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Forget Europe. That’s old news. The next surprise might just be a bursting of Japan’s bond bubble.  Nay, a bursting of Japan itself?

According to Fitch, gross general government debt of Japan is likely to reach 239 percent of GDP by end-2012, the highest for any Fitch-rated sovereign. Moreover, Japan’s Fiscal Management Strategy envisages declines in the government debt/GDP ratio only from fiscal year 2021.

Would you lend Japan money (or any country with these financials) at rates approaching zero?

Strong private savings contribute to the country’s persistent current account surpluses. But that’s all going to change as ageing baby boomers (who the government has been borrowing money from at near zero rates – its called financial repression) start to ‘dissave’. As they get older they will stop saving and start needing the cash to finance retirement and healthcare. The result is that the government will need to turn to foreign investors for cash and they are not going to accept zero rates when the country has debt of 240% of GDP.

According to Bloomberg: “How low can bond yields go without triggering a meltdown?

“This question gains urgency as 10-year government yields disappear before the world’s eyes. At 0.83 percent, the lowest level since 2003, they hardly compensate investors for the risks inherent in buying IOUs from the most indebted nation. Public debt is more than twice the size of the $5.5 trillion economy. Worse, it’s still growing. Fitch Ratings today lowered the sovereign-credit rating by one step to A+ with a negative outlook because of Japan’s “leisurely” efforts to cut debt.

“Ignore news that gross domestic product rose an annualized 4.1 percent from the final three months of 2011. The only reason Japan is growing at all is excessive borrowing and zero interest rates. The moment Japan trims its debt, growth plunges, deflation deepens and politicians will demand that the Bank of Japan do more. That’s been Japan’s lot for 20 years now.
Yet what if the BOJ isn’t just setting Japan up for the mother of all crises, but holding the economy back?

“A bizarre dynamic is dominating Japan’s financial system, one evidenced by two-year debt yields falling to about 0.095 percent. That is below the upper range of the BOJ’s zero-to-0.1 percent target for official borrowing costs. It’s below the 0.1 percent interest rate the BOJ pays banks for excess reserves held at the central bank. Such rates raise serious questions.

“The BOJ does reverse auctions where it buys government debt from the market. Last week, it failed to get enough offers from bond dealers. Now think about that: The BOJ prints yen and uses it to buy government debt from banks, which typically hoard the stuff. Last week, banks essentially said: “No, thank you. We’d rather have these dismal interest-bearing securities than your cash, because there’s really nowhere to put that cash anyway.” Banks certainly aren’t lending.

“Politicians are pounding the table demanding that the BOJ expand its asset-purchase program. That, of course, isn’t possible. The BOJ can hardly force banks to swap their bonds for cash. So Japan is left with a problem unique to modern finance. Banks like to keep more cash on deposit at the BOJ than they need to in order to earn a 0.1 percent rate of return, which is pretty good by Japan standards. To pay that rate, the BOJ creates new money, which does nothing to help the economy.

“This dynamic keeps Japan’s monetary engine in neutral at best, and at times running in reverse. Japan’s central bank is essentially now there to support bond prices. It’s a huge intervention that gets little attention. Headlines roll every time the Ministry of Finance sells yen in currency markets. The BOJ’s debt manipulation barely registers.”

Why today?

Last year it was Iron Ore and recently it was minings services for which we suggested conventional wisdom should be questioned.  I am posting this topic today because Fitch Ratings lowered Japan’s credit ratings citing rising risks to the sovereign credit profile due to higher public debt ratios.

The long-term foreign and local currency Issuer Default Ratings were lowered to ‘A+’ from ‘AA’ and ‘AA-‘ respectively. The Negative outlook on ratings was maintained.

“The country’s fiscal consolidation plan looks leisurely relative even to other fiscally-challenged high-income countries, and implementation is subject to political risk,” Andrew Colquhoun, Head of Asia-Pacific Sovereigns at Fitch.

The agency warned that a lack of new fiscal policy measures aimed at stabilizing public finances amid continued rises in government debt ratios could lead to a further downgrade.

Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 22 May 2012.

by Roger Montgomery Posted in Foreign Currency, Global markets, Market Valuation.

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Facebook floated last week and amazingly it has been holding above its IPO price of $38 per share. I say amazingly because I reckon its value to be substantially lower. I will publish my completed calculations in the near future

Here’s a taster:  “For a purchaser of Facebook shares today and wanting 15 percent per year over the next five years (doubling your money),  Facebook’s market capitalization has to double to $200 billion without any additional shares being issued (options to be exercised will put paid to any fairy tale notions about that). Google is valued by the market today at $200 billion.  Both businesses are similar in terms of margins etc so arguably Facebook needs to increase its sales tenfold in the next five years to achieve the same valuation as Google today.  But keep in mind, Google has about $40 billion of cash in its accounts.  Facebook has nothing like that.”

For now I thought the trading in Facebook on its first day was a useful entrée to the world of High Frequency and Algorithmic trading and I also thought that comic Andy Borowitz’s tongue-in-cheek look at Facebook provided a welcome break from the doom and gloom pervading investment markets.

From: http://www.borowitzreport.com/

MENLO PARK, CA (The Borowitz Report) – On the eve of Facebook’s IPO, Founder and CEO Mark Zuckerberg published the following letter to potential investors:

Dear Potential Investor:

For years, you’ve wasted your time on Facebook. Now here’s your chance to waste your money on it, too.

Tomorrow is Facebook’s IPO, and I know what some of you are thinking. How will Facebook be any different from the dot-com bubble of the early 2000’s?

For one thing, those bad dot-com stocks were all speculation and hype, and weren’t based on real businesses. Facebook, on the other hand, is based on a solid foundation of angry birds and imaginary sheep.

Second, Facebook is the most successful social network in the world, enabling millions to share information of no interest with people they barely know.

Third, every time someone clicks on a Facebook ad, Facebook makes money. And while no one has ever done this on purpose, millions have done it by mistake while drunk. We totally stole this idea from iTunes.

Finally, if you invest in Facebook, you’ll be far from alone. As a result of using Facebook for the past few years, over 900 million people in the world have suffered mild to moderate brain damage, impairing their ability to make reasoned judgments. These will be your fellow Facebook investors.

With your help, if all goes as planned tomorrow, Facebook’s IPO will net $100 billion. To put that number in context, it would take JP Morgan four or five trades to lose that much money.

One last thing: what will, I, Mark Zuckerberg, do with the $18 billion I’m expected to earn from Facebook’s IPO? Well, I’m considering buying Greece, but that would still leave me with $18 billion. LOL.

Friend me,

Mark

Following that lighthearted distraction, if you are interested in how High Frequency Trading and [some examples] of Algorithmic (Algo) Trading looks in the real world, watch this:

As the following chart reveals (you will have to suspend reality and imagine that the future always looks exactly the same as the past) some analysts think Facebook’s growth will mimic that of other high profile social networks.  No doubt the underwriters of Facebook will hope they’re wrong.

Either way it will be more than a little interesting to watch. Did you buy shares in Facebook?  If not, why not? And if you did, what were the reasons?

Posted by Roger Montgomery, Value.ableauthor, SkaffoldChairman and Fund Manager, 21 May 2012.

by Roger Montgomery Posted in Insightful Insights, Value.able.

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PORTFOLIO POINT: Office provider Servcorp is basking in strong earnings forecasts from analysts, but a capital raising in 2010 raises some important questions about the company.

Recently (Click here), I discussed Leighton and the quality of management’s relationship with its employees. Here I look at another company with a shareholder who holds a controlling stake, and examine its relationship with minority shareholders.

You can look at anything from a number of angles and, more often than not, reach an entirely different conclusion. Two investors, for example, presented with the same set of facts can reach polar opposite conclusions. It’s the old glass half-full versus half-empty line.

I find that having a set view and unwittingly being tied to that perspective limits one’s ability to switch fast enough when the evidence is mounting that the view might be wrong. Few are completely immune, but self-awareness is the first step to conquering any weaknesses.

The investing consequence of opening one’s mind to change is that portfolio turnover goes up. I may buy something back that I recently sold, because new evidence suggests I should, and that ‘re-purchase’ may be at a higher price. This may be seen as somewhat flaky and I agree it would be, if it were not evidence-based.

Looking at things differently, however, is necessary because it does produce fresh insights. On page 20 of Warren Buffett’s 2003 annual letter to shareholders, he wrote: “…I made a big mistake in not selling several of our larger holdings during The Great Bubble.” Shining a light – or perhaps a light with a different filter – undeniably helps our investment analysis.

With that in mind, I want to present some numbers from Servcorp’s annual reports and ask you to think about what your conclusion might be.

This service and virtual office provider has not produced growing profits since 2007.

Source:  www.Skaffold.com PATENTS PENDING.

Back then, profits were $34 million, and while they grew to $39 million in 2009, they subsequently fell to $5 million in 2010 and $4 million in 2011. For the record, analysts are in aggregate forecasting profits to grow to $13 million in 2012, and $28 million and $37 million in 2013 and 2014, respectively.

So that’s one way of looking at this business and on that basis, you may be tempted to investigate the opportunity as a turnaround story. I certainly am, as any global recovery from the Euro crisis would position Servcorp well with the rollout of its floor leasing operations.

Is there another perspective?

But before I go jumping in, here’s another way to consider the information. In 2010, the full year profits plunged to $5 million, the company raised $78 million – on top of the $76 million already invested – by issuing 18 million shares. This move took shares on issue to 98 million and capital raised to $154 million. And looking at the retained earnings account for that year reveals that the balance declined by $10 million.  This is something I want to pick up on.

When a company earns a profit of $5 million, as Servcorp did in 2010, retained earnings rise by this amount. Then, if dividends are paid, retained earnings goes down by the amount of the dividend. A net decline of $10 million in retained earnings after a $5 million profit suggests $15 million was paid in dividends.

One way to look at this situation is to assume that the capital raising is for growth; I will give the company the benefit of the doubt and agree. An alternative and admittedly more cynical way to look at it is to assume the capital raising might have been designed to pay for the dividend.

One response to the latter proposition and the one I am leaning towards is that the capital raising was much larger than the amount the dividend exceeded earnings by and therefore the real intention of the capital raising was, indeed, growth. In turn, one retort from a much more jaded or cynical investor could be that the capital raising was made larger to disguise the fact that a larger dividend was desired. It’s all rather circular, as you will discover in a moment.

Perhaps we might never know the thought process of the board at the time and such postulations are only speculative at best, but there are two important questions, answers to which would provide some illumination. The first would be whether the money invested does indeed lead to the growth in earnings that the analysts seem to be expecting – albeit growth that will only produce profits in 2014 that are in line with those of 2007/08. The second might be to ask whether a majority and controlling shareholder is present. Once again, we can’t prove motives, but as investors we are certainly within our rights to enquire.

In the first instance, only time will tell us whether the money is invested profitably. The cash is certainly now available to help grow the business, revenue and profits. To the credit of management, first-half 2012 profits were over $8 million. So the numbers are indeed moving in the right direction.

Regarding the latter issue of ownership, we find the managing director and CEO also owns 51% of the company. Of course, to retain control they must have participated in the capital raising during the 2010 financial year, but keep in mind it could be argued that half the dividend helped fund it.

And I always ask the following question: If a company is in need of capital, why pay a dividend? It’s a basic question and often – but not always – the answer seems to point to maintaining support for the share price, a noble (if perhaps unsustainable and diluting) goal. Directors are arguably acting in shareholder’s best interests by doing things that support the share price but it is imperative the techniques are sustainable. Ultimately the best method is a sound business.

In 2011, the company did almost the same thing as it did in 2010. While no additional equity was raised, and thus the controlling shareholder was therefore spared the requirement of writing another cheque, profits of $4 million were reported, but dividends of $16 million (51% of which went to entities associated with the CEO/MD) ensured that retained earnings fell to $59 million. The $8 million dollars (50% of the dividend) arguably further reduced the personal contribution of the majority shareholder to the capital raising.

For our fund, a return on equity now of just 7% suggests Servcorp is currently not investment grade, and its share price also appears to be expensive compared to our estimate of its intrinsic value. That would change if upgrades to guidance are provided.

While we haven’t answered the questions we posed, we have certainly raised the one we should ask management before we decide to invest. In theory the board works for the shareholders so you are within your rights to ask questions such as these of the board. For your own investing, I can only leave it to you to decide whether the cup is half-full or half-empty.

Posted by Roger Montgomery, Value.able author, SkaffoldChairman and Fund Manager, 3 May 2012.

by Roger Montgomery Posted in Insightful Insights, Skaffold.

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One of the companies that is bound to suffer amid the western world’s slump in house prices, home starts and weak credit growth is Boral.

Today, Boral (BLD) cut their full year profit guidance by $22m after weak house activity and heavy rain in NSW and QLD have impacted their operations. BLD had forecast profit to be $150m-$175m and now expect $128m-$153m.  Boral’s Mark Selway noted that Australia’s residential building sector is “aweful” and the construction and building materials company blamed continued wet weather and slow housing starts for cutting its profit forecast by the $22 million noted.  In an interview with Dow Jones today Selways said; “The residential housing market looks tough and, by the way, I think it’s going to get a whole lot tougher,” and 2013 was likely to be “the tough year”.

Below: Skaffold.com estimated Intrinsic Value for Boral.

The consensus analysts estimates that produce Skaffold’s current intrinsic value estimate will now decline further as will the estimate of value itself.  Since 2003 Boral’s estimated intrinsic value has been in decline as can be seen in the Skaffold Line Evaluate Screen.  You should also note the hockey stick – like increase from analysts earnings optimism.

Over in the US the situation isn’t much better.  After Warren Buffett noted his 2010/11 prediction of a bottom in housing “was dead wrong” one analyst said “March, housing starts, expected to print at 705K (which is crawling along the bottom as is, so it is all mostly noise anyway, but the algos care), came at a disappointing 654K, the lowest since October 2011, and a third consecutive decline since January. Want proof that the record warm Q1 pulled demand forward? This is it. As the chart below shows, the all important single-unit housing starts have not budged at all since June 2009. So was there any good news in today’s data? Well, housing permits, which means not even $1 dollar has been invested in actually ‘building’ a home soared to 747K, from 715K in February, and well above expectations of 710K – the highest since September 2008. That a permit is largley meaningless if unaccompanied by a start, not to mention an actual completion goes without saying.”

Total starts versus unit starts.

Apparently Harry S. Dent the author of various predictions of impending doom (and someone who’s rpredictions have been wrong as frequently as they have been right, is on Australia and said that we have a real estate bubble that is set to burst. He thinks there’ll be another worldwide economic downturn in 2012, and this will cause Australian real estate values to fall back to where they were 10 years ago.

“People in places like Sydney or Tokyo or Miami say, ‘Hey, real estate can never go down here, we’re a great place, everyone wants to move here, there’s not much land for development’, and what I say is that is exactly the kind of place that bubbles.” “Outside Hong Kong and Shanghai, Australia is the most expensive real estate market in the world compared to income.”

Thanks Harry!  My own definition of a bubble is a debt fuelled asset purchasing binge where the income from the asset cannot pay for the interest on the debt that is funding it.  Actually…that does sounds a whole lot like negative gearing????

Of course, some observers reckon the empty houses in Brisbane as sellers wait for prices to improve is a sign that the market is already crashing.  Others suggest for a crash to happen home owners have to be willing to sell their property at that lower price. A lot of home owners are removing their property from the market if they can’t get the price they want. Whether the lower price gets a print or not however is not relevant.  If my neighbour cannot sell his house for the price he wants, then the market price must be lower.  We don’t need a transaction to occur to confirm it.

Gone are the days when the dream was to have one nice house with a Clark Pool, a BBQ and a new Holden in the carport.  Now everyone wants to be a millionaire DIY developer and fixer-upper with his and hers BMW X5s.  That simple progression leads to more volatility in the prices of assets those investors pursue.  So what’s the impact on QBE and the banks now that Genworth have pulled their float?  Would love to hear your thoughts, insights and observations.  What are property prices doing in your area?

Posted by Roger Montgomery, Value.able author, SkaffoldChairman and Fund Manager, 20 April 2012.

by Roger Montgomery Posted in Property.

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PORTFOLIO POINT: Given the outlook for Chinese growth and iron ore prices, is it time to cast a critical eye over your BHP holding?

The 2001 merger of BHP Limited and Billiton Plc created the world’s largest diversified resource company. The company is also one of the largest in the world by market capitalisation and I would guess one of the longest-held stocks in many investors’ portfolios, as well as one of the most likely to have been inherited by superannuants from their parents.

Operationally, the company is nothing like it once was. Seriously underperforming assets and overpriced acquisitions had to be written off in the late 1990s, and since then external candidates including Paul Anderson, Brian Gilbertson, Chip Goodyear and, most recently, Marius Kloppers have taken the top job at the Big Australian. Under their sound stewardship – and the biggest mining boom in history – BHP’s share price has risen from less than $10 when the merger was consummated to almost $50 prior to the GFC, and again a year ago. But since then, BHP’s share price has crashed 30%.

A year ago, with the share price at its zenith, many analysts were extolling the virtues of BHP. I note one company said their positive view on BHP was due to low-cost and long-life mines, growing production and cost discipline. With demand from China strong, the common refrain of course was – and still is – that the outlook for BHP’s products was (and is) bright. Many also went on to add that copper had a strong bullish case over the next two years, and with global consumption outpacing supply and a lack of new high-grade deposits coming into production imminently, the marginal cost of copper was set to rise, which could only be positive for the price. And back in November 2010, some analysts were applying a notional price/earnings multiple of 12 to the EBIT numbers of UBS and Goldman Sachs of $US12.4 billion to $US12.8 billion, to arrive at an independent iron ore business valuation of $US144 billion – roughly the same as the market of the entire conglomerate at that time.

So what has happened?

Well, the copper price is indeed up 13% since March 2010, but BHP’s share price languishes. And I wonder whether the talk of new in-the-ground metrics to value iron ore assets is akin to the bubble-talk price/sales and price-per-click ratios being proffered as a new way to value internet companies back in 1999 and early 2000.

BHP’s principle revenue drivers are the price of iron ore (for the manufacture of steel), the price of oil and base metal prices (predominantly copper). Emerging economies and their insatiable demand for construction and manufacturing materials has thus far ensured BHP grows its revenues and earnings.

Talk to BHP employees and they’ll tell you it’s all really quite simple: ‘Dig it (iron ore) out of the ground for $33 and sell as much of it as you can (currently the price is $US140/mt)’.

But how much of it can they sell? And at what margin?

China’s economic data shows its economy is growing at the slowest pace in recent memory. China’s economy expanded at its weakest pace in 2.5 years in the fourth quarter of 2011. Sagging real estate (something I have warned investors here to watch) and export sectors have heralded a sharper slowdown, while triggering pro-growth responses from the government.

Most recently, gross domestic output rose just 2% from the previous quarter, suggesting to some economists that underlying momentum is slowing more rapidly than expected.

Interestingly, the fourth-quarter growth rate was the slowest pace since the second quarter of 2009. And this was when the global economy was emerging from a deep recession. It also marked the fourth straight quarter in which growth had slowed down.

Importantly, recent data shows net exports and property investment subtracting from growth. This latter development is a serious concern for investors in BHP, because the property sector is worth some 13% of total economic output and steel is the primary input for building construction.

Back in March 2010, I wrote: “The key concern for investors is to examine the valuations of companies that sell the bulk of their output to China. Any company that is trading at a substantial premium to its valuation on the hope that it will be sustained by Chinese demand, without a speed hump, may be more risk than you care for your portfolio to endure.

“The biggest risks are any companies that are selling more than 70% of their output to China, but anything over 20% on the revenue line could have major consequences.

“BHP generates about 20%, or $11 billion, of its $56 billion revenue from China; and Rio 24%, or $11 billion, from its $46 billion revenue. BHP’s adjusted net profit before tax was $19.8 billion last year and Rio’s was $8.7 billion.

“…BHP’s profitability would be substantially impacted by any speed bumps that emerge from China…”

Annual growth in China’s property investment of 12.3% as at December marked a sharp slowdown from November’s 20.2% pace. Housing investment dropped precipitously in December, while many property developers are warning 2012 looks worse.

The booming housing market helped drive China’s parabolic growth, but the government’s attempts to engineer a ‘deflation’ of the property bubble appear to have had a sharper effect.

This compounds the adverse impacts on the country’s manufacturers and exporters from weakening European export markets, rising labour costs and inflation, as well as the widely reported leadership handover.

If you inherited BHP Billiton (BHP) and/or own it in your superannuation fund, you have to do more than simply keep a close eye on China. If indeed the writing is already on the wall, you need to decide whether you are going to respond.

Skaffold’s valuation for BHP has, as I previously predicted, been falling. The 2012 valuation of $36.85 has indeed been leading the share price lower, as Ben Graham might have suggested it would when he explained that in the long run the market is a weighing machine. (BHP is currently trading at about $34.51) For those who are interested, my Rio valuation is $70.62 (Rio is currently trading at about $66.12).

However, my BHP valuation currently rises to $44 for 2014, but I say “currently” because I suspect by 2014 an iron ore supply response will have forced the iron ore price lower, and triggered a raft of earnings revisions that will reduce BHP’s valuation.

China may continue to drive GDP with capital and fixed investment spending on fast trains, highways, cities and airports, but irrespective of whether the GDP is 9% or 6%, the proportion of fixed-asset investment cannot be sustained at 60% of GDP. More importantly, the iron ore China does require may be purchased at much lower prices and like the declining margins Apple faces on its new generation iPads, and Gerry Harvey endures on sales of widescreen TVs, BHP may also have to endure lower margins on iron ore while also selling less.

Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 18 April 2012.

by Roger Montgomery Posted in Companies, Energy / Resources.

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On ABC Radio’s ‘The World Today’ Roger Montgomery discusses with David Taylor why he can foresee a corrections to the US equity markets. Read/Listen here.

This program was broadcast on the 19th March 2012.

by Roger Montgomery Posted in In the Press, Market Valuation, Radio.

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At the outset, let me say I am not going forecast anything.  I don’t know whether the market will rise or fall next.  Andy Xie however, in his column entitled; A world flying blind wrote:  “Playing with expectations works temporarily. The risk-on trade is in a mini bubble, as today’s, buyers want to be ahead of the slower ones. The buying trend is sustainable only if the global economy strengthens, which is unlikely. The stocks aren’t cheap. Desirable consumer stocks are selling for 20 times earnings. Banks are cheap for a reason. Internet stocks suggest another bubble in the making. The Fed is trying to inflate an expensive asset. The rally, hence, is quite fragile. As soon as a shock like Greece defaulting or bad economic news unfolds, the market will quickly head south.”

In the great de-leveraging we are witnessing, cutting interest rates (monetary policy) doesn’t spur economic activity because businesses and individuals are simply trying to get out from under a mountain of debt first.  The next option is to simply hand over money (quantitative easing) and then if that doesn’t work expand budget deficits through government spending (fiscal policy).  A positive by-product of the money printing is that lower long-term bond rates guarantee a negative real yield – How can bonds be seen as ‘safe’ if they are 100% guaranteed to result in less purchasing power? – and investors are forced to buy other assets like stocks and pile into the “risk on” trade referred to above.  Sadly, just as the money being printed isn’t finding its way into the economy – its being hoarded by the zombie banks who should have been allowed to collapse and/or write off their bad loans – the rally in the stock market isn’t helping the masses and indeed may itself be fading.

Chart 1 suggests to some investors that the latest attempt to encourage participation in the stock market hasn’t worked.

Chart 1 reveals that not only have retail investors continued to pull out cash from US equity mutual funds (about $66 billion since October), but the market peak of the week of February 29 coincided with the biggest weekly outflow for 2012 – $3 billion.

Chart 2.  Ratio of accumulators to dissavers plotted against P/E ratios

Back to more recent observations and the 20% stock market rally over the last four months has been described as a completely artificial “ramp” by some and has been driven entirely by the global liquidity injections of the US, UK, European and Japanese central banks.  The conclusions for some investors is that the smart money – those that have bought in anticipation of retail ‘follow-through’ will soon scramble for the exits.  What do you think?

Skaffold’s ASX200 Value Indicator is a live and automatically-updated valuation estimate of the ASX200.  It updates and changes every day.  The future valuation estimates are based on the the constantly updated forecasts for earnings and dividends of the biggest 200 companies.  You can’t beat it as a guide to the overall market level and whether you should be enthusiastic or not about looking more deeply for value.

Chart 3.  ASX200 Value Indicator

Source: Skaffold.com

Based on current forecasts for 2012 you can see that the market looks about fair value.  It isn’t overly expensive but neither is it, in aggregate, cheap.  Based on 2013 forecasts however the market appears to be reasonable value.  So the question is whether those 2013 forecasts are reasonable.  Typically, forecasts are optimistic.  We have previously written here of the persistence of optimism in forecasts by analysts.  If that is again the case for 2013, then you wouldn’t be getting overly enthusaistic about our market unless there was a pull back.  And according to those referenced above, a pull back is on the cards.  What do you think?

I believe there are individual companies that have produced amazing results this reporting season and in an upcoming post we will list the very best.  I also think that there is still some value among these companies.  The challenge for those new to long term value investing is to be able to stick to your guns, accumulate positions in extraordinary companies at deep discounts to rational estimates of intrinsic value and stand apart from the daily gyrations of fear and rumour about default, money printing and recession.

Looking forward to your comments.

Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 8 March 2012.

by Roger Montgomery Posted in Companies, Insightful Insights, Market Valuation.

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Their is something prescient in the name John Deason and Richard Oates gave to their 1869 gold nugget the ‘Welcome Stranger’ and the one Kevin Hillier gave to his 875 troy ounce find ‘The Hand of Faith’.  Today’s gold price is indeed very welcome to gold bugs and there is plenty of faith needed that prices will rise even further.  But gold bugs have received a terse warning from none other than Warren Buffett who has just released Berkshire’s 2011 letter.  For those of you who believe gold (A.K.A. the barbarous relic) is the best investment you won’t find any more support from Warren this year than any other (with the exception of his 1999 dalliance into silver) . You can find his complete letter here: Berkshire 2011 Annual Report.

Here’s the section on gold:

“The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else – who also knows that the assets will be forever unproductive – will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century.

This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it even more avidly in the future.

The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.

What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis.

As “bandwagon” investors join any party, they create their own truth – for a while. Over the past 15 years, both Internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well-publicized rising prices. In these bubbles, an army of originally skeptical investors succumbed to the “proof” delivered by the market, and the pool of buyers – for a time – expanded sufficiently to keep the bandwagon rolling. But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again: “What the wise man does in the beginning, the fool does in the end.”

Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A. Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge).

Can you imagine an investor with $9.6 trillion selecting pile A over pile B? Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers – whether jewelry and industrial users, frightened individuals, or speculators – must continually absorb this additional supply to merely maintain an equilibrium at present prices.

A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

Admittedly, when people a century from now are fearful, it’s likely many will still rush to gold. I’m confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.”

Before simply believing Warren WILL be right…There’s this in the annual report as well: “Last year, I told you that “a housing recovery will probably begin within a year or so.” I was dead wrong”

A much older quote that summarizes Buffett’s long-held view is this one “It gets dug out in Africa or some place. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

In my earlier post on this subject HERE, I note; “But I trust you can see the irony in claiming gold is ‘useless’ and yet it can buy [all the agricultural land in the United States, sixteen companies as valuable as Exxon and a trillion dollars in walking-around money].

For those of you who are interested in two alternative perspectives, (assuming the debasing of fiat money across the globe is not enough to encourage you), I thought you might find some of what you need in the following points, and also Warren Buffett’s father’s views. (Note: we only own three or four gold stocks all of which have rising production profiles and do not require ever increasing gold prices to support the returns on equity that justify much higher valuations.  So we aren’t quite in the ‘carried-away’ camp even though some have doubled in price.  This latter development delights us in this market).

And now a short commercial break…

Here are two Skaffold screenshots, each gold stocks we currently own.  If you are a member of Skaffold, you should be able to pick them right away.  If you aren’t a member, what are you waiting for?  Head over to www.skaffold.com and become a member today.

And now back to our regular programming…

From gold’s mouth itself;

Let’s start with the basics of my enduring characteristics. I have some characteristics that no other matter on Earth has…

I cannot be:

Printed (ask a miner how long it takes to find me and dig me up)
Counterfeited (you can try, but a scale will catch it every time)
Inflated (I can’t be reproduced)

I cannot be destroyed by;

Fire (it takes heat at least 1945.4° F. to melt me)
Water (I don’t rust or tarnish)
Time (my coins remain recognizable after a thousand years)

I don’t need:

Feeding (like cattle)
Fertilizer (like corn)
Maintenance (like printing presses)

I have no:

Time limit (most metal is still in existence)
Counterparty risk (remember MF Global?)
Shelf life (I never expire)

As a metal, I am uniquely:

Malleable (I spread without cracking)
Ductile (I stretch without breaking)
Beautiful (just ask an Indian bride)

As money, I am:

Liquid (easily convertible to cash)
Portable (you can conveniently hold $50,000 in one hand)
Divisible (you can use me in tiny fractions)
Consistent (I am the same in any quantity, at any place)
Private (no one has to know you own me)

From an entirely different perspective on gold it may be worth reading the Hon. Howard Buffett.  Congressman Buffett argues that without a redeemable currency, an individual’s freedoms both financial and more broadly is dependent on politicians. He goes on to observe that fiat (paper) money systems tend to collapse eventually, producing economic chaos. His argument that the US should return to the gold standard was not adopted.

Human Freedom Rests of Gold Redeemable Money
Posted Thursday, May 6, 1948

By HON. HOWARD BUFFETT

U. S. Congressman from Nebraska
Reprinted from The Commercial and Financial Chronicle 5/6/48

Is there a connection between Human Freedom and A Gold Redeemable Money? At first glance it would seem that money belongs to the world of economics and human freedom to the political sphere.

But when you recall that one of the first moves by Lenin, Mussolini and Hitler was to outlaw individual ownership of gold, you begin to sense that there may be some connection between money, redeemable in gold, and the rare prize known as human liberty.

Also, when you find that Lenin declared and demonstrated that a sure way to overturn the existing social order and bring about communism was by printing press paper money, then again you are impressed with the possibility of a relationship between a gold-backed money and human freedom.

In that case then certainly you and I as Americans should know the connection. We must find it even if money is a difficult and tricky subject. I suppose that if most people were asked for their views on money the almost universal answer would be that they didn’t have enough of it.

In a free country the monetary unit rests upon a fixed foundation of gold or gold and silver independent of the ruling politicians. Our dollar was that kind of money before 1933. Under that system paper currency is redeemable for a certain weight of gold, at the free option and choice of the holder of paper money.

Redemption Right Insures Stability
That redemption right gives money a large degree of stability. The owner of such gold redeemable currency has economic independence. He can move around either within or without his country because his money holdings have accepted value anywhere.

For example, I hold here what is called a $20 gold piece. Before 1933, if you possessed paper money you could exchange it at your option for gold coin. This gold coin had a recognizable and definite value all over the world. It does so today. In most countries of the world this gold piece, if you have enough of them, will give you much independence. But today the ownership of such gold pieces as money in this country, Russia, and all divers other places is outlawed.

The subject of a Hitler or a Stalin is a serf by the mere fact that his money can be called in and depreciated at the whim of his rulers. That actually happened in Russia a few months ago, when the Russian people, holding cash, had to turn it in — 10 old rubles and receive back one new ruble.

I hold here a small packet of this second kind of money – printing press paper money — technically known as fiat money because its value is arbitrarily fixed by rulers or statute. The amount of this money in numerals is very large. This little packet amounts to CNC $680,000. It cost me $5 at regular exchange rates. I understand I got clipped on the deal. I could have gotten $2½ million if I had purchased in the black market. But you can readily see that this Chinese money, which is a fine grade of paper money, gives the individual who owns it no independence, because it has no redemptive value.

Under such conditions the individual citizen is deprived of freedom of movement. He is prevented from laying away purchasing power for the future. He becomes dependent upon the goodwill of the politicians for his daily bread. Unless he lives on land that will sustain him, freedom for him does not exist.
You have heard a lot of oratory on inflation from politicians in both parties. Actually that oratory and the inflation maneuvering around here are mostly sly efforts designed to lay the blame on the other party’s doorstep. All our politicians regularly announce their intention to stop inflation. I believe I can show that until they move to restore your right to own gold that talk is hogwash.

Paper Systems End in Collapse
But first let me clear away a bit of underbrush. I will not take time to review the history of paper money experiments. So far as I can discover, paper money systems have always wound up with collapse and economic chaos.
Here somebody might like to interrupt and ask if we are not now on the gold standard. That is true, internationally, but not domestically. Even though there is a lot of gold buried down at Fort Knox, that gold is not subject to demand by American citizens. It could all be shipped out of this country without the people having any chance to prevent it. That is not probable in the near future, for a small trickle of gold is still coming in. But it can happen in the future. This gold is temporarily and theoretically partial security for our paper currency. But in reality it is not.

Also, currently, we are enjoying a large surplus in tax revenues, but this happy condition is only a phenomenon of postwar inflation and our global WPA. It cannot be relied upon as an accurate gauge of our financial condition. So we should disregard the current flush treasury in considering this problem.

From 1930-1946 your government went into the red every year and the debt steadily mounted. Various plans have been proposed to reverse this spiral of debt. One is that a fixed amount of tax revenue each year would go for debt reduction. Another is that Congress be prohibited by statute from appropriating more than anticipated revenues in peacetime. Still another is that 10% of the taxes be set aside each year for debt reduction.
All of these proposals look good. But they are unrealistic under our paper money system. They will not stand against postwar spending pressures. The accuracy of this conclusion has already been demonstrated.

The Budget and Paper Money
Under the streamlining Act passed by Congress in 1946, the Senate and the House were required to fix a maximum budget each year. In 1947 the Senate and the House could not reach an agreement on this maximum budget so that the law was ignored.

On March 4 this year the House and Senate agreed on a budget of $37½ billion. Appropriations already passed or on the docket will most certainly take expenditures past the $40 billion mark. The statute providing for a maximum budget has fallen by the wayside even in the first two years it has been operating and in a period of prosperity.

There is only one way that these spending pressures can be halted, and that is to restore the final decision on public spending to the producers of the nation. The producers of wealth — taxpayers — must regain their right to obtain gold in exchange for the fruits of their labor. This restoration would give the people the final say-so on governmental spending, and would enable wealth producers to control the issuance of paper money and bonds.

I do not ask you to accept this contention outright. But if you look at the political facts of life, I think you will agree that this action is the only genuine cure. There is a parallel between business and politics which quickly illustrates the weakness in political control of money.

Each of you is in business to make profits. If your firm does not make profits, it goes out of business. If I were to bring a product to you and say, this item is splendid for your customers, but you would have to sell it without profit, or even at a loss that would put you out of business. — well, I would get thrown out of your office, perhaps politely, but certainly quickly. Your business must have profits.

In politics votes have a similar vital importance to an elected official. That situation is not ideal, but it exists, probably because generally no one gives up power willingly.

Perhaps you are right now saying to yourself: “That’s just what I have always thought. The politicians are thinking of votes when they ought to think about the future of the country. What we need is a Congress with some ‘guts.’ If we elected a Congress with intestinal fortitude, it would stop the spending all right!”

I went to Washington with exactly that hope and belief. But I have had to discard it as unrealistic. Why? Because an economy Congressman under our printingpress money system is in the position of a fireman running into a burning building with a hose that is not connected with the water plug. His courage may be commendable, but he is not hooked up right at the other end of the line. So it is now with a Congressman working for economy. There is no sustained hookup with the taxpayers to give him strength.

When the people’s right to restrain public spending by demanding gold coin was taken from them, the automatic flow of strength from the grass-roots to enforce economy in Washington was disconnected. I’ll come back to this later.

In January you heard the President’s message to Congress or at least you heard about it. It made Harry Hopkins, in memory, look like Old Scrooge himself.
Truman’s State of the Union message was “pie-in-the-sky” for everybody except business. These promises were to be expected under our paper currency system. Why? Because his continuance in office depends upon pleasing a majority of the pressure groups.

Before you judge him too harshly for that performance, let us speculate on his thinking. Certainly he can persuade himself that the Republicans would do the same thing if they were In power. Already he has characterized our talk of economy as “just conversation.” To date we have been proving him right. Neither the President nor the Republican Congress is under real compulsion to cut Federal spending. And so neither one does so, and the people are largely helpless.

But it was not always this way.
Before 1933 the people themselves had an effective way to demand economy. Before 1933, whenever the people became disturbed over Federal spending, they could go to the banks, redeem their paper currency in gold, and wait for common sense to return to Washington.

Raids on Treasury
That happened on various occasions and conditions sometimes became strained, but nothing occurred like the ultimate consequences of paper money inflation.
Today Congress is constantly besieged by minority groups seeking benefits from the public treasury. Often these groups. control enough votes in many Congressional districts to change the outcome of elections. And so Congressmen find it difficult to persuade themselves not to give in to pressure groups. With no bad immediate consequence it becomes expedient to accede to a spending demand. The Treasury is seemingly inexhaustible. Besides the unorganized taxpayers back home may not notice this particular expenditure — and so it goes.

Let’s take a quick look at just the payroll pressure elements. On June 30, 1932, there were 2,196,151 people receiving regular monthly checks from the Federal Treasury. On June 30, 1947, this number had risen to the fantastic total of 14,416,393 persons.

