therefore P/E - movements that is not related to the company's earnings is transient.  If the stories - not the numbers - cause the price to move, the change won't last.  What goes up will come down, and what goes down will come up.,  You have to be concerned only when the sales, pretax profits, or earnings cause the change, and then only if you find that the performance decay is related to a major long-term problem that is beyond the management's ability to resolve.

Remember also that a sizable segment of Wall Street doesn't make its money investing as you do; it makes its money on the "ocean motion."  Buy or sell, it makes little difference to them what you do.  They make their money either way.  But it sure makes a big difference to you!

Understanding the Financial Crisis - very well explanation!

Compound Interest: Present Value/Future Value

Equity Bond

To Warren Buffet's way of thinking, companies with durable competitive advantage have such consistent earnings that their stocks become a sort of bond.  He calls the stock an equity/bond, and it pays an interest rate equal to the yearly return on equity that the business is earning.  The earnings-per-share figure is the equity/bond's yield.  If the company has a shareholders' equity value (book value) of $10 a share and net earnings of $2.50 a share, Warren would say that the company is getting a return on its equity/bond of 25% ( $2.50 / $10 = 25%).

But since a business's earnings fluctuate, the return on the equity/bond is not a fixed figure as it is with other bonds.  Warren belives that with an equity/bond, one is buying a variable rate of return, which can be positive for the investor if earnings increase, or negative if earnings decrease.  The return on the equity/bond will fluctuate as the relationship of equity (book value) to net earnings changes.

http://books.google.com.my/books?id=COhQRkmYD_sC&pg=PA215&lpg=PA215&dq=equity+bond+of+buffett&source=bl&ots=_eVqbLzNyw&sig=uRfYVkjehVk5rrjw1v0l-vvo-hs&hl=en&sa=X&ei=55_uT5erGo_zrQfi4vm9DQ&ved=0CFMQ6AEwAjiCAQ#v=onepage&q=equity%20bond%20of%20buffett&f=false

Great Companies

"Great" Business Leadership Defined

"Great" business leadership refers to the world-class business leadership and financial results described in the business best seller,Good to Great - listed as one of Amazon's Top 100 books and one of Amazon's top leadership books for the last 10 years.

The book's research team analyzed the financial results of 1,435 companies (all companies listed on the Fortune 500 list, 1965-1995). After an extensive review of the financial performance of these companies, it was determined that 11 companies stood out from the rest.These companies achieved incredible financial results - going from "good" to extraordinarily "great" financial results.

"Great" companies achieved an 6.9x greater financial results than the general market
for 15 years following their transition point from "Good" to "Great" financial results. 

http://www.johnlutz.com/resume/ecommerce/good_to_great.htm

Margin of Safety — Your Safety Net

Stock valuation is not an objective science — you cannot just plug in numbers and come up with a price set in stone. There is a lot of subjectivity around it such as your familiarity with the industry and the company, your projections on the future of the company, your evaluation of management competency, etc.

So if the outcome of the valuation process is so uncertain, do we even need to bother doing all the work?

We think it is well worth it. The process forces you to think about and research the company, its structure and functioning, the way it generates cash. We recognize the probabilities associated with the final price. As an added level of protection, we use a margin of safety.

What is Margin of Safety?

Let's consider an example.

When engineers design a bridge, several variables go into their calculations. The bridge needs to hold up against the heaviest load allowed and should also be strong enough to overcome normal wear and tear over the years.

A bad design will lead to failure, which would be disastrous. That's why, when choosing the material and its thickness in the design phase, engineers use what is called a factor of safety to minimize the probability of failure.

So they estimate, for example, the highest load the bridge would encounter. Then they bump this number up by multiplying it with a factor — the factor of safety. Now the bridge may never ever have to bear such load, but it still is designed for that.

A bridge is a complex engineering structure requiring intricate design. What if some of the assumptions in the design were wrong or off target? The factor of safety helps guard against inaccurate assumptions.

In stock investing, margin of safety behaves identically to the factor of safety in mechanical design.

When you value a stock, you use certain assumptions on the future of the company. As time goes by, some of these assumptions will most likely be off. Using a margin of safety on the estimated price helps reduce potential losses.

How Do We Use Margin of Safety?

Let's say you're doing your valuation on a company that owns a chain of restaurants. You come up with a fair price of $25.

Let's also say that you are very familiar with the restaurant business and have actually worked in that field. You've even gone out to eat several times at this particular chain. You feel fairly confident that this restaurant has the potential to continue it's profitable streak.

