Edward Goodwin: Investing

Tue, 04 May 2004 14:59:30 GMT

Apparently, investors, on average, know very little about what they are doing. Professor Bainbridge links to an LA Times article detailing the results of a study by the NASD (National Association of Securities Dealers) which shows how woefully incompetent the average securities investor is. Quoting from the article:

Recent surveys found widespread confusion about the relationship between interest rates and bond prices. The National Assn. of Securities Dealers surveyed more than 1,000 investors last year and found that 6 of 10 didn't understand that bond prices fall when interest rates rise.

That is just scary. Quick primer for those of you who can manage to stay awake: As an investor, bonds are a promise to pay a sum (known as principal), on a certain date (maturity date), at a specified rate of interest (the coupon rate). Along with the coupon rate is a schedule of interest payments (typically annually or semi-annually). So let's say you buy a $10,000 bond from Incredible, Edible, Inc. with a 5% coupon rate, payable annually, that matures 5 years from today. Every year on this date (for the next 5 years) Incredible, Edible, Inc. will send you a payment of $500. On May 4th, 2009, Incredible, Edible, Inc. will pay you your last interest payment ($500) + the return of your principle ($10,000).

Now, the coupon rate stays static for the life of the bond. Basically, you are getting the same annual coupon payment for the life of the bond (as with everything there are exceptions but we're keeping this simple). Meanwhile, in the real world, interest rates are changing on a daily basis. What does this mean for the investor buying bonds? Well as interest rates rise, your bond is losing value, and as they fall, the bond is gaining value. To explain why, imagine that I make a promise to give you $10 every year for the rest of my life. If we experience inflation from one year to the next, the $10 I give you can buy less than the $10 from the year before. If we experience deflation from one year to the next then the $10 I give you can buy more than the year before. If you were to try to sell my promise to someone else they will be willing to pay more or less depending on what they expect inflation to do. Bonds work the exact same way.

If a company promises to give you a 5% return on your money and the banks are offering you a 10% return on your money the rational person is going to put their money in the bank instead of buying the bonds. So, in order to avoid having to rewrite bond contracts whenever interest rates change, companies just offer the lower return bond at a discount to the face value (the principle) of the bond in order to bring returns in line with the market. So if you have a 5 year, risk free $10,000 bond at a 5% annual coupon rate and the prevailing interest rate is 10% then the bond will be issued at about $8,100. This brings the "real" return of the bond up to 10% even though the coupon rate is only 5%.

So as interest rates rise, the bonds have to be incrementally discounted to keep them in line with the market. For future buyers of these bonds this is a good trend, but for current holders it is like watching someone siphon dollar bills out of your wallet.

If you fall into the above category (of not knowing what you're doing), you probably shouldn't be managing your own money. via [Professor Bainbridge]

Mon, 26 Apr 2004 19:12:40 GMT

Get your random numbers right here. via [ Marginal Revolution ]

Mon, 26 Apr 2004 19:01:10 GMT

Bush's Pension Relief plan that was signed into effect a few weeks ago is definitely a step in the wrong direction. Oligopoly Watch has a pretty good analysis of the situation.

Pension plans are federally insured, so that, if worse comes to worse, pension funds can dump liability on the government. In this way, once again taxpayers are being asked, indirectly, to subsidize large corporations, many of whom, it has been recently revealed, manage to avoid paying nay income taxes at all.

The entry also points to the Heritage Foundation which say on its website:

By allowing companies to avoid funding their pension plans' deficits, the new law makes it likely that taxpayers will have to pick up that liability. The sad fact is that many companies that qualify for the funding holiday will be in equally poor financial shape in 2006. The delay is likely to cause these plans to accrue even higher funding deficits. Moreover, once the companies submit their even more underfunded plans to PBGC, that agency will be further down the road toward an inevitable taxpayer-funded, multibillion-dollar bailout.

via [Oligopoly Watch]

Mon, 19 Apr 2004 14:25:03 GMT

SEC Suspends Ernst & Young (Reuters). Reuters - A judge suspended Big 4 accounting firm Ernst & Young LLP on Friday from accepting new, SEC-registered audit clients for six months in a case involving software group PeopleSoft Inc. (PSFT.O), handing a victory to the U.S. Securities and Exchange Commission. Is this the beginning of the Big3? I wonder at what point the government will actively step in and try to save a Big Accounting firm? via [Yahoo! News - Business]

Wed, 10 Mar 2004 16:00:33 GMT

FastCompany discusses Google.