This 14½ million figure does not include about 2 million receiving either unemployment benefits of soil conservation checks. However, it includes about 2 million GI’s getting schooling or on-the-job-training. Excluding them, the total is about 12½ million or 500% more than in 1932. If each beneficiary accounted for four votes (and only half exhibited this payroll allegiance response) this group would account for 25 million votes, almost by itself enough votes to win any national election.

Besides these direct payroll voters, there are a large number of State, county and local employees whose compensation in part comes from Federal subsidies and grants-in-aid.

Then there are many other kinds of pressure groups. There are businesses that are being enriched by national defense spending and foreign handouts. These firms, because of the money they can spend on propaganda, may be the most dangerous of all.

If the Marshall Plan meant $100 million worth of profitable business for your firm, wouldn’t you Invest a few thousands or so to successfully propagandize for the Marshall Plan? And if you were a foreign government, getting billions, perhaps you could persuade your prospective suppliers here to lend a hand in putting that deal through Congress.

Taxpayer the Forgotten Man
Far away from Congress is the real forgotten man, the taxpayer who foots the bill. He is in a different spot from the tax-eater or the business that makes millions from spending schemes. He cannot afford to spend his time trying to oppose Federal expenditures. He has to earn his own living and carry the burden of taxes as well.

But for most beneficiaries a Federal paycheck soon becomes vital in his life. He usually will spend his full energies if necessary to hang onto this income.
The taxpayer is completely outmatched in such an unequal contest. Always heretofore he possessed an equalizer. If government finances weren’t run according to his idea of soundness he had an individual right to protect himself by obtaining gold.

With a restoration of the gold standard, Congress would have to again resist handouts. That would work this way. If Congress seemed receptive to reckless spending schemes, depositors’ demands over the country for gold would soon become serious. That alarm in turn would quickly be reflected in the halls of Congress. The legislators would learn from the banks back home and from the Treasury officials that confidence in the Treasury was endangered.

Congress would be forced to confront spending demands with firmness. The gold standard acted as a silent watchdog to prevent unlimited public spending.

I have only briefly outlined the inability of Congress to resist spending pressures during periods of prosperity. What Congress would do when a depression comes is a question I leave to your imagination. I have not time to portray the end of the road of all paper money experiments.

It is worse than just the high prices that you have heard about. Monetary chaos was followed in Germany by a Hitler; in Russia by all-out Bolshevism; and in other nations by more or less tyranny. It can take a nation to communism without external influences. Suppose the frugal savings of the humble people of America continue to deteriorate in the next 10 years as they have in the past 10 years? Some day the people will almost certainly flock to “a man on horseback” who says he will stop inflation by price-fixing, wage-fixing, and rationing. When currency loses its exchange value the processes of production and distribution are demoralized.

For example, we still have rent-fixing and rental housing remains a desperate situation.

For a long time shrewd people have been quietly hoarding tangibles in one way or another. Eventually, this individual movement into tangibles will become a general stampede unless corrective action comes soon.

Is Time Propitious
Most opponents of free coinage of gold admit that that restoration is essential, but claim the time is not propitious. Some argue that there would be a scramble for gold and our enormous gold reserves would soon be exhausted.

Actually this argument simply points up the case. If there is so little confidence in our currency that restoration of gold coin would cause our gold stocks to disappear, then we must act promptly.

The danger was recently highlighted by Mr. Allan Sproul, President of the Federal Reserve Bank of New York, who said:
“Without our support (the Federal Reserve System), under present conditions, almost any sale of government bonds, undertaken for whatever purpose, laudable or otherwise, would be likely to find an almost bottomless market on the first day support was withdrawn.”

Our finances will never be brought into order until Congress is compelled to do so. Making our money redeemable in gold will create this compulsion.
The paper money disease has been a pleasant habit thus far and will not he dropped voluntarily any more than a dope user will without a struggle give up narcotics. But in each case the end of the road is not a desirable prospect.

I can find no evidence to support a hope that our fiat paper money venture will fare better ultimately than such experiments in other lands. Because of our economic strength the paper money disease here may take many years to run its course.

But we can be approaching the critical stage. When that day arrives, our political rulers will probably find that foreign war and ruthless regimentation is the cunning alternative to domestic strife. That was the way out for the paper-money economy of Hitler and others.

In these remarks I have only touched the high points of this problem. I hope that I have given you enough information to challenge you to make a serious study of it.

I warn you that politicians of both parties will oppose the restoration of gold, although they may outwardly seemingly favor it. Also those elements here and abroad who are getting rich from the continued American inflation will oppose a return to sound money. You must be prepared to meet their opposition intelligently and vigorously. They have had 15 years of unbroken victory.
But, unless you are willing to surrender your children and your country to galloping inflation, war and slavery, then this cause demands your support. For if human liberty is to survive in America, we must win the battle to restore honest money.

There is no more important challenge facing us than this issue — the restoration of your freedom to secure gold in exchange for the fruits of your labors.
I am internationally accepted, last for thousands of years, and probably most important, you can’t make any more of me.”

Posted by Roger Montgomery, Value.able author, Skaffold Chairman and Fund Manager, 26 February 2012.

by Roger Montgomery Posted in Energy / Resources, Insightful Insights, Skaffold, Value.able.

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On one side of the investing coin is the idea that you lay out money today to get more back later. The flipside is that buy purchasing today you forego consumption today for the ability to consume more later.

They aren’t quite the same thing of course, because the latter idea introduces inflation and suggests the purpose of investing is to at least maintain purchasing power (generate returns in line with inflation) or increase purchasing power (generate real returns in excess of inflation).  In a useful reminder Buffett observes:

“Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power. Its managers would have been kidding themselves if they thought of any portion of that interest as “income.””

Therefore an investment that is price stable but loses purchasing power is very risky (think US T-Bonds) while an asset that is volatile in price but almost certain to increase purchasing power over time is less risky than the conventional measures of risk would dictate.

This is how Buffett begins an excerpt of his forthcoming letter to Berkshire Hathaway shareholders HERE. One scenario his introduction does not contemplate of course is deflation. Japanese real estate and equity prices are fractions of their previous levels and a bond offering even a miniscule return would produce an increase in purchasing power. Like many readers, you might reach the conclusion that the absence of this scenario in his letter along with the knowledge of aggressive equity purchases in recent months, indicates he does not believe deflation is a possibility.

The other subject of his letter is Gold. Melted down all the gold in the world would amount to one 68 cubed foot of uselessness. Somewhat ironically he reflects on its purchasing power today – all the agricultural land in the United States, sixteen companies as valuable as Exxon and a trillion dollars in walking-around money.

But he points out that the companies will have thrown off dividends and the land would have produced food. And so the article leads to the defence of buying businesses as a superior strategy (to owning gold ‘that just sits there’) – as we believe at Montgomery Investment Management, and you might as Value.able graduates (after seeking and taking personal professional advice).

I believe Buffett’s take on the investing landscape is ultimately correct (bubbles are always followed by a bust and nothing goes up forever);

“What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As “bandwagon” investors join any party, they create their own truth — for a while.”

But I trust you can see the irony in claiming gold is useless and yet it can buy 16 Exxons and so on. As the chart shows, it has underperformed stocks over the long term and without boasting about it Buffett uses the S&P500 index to demonstrate the superiority of stocks. In a thinly veiled warning to gold bugs he likens the current enthusiasm for gold to the internet bubble and US housing speculation pre-2007.

In his enthusiasm for stocks being best able to retain purchasing power or increase it, I can’t but help remembering that Buffett was a more circumspect proponent of stocks in the seventies – a period of very high inflation. While in 1974, when Forbes asked Buffett how he felt about the stock market at the time, Buffett replied, “Like an oversexed guy in a whorehouse”, his 1979 letter to investors serves as a useful reminder of the limits of any asset to retain purchasing power during bouts of high inflation.

“Just as the original 3% savings bond, a 5% passbook savings account or an 8% U.S. Treasury Note have, in turn, been transformed by inflation into financial instruments that chew up, rather than enhance, purchasing power over their investment lives, a business earning 20% on capital can produce a negative

real return for its owners under inflationary conditions not much more severe than presently prevail.

If we should continue to achieve a 20% compounded gain – not an easy or certain result by any means – and this gain is translated into a corresponding increase in the market value of Berkshire Hathaway stock as it has been over the last fifteen years, your after-tax purchasing power gain is likely to be very close to zero at a 14% inflation rate. Most of the remaining six percentage points will go for income tax any time you wish to convert your twenty percentage points of nominal annual gain into cash.

That combination – the inflation rate plus the percentage of capital that must be paid by the owner to transfer into his own pocket the annual earnings achieved by the business (i.e., ordinary income tax on dividends and capital gains tax on retained earnings) – can be thought of as an “investor’s misery index”. When this index exceeds the rate of return earned on equity by the business, the investor’s purchasing power (real capital) shrinks even though he consumes nothing at all. We have no corporate solution to this problem; high inflation rates will not help us earn higher rates of return on equity.”

Another warning to stick to high ROE businesses…

Finally remember that if you are buying stocks, unlike commodities, there exists management risk, execution risk, result risk, competitor risk, economic risk, currency risk etc. Anything can go wrong in a business and frequently does. And while Chalrie Munger has pointed out that “Almost all good businesses engage in ‘pain today, gain tomorrow’ activities”, you must know what you are doing.

I think stocks are indeed the best opportunity to retain and increase purchasing power but only the good quality ones.  Knowing what you are doing and sticking to high rates of return on equity, little or no debt and A1 or A2 businesses increases your chances of doing even better than the both the stock market index of which they are constituents and inflation.

Posted by Roger Montgomery, Value.able and Skaffoldauthor and Fund Manager, 14 February 2012.

by Roger Montgomery Posted in Companies, Insightful Insights, Skaffold.

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This piece by Satyajit Das was just sent to us and we thought it worth sharing.

Why Europe’s Plan to End the Debt Crisis Can’t and Won’t Work

The most recent summit failed to reach even the lowest expectations. Euro-Zone leaders displayed poor understanding of the problems, confused strategies, political bickering and infighting as well as inability to take decisive steps and stick to a course of actions.

The actions need to try to stabilize the European debt crisis are well recognized. Countries like Greece need to restructure its debt to reduce the amount owed – a euphemism for default. Banks suffering large losses as a result of these debt write-downs need to be stabilized by injecting new capital and ensuring access to funding to avoid insolvency.

A firewall needs to be erected to quarantine Spain and Italy as well as, increasingly, Belgium, France and Germany from the further spread of the debt crisis. Steps must be taken to return Europe to sustainable growth as soon as possible.

Even if all these measures could be implemented as soon as possible, success is not assured. But without them, the chance of a disorderly collapse is increasingly significant.

What’s Chinese for Begging Bowl

Another option proposed is to enhance the European Financial Stability Fund using resources from private and public financial institutions and investors through Special Purpose Vehicles (SPV). Few details are available currently.

The idea seems to be to raise money from emerging nations with large foreign exchange reserves, such as China, or sovereign wealth funds. The EFSF would provide the equity in the SPV with the investors providing senior debt to increase the funds capacity. The scheme appears reminiscent of leveraged investment vehicles such as collateralized debt obligations (CDOs) and Structured Investment Vehicles (SIVs).

Support for the idea amongst potential investors is uncertain. French President Sarkozy solicited Chinese support by a direct appeal to Chinese President Hu Jintao. China’s position remains guarded in the absence of additional information. The Chinese position to date has been that Europe must get its house in order first and then China will assist. The current European position is different – China must give money to Europe to get its house in order.

China has considerable “skin in this game.” Europe is China’s biggest trading partner. China has around $800-1,000 billion invested in euros and European government bonds. Continuation of the European debt problems will have serious effects on China’s economy and its investments.

The Chinese leadership also has to consider the internal political reaction to increased investment in Europe. Chinese foreign investments, including in foreign financial institutions in 2007 and 2008, have incurred losses. China’s leaders face criticism from a large section of population for having invested Chinese savings poorly. China’s officials will not want to be seen to risk even more capital on a potentially lost cause. It is not clear that the EU proposal has sufficient chances of success to encourage China increasing its exposure to Europe, especially as relatively wealthy European countries, like Germany and France, are unwilling to put up more money and are seeking to limit their exposure.

China also faces domestic problems – inflation (partly as a result of the weak currency policies of the developed nations) and attendant wage pressures that are reducing its competitiveness, serious bad debt problems in their banking system and pressure to accommodate the economic aspirations of an increasingly restive population. China’s flexibility to act may be limited.

But China seems desperate to be seen as a “global power.” Ego might seduce them into committing more money.

Contributions from China and other emerging countries will not resolve the problems. China’s contribution, expected to be around euro 70 billion, is small relative to the total requirements. As its foreign exchange reserves have risen in recent years, China has purchased substantial volumes of euro-denominated assets, both directly and via bonds issued by the EFSF, without preventing peripheral European bond yields rising. The need for this special scheme is also not clear as the Chinese can presumably invest directly if they wish to and see value in doing so.

Any Chinese involvement would probably require additional support from the Euro-zone countries, which may be opposed by Germany and other nations. China is inherently risk averse and will seek to negotiate additional political concessions, such as reducing pressure on the revaluation of the Renminbi, trade and currency sanctions and criticism on human rights issues. It is not clear whether these will be acceptable.

The negotiating stance of China is evident from its desire to denominate any funding in Renminbi. The EFSF have not ruled this out. The idea is dangerous, as Europe would incur currency risk, becoming exposed to an appreciating Renminbi, adding to its long list of problems.

The entire proposal smacks of desperation and belief in a simple, quick solution where no such option exists.

At best, the plan provides funds to tide over the immediate funding problems of weaker Euro-Zone members. It does little to deal with the Euro-Zone’s structural problems. There is still the risk that Europe enters a prolonged period of low growth or recession. The plan does not address the economic divergences that exist within the Euro-Zone or ease the painful adjustment processes that weaker members will still have to undergo within the constraints of the single currency. These problems are far more difficult to fix than the task of finding buyers for the required amount of government debt.

Balancing Imbalances

The EU refuses to deal with fundamental problems. The austerity and balanced budget measures, reinforced and reiterated in the plan, cannot deal with the primary problem – the deflation of the debt-fuelled bubble.

The EU is seeking to enforce the rarely adhered to rules for membership of the euro, the Stability and Growth Pact requires a deficit no larger than 3% in any one year and a Debt to GDP ratio no larger than 60%. Based on 2010 figures, Austria, Belgium, Cyprus, France, Ireland, Italy, Portugal, Spain and Greece do not meet one or both of these tests on current measures. Only Germany, Finland and the Netherlands are in compliance and would pass in 2013 on current projections.

Strict enforcement of this rule about deficits would prevent counter-cyclical spending by governments undermining economic recovery and lock the Euro-Zone into a death spiral of budget deficits, further budget cuts and low growth.

The problem is compounded by the competitiveness gap between Northern and Southern countries, estimated at 30% difference in costs. The EU’s refusal to contemplate a break-up or restructuring of the euro makes dealing with this problem difficult.

For many of the weaker countries, the best option would be to devalue their currency in the same way that the U.S. and Britain are debasing dollars and sterling respectively. Unable to devalue or control interest rates, these weaker countries are trapped in a vicious and ultimately self-defeating cycle of cost reduction.

An additional problem is the internal imbalances exemplified by Germany’s large intra-Euro-Zone trade surplus at the expense of deficit states, especially the Club Med countries like Greece, Portugal, Spain and Italy. German reluctance to boosting spending and imports makes any chance of resolving the crisis even more remote.

German hypocrisy, in this regard, is problematic. German banks lent money to many countries to finance exports, which benefited Germany. Germany also gained export competitiveness from a weaker euro–an exchange rate of euro 1 = U.S. $ 2.00 would be a realistic exchange rate if the euro were to be a purely German currency. Reluctance to confront these problems makes a comprehensive resolution of the crisis difficult.

Endgame

In chess, endgames require using the few pieces left on the board to achieve a result. Strategic concerns in endgames are different to those earlier in the game. The King becomes an attacking piece. Pawns become more important because of the potential to promote it to a queen. Endgames are more limited and finite than say openings.

The plan has bought time, though far less than generally assumed. As the details are analysed, weaknesses, unless remedied, will be quickly exposed.

The European debt endgame remains the same: fiscal union (greater integration of finances where Germany and the stronger economies subsidize the weaker economies); debt monetization (the ECB prints money); or sovereign defaults.

The accepted view is that, in the final analysis, Germany will embrace fiscal integration or allow the printing of money. This assumes that a cost-benefit analysis indicates that this would be less costly than a disorderly break-up of the Euro-Zone. This ignores a deep-seated German mistrust of modern finance as well as a strong belief in a hard currency and stable money. Based on their own history, Germans believe this is essential to economic and social stability. It would be unsurprising to see Germany refuse the type of monetary accommodation and open-ended commitment necessary to resolve the crisis by either fiscal union or debt monetization.

Unless restructuring of the euro, fiscal union and debt monetization is removed from the verboten list, sovereign defaults may be the only option available.

Regards,

Satyajit Das

And Ray Dalio’s piece will give you a terrific framework to help you understand what Satyajit is talking about, where we are, how we got here and where we are going…Click Here

Posted by Roger Montgomery, Value.able and Skaffoldauthor and Fund Manager, 9 February 2012.

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The banks are in the firing line again. A few months ago it was their record profits; today its talks of job cuts that dominate.  In November I noted that an industry insider had informed me that tens of thousands of jobs would be cut from financial services in 2012.  News today of job losses at one credit union suggests the process is underway.

But is something even bigger brewing?  Something that’s getting little or no headline attention? We believe so.  Collectively our banks made $24.26b in profits in 2011 (CBA $6.4b,NAB $5.5b, WBC $7b, ANZ $5.36b), but remember, banking is one of if not the most highly leveraged businesses on the Australian stock market. And being highly leveraged into any downturn means the economy can bite and bite hard.

While everyone’s focus is on cost cutting and net interest margins – so that the banks can maintain their profits – what are the numerous issues facing them:

• Elevated funding costs squeezing bank margins – Australian Financial Institutions source $310.5b in offshore borrowings.
• Declines in the share market impacting on wealth management profits.
• A higher frequency of natural disasters impacting insurance profits.
• The implementation of Basel III and higher capital requirements.
• Mortgage margins contracting given heavy competition for new loan business in a low growth environment.
• Low levels of system credit growth.
• Low levels of bad debt provisioning. Levels around pre-GFC 2008 levels and ratings agency Moody’s having serious misgivings about Australia’s housing market amid fears the property bubble will burst if Europe’s debt crisis is not contained.
• Analysts expecting house prices to drop further in 2012.
• Below 40% auction clearance rates across Australia.
• High historical levels of private and corporate debt levels.
• Falling property prices in China – the country’s Homelink property website reported that new home prices in Beijing fell a stunning 35 per cent in November from the month before.
• A broader economic slowdown in China and Japan as a result of Europe and US economies.
• Falling commodity prices for many of Australia’s key exports.

My view is that our highly leveraged banking system faces many pressures – from higher funding costs to increased unemployment (not just in the banking sector, some 100,000 jobs will be lost in retail alone) and the uptake of Basel III and that these pressures will see them needing to increase their capital. The canary in the coal mine is always of course bad debts.

Like my early prediction last year of a possible Qantas takeover, I may be wide of the mark, but I cannot rule out the possibility of the banks needing to raise capital in 2012.

If you work in the banking sector or are an avid follower of the Australian Banking system or know someone who is, I have a question to ask – despite the possible layoffs, what are you seeing? Clearly growth for banks is anemic and there are many headwinds to current consensus analysts’ earnings forecasts and their growth profiles. Are they achievable for our major banks in the coming years?

It is these forecasts that feed into valuation models which determine whether or not a margin of safety exists at current prices, so I’m throwing a call out to you. Do you agree with the current consensus view that jobs cuts are being made to preserve profits, or do you also see more to the story?

Posted by Roger Montgomery, Value.able author and Fund Manager, 11 January 2012.

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We have talked here at the blog about hypothecation, re-hypotecation and hyper-hypothecation, about credit default swaps about a Chinese property bubble bursting, about lower iron ore prices, slower economic growth, increased savings and declining rates of credit expansion and a European sovereign default.  Always the value investor, we are on the look out for anything that can impact the values of companies and those things that might offer the prospect of picking up a few bargains.

If your portfolio still has some rubbish in it, then being able to identify it is a key part of preparing for cheaper prices if they eventuate.

I recently wrote a column for the ASX and pondered the possibility of a climactic event coinciding with a complete throwing in of the towel by equity investors who are simply fed up with poor medium term returns and increased volatility recently.

The ASX200 hasn’t generated a positive capital return since 2005 but quality companies have.  The ASX200 contains stocks that are rubbish so it is no wonder that an index based on that rubbish has gone nowhere.  Step 1 then is to clean up the portfolio and step 2 is to be ready for quality bargains when they arise.

This is just one of many scenarios and frameworks I am operating with and I wonder what would transpire if the poor returns or the recent heightened volatility continues for a little longer?  Will investors simply throw in the towel, leave equities and believe all those advisors offering their own brand of ‘safe’, ‘secure’ and stable investments?  On the one hand, I hope so.  It would mean certain bargains.

Here’s the Column:

As global sharemarkets decline, remain volatile and produce poor historical returns compared to other asset classes, it will be easy to be swayed by the latest investment trend – to move out of shares. I believe the trend away from shares will gather pace soon as more and more “experts” use the rear-view mirror to demonstrate why sharemarket investors would have been better off somewhere else.

In 1974 US investors had just endured the worst two-year market decline since the early 1930s, the economy entered its second recessionary year and inflation hit 11 per cent as a result of an oil embargo, which drove crude oil prices to record levels. Interest rates on mortgages were in double digits, unemployment was rising, consumer confidence did not exist and many forecasters were talking of a depression.

By August 1979, US magazine BusinessWeek ran a cover story entitled ‘The Death of Equities’ and its experts concluded shares were no longer a good long-term investment.

The article stated: “At least 7 million shareholders have defected from the stockmarket since 1970, leaving equities more than ever the province of giant institutional investors. And now the institutions have been given the go-ahead to shift more of their money from stocks – and bonds – into other investments.”

But be warned. The time to get interested in share investing and make good returns is precisely when everyone else isn’t.

Your own once or twice-in-a-lifetime opportunity may not be that far away and Labor’s promised tax cut on interest earnings may sway even more to give up shares and put their money in a bank, providing the opportunity to obtain even cheaper share prices.

If prices do fall further – and they could – you will need to be ready and will need some cash. The very best returns are made shortly after a capitulation.  Cleaning up your portfolio becomes crucial and this article looks at how to do that.

Rule one: Don’t lose money

The key to slowly and successfully building wealth in the sharemarket is to avoid losing money permanently. Sure, good companies will see their shares swing but the poor companies see the downswings more frequently.

Therefore, the easiest way to avoid losing money is to avoid buying weak companies or expensive shares. One of the simplest ways I have avoided losing money this year in The Montgomery [Private] Fund has been to steer clear of low-quality businesses that have announced big writedowns.

These are easy to spot using Skaffold.

Not-so-goodwill

I have often seen companies make large and expensive acquisitions that are followed by writedowns a couple of years later. Writedowns are an admission by the company that they paid too much for an asset.

When Foster’s purchased the Southcorp wine business in 2005 for $3.1 billion, or $4.17 per share, my own valuation of Southcorp was less than a quarter of that amount. Then in 2008 Foster’s wrote down its investment by about $480 million, and then again by another $700 million in January 2009 and a final $1.3 billion in 2010.

When too much is paid for an acquisition, equity goes up but profits do not and you can see that too much was paid because that ratio I have worked so hard to make popular, return on equity (ROE), is low.

These low rates of return are often less than you can get in a bank account, and bank accounts have much lower risk. Over time, if the resultant low rates of return do not improve, it suggests the price the company paid for the acquisition was well and truly on the enthusiastic side and the business’s equity valuation should now be questioned. If return on equity does not improve meaningfully, a large writedown could be in the offing. This will result in losses if you are a shareholder, and you have also paid too much.

Just remember one of the equations I like to share:
Capital raised + acquisition + low rate of return on equity = writedown.

When return on equity is very low it suggests the business’s assets are overvalued on the balance sheet. That, in turn, suggests the company has not amortised, written down or depreciated its assets fast enough, which in turn means the historical profits reported by the company could have been overstated.

Scoring bad companies: B4, B5, C4 and below…

These sorts of companies tend to have very low-quality scores and often appear down at the poor end of the market – the left side of the screen shot in Figure 1 below.

Figure 1. The sharemarket in aerial view (Source; Skaffold.com)

Each sphere in Figure 1. represents a listed Australian company and there are more than 2000 of them. The diagram is taken from Skaffold. Their position on the screen can change daily as the price, intrinsic value and quality changes. The best quality companies and those with positive estimated margins of safety (the difference between the company’s intrinsic value and its share price) appear as spheres at the top right.

Companies that are poor quality (I call them B4, C4 and C5 companies, for example) are found on the left of the screen and if they have an estimated negative margin of safety, they are estimated to be expensive and will be located towards the bottom of the screen.

Highlighted with blue rings in Figure 1 are eight of the companies that announced this year’s biggest writedowns. Notice they tend to be at the lower left of the Australian sharemarket, according to my analysis.

If your portfolio contains shares that are red spheres and on the lower left, you could also be at risk because these companies tend to have low-quality ratings and are also possibly very expensive compared to their intrinsic value.

As is clear from Figure 1, this year’s biggest writedown culprits were all already located in the area to avoid.

The impact of owning such a business outright would be horrendous. Table 1 below reveals the size and details of these writedowns and as you can see, collectively the losses to shareholders amount to $4.6 billion.

Table 1. Predictable losses?

Warren Buffett once said that if you were not prepared to own the whole business for 10 years, you should not own a piece of it for 10 minutes.

Clearly you would not want to own businesses that pay too much for acquisitions and subsequently write down those assets. If you are not willing to own the whole business, don’t own the shares. Although in the short run the market is a voting machine and share prices can rise and fall based on popularity, in the long run the market is a weighing machine and share prices will reflect the performance of the business. Time is not the friend of a poor company, and companies Skaffold rates C4 or C5 are best avoided if you want the best chance of avoiding permanent losses.

Look at Figure 2 below. Those big writedown companies not only performed poorly but so did their shares. These companies (shown collectively as an index in the blue line below) produced bigger losses for investors than the poorly performing indices of which they are part. And that’s just over one year.

Figure 2. The biggest writedowns compared to the market

Take a look at the companies in your portfolio. Do they have large amounts of accounting goodwill on their balance sheet as a portion of their equity? Have they issued lots of shares to make acquisitions and are they producing low and single-digit returns on equity? If the answer to all these questions is yes, you may have a C5 company.

Cleaning up your portfolio not only lowers its risk but will produce cash that may just prove handy in coming months.

If you have made it this far then here’s evidence of the giving up I referred to in the column:  http://www.smh.com.au/business/investors-turn-to-term-deposits-in-shift-away-from-equities-20111219-1p2ir.html

Posted by Roger Montgomery, Value.able author and Fund Manager, 20 December 2011.

by Roger Montgomery Posted in Companies, Insightful Insights, Market Valuation, Skaffold, Value.able.

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In 2010 here at the Insights Blog I wrote:

“a bubble guaranteed to burst is debt fuelled asset inflation; buyers debt fund most or all of the purchase price of an asset whose cash flows are unable to support the interest and debt obligations. Equity speculation alone is different to a bubble that an investor can short sell with high confidence of making money.

The bubbles to short are those where monthly repayments have to be made. While this is NOT the case in the acquisitions and sales being made in the coal space right now, it IS the case in the macroeconomic environment that is the justification for the  purchases in the coal space.

China.

If you are not already aware, China runs its economy a little differently to us. They set themselves a GDP target – say 8% or 9%, and then they determine to reach it and as proved last week, exceed it. They do it with a range of incentives and central or command planning of infrastructure spending.

Fixed asset investment (infrastructure) amounts to more than 55% of GDP in China and is projected to hit 60%. Compare this to the spending in developed economies, which typically amounts to circa 15%. The money is going into roads, shopping malls and even entire towns. Check out the city of Ordos in Mongolia – an entire town or suburb has been constructed, fully complete down to the last detail. But it’s empty. Not a single person lives there. And this is not an isolated example. Skyscrapers and shopping malls lie idle and roads have been built for journeys that nobody takes.

The ‘world’s economic growth engine’ has been putting our resources into projects for which a rational economic argument cannot be made.

Historically, one is able to observe two phases of growth in a country’s development.  The first phase is the early growth and command economies such as China have been very good at this – arguably better than western economies, simply because they are able to marshal resources perhaps using techniques that democracies are loath to employ. China’s employment of capital, its education and migration policies reflect this early phase growth. This early phase of growth is characterised by expansion of inputs. The next stage however only occurs when people start to work smarter and innovate, becoming more productive. Think Germany or Japan. This is growth fuelled by outputs and China has not yet reached this stage.

China’s economic growth is thus based on the expansion of inputs rather than the growth of outputs, and as Paul Krugman wrote in his 1994 essay ‘The Myth of Asia’s Miracle’, such growth is subject to diminishing returns.

So how sustainable is it? The short answer; it is not.

Overlay the input-driven economic growth of China with a debt-fuelled property mania, and you have sown the seeds of a correction in the resource stocks of the West that the earnings per share projections of resource analysts simply cannot factor in.

In the last year and a half, property speculation has reached epic proportions in China and much like Australia in the early part of this decade, the most popular shows on TV are related to property investing and speculation. I was told that a program about the hardships the property bubble has provoked was the single most popular, but has been pulled.

Middle and upper middle class people are buying two, three and four apartments at a time. And unlike Australia, these investments are not tenanted. The culture in China is to keep them new. I saw this first hand when I traveled to China a while back. Row upon row of apartment block. Empty. Zero return and purchased on nothing other than the hope that prices will continue to climb.

It was John Kenneth Galbraith who, in his book The Great Crash, wrote that it is when all aspects of asset ownership such as income, future value and enjoyment of its use are thrown out the window and replaced with the base expectation that prices will rise next week and next month, as they did last week and last month, that the final stage of a bubble is reached.

On top of that, there is, as I have written previously, 30 billion square feet of commercial real estate under debt-funded construction, on top of what already exists. To put that into perspective, that’s 23 square feet of office space for every man, woman and child in China. Commercial vacancy rates are already at 20% and there’s another 30 billion square feet to be supplied! Additionally, 2009 has already seen rents fall 26% in Shanghai and 22% in Beijing.

Everywhere you turn, China’s miracle is based on investing in assets that cannot be justified on economic grounds. As James Chanos referred to the situation; ‘zombie towns and zombie buildings’. Backing it all – the six largest banks increased their loan book by 50% in 2009. ‘Zombie banks’.

Conventional wisdom amongst my peers in funds management and the analyst fraternity is that China’s foreign currency reserves are an indication of how rich it is and will smooth over any short term hiccups. This confidence is also fuelled by economic hubris eminating from China as the western world stumbles. But pride does indeed always come before a fall. Conventional wisdom also says that China’s problems and bubbles are limited to real estate, not the wider economy. It seems the flat earth society is alive and well! As I observed in Malaysia in 1996, Japan almost a decade before that, Dubai and Florida more recently, never have the problems been contained to one sector. Drop a pebble in a pond and its ripples eventually impact the entire pond.

The problem is that China’s banking system is subject to growing bad and doubtful debts as returns diminish from investments made at increasing prices in assets that produce no income. These bad debts may overwhelm the foreign currency reserves China now has.”

I now wonder whether we are seeing the bubble slip over the precipice?  Falling property prices (10 per cent of the Chinese economy) leads to lower construction activity, leads to declining demand for Australian commodities, leads to falling commodity prices, leads to bigs drops in margins for a sizeable portion of the market index…

Watch this video and decide for yourself.

Posted by Roger Montgomery, Value.able author and Fund Manager, 8 December 2011.

by Roger Montgomery Posted in Energy / Resources, Insightful Insights, Market Valuation, Property, Value.able.

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I’m always looking for Value.able contributions that will enahnce the value of our Insights blog.

Scott’s comparison of the performance of a Value.able A1 portfolio and a conventional portfolio promoted by a large bank over the last six months is one such example. Nick’s contribution here about independent thinking is another. Take it away Nick…

“Most people would rather die than think, in fact they do so.” Bertrand Russell

The title of this post which Roger has kindly let me write for his blog may seem like such elementary and common sense advice that it need not be written at all – kind of like telling a friend to make sure he looks both ways before crossing the freeway.

Is thinking independently when it comes to investing really so obvious? And do people practice it consistently? I would say not. Just because something is obvious does not mean it will be practiced and not thinking independently, by which I mean not thinking for yourself and making up your own mind on an issue (not necessarily having a contrary opinion for the sake of having a contrary opinion), is one of the surest ways to destroy wealth and end up dissatisfied as an investor (aside from the strong likelihood of losing money you will also lack autonomy over your future). I have made this mistake in the past and can speak from experience.

Ben Graham once said “You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.”

And in the 1985 Berkshire Hathaway Annual Letter to Shareholders, Warren Buffett shares with his readers this story passed down from Ben Graham which illustrates the lemming-like behaviour of the crowd: “Let me tell you the story of the oil prospector who met St. Peter at the Pearly Gates. When told his occupation, St. Peter said, “Oh, I’m really sorry. You seem to meet all the tests to get into heaven. But we’ve got a terrible problem. See that pen over there? That’s where we keep the oil prospectors waiting to get into heaven. And it’s filled – we haven’t got room for even one more.” The oil prospector thought for a minute and said, “Would you mind if I just said four words to those folks?” “I can’t see any harm in that,” said St. Pete. So the old-timer cupped his hands and yelled out, “Oil discovered in hell!”. Immediately, the oil prospectors wrenched the lock off the door of the pen and out they flew, flapping their wings as hard as they could for the lower regions. “You know, that’s a pretty good trick,” St. Pete said. “Move in. The place is yours. You’ve got plenty of room.” The old fellow scratched his head and said, “No. If you don’t mind, I think I’ll go along with the rest of ’em. There may be some truth to that rumour after all.”

This is not the fate you want for yourself!

And don’t let hubris get in the way. Intelligence alone will not keep you away from the dangers of crowd behavior and emotion. One of history’s most gifted minds and scientists, Sir Isaac Newton, was caught up in the emotion and chaos of crowd behavior which resulted in him losing his fortune in the South Sea Shipping Company Bubble. Sir Isaac Newton had previously made a packet on this very same company although after selling and watching the share price continually keep rising, he reinvested everything he had before the crash. For as long as he lived he forbid the words South Sea Shipping Company to ever be mentioned in his presence. It was not a lack of intelligence which brought Sir Isaac unstuck, it was, I argue, his lack of independent thought on the merits of the South Sea Shipping Company as a suitable investment.

“An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” Ben Graham.

Once you have determined to think independently and make up your own mind on a company’s current strengths and weaknesses, and its current and future earnings prospects, how do you best do this? Perhaps the most effective way is to follow the advice of the famous algebraist Carl Jacobi who said ‘Invert, always invert.’ So if from your reading you believe company XYZ to be possible investment material (either from Roger’s blog, the newspaper, a friend, your stockbroker) read everything you can and formulate as strong a case as you can on why it would make a lousy investment. If, after having made as strong a case against the company as the information allows, it still looks pretty good and is selling at an attractive price, then it is worthy of further consideration. It has also been useful to me in the past having friends help me out with this. Usually before making an investment I’ll ask my most intelligent and able friends for their opinion on why I shouldn’t invest in company XYZ. This will not mean that you’ll never make a mistake again, although when you do at least you’ll be able to understand why (having studied the reasons against making the decision in the first place).

“I want to be able to explain my mistakes. This means I do only the things I completely understand.” Warren Buffet

Charlie Munger, in a speech given at USC (which you can all view on YouTube) says “I have what I call an iron prescription that helps me keep sane when I naturally drift to preferring one ideology over another and that is I say I am not entitled to have an opinion on this subject unless I can state the arguments against my position better than the people who are supporting it.” This is great advice, and to tailor it to investing all you need to do is replace the word ‘subject’ with ‘company.’

Charlie Munger also likes to talk about the importance of having a latticework of mental models in your head and how the big ideas from across a broad range of disciplines can often be used in sync to best analyse a particular problem. I won’t expand on this now, although can recommend his speeches and essays which are easily available on the internet.

Having a great interest in investing, I find this blog is a wonderful source of ideas and learning and really enjoy reading the comments written every day. That said, one way in which I believe it could be improved is for there to be more argument and questioning, something which is happening more and more as the share price of recent blog favorites has dropped. If someone says they believe XYZ to be a great quality company without providing reasons they should be held to account and asked why? If the only response is that Roger has it as an A1 then a fail grade would be mandatory. If someone says they believe that company XYZ has excellent earnings prospects they should again be asked why? And if their response is that the analysts consensus on Comsec says so then again, another F.

I hope that this post may have been of some interest and if you have some stories of success as a result of independent thinking, I would be very interested in reading them.

Nick Mason

Roger’s Note: And if you have a similarly lucid and instructive idea that you would like share here at our Insights blog, go ahead and submit. Not every contribution can be published as a post, but we will certainly post those we like.

Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 stock market service, 23 September 2011.

by Roger Montgomery Posted in Insightful Insights, Investing Education, Value.able.