What price should you buy the stock at?

No matter how well you know the business, the future will not play out exactly like you've assumed. So we don't think you should buy it at $25.

How much of a discount margin should we apply? Since you're pretty familiar with the business and have done good research, you could probably use a discount margin of 20 to 30%. In other words, you could buy the stock for 70 to 80% of your estimated price, which works out to $17.50 to $20.

This 20 to 30% discount is your margin of safety.

The less confident you are in your assumptions, the higher the margin that should be applied. We tend to use 30 to 50% (i.e. we shoot for a price that is 50-80% of our estimated price).

In addition, think of what would happen if your assumptions turn out to be fairly conservative and the company does much better than you assumed. That discount margin now boosts your returns significantly!

In summary, we discussed what exactly margin of safety is and why we need it. We looked at an example to help us apply this concept.

Your discount margin will depend on your familiarity with the company, the quality of its fundamentals, how good its management is, and your projection of its future business growth, among other factors. The more uncertain you think your price estimate is, the higher the margin you should use.

http://www.independent-stock-investing.com/Margin-Of-Safety.html

BUFFETT’S EQUITY BOND.

BUFFETT’S COMPANY ANALYSIS TEMPLATE.

Below is a Summary of what Warren Buffett targets in a company’s three Financial Statements and his use of his Equity Bond Theory in order to evaluate a company and to determine a preferable purchase price.

In my opinion, one could regard all these requirements as a form of COMPANY ANALYSIS TEMPLATE with which an Industrial type company should comply in order to satisfy Buffett’s Investment Criteria, which should, in turn, lead to a profitable long-term investment.

_______________________________________________________________

INCOME STATEMENT.

GROSS PROFIT :- Gross Profit = Cost of Sales/Revenue >40%

SG&A EXPENSES :- SG&A < 30% x Gross Profit

R&D EXPENSES :- Little or Nil

DEPRECIATION :- Depreciation < 10% x Gross Profit

INTEREST EXPENSE :- Interest Expense < 15% x Operating Income (i.e. EBIT)

PRETAX INCOME :- VERY IMPORTANT NUMBER, especially for previous 12 months

NET EARNINGS :- Net Earnings > 20% x Total Revenue

EARNINGS PER SHARE :- 10 Year Trend showing Consistency & Upward Trend

_______________________________________________________________

BALANCE SHEET.

ASSETS.

CASH & SHORT TERM INVESTMENTS :- Ongoing increase from Business Operations NOT from One-Time events

INVENTORY :- Corresponding Rise in both Inventory & Net Earnings

CURRENT RATIO :- Current Assets/Current Liabilities < 1, due to Strong Earning Power

PROPERTY, PLANT & EQUIPMENT :- Low as possible

LONG TERM INVESTMENTS :- Large as possible. Should be Quality Investments, preferably in other DCA companies

RETURN ON ASSETS (ROA) :- High BUT with Large Total Assets to reduce Vulnerability

LIABILITIES.

SHORT TERM DEBT :- Avoid bigger borrowers of Short Term money rather than Long term money

LONG TERM DEBT DUE :- Little or Nil

LONG TERM DEBT :- Long Term Debt < 3 x Annual Net Earnings

DEBT/SHAREHOLDER’S EQUITY :- Debt/S.H.Equity < 0.8 where S.H.Equity INCLUDES Value of Treasury Stock

PREFERRED STOCK :- Nil

RETAINED EARNINGS :- Annual Increase > 7%

TREASURY STOCK :- Should appear and be regularly purchased

RETURN ON SHAREHOLDER’S EQUITY (ROE) :- Net Income/S.H.Equity > 25%

_______________________________________________________________

CASH FLOW STATEMENT.

INVESTING OPERATIONS :- Based on +/-10 Year Period, Capital Expenditure/Net Earnings < 50%

For DCA company this ratio is consistently < 25%.

FINANCING ACTIVITIES :- “Issuance (Retirement) of Stock, Net” to be a regular NEGATIVE Value.

This indicates a NET Buying Back of its own Shares compared to a NET Issuance of its Shares.

_______________________________________________________________

BUFFET’S EQUITY BOND.

THE THEORY. 

Companies with DURABLE COMPETITIVE ADVANTAGE (DCA) can be seen as an EQUITY BOND with a COUPON.

Equity Bond = Share Price
Bond Coupon = Pretax Earnings/Share

DETERMINE SHARE PRICE. 