"Flexibility is expensive," says Craig Silverstein, a 30-year-old engineer who dropped his pursuit of a Stanford PhD to become Google's first employee. "But we think that flexibility gives you a better product. Are we right? I think we're right. More important, that's the sort of company I want to work for."

The emphasis added was mine. While I applaud the man's passion about his job, and I applaud the work that Google has done, I question the veracity of the statement. As an engineer you should be searching for the empirical evidence, not giving knee-jerk responses. Also, you need to understand that the sort of company you want to work for is irrelevant to the survivability of said company.

I'm sure anyone who reads this will assume I'm bashing Google. I'm not. I'm extremely interested in the upcoming IPO because it will lay bare the truth of the enterprise. How much money do they make? How much do they spend on employee perks? Do these things really contribute to the bottom line? Most importantly, can Google survive being a public company? Wall Street has an insane pull on people and Google's culture seems to border on geek-communism. It will be an interesting clash.

Mon, 08 Mar 2004 14:14:41 GMT

Berkshire Hathaway's 2003 Annual Report is out. I'm super-swamped at work and school right now, but I plan on sitting down and going through it over the next few days when I get a chance.

Tue, 24 Feb 2004 17:56:00 GMT

Lessons Learned the Hardest Way, by Going Belly-Up. Fifty percent of small business fold after four years. The reasons vary, but the failures often carry valuable lessons for the owners and administrators.

The dot.com bubble ran about 4 years (1997-2001) from beginning to absolute end. Coincidence? Probably not. via [New York Times: Business]

Mon, 09 Feb 2004 15:12:11 GMT

Apparently, U.S. Consumers are struggling under a mountain of debt. Who knew? I believe this is the primary reason that the Fed has been so hesitant to raise interest rates. If you haven't noticed, most of those 0% interest plays in the auto, and high-end retail sector move to an APR style agreement after about a year. If the interest rates rise (which they will) then American consumers could be in a world of hurt.

That's my reasoning for taking fixed rates (which are slightly higher) on everything. Of course I could be wrong and end up looking like a sucker in 5 years. The good news is that I already look like one since I'm paying higher rates today so it won't be too much of a change. I'm willing to look stupid for the sake of safety.

The problem that I see coming is that the low rates encourage more borrowing, not resolution of the debt issues. So right now we're just digging ourselves deeper and hoping for a bailout from somewhere. Many people point to the rise in equity prices as a solution. If the market is growing at a 15% clip and we're paying 12% on credit cards, then we're okay. This fails to resolve for two primary reasons.

The market is like the lotto, "you gotta be in it to win it." Every dollar spent servicing debt or consuming goods is another dollar that can't go into equity investments. So the issue becomes what percentage is invested vs. servicing debt and for most Americans the math won't work out in their favor. American consumers have the highest worldwide debt level per capita of any nation. This is money that is not flowing into the markets to take advantage of any gains. Also, all this consumer debt is driving earnings at companies. If interest rates rise people will curtail spending, and begin servicing debt which will drive earnings down, which will dampen market returns.
Inflation drives down market returns. Inflation basically means that cash is weakening relative to other assets. You can buy less with the same amount of cash. The value of a stock is simply a determination of what the market thinks the present value of a companies future cash flow is. In a world of rising inflation, future cash flows mean less than they did the day before. As this happens people place less and less value on the size of future cash, driving prices down. In short as inflation goes up, market returns go down in an absolute sense. If your interest rate on your debt level is rising in step with inflation then the spread between market returns and the debt interest narrows at an alarming rate and will most likely invert at some point.

Tue, 13 Jan 2004 15:03:59 GMT

Restatement of annual reports by public companies rose this year according to an article in the New York Times. I find that more than a little disturbing since the number of companies that file with the SEC has actually decreased over the last year. This means that on a percentage basis, accounting restatements of annual financials (which must be audited) has risen.

Total restatements, a combination of annual and quarterly reports (which do not need to be audited), have fallen. Still, since quarterly reports do not need to be audited malicious managements are more likely to sweep things under the rug on a quarterly basis. Ethical, but lazy management is inclined to do the same but for different reasons.