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Did you know some of Qantas’ planes are more than twenty years old? And our estimate is that they fly, on average, 14 hours per day. The rest of the time they mimic that expensive bit of fashion in your garage, earning no income. That garage/hangar time has expensive ramifications for the economics of airlines, just as your decision to buy an expensive but garaged ‘fashion’ item has expensive ramifications for you.

Capital-intensive businesses, such as airlines, erode shareholder wealth. Inflation ensures their maintenance and replacement is a significant proportion of cash flow, which could otherwise be paid out to shareholders. Parts plus labour, which protect the business assets from wear and tear, actually causes wear and tear on shareholders’ funds.

Raising capital and increasing debt, has hitherto been easy for Qantas, but the market is slowly coming to the realisation that it cannot continue.  The market capitalisation of Qantas – the ‘value’ the market ascribes – is less than all the equity that the company has raised – much less.

As a result of the market’s slow migration to understanding the economics of airlines, fresh management have had to respond quickly.

The best measure of economic performance is Return on Equity (ROE). This year QAN achieved a ROE of just over four per cent.  Meanwhile, Oroton shareholders have been enjoying eighty per cent returns. Did you know there are 267 companies that earn more than 15 per cent returns on equity?

The business of selling seats is an expensive one for Qantas, and while the business of selling the hope-of-getting-a-seat (the Frequent Flyer program) is extremely profitable, owning planes means the cash is always inhibited – it can’t be distributed to shareholder owners.

Qantas however isn’t the only seller of seats on planes. Indeed there are businesses that sell seats on planes and they don’t have any planes. Let’s compare two seat-sellers: Qantas and Webjet.

I believe the very best businesses online are lists – lists of jobs, lists of apps, lists of songs, lists of cars, lists of houses, list of flights and lists of seats. What is particularly attractive is that a business with a list of seats doesn’t have any planes. Sure its revenue is going to be lower, but what about its profit?

Let’s compare…

Now, lets take a look the economics of these businesses over the past ten years.

As the following sneek peek charts from our soon-to-be-released next-generation A1 stock market service display, Webjet has scored, on average, an A2 since 2005.

In this example, the Quality Score information tells us that something dramatic happened in the 2004/2005 financial year.

Webjet was once called Roper River Resources Company and in July 1999 the shares, under the ASX code; RRR, were trading at 25 cents. By March 2000 – near the peak of the internet bubble – RRR shares were trading at $1.38.

The reason is now obvious, although at the time it may have been a bit of a mystery.

In January 2000, Roper received a ‘speeding ticket’ from the ASX to which it responded on 14 January with the following statement:

“1. There are no, matters of importance, about to be released to the market.

“2. The Company is not aware of any information to explain the recent trading in the shares.

“3. The Company can offer no other explanation for the price change and increase in volume in the securities of the Company.”

“4. I confirm that the Company is in compliance with the listing rules, in particular, listing rule 3.1.”

On 27 January 2000 however – less than two weeks later – Roper River Resources (ASX:RRR) announced it was issuing 50 million shares to acquire Webjet Pty Ltd.

By June 2004 the shares were still trading at 15 cents, however the company announced the previous October that it was trading in the black for the first time. By November 2004, it was reporting 400 per cent monthly increases in sales. Almost every month to its full year results in June 2005, it continued to report 400 plus percentage increases in monthly sales.

And in that year Webjet’s Quality Score jumped from C4 to A1. As you can see, Webjet has maintained an A1 or A2 quality rating since.

By comparison, Qantas’s Quality Score profile has been more marginal. This should be unsurprising to many, if not most Value.able Graduates, who understand the downside of capital intensity. Lots of property plant and equipment results in more equity for a given profit, and that means lower returns.

So, what do you think?

With reporting season about to end, your mission, if you choose to accept it, is:

Source the latest Annual Report for each business in your portfolio. Go to the Balance Sheet and under ‘Non-Current Assets’ find ‘Property, Plant and Equipment’.

If you have any, how many capital-intensive businesses are hiding in your portfolio?

Making this process simple and easy is something we have been working on for you. We created our next-generation A1 service because we wanted to make finding extraordinary companies offering large safety margins easy. And, of course we love investing. The above graphics are just one

It’s an A1 service that is like nothing you have ever seen before.value

Value.able Graduates – your invitation to pre-register is coming soon.

If you haven’t graduated to guarantee your invitation, click here to order your copy of Value.able immediately. Once you have 1. Read Value.able and 2. changed some part of the way you think about the stock market, my team and I will be delighted to officially welcome you as a Graduate of the Class of 2011 (and invite you to become a founding member of our soon-to-be-released next-generation A1 service).

Posted by Roger Montgomery and his A1 team, fund managers and creators of the ext-generation A1 stock market service, 30 August 2011.

by Roger Montgomery Posted in Airlines, Companies, Insightful Insights, Value.able.

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Irrational exuberance and tech stocks are old bedfellows. In my previous post, Is this time different?, I wrote “I never ever allow myself to believe this time is different to the last”.

With that in mind, approach the following list of upcoming IPOs with the same trepidation as a Value.able Graduate would the P/E ratio. Don’t get too distracted.

Facebook, Groupon, Kayak, HomeAway, Milennial Media, Trulia and Zillow Inc are expected to float in the near future. I’ll be watching them for signs of irrational exuberance. Why? Because locally, James Packer is buying into similar companies (Scoopon.com.au, catchoftheday.com.au and groceryrun.com.au), one suspects to subsequently spin them off, through an IPO, to you.

If you would like to keep this list updated, go right ahead.

On behalf of Value.able Graduates and every other investor who reads my Insights blog, I would be delighted to see you expand this list.

In your comments, feel free to add any upcoming floats or recent floats that I have left out (Zipcar, for example). Stay tuned for MQR’s and intrinsic valuations for these companies too! (they’re just a small part of our new A1 service – my team will invite all Value.able Graduates to pre-register soon).

Facebook: If floated, as many expect, in April 2012, Facebook could be valued at $100 billion. You can imagine the float price will be a bit silly… the company will tell 700 million users about it and will attract many first time Gen Y ‘investors’. Facebook is currently valued around $70 billion on the private market.

Groupon: One of the very first deal-of-the-day websites set up all the way back in 2009, Groupon has already filed to go public. The company estimated sales of $2 billion and is expected to float at $30 billion but that sales figure is based on the revenue from selling coupons.  A significant percentage of that must go to the business that offers the goods/service in the first place.  If ebay reported its sales revenue as the total value of all goods sold, it would amount to $61 billion rather than the $9 billion they did report.  The correct sales number for Groupon is about $530 million.  The valuation compares to $135 million funding in April 2010 that gave the company a $1.35 billion valuation, Google’s offer in November 2010 of $6 billion, and a $590 million raising in January 2011 that valued the company at 15 billion.  At $30 billion the price-to-sales ratio is 51 times.  This compares to Google at 6 times, Microsoft at 3.5 times, Apple at 5 times, and Amazon and Yahoo at 3 times.

Kayak: The leader in travel search filed for an IPO in November 2010. It generated $53 million in revenue for the quarter ending March 31, up 43 per cent from pcp (previous corresponding period). The company processed 214 million queries in the quarter, up 48 per cent from pcp and there were more than one million downloads of its mobile applications in the quarter, up 226 per cent from pcp. Kayak had a net loss of $6.9 million in the quarter, up from $854,000 in the year-ago period. But the company took a $15 million charge for dropping its Sidestep.com URL. The company stated:

“During the first three months of 2011 we determined that we would no longer support two brand names and URLs in the United States and decided to migrate all traffic from www.sidestep.com to www.kayak.com, resulting in the impairment charge.”

Kayak sources 56 per cent of content for the Kayak flight queries from a company called ITA Software. Google has acquired ITA software and is expected to build a competing product. On this development, Kayak has said that it received 7.8 per cent of total advertising from Google in the most recent quarter. It notes that a consent decree requires Google to renew Kayak’s contract with ITA. If, however, Google limits Kayak’s access to ITA or develops replacement software, Kayak could be hurt.

HomeAway: The vacation rental site filed for a $230 million IPO in March 2011, hoping to sell 9.2 million shares at $24 to $27 each. HomeAway will list this week. Last week the company raised the goal for its initial stock offering to $248.4 million giving it a proposed value of $2 billion. 2010 revenue was $167.9 and net profit was $16.9 million. HomeAway makes more than 91 per cent of its cash annual subscription fees. Most property managers/owners pay $329 per listing per year to be featured on HomeAway.com, HolidayRentals (UK) and HomeAway FeWo-direkt (Germany). It’s a subscription fee business model that doesn’t rely on ad dollars, but according to the company, is “highly predictable and profitable”. Last year, more than 75 per cent of HomeAway’s clients renewed their existing listings. But $2 billion for a profit of $16 million in profits? Fairfax got a steal when they bought OzStayz! The auditors can relax about the valuation of goodwill on the company’s balance sheet.

Milennial Media: The third-largest mobile-advertising company in the US is talking to bankers about a potential initial public offering. The IPO is expected late this year or in early 2012, values the company at $700 million to $1 billion. Milennial Media helps advertisers find space on mobile devices, such as smartphones. It’s increasing its market share in the industry, but its competitors include global dominators Google and Apple. According to research firm IDC, Millennial accounted for 6.8 percent of mobile-ad revenue last year, up from 5.4 percent in 2009. Also according to IDC, total US mobile-ad market, however, generated just $877 million in 2010.

Trulia: Real estate search engine Trulia hired former Yahoo CEO Paul Levine in February.  Trulia won’t say when it plans to float, but Chief Executive Pete Flint recently told Reuters that an offering is part of the company’s longer-term plans. “Building an IPO-ready management team is our focus, but we’re certainly in no rush, and as we announced, we’re profitable, so we’re not in need of external capital.” Its main competitor is Zillow.com (see below).

Zillow Inc: Filed on April 18 to raise $51.8 million, the company is backed by venture capital firms Accel Partners and Sequoia Capital . Zillow has hired Citigroup Inc. to handle the IPO. In three years its revenue mix has gone from being advertising-based, to fees and subscriptions from its Zillow Mortgage Marketplace, which connects borrowers with lenders. In 2009, Zillow earned 22 percent of its revenues from the marketplace, and 78 per cent from display advertising.

In 2010 display advertising dropped to 57 per cent of the total pool, while marketplace revenues more than doubled. Display advertising revenues however grew by 27 percent this year.  In total, Zillow earned $30.4 million last year, and made a loss of $14.1 million in 2010 after a loss of $12.9 million in 2009. Its venture capital investors have sunk $87 million into the company.

So there’s the list and I would be delighted to see you expand it.  Irrational exuberance in the US can spread like a virus here.  James Packer’s investment in the founders of catchoftheday, dealsdirect and groceryrun values the coupon business at $200 million.  What valuation will be given when they are dressed up for a float here?  Watch this space…

What upcoming or recent floats are you watching? Feel free to submit the new Aussie floats that you are watching and I’ll add the Montgomery Quality Ratings and Value.able intrinsic valuations to them over the coming weeks.

Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 20 June 2011.

by Roger Montgomery Posted in Companies, Technology & Telecommunications.

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“If you’re playing a poker game and you look around the table and can’t tell who the sucker is, it’s you.”  Paul Newman

“Great men are not always wise” Job 32:9

“If one man says to thee, ”Thou art a donkey’,’ pay no heed. If two speak thus, purchase a saddle.”  “Doubt cannot override certainty”  The Talmud

“The seed ye sow, another reaps; The wealth ye find, another keeps; The robes ye weave, another wears; The arms ye forge, another bears.”  Percy Bysshe Shelley

If you are watching events unfold in the US like me, you’re probably hearing a lot about the tech stock frenzy going on over there.  Stunning IPO successes this financial year are once again drawing a crowd. But are we looking at a Tech Bubble MkII? Are the big banks, without a suite of CDSs and CDOs to sell, now performing the same cup-and-ball trick on a different table? Or is this time genuinely different?

Read on – you be the judge (my mate Jim Roger’s is short “US Tech”, and I never ever allow myself to believe this time is different to the last).

YouKu

Based in Beijing and now listed on the Nasdaq, YouKu is China’s answer to YouTube. The stock closed at $33.44 on its first day of trading in December 2010 (its now $28.04) – that’s 160 percent above its offer price of $12.80! The company offered 15.8 million shares of American Depository Receipts (ADRs), representing 16 percent of the total shares, giving it market cap of $3.3 billion or 71 times revenue. Youku generated revenue of $35 million in the first nine months to 31 December 2010 and lost $25 million during the same period.

Founded in November 2005 and launched in December 2006, YouKu never really relied on user-generated content. More than 60 per cent of its videos are from traditional media companies in China. The company has 40 per cent penetration amongst China’s 420 million internet users. YouKu claims 200 million unique visitors a month in China, however independent comScore estimates a smaller 78 million.