Stock Market will price a DCA company’s Equity Bond at a level that approximately reflects the Value of its Earnings RELATIVE to the Yield on LONG TERM CORPORATE BONDS (LTCB)

Equity Bond = Share Price = Coupon Rate/Long Term Corporate Bond Rate (LTCBR)
Coupon Rate/LTCBR = Pretax Earnings/LTCBR

WHEN TO BUY. 

(1) Buy during Bear Markets or when share prices are depressed due to no fault of the company

(2) Buy when Share Price < Pretax Earnings per Share/LTCBR by a reasonable discount

WHEN TO SELL.

(1) Sell when presented with a BETTER company at a BETTER Price

(2) Sell when a current DCA company is losing its Durable Competitive Advantage

(3) Sell during Bull Markets or when prices are at unrealistically HIGH levels

(4) Sell when P/E ratios > 40+, especially if the stock’s price far EXCEEDS THE LONG-TERM ECONOMIC REALITIES OF THE BUSINESS


http://www.siliconinvestor.com/readmsg.aspx?msgid=26423391

BUFFETT’S 'EQUITY BOND' STRATEGY.

BUFFETT’S 'EQUITY BOND' STRATEGY. (A) THE THEORY. Warren Buffett has determined that companies which show great Strength and Predictability in Earnings Growth, especially those with Durable Competitive Advantage (DCA), can be seen as a kind of EQUITY BOND with a COUPON. The company’s SHARE PRICE equates with the EQUITY BOND, and their PRETAX EARNINGS/SHARE equates with a Bond’s COUPON or INTEREST PAYMENT. Therefore .... EQUITY BOND = SHARE PRICE BOND COUPON = PRETAX EARNINGS/SHARE The DIFFERENCE between a normal Bond’s Coupon Rate and an EQUITY BOND’s Coupon Rate is that the former’s rate remains static while the latter’s rate can increase yearly due to the inherent Positive Performance of a DCA company. This is how Buffett buys an Entire Business or a Partial Interest in a company via the Stock Market. He interrogates its PRETAX EARNINGS and then determines if the purchase is a Good Deal relative to the ECONOMIC STRENGTH of the company’s underlying Economics and its ASKING PRICE. The strong underlying Economics of DCA companies ensures a CONTINUING INCREASE in the company’s PRETAX EARNINGS which gives an Ongoing Increase in the EQUITY BOND’s COUPON RATE. This results in the INCREASE in the VALUE of the EQUITY BOND and hence its SHARE PRICE. Here’s how Buffett’s Theory works .... In the 1980’s Buffett bought Coca Cola shares for $6.50c against PRETAX EARNINGS of $0.70c/share. Buffett saw this as buying an EQUITY BOND paying an INTEREST RATE of 10.7% (0.70/6.50) on his $6.50 investment. Historically, Coca Cola’s Earnings had been increasing at an annual rate of about 15%. Therefore he could argue that his 10.7% Yield would increase at a projected Annual Rate of 15%. By 2007 Coca Cola’s PRETAX EARNINGS had grown at about 9.35%/annum to $3.96c/share. Buffett now had an EQUITY BOND with a Pretax Yield of 61% (3.96/6.50) which could really only increase with time due to Coca Cola’s DCA “status”. (B) DETERMINE SHARE PRICE. From his own experience Buffett has determined that the Stock Market will price a DCA company’s EQUITY BOND at a level that approximately reflects the VALUE OF ITS EARNINGS RELATIVE TO THE YIELD ON LONG TERM CORPORATE BONDS. This can be written as the following equation .... EQUITY BOND = SHARE PRICE = COUPON RATE/LONG TERM CORPORATE BOND RATE (L.T.C.B.R.) and .... COUPON RATE/(L.T.C.B.R.) = PRETAX EARNINGS/( L.T.C.B.R.) Examples :- (1) In 2007 The Washington Post had Pretax Earnings of $54/share = Coupon Rate. The L.T.C.B.R. was about 6.5%. EQUITY BOND = Coupon Rate/L.T.C.B.R. = $54/6.5% = $830/share. In 2007 The Washington Post shares traded between $726 and $885 a share. (2) In 2007 Coca Cola had Pretax Earnings of $3.96/share = Coupon Rate. The L.T.C.B.R. was about 6.5%. EQUITY BOND = Coupon Rate/L.T.C.B.R. = $3.96/6.5% = $61/share. In 2007 Coca Cola shares traded between $45 and $64 a share. (The following web site will give you values for Corporate Bond rates :- http://finance.yahoo.com/bonds/composite_bond_rates ) The stock market, seeing this ongoing return, will eventually revalue these EQUITY BONDS to reflect this increase in Value. Because the Earnings of these companies are so consistent, they are also open to a LEVERAGED BUYOUT. If a company carries little debt and has ongoing strong earnings, and its stock price falls low enough, another company will come in and buy it, financing the purchase with the acquired company’s earnings. Therefore, WHEN INTEREST RATES FALL, the company’s EARNINGS ARE WORTH MORE because they will SUPPORT MORE DEBT, which makes the company’s shares worth more. Conversely, WHEN INTEREST RATES RISE, EARNINGS ARE WORTH LESS because they will SUPPORT LESS DEBT, making the company’s shares worth less. In the end it is LONG-TERM INTEREST RATES that determines the Economic Reality of what Long-Term investments are worth. (C) WHEN TO BUY.  In Buffett’s world the PRICE you pay directly affects the RETURN on your INVESTMENT. Therefore the MORE one pays for an EQUITY BOND the LOWER will be the INITIAL Rate of Return and also the LOWER the RATE OF RETURN on the company’s EARNINGS in, say, 10 years time. Example :- In the late 1980’s Buffett bought Coca Cola for about $6.50c/share. The company was earning about $0.46c/share after tax. Initial Rate of Return = 0.46/6.50 = 7%. By 2007 Coca Cola was earning $2.57c/share, after tax. Rate of Return = 2.57/6.50 = 40%. If he had originally paid, say, $21/share back in the 1980’s his Initial Rate of Return would only have been 2.2%, and this would have only grown to about 12% ($2.57/$21) 20 years later in 2007, which is a lot less than 40% ! Therefore the LOWER THE PRICE one pays for a DCA company the BETTER one will do OVER THE LONGER TERM. SO WHEN DO YOU BUY INTO DCA TYPE COMPANIES ? One of the best times to buy into these companies is during BEAR MARKETS when the price of shares are generally depressed, in some cases due to no fault of a DCA type company but due to adverse Market conditions. This is in line with Buffett’s creed that one should “Be Greedy When Others Are Fearful”. In addition, one can also buy into a DCA type company when its price is at a discount to the price obtained from the formula in (B) above .... Once again, referring to Coca Cola, we see that ... Pretax Earnings per Shares in the late 1980’s = $0.70c. At that time the L.T.C.B.R. was about 7%. That would give a “Market Valuation” = $0.70/7% = $10 per share. Buffett bought it at $6.50c/share, a “discount” of 35%. (D) WHEN TO SELL, OR NOT TO BUY.  There are at least THREE occasions ... (1) One can SELL when one needs the money to invest in an even BETTER company at a BETTER PRICE. (2) One can SELL when, what was a DCA type company, is now losing its Durable Competitive Advantage. Examples could be Newspapers and Television Stations which were great businesses until the advent of the Internet and the Durability of their Competitive Advantage could be called into question. (3) One can SELL, or NOT BUY, during BULL MARKETS when the stock market often sends share prices through the ceiling. At these times the current selling price of a DCA’s stock often far EXCEEDS the long-term ECONOMIC REALITIES of the business. Eventually, these Economic Realities will pull the share price back down to earth. In fact, it may be time to SELL when one sees P/E ratios of 40, or more, in these great companies. To once again quote Buffett ... at these times, “Be Fearful When Others Are Greedy”.

http://www.siliconinvestor.com/readmsgs.aspx?subjectid=56822&msgnum=1131&batchsize=10&batchtype=Previous

July 9, 2012 7:53 AM

How to tell people what they don't want to hear

Steve Tobak

(MoneyWatch) COMMENTARY Everyone knows how hard it is to achieve any kind of objectivity when you're too close to an important situation. Why we dig ourselves in deeper instead of stepping back to gain some perspective is a mystery. It's also human nature.

Just when we need a clear head, we do our very best to bury it in denial and drama. It's probably happened to each and every one of you at some point. But you know what? You're in good company. Top executives from big companies do it all the time.

For years, former Sony CEO Howard Stringer tried to convince everyone who would listen there was synergy between the company's consumer electronics products and its movie business. There isn't. Not even a little. He should have known better. Now the company's falling apart at the seams.