Thu, 08 Jan 2004 21:36:04 GMT

Congress is talking about repealing PUHCA, which could have huge ramifications for the energy sector and in the U.S.

I haven't collected my thoughts on the matter but it could mean really nifty ramifications for Berkshire Hathaway as their equity holdings in Mid-America could be more fully utilized. As the article states Buffett has already indicated he would be willing to invest up to $15 billion more (about 1/7 of Berkshire's current worth) if the act was repealed.

Of course by the time PUHCA gets repealed the energy sector may well be out of its doldrums, forcing Berkshire to go elsewhere for returns.

Wed, 10 Dec 2003 19:32:54 GMT

More fuel for the anti-Ford fire (no pun intended).

Tue, 09 Dec 2003 15:20:55 GMT

Hey guys remember Global Crossing?

Global Crossing, which is about to emerge from bankruptcy protection, revealed that it had losses of $25.7 billion in 2000 and 2001 after writing down the value of its fiber-optic network.

Most of the loss came in 2001, when Global Crossing had $17.2 billion in charges, the company said in its first full-year filing with the Securities and Exchange Commission since 2000.

I'm really trying to get my head around the bankruptcy process in this country. It seems ripe for abuse (a la the airline industry). But is it really just an incentive for entrepeneurs to innovate and take risk on business models that might never see the light of day otherwise? When dealing with large cap enterprises ($1 billion+) it seems like bankruptcy does less to protect the debtors of an enterprise and more to encourage companies to enter into industry destructive behavior since there is little real repercussion. Airlines that emerge from bankruptcy do nothing but force other airlines into the process as they are leaner, and more competitive. The same seems to hold true for the telecoms.

I have a feeling the above little rant is going to be something I look back on in a year and laugh about since it probably contains a lot of ignorant statements. However, it's a good starting point for analysis.

Wed, 03 Dec 2003 18:39:45 GMT

VoIP's Big Week.

Voxilla.com has a great summary of activity in the VoIP industry, including announced plans from Qwest, AT&T and SBC to roll-out consumer VoIP products in conjunction with their broadband services (DSL), as well as details from the FCC Hearing on VoIP. I've become an active user of VoIP telephony services -- it's unbelievable how quickly this is happening, and how the standards convergence combined with a critical mass of broadband users is transforming this industry overnight.

More proof positive that market forces will almost always take away any high margins your business is enjoying. If there is a big enough discrepancy between your products cost (including start up costs) and the return you are enjoying than you will eventually succumb to profit erosion as competitors flood the marketplace. This is the lesson that VoIP taught the telcos and now the telcos are fighting back and teaching it to the VoIP companies. Given that there is a huge amount of uncertainty in how this market place is going to shake out I find it surprising (though I shouldn't) that it has become the hot new fad on Wall Street lately.

While I suck at macro-economic predictions I think it's safe to say that not all of these companies will survive and prosper, especially now that the traditional telcos are putting their might behind the technology. Sure everyone might eventually move from traditional phone to VoIP but there will be a handful of dominant companies. Moreover, part of the traditional success of telcos stemmed from their government protected monopoly and their cooperative price fixing model. This is a whole new ball game this time around and the winners won't be visible for awhile.

via [Jeremy Allaire's Radio]

Sat, 01 Nov 2003 23:45:50 GMT

How much are you paying for growth in your common stocks?

Tue, 25 Nov 2003 17:59:32 GMT

Boeing Ejects CFO. CFO Mike Sears is out over inappropriate hiring of former Air Force official.via[The Motley Fool]

Mon, 24 Nov 2003 16:52:30 GMT

Employees, Pay, and Risk. Taking the Wal-Mart/Union/Employee Compensation issue which seems to be dominating the business press Prof Bainbridge seems to indicate that employees are the last people in line when it comes to sharing in corporate profits, and this is how it should be.

Some highlights from the entry:

I think unions serve important social and economic functions, as I've explained before, but when I hear actual union leaders talk I am reminded of an old Peanuts cartoon in which Linus says: "I love Mankind, its people I can't stand!" It's a lot easier to think positive thoughts about unions at the level of economic theory than when watching them work in practice.

and

In sum, Ms. Maynard is asