CAN'T GO WRONG WITH A FAMILY RUN COMPANY

I have a lot of beef against the way stock markets are behaving these days and how companies and their management play chicken with investors, telling us only what they want us to know, sometimes waiting right to the time before filing for bankruptcy. There is little investors are able to do. They take their lumps and move on to play another game, hoping this time the custodian of their capital will behave in a more honest manner. I am sure you know as many examples as I, ranging from the world leading technology company, Nortel, whose CEO kept telling you all is well right to the end, to the world’s largest insurance company AIG, whose founder is still insisting that in fact he was ripped off by the current management when they turfed him out. That may have been the only reasonable decision AIG managers ever made.

What is getting me hot under the collar today is this wave of large financial companies blaming the US government and Federal Reserve for their problems and their desire to return the TARP money. Now, I am all for free enterprise and coporations reposnsible for their own fate but just two months after the fiancail world came to a dead halt, when the same banks wouldn’t even return the other’s phone call, big unfailable institutions went under or nearly did; we are being asked to trust them to handle their own affairs. Go past the obvious, this is simply a repsonse to the threat that Obama may nto let these self procalimed masters of the universe continue to pay themselves obscenely at your expense. What is the downside for the big boys; how about nothing. I just learnt that the ex-CEO of Lehman Brothers bought a new pad in New York, for several Million. Hey you can’t pass up abargian, can you, not if your uncle, Sam is ready to pay the bills when you run into trouble. If this is not heads I win, tails you lose, I don’t know what else could be. My message to the Obama administration, don’t le t them off that easy, keep the screws on.

Of course, the investors have a bigger problem, not a new problem just a tougher one. Who do we believe, the CEO’s who want to pay off the TARP money so that that they can engorge some more and may be return the company to its previous glory or be suspicious that this is yet another ruse which will lead us back into the same abyss we were in just short few months ago. I am not sure I am ready to plunge in here and buy some of these US banks particulalry because of what their management tell me. Of course, I will loose out a lot of the initial move the stocks have made and will make. But if this turn is for real and we are off to the races in economic recovery and beyond, the stock market will be much higher with enough room to prosper for some years to come.

I, for one, am looking at the other part of the stock market where investors have dumped the shares or ignored them in favour of the fast moving sectors of resources and finance. There are quite a few such casualty , particularly defensive ones which have been left for dead and not participated in the current move since March. Today I point you to the utilities sector and Atco Group (TSX: ACO.X) in particular. The stock was trading over $50 a year ago. It dropped along with the world of stocks, down to $33 in October 2008, made a series of attempts to rise along with the market but it is back down to the $34 range, even though TSX is up nearly 12% year to date in 2009.

First let me introduce you to Atco, an Alberta based what seems to be a family controlled and managed company; there are two Kiefers and two Southerns among the executives. Now, much has been said about the ill prospects of family enterprise but the recent meltdown has convinced me that families tend to look after their wealth a lot more than MBA’s for hire. Check out the way Teck has managed to escape death and how CanWest is still sputtering. There was a time when investors worried that family control will inhibit juicy buy out bids but those were the days when money was plentiful and financial players were robust. As we discussed above, there is little of such genre in the game at this time. Right now the motherly protection of a family can keep your shares safe in storms. With more than 7,700 employees and $9.8 billion in assets, ATCO Group is conglomerate of companies comprised of three main business divisions: Power Generation; Utilities (natural gas and electricity transmission and distribution) and Global Enterprises (industrial manufacturing, technology, logistics and energy services).

ATCO reported sales of over 3.2 Billion in 2008 and more recently reported $875 million in the first quarter of 2009. In both cases earnings are up amounting to $4.60 per share last year. Assuming they hold the earnings level, the stock is currently trading at less than eight times earnings. That makes the company quite undervalued according to my model. Sure, you can assign a holding company discount but this is going too far if you compare with other conglomerates in Canada. For instance Power Corporation (POW) trades closer to 18 P/E. Some may compare it with pipeline companies like TransCanada Pipelines (TRP) which trades are over 14 P/E. In fact there are very few companies other than some banks and insurance companies which trade this cheap. And for the financial companies, need I say again that my confidence in their ability to deliver what they say is much lower than this family enterprise. So, buy.

Intel a Cheap Stock?

Here is a question. Name a company that is a near monopoly in its sector, a sector that is on the cutting edge of technology, it spends the most amount of money in R&D of nearly any company on the planet, employs nothing but the best of brains and is often considered a model employer. If you thought Apple or Google or Lululemon, I don’t blame you as they are the names grabbing all the headlines and investor dollars these days and once more you just drove down that linear thinking highway. To top that, the company is actually trading at price earnings ratio of low double or high single digits. If analysts’ forecast comes true next year, then it is trading at a low P/E of 10, a level which used to be reserved for utilities and banks.

But the company I am actually thinking of is not a bank or a pipeline (which by the way trade at considerably higher multiples of P/E) but it is the leading high technology company called Intel Corporation (INTC, Nasdaq). You can’t call INTC a “has-been” microprocessor company as even today, PC’s intelligent hearts belong to this company. Curiously in the bin of lost of found stocks, Intel is not alone. Nearly all semiconductor big wigs are trading close to ten P/E. And it is not just technology companies, there is the entire drug sector which can’t find any respect and as we saw in my last article, they are practically given away the telecoms with a handsome dowry in the form of dividends to boot.

What is going on here? It seems that the split between growth and value stocks and investment strategy we learned in the eighties and nineties were actually a delusion, based on too simple a math. Coined by the famous Peter Lynch, PEG ratio (defined as growth rate divided by PE ratio) has now become the meat and potato ratio; every one talks of it and uses it to decide what value to assign a stock. Corporate finance did not have that in mind. Just because a company is likely to increase its profits from a very small base today to twice the number next year, it shouldn’t qualify as a growth stock. The trick is to keep doing that over and over and convince the street that it is going to be so.

And that is what went wrong. Yesterday’s growth companies just can’t deliver consistent increase in profits. The days when you turned your $10,000 investment in Dell to over a million in less than a decade are gone. In fact if you don’t watch it you will give back most of that million if you stick around too long. The story can be repeated for GE, Microsoft and Pfizer to name just a few.

So what is an investor to do? We could chase after the new PEG ratio titans to recreate the old magic. It is the search engine Google that will deliver the elixir or is it the fancy iPhone maker Apple. No, it is the make-my-butt-look-good (that’s how a customer described why she liked LuLu’s slacks) yoga pants maker LuLulemon Athletica. Go ahead but be prepared for heartache for the magic that was high tech of the nineties or free money by selling drugs legally is really gone for some time. It may come back but it is unlikely to be a retailer or a pipeline company. No, you have to expect and accept less.

And with that dose of reality check let me suggest that Intel, which even today is a near monopoly in microprocessors, the little chips that now drive everything from your calculator to spaceship, is still an awesome company and even a decent stock to grow old with. Would you believe that the dividend is now 2.79%, better than five year bonds? Intel Corporation makes markets and sells integrated circuits for computing and communications industries worldwide. If you want further details on what they make (or perhaps what they do not make), check out their website. If it is an intelligent electronic device, Intel has most likely got the largest share.

What it seems to be lacking is a niche product, a novelty and a fast grower like Apple’s innards. But history may be about to repeat itself. Years ago, Apple invented the small computer market and then lost it Intel Corp. (and IBM and Microsoft), whose chips run about 80 percent of the world’s PCs. Apple’s new innovation with iPhone and iPad has again moved other manufacturers to come up with similar devices like smart phones and tablet computers to compete with them. And again the new products will be open, i.e. any one can build it and make it cheaper. At the heart of this move is Intel.

Products of note to compete with Apple are many. For example, Dell has Latitude tablets based on Microsoft Windows, claims to provide a flexible and intuitive tablet-PC computing experience. Dell will begin selling a combination smart phone and tablet with a 5-inch (13-centimeter) screen in the U.K. this month. It should be in the U.S. later in the summer. Called the Streak, the device uses Googles’s Android. Hewlett- Packard is also (but using a Qualcomm chip) in a new Android product called AirLife, which it began selling in Spain this year. Both companies plan to continue offering Windows tablets.

Micro-Star is developing a tablet that uses Atom, an Intel processor originally designed for low-cost net books. Unfortunately it has less power than the iPad, Asustek Computer Inc., the Taipei-based maker of Eee PCs, has a Windows 7 tablet with an Intel dual-core chip. It can run for six hours. Still, that’s about half the 10 hours offered by the iPad.

Intel plans to improve battery life by releasing a dual- core version of Atom for tablets early next year. It will use half the power while offering enough processing to provide smooth video and fast Web surfing.

One roadblock is actually Microsoft which is so entrenched in Windows; they seem to be missing these larger opportunities. But if the PC versus Apple McIntosh war or a new TV system almost every Christmas taught us anything, it is that cheap tech products end up being adapted by the consumer en mass. Will it happen again is uncertain but that is why you are getting Intel at a forward P/E for ten, nearly half that of Apple.

Of course, before investing in a stock these days you have to check with Shamans and Tarot card readers also known as seasonal investors. You know the ones who told you to sell in May and go away while you missed nearly a double in 2009 or waited for a Santa Claus rally that never came. Well the fortune tellers’ take on technology is that you don’t buy tech in the summer, a bad time. I say you follow a Hindu priest’s ritual and eat some yogurt before taking the plunge. Apparently that wards off any evil spirits for at least a day or until your project is done.

THE BURMAH FABLE TRADE

There is a very old fable about a parrot and the bird trapper in the jungles of Burmah where the trapper sets a trap, sprinkles some seeds and waits for the hapless parrots to walk right into the trap, while chanting verses taught by a kind sage; “trapper will come, set a trap, sprinkle some seeds, don’t even go near it.” Currently the stock market feels like that trap. For months we have known about high valuation in many markets like India, China and even Canadian real estate. All central bankers have spoiled us with their generosity by keeping rates near zero forcing us to buy the seeds of destruction, either chasing higher than nothing as yield or in hopes for capital gains. Oh yes, we know the verses as well as our own sage of Omaha has taught us well. Do you think we will escape the trap? Not a chance.

Curiously most investors are still smarting form the debacle of 2008-2009. Only a very small fraction of the portfolios is anywhere near the level it saw in the fall of 2007. This is true of most equity investors, be they in North America, Europe or Asia. Back then also, there were ample signs of doom ahead.

How close are we to the precipice? What kind of evidence suits your fancy? Technicals have deteriorated in the last month to a point that you have to do some serious wishful thinking to find a pointer that says markets are still trending higher in the short term. Fundamentally, Chinese tightening is being ignored, Indian Reserve Bank seems to be a non-entity and of course Greece and Spain have joined the basket of failed economies along with Ireland and even UK. Of course we hope that there will always be lenders to the trillions demanded by US government operations to feed the already obese.

Australia has been tightening for months and it is only matter of time before we too get on the rates too-lose-to-win band wagon. Sages have long taught us that rising rates are no good for you.

How have we reacted? Like always with complete lack of concern. Investor still keep looking for reports that support a bullish view recommending the current 10% lower prices as a bargain. The question is should you bite or stay clear of the trap.

Unfortunately the answer is far more complicated than either, or. If you bite, there is certainly a better than fair chance of getting hit with another wave of selling and a further 10 or even 20% drop in value. Staying clear could be a repeat of what has been happening since March of last year as the other parrots keep piling in making the seeds even more expensive, they call it buying the dip.

I have and continue to follow the now very ancient and often ignored strategy of spreading your assets into a diversified portfolio. The term asset allocation is hackneyed and in all fairness it works much less now than it did twenty years ago. The streaming parrots have fouled it up. Nonetheless it is the least of all evils if you pay close attention.

The strategy is pretty simple; you never put all your investment in the same asset class like equity or bonds, or the same sector like oil or banks, or even in the same region like Americas or China. Implementing is much more difficult though. Not because there aren’t products available for you to do this well. Au contraire, too many products like ETF’s, closed end funds, country funds and mutual funds are spread wide and thin all over the country side by the trapper.

The problem is that most of these are the same and behave the same, so how can they achieve your primary objective of diversification? Check out the response to the market corrections or crashes by each of the asset classes including gold, going right back to 1987. No, all parrots seem to behave the same way except for a few odd ones. And it is the odd ones that you need to keep an eye on. Professor Taleb calls them Black Swans. I call them cash or cash equivalent. True, having an out of money call or put (a right to buy or sell something if it drops or rises dramatically at a really cheap price) is good insurance. But like most insurance products, they expire worthless. You really need to die (or crash) before you can collect.

So, cash is the best asset class when you don’t know how wide is the trap and how long is the trapper willing to wait for you to make the mistake and buy or sell at the wrong time. Unfortunately as we know, the central bankers have made it very difficult to make any return if you want to take no risk. They too are part of the game.

So reluctantly, I take some risk. First asset class that is still likely to stay close to even if this correction deepens, is short maturity corporate bonds. These are debts issued by the likes of banks, insurance companies and even industrial corporations like General Electric. My rationale for making this a choice sector is that if a company did not collapse over the last two years like a Lehman Brothers or Bear Sterns, chances are good that they will survive a second rout of trouble. Depending upon your need and greed, you can buy shorter term bonds (under five years) for safety and longer term (going to infinity in case of perpetual preferred shares) for decent return. In either case, I feel comfortable that as long as I follow the rule of thumb of not having ANYTHING that is more than 3% of my portfolio, I will get back my capital and some.

Of course my greed (perhaps like yours) knows no limit, so like the parrot I look for better returns at higher risk. And now, the dividend paying stocks like Canadian Banks and Utilities look mighty appetizing now that they have come down form their lofty valuations just a few weeks ago. Here I like Trans Canada, Bank of Montreal and National Bank. But whatever you do, keep an ear open for the sound of the trap snapping shut.

What to do with Preferred Shares?

Truth is defined differently, as compared to the religious definition, on Wall Street. Their truth tends to be relative. Our intellectual evolution has led us to give up the swords and six shooters as way to settle individual supremacy and rely more on the battle of wits. This happens to play out almost perfectly on the investment scene as nearly everyone is interested in accumulating wealth, even the churches and the temples need cash to pay bills. And in this pursuit of wealth playing a game of hide and seek with information has become the norm. Ones controlling information try to hide it as long as they can while those wanting to get a little edge seek and never find all. Add lawyers and the Internet into this mix which makes definition of the rules to battle wits a mine field of legalese and transmission of such information instant. Now you can see why there is such a proliferation of investment advisors and professionals as individuals give up the market and find it safer to get paid 0.25% in bank accounts. Last winter’s performance has made it quite vivid that chances are, you could lose a lot of money if uninformed.

Among the investment instruments that clearly illustrate this battle between wise and unsuspecting, preferred shares are close to the top. There are others like asset backed commercial papers (ABCP of yore) and swaps but many of these are thankfully, still fairly uncommon. Most prefs come with some sort of a clause like retraction, redemption, maturity, reset, conversion and many more. Not knowing what features adorn your piece of paper can be very unhealthy for your portfolio.

Great-West Lifeco Inc. redeemed all of its outstanding Series E first preferred shares on Dec. 31, 2009. The redemption price was $26 for each Series E first preferred share plus an amount equal to all declared and unpaid dividends, less any tax required to be deducted and withheld by the corporation. The paid-up capital of the Series E first preferred shares is $22.78 per share.

A formal notice and instructions for the redemption of the Series E first preferred shares will be sent to shareholders in accordance with the rights, privileges, restrictions and conditions attached to the Series E first preferred shares.

This is the first warning shot and you should pay heed. Many pref’s will be called as the years go by and you may face significant capital losses if you end up buying them now and get called later.

HOMEX FOR GROWING MEXICO

In every market correction, crash or significant downturn, there is at least one spectacular collapse. In this one, we have had many, from the bankruptcy of Lehman Brothers to near demise of AIG, Mae (Fannie) and the Mac (Freddie ). In Canada, one of the most significant event was the sale of AIC; a mutual fund company known for its buy, hold and prosper strategy. Other than Warren Buffet, you will be hard pressed to find a manager associating himself with buy and hold strategy these days. And even the Oracle(of Omaha) has been known to do lot more than simply buy and hold stocks; he has dabbled in silver, futures and quite a bit of trading. Is this strategy really dead or have most interpreted it wrong?

For AIC, buy hold and prosper was a great marketing strategy, not to be taken or followed literally. Investment strategy should be commensurate with asset type, region, markets and sectors. Buying and holding anything in the pulp and paper sector would surely have sent you to a poorhouse. In fact, virtually anything other than cash and bonds in the U.S. failed. Not so if you happen to be in markets like China, India or even Mexico. For these are the markets where demand has been growing steadily over the last couple of decades, placing them significantly higher than a decade ago numbers,, even after a similar or an even more pronounced trouncing they got last year. It is growth that is the key missing ingredient if you practice buy and hold here in the developed market. In other words, a buy and hold strategy is highly dependent upon the momentum in the stock market and the economy. If you hold on to an asset no matter where, that is growing steadily, producing positive earnings, the strategy works beautifully.

So, when last year a friend told me that he had bought a house on the beach in Mexico for under $50 K long before the market blew up in California where an average house went for over a million, I wanted to know who is doing this. First of all, Mexico does fit with the scenario I just described, a region where demand is likely to persist for generations not just years or decades. And practicing buy and hold in such a region should pay off and in fact has. To get in, You could go buy the country index ETF (exchange traded fund) but you have to be careful as impact of US juggernauts has made most indices in the world US like. That is one reason most markets are correlated, i.e. they go up and down at the same time. There has not been a place to hide in this mayhem. So a simple “buy the country and hold” may not be as effective as picking sectors or stocks in a growing region.

One sector that used to be a barometer of market and economy here in Canada and U.S., is real estate and construction. Unfortunately it truly has become a has been sector now; if you think the average price of a Vancouver house will continue to rise at double digit rate from the current base of over $800,000, you obviously haven’t learnt much. My thesis is to look for housing stocks in countries like India, China and Mexico. I haven’t found many Chinese construction stocks yet, but a company I have written about a few times here, Homex Development Corp. traded as an ADR (NYSE:HXM) , continues to prosper. It was Homex that built my friend’s beach front property.

Economy Stinks but Market is Up, What Gives?

The market is going up for reasons similar to the ones that drove it down last fall and this winter; uncertainty. Here is a simple example, in March most analysts thought that Bank of America will not survive, or it will lose money for many years. The stock was driven down to under $5. The company and some analysts now believe that BA will survive and may make about $1 per share next year. That is far lower than $5 estimated a year ago but is much higher than zero or a loss. So majority of investors believe that to be the case now and are willing to pay $11 today. 

Do this same exercise for all of the stocks in the DOW and you will come up with the answer to your question. Bottom line is, today most investors believe that they got it wrong in March when they sold everything and thought the world economy will be in a depression for years. Is there a chance that the current wisdom will prove to be wrong again? Quite likely.

 

As for the economy and the factory output, they will keep going down but as long as they are not getting worse than last fall, investors will be positive.

 

One reason my clients have done better than the rest is because I never bought into the depressed scenario in March and sell everything at the bottom nor am I buying into the euphoria and buy everything. On the whole I am waiting for a recovery in China to take hold. That will repair a lot of problems for exporters to China like Japan and Europe and Canada and Australia and even USA. With this as a foundation, economies will start to build themselves again. This won't be easy nor quick, making the current strategy of dividend payers and bonds a reasonable one. Although investing in China is my next objective when a second bout of pessimism hits the market which could happen any time.

 

Can I be wrong in this wisdom? Quite likely.

Do stocks still face deflationary collapse?

There is a saying in the investment world; stock markets have predicted nine out of the last five recessions. Something similar is true of depressions and Mr. Prechter. Let’s just go by facts. 

Drops in GDP, employment levels and trade are serious but no worse than any of the previous recessions. I lost my last paying job in the last recession in 1990 and I can definitely tell you that this one is not worse than the 90, 80 or even the 70’s recession. In the thirties, unemployment went to 20% and GDP dropped by 10% per year. Sure, we could get there but that is assuming all this money being thrown at the problem worldwide will not work. I doubt that. 

But Stock markets don’t follow the economy. We will have ups and downs as he suggests. But does the SP500 go to 333, or the DOW to 4000? That would mean earnings of the 500 largest companies will drop by 50%, which means all manufacturing, computer, software, oil and gas and agriculture will drop by 50%.  I doubt that too.

I do agree that government bonds are overpriced and stocks have become quite risky for now. I think that most US companies will still be around except GM and Chrysler although even they will survive in a different form. This tells me that we should be okay with good quality corporate bonds and preferred shares which pay good dividends.

 

Debt is a problem and toxic debt at the banks and mortgages which may still be in trouble will keep the economies in a soft mode for some time but does that mean people who are making a lot of money (per capita 40K +) will stop buying iPhones and plasma tv’s? Problem loans will have trouble for the banks again and they will react the same way as they did last six months or so. And yes, people will dump stocks but end of the world? Not really…

This is a probability game, so there is always a chance that every one panics and does the wrong thing with a depression to follow. Chance is less than 5% in my opinion. This is also known as the Black Swan event. So keep some cash handy to buy things if he does turn out to be right.  I think chances are most who follow Prechter will end up regretting having missed one of the better opportunities’ to buy. Gloom and doom sells newspapers and letters.

Another saying in my world; even a broken clock strokes true twice a day.

Here's the original link if you want to verify this article:
http://uk.reuters.com/article/companyNewsMolt/idUKTRE54D4IL20090514

Stocks still face deflationary collapse: Prechter