10 big mistakes successful leaders make10 signs you're in denial

Even as Apple and Google took the smartphone and tablet worlds by storm, Blackberry maker RIM's founders spent years thinking their little Crackberry kingdom was safe and sound. Nokia's leaders made the same fatal mistake. Now both of these once great companies are fighting for survival. 

Ever wonder how you could possibly know when executives at your company or one you invested in are doing something remarkably dumb when you're on the outside with no information? Now you know. Sometimes you can see what they can't. 

I've made a career out of giving executives, management teams, and individuals advice they could easily have figured out on their own. It's not that I see things others don't. When I'm knee-deep in a sticky situation, I'm just as myopic as the next guy. Ironic, isn't it?

In any case, there's a distinct, five-step method for getting people to see what's right in front of their face. Whether it's a CEO, an executive management team, or someone stuck in her career, the process is more or less the same:

Get the straight story from everyone involved. It's amazing what you can find out just by sitting down one-on-one with people and asking a few leading questions. Eventually, they'll spill their guts. Just make sure you hit all the key stakeholders so you get a complete picture of what's really going on.

Guarantee anonymity to "sensitive" sources. The best sources of information usually have very good reasons to remain anonymous. That's fine. It's powerful enough to tell a CEO what customers, employees, or managers have to say without identifying them. Just make sure you never give anyone a reason to doubt your confidentiality or it'll blow up in your face.

Make sure you get it right. Take your time, and make sure that the conclusions you reach are the right ones before you even think about how you're going to share that information. Also make sure it hits home. The reason is simple. If there's a reasonable chance you're wrong, your conviction and confidence will waiver and it won't ring true -- which is exactly as it should be.

Hit hard and all at once. After you get all your ducks in a row and it's time to present whatever it is you've figured out, put your pitch together and hit all the key stakeholders straight between the eyes with both barrels. If you don't have compelling data and anecdotes to present, it won't be enough to get everyone over their denial or whatever is keeping them from seeing the truth on their own. Also, if everyone's there, any doubt, finger-pointing, blame games, whatever can be dealt with in real time.

Always be straight, never BS. Never say you're sure when you're not or your credibility will be shot. People have to know you mean what you say and say what you mean. Remember, you're not there to sell anybody on anything, just to get them to see the truth. Keep it genuine and simple and there's a good chance you'll see heads nodding up and down instead of left to right.

One more very important thing. I've done this enough times to know it doesn't always work. When that happens, don't be defensive; just walk away and move on knowing you've done your best. One time many years ago, in the face of undeniable evidence, both qualitative and quantitative, the CEO of one $500 million company remained in denial and refused to see what was right in front of his face. That guy's now out of a job because the company no longer exists. Go figure. 

http://www.cbsnews.com/8301-505125_162-57468119/how-to-tell-people-what-they-dont-want-to-hear/?tag=nl.e664

Share Buybacks: A Buy Signal You Can’t Ignore

Alexander Green, Tuesday, March 13th, 2012

Your Money >>>

Share Buybacks: A Buy Signal You Can’t Ignore

There are a number of signals that bode well for price appreciation with individual stocks: growing market share, rising sales, strong earnings growth and improving margins…But you shouldn’t overlook another excellent indicator: share buybacks.


According to Standard & Poor’s, U.S. public companies spent at least $437 billion last year buying their own shares back. That was 46% more than in 2010.


Is this a good thing? Absolutely.
Regardless of whether you’re an individual or a corporation, sitting on cash isn’t terribly rewarding these days with the average money market fund paying five one-hundredths of 1%. And if the outlook is uncertain, a business owner doesn’t want to commit to building new facilities or taking on employees that aren’t needed. Nor is it necessarily in the best interest of shareholders to distribute this cash in the form of taxabledividends.


So buying back shares often makes good sense. Why? Because when you divide net income into a smaller number of shares outstanding, you get greater growth in earnings per share. And, ultimately, that’s what drives share prices higher.


Of course, stock buybacks boost earnings per share only if they’re larger than stock issuance. Historically, that hasn’t always been the case. (Much executive compensation today comes in the form of stock options that have a dilutive effect on existing shareholders.)


But in recent quarters, the supply of shares outstanding has been shrinking. And, according to analyst Howard Silverblatt at Standard & Poor’s, during the current earnings season, 97 of the S&P 500 enjoyed a boost to earnings per share of at least 4% from repurchases alone.


More buybacks ahead
Expect to see more of these buyback announcements in the weeks ahead. Why? Because U.S. corporations are sitting on more than $2 trillion in cash. That’s enough to buy all of ExxonMobil (NYSE: XOM),Microsoft (Nasdaq: MSFT) and IBM (NYSE: IBM).

There are some caveats, however. Some companies announce their intention to buy back shares and then don’t follow through. If business conditions change, interest rates rise or cash flow decreases, a repurchase program may never get completed.


The other thing to watch is the exercise of stock options, as mentioned above. If a company is only buying back enough shares to offset the dilution that occurs when executives exercise stock options, you won’t see the buyback boost earnings per share.


But, generally speaking, share repurchase programs are a decided positive. And right now, with money cheap and corporate earnings strong, buybacks are occurring at record levels. Attractive companies in the midst of major share buybacks right now include L-3 Communications (NYSE: LLL) and ConocoPhillips(NYSE: COP).


Having your cake and eating it, too…
Of course, some analysts would rather see corporate executives buying shares with their own money rather than the company’s money. And I don’t disagree.


But sometimes you can have your cake and eat it too. In a recent study, stocks that were subject to repurchases but not insider buying beat other stocks by nearly nine percentage points over four years. But stocks that were the subject of both repurchases and insider buying beat others by a whopping 29 points over four years.


Which companies have enjoyed share buybacks and insider buying recently? Two of them are Boston Scientific (NYSE: BSX) and Bank of New York Mellon (NYSE: BK).These are the kind of companies that should handily outperform the market in the months ahead.

Wondering when you should exit the market? Use Lynch's rule of thumb.

Wondering when you should exit the market? Use Lynch's rule of thumb.

Should we all exit the market to avoid the correction?  Some people did that when the Dow hit 3000, 4000, 5000, and 6000. 

• A confirmed stock picker sticks with stocks until he or she can't find a single issue worth buying. 
• The only time I took a big position in bonds was in 1982, when inflation was running at double digits and long-term U.S. Treasurys were yielding 13 to 14 percent. I didn't buy bonds for defensive purposes. 
• I bought them because 13 to 14 percent was a better return than the 10 to 11 percent stocks have returned historically. 

I have since followed this rule: 
When yields on long-term government bonds exceed the dividend yield on the S&P 500 by 6 percent or more, sell stocks and buy bonds. 


As I write this, the yield on the S&P is about 2 percent and long-term government bonds pay 6.8 percent, so we're only 1.2 percent away from the danger zone. Stay tuned.

So, what advice would I give to someone with $1 million to invest? The same I'd give to any investor: Find your edge and put it to work by adhering to the following rules:

With every stock you own, keep track of its story in a logbook. Note any new developments and pay close attention to earnings. Is this a growth play, a cyclical play, or a value play?Stocks do well for a reason and do poorly for a reason. Make sure you know the reasons.
Stocks do well for a reason, and poorly for a reason.

1. *Pay attention to facts, not forecasts.
2. *Ask yourself: What will I make if I'm right, and what could I lose if I'm wrong? Look for a risk-reward ratio of three to one or better.
3. *Before you invest, check the balance sheet to see if the company is financially sound.
4. *Don't buy options, and don't invest on margin. With options, time works against you, and if you're on margin, a drop in the market can wipe you out.
5. *When several insiders are buying the company's stock at the same time, it's a positive.
6. *Average investors should be able to monitor five to ten companies at a time, but nobody is forcing you to own any of them. If you like seven, buy seven. If you like three, buy three. If you like zero, buy zero.
7. *Be patient. The stocks that have been most rewarding to me have made their greatest gains in the third or fourth year I owned them. A few took ten years.
8. *Enter early -- but not too early. I often think of investing in growth companies in terms of baseball. Try to join the game in the third inning, because a company has proved itself by then. If you buy before the lineup is announced, you're taking an unnecessary risk. There's plenty of time (10 to 15 years in some cases) between the third and the seventh innings, which is where the 10- to 50-baggers are made. If you buy in the late innings, you may be too late.
9. *Don't buy "cheap" stocks just because they're cheap. Buy them because the fundamentals are improving.
10. *Buy small companies after they've had a chance to prove they can make a profit.
11. *Long shots usually backfire or become "no shots."
12. *If you buy a stock for the dividend, make sure the company can comfortably afford to pay the dividend out of its earnings, even in an economic slump.
13. *Investigate ten companies and you're likely to find one with bright prospects that aren't reflected in the price. Investigate 50 and you're likely to find 5.

http://myinvestingnotes.blogspot.com/2012/01/whats-best-way-to-invest-1million-peter.html