LinkedIn

LinkedIn was priced at $45 per share but traded between $80 and $120 for more than a week after listing, giving the company a market ‘valuation’ as high as $11 billion. Unlike many of the tech stocks that tempted investors in 1999 and early 2000, LinkedIn is profitable.

The company reported its first quarter revenue in 2011 was up 110 percent to $93.9 million compared to pcp (previous corresponding period) and ‘Net income’ increased to $2.08 million for the same period, compared to $1.81 million for pcp.

But there is profitable and there is ridiculous. An $11 billion valuation, or more than 22 times revenue for a business that earns 2 per cent on its revenue, seems, at best, unconnected to the underlying financials. Even someone like me that pays no attention to price or revenue multiples can see that.

Yandex

On 26 May 2011, Yandex NV (YNDX), owner of Russia’s version of Google and the country’s most popular Internet search engine, listed on the NASDAQ. Yandex sold 52.2 million shares (or 16.2 percent) at $25 per share, raising $1.3 billion and valuing the company at $8 billion. On their first day of trading the shares rose $13.84, to $38.84, giving the company a market capitalisation of $12.4 billion or a multiple of 43 times next year’s forecast earnings. For those seeking a reference point (not a valuation), Google trades at about 13 times estimated 2012 earnings.

Total online advertising in Russia climbed 51 percent from 2008 through 2010, but still amounts to just $940 million! Private equity accounted for seventy per cent of the shares sold in the Yandex float.

Renren Network

The demand for shares in Renren – the Facebook of China with 117 million users* – was clear days before it floated on 2 May 2011 (the company raised the expected price range of its IPO of 53.1 million shares by 30 percent to $12 to $14 per share from a previous range of $9 to $11). The float raised about $743 million and gave the company a valuation of more than $4 billion, or 52 times sales. Renren’s net revenues were $76.5 million in 2010, up 64 per cent from $46.7 million in 2009 and up from $13.8 million in 2008. Renren had a net loss in 2010 of $64.1 million, down from $70.1 million in 2009.

The head of Renren’s audit committee, who is also a board member, quit after allegations of fraud against Longtop Finanicial Technologies. The company also revised down its unique user numbers to a rise of 19 per cent (it originally advised 29 per cent).

Renren said in its prospectus that it operates under a prohibition against posting content that, “impairs the national dignity of China” or is “superstitious”, or content that is “socially destabilising.”

If Renren fails to comply, the company says its websites could be shut down. Clearly that could put it out of business.

The company also has a “material weakness” and a “significant deficiency” in its internal financial controls: it doesn’t have enough people with knowledge of U.S. GAAP (Generally Accepted Accounting Principles). Eighty seven per cent of Renren’s leased office floor area did not have the proper title documents.

*Renren doesn’t really seem sure how many users it has. According to its April 27 revised IPO filing, monthly unique log-in user base grew by only 5 million, or 19 per cent, in the first quarter of 2011 – not the 7 million, or 29 per cent, it reported in its first filing only 12 days earlier.

Pandora (not the charms)

Online radio operator Pandora runs an online personal music service – with applications for the iPhone and Google’s Android mobile operating system – that lets users pick songs, styles/genres and bands from which to build a personal radio station. As at the end of April, Pandora has about 94 million registered users, of which 34 million are considered active. This is up from 18 million at the same time last year.

Pandora offered 14.7 million shares, or just 10 per cent of the total float at $16, raising around $235 million and putting a valuation of $2.6b on the whole shebang. Pandora was priced at about 19 times revenue for last year. Revenue Value.able Graduates, not NPAT.

Pandora has not reported any profits in 2010 or 2011. Indeed in the last three years, Pandora has lost $46.7 million and the company said in its IPO filing that it doesn’t expect to be profitable this year or next. Worryingly, it doesn’t say when it expects to be profitable.

In the weeks prior to listing, the lead manager, Morgan Stanley, raised the expected price range from $7-$9 to $10-$12. Then, after the marketing period ended, priced the shares at the final listing price of $16.

And it gets more fascinating. On its first day of trading, Pandora shares rose as much as 63 per cent to a high of $26, giving it a market capitalisation of $4.2b. A competitor listed on the Nasdaq, Sirius XM, trades at 2.6 times revenue.

According to documents filed with the SEC just six months ago, Pandora’s own board reckoned its stock’s value was/is $3.14 a share, or a market capitalisation of about $500 million.

Pandora generated revenue of $51 million in the first quarter ending April 30 – more than double the $21.6 million for the pcp. The company however lost $6.8 million in the first quarter this year, up from around $3 million in the same quarter last year.

Until recently advertising has represented more than 90 percent of revenue, however revenue from subscriptions (which lets subscribers skip the advertisements the company’s other customers pay for to appear between songs) has been growing. At the end of April, subscription revenue was about 15 per cent and is growing at more than 100 per cent per annum.

But more than 50 per cent of total revenue is paid for song rights and the more people that listen to music through Pandora, the higher this royalty grows. Pandora has an agreement with SoundExchange for its streaming rights that expires in 2015. Between now and 2015, the rates Pandora pays are expected to go up by 37 per cent for songs streamed by free listeners, and by 47 per cent for songs streamed by paid subscribers. In addition to these fees, Pandora has deals with BMI and SESAC to pay 1.75 per cent and 0.38 per cent of gross revenue respectively. In order to become profitable, Pandora will need revenue per user to go up. And it will need a new deal with the music labels.

The share price is now below $16.

Bubbles? This Time is Different!

Ok. Enough of the fundamentals, no one is paying attention to those anyway. From what I have been reading there are many experts who are saying… what exactly? That this time is different!

Those who believe this time is different to the tech boom of the late 90’s point out that 90’s technology companies never generated profits or even revenue. Pandora however has a revenue model, and it’s rare to see today’s tech IPO without one. Effectively the ‘experts’ are suggesting the tech stocks listing today are more mature. Some investors and analysts even brushed off red flags like Renren revising down its user and user growth numbers just before its float, saying China is still the biggest internet market in the world and its rapid growth will continue. They suggest that figures reported by Chinese companies should be used for directional guidance, rather than as quantitative truths.

And that’s pretty much their argument.

My team and I have the ability to analyse every single listed company, globally (and the indices on which they are based), with fundamental data that is updated daily (very soon you will have the opportunity to use our extraordinary A1 service for every Australian company too, so don’t be tempted by all those end of financial year special offers).

Our intrinsic value analysis for the companies described above, and many of their more mature peers in the US and elsewhere, reveals gullible investors are once again being taken for a whimsical ride accompanied by a flagrant disregard for value.

Bubbles can go a long time before popping, and given that bubbles are best identified by credit excesses, not solely valuation excesses, we may be only in the very early stages of the bubble in technology stocks (but very close to the bubble bursting in US TBonds).

Your thoughts?

Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 19 June 2011.

by Roger Montgomery Posted in Global markets, Technology & Telecommunications.

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Less than an hour ago, Microsoft Corp. agreed to buy the Internet telephone company Skype SA for $8.5 billion. The company was started by Niklas Zennstrom (who remained CEO until September 2007) and Janus Friis (one of Time Magazine’s 100 Most Influential People 2006) in 2002 and they sold it to eBay in 2005 for $3.1 billion.

eBay bought Skype in 2005 for $3.1 billion and sold 70% to private equity for $2 billion in late 2009. Up until yesterday, it was owned by private equity, the Canadian Pension Plan Investment Board and eBay. Now Microsoft is buying the company for three times what private equity paid —an increase in value of more than $5.5 billion in about 18 months. Skype’s original founders also ended up in the syndicate through their company Joltid.

It is the biggest deal in Microsoft’s history. Some of that 36-year history includes a friendship between former CEO Bill Gates and Warren Buffett. One wonders if Warren was consulted because the initial metrics are staggering. Some may argue the high price is because Microsoft was competing against an imminent IPO. With more than $50 billion in cash (much held offshore for tax purposes), Microsoft merely needs to beat the aggregate cash return, which in the US is somewhere just north of zero.

Skype’s ‘customers’ made 207 billion minutes of voice and video calls last year – up 150% on 18 months ago. Most of those calls however are free. Less than 9 million customers per month, or a little more than five percent, paid Skype anything.

The company did produce revenue of $860 million last year, but Skype lost $7 million. $8.5 billion is quite staggering. I think Skype is great and I know many who use it to avoid paying anyone for phone and video calls.

You may recall Microsoft has previously bid $47.5 billion for Yahoo Inc. Yahoo rejected Microsoft’s advances and Microsft dodged a bullet; Yahoo is now available at half the price.

Perhaps we are not in bubble territory? Perhaps it all works out? Perhaps its just a repeat of Foster’s purchase of Southcorp – on a much grander scale? Or perhaps Microsoft will start charging everyone for a call? A charge of 1 cent per minute – and no loss of customers – would be worth $2.07 billion in revenue… What percentage of Skype’s free riders do you think would submit credit cards etc. to subscribe and be willing to be charged?

Posted by Roger Montgomery, Value.able author and fund manager, 11 May 2011.

by Roger Montgomery Posted in Companies, Insightful Insights, Investing Education, Market Valuation, Takeovers, Value.able.

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CONTRIBUTIONS ARE NOW CLOSED.

I have an assignment for you.

Before we start, two things…

1. If you are looking for a gift that keeps on giving in 2011, give your loved ones a copy of Value.able. To guarantee your gift makes it into Santa’s sleigh, you must order before 5pm next Monday, 13 December.

2. Put Thursday 16 December @ 7pm in your diary. Sky Business has invited me to appear on their Summer Money program.

Within Summer Money, Sky is running a series called The Twelve Stocks of Christmas and I have been asked to present one of the twelve stocks. What I would like to do is let everyone on Sky Business know about you – the Value.able Graduate class of 2010!

You have been instrumental in contributing to the knowledge and awareness of value investing and I would like to say thank you by reviewing your suggestions on air.

So, what will it be? You can nominate one of the companies we have already discussed. More points can be earned by contributing a company of which you have industry-level knowledge. Think about your industry or business:

– Who is the strongest [listed] competitor in your industry?

– Who would you like to see out of business because they are an emerging threat?

– What are their competitive advantages, their opportunities for growth and why do you think they will sell more of their product or services in the future or at higher prices?

– Perhaps they are out of favour in the share market, but you believe it’s a case of a temporary set back being treated like a permanent impairment?

I encourage you all to post your contribution. There are just two rules:

1. One stock (your best pick) per Value.able Graduate. The more detailed your information, the better; and

2. Ideas must be submitted by Wednesday 15 December

Before the live show at 7pm next Thursday, 16 December, I will run my valuation eye over every suggestion and give each my Montgomery Quality Rating (MQR). But the list will be yours – a contribution from the Value.able Class of 2010.

Whilst only one stock will make it to the show, EVERY SINGLE STOCK  contributed on this post with sufficient supporting detail will be subsequently listed in my final pre-Christmas post for 2010, complete with MQRs, current valuations and prospective valuations (I have decided to called these MVEs – see below).

Embrace this opportunity to practice what you have learned over the past twelve months, and get the official Montgomery Quality Rating (MQR) and Montgomery Value Estimate (MVE) for your favourite stock. You never know, your stock may just be the one I contribute on national television to The Twelve Stocks of Christmas.

Post your suggestion here at the blog by Wednesday 15 December 2010.

I look forward to reviewing your insights and hearing what you think of your classmates’ suggestions. Simply click the Leave a Comment button below.

Posted by Roger Montgomery, 9 December 2010.

Postscript: thank you for your kind words and birthday wishes. I’m thoroughly enjoying my time away and am very much looking forward to reading and replying to your comments when I return to the office next Monday.

Postscript #2: Steven posted his own Value.able 12 Days of Christmas at my Facebook page last Friday – brilliant!

On the twelfth day of Christmas,
My independent analyst’s blog gave to me
12 A1s humming
11 valuations piping
10 C5s a-sleeping
9 forecasts prancing
8 capital raisings milking
7 floats a-sinking
6 CEOs praying
5 golden A1s!!
4 C5 turds
3 emerging bubbles,
2 editions of Value.able
And a market leader with a high ROE!

Here is Steven with his daughter Sophie.

Roger, you were good enough to sign my book…

“To Steven, Your guide to avoiding the dogs you told me you were so worried about, RM”.

Here I am reading Value.able to my little two year old Sophie at bedtime, holding her toy dogs. The moral of the story for Sophie? Roger shows dogs make fun toys and pets but must be avoided at all costs when investing in great businesses!”

Steven

by Roger Montgomery Posted in Companies, Insightful Insights, Investing Education, Value.able.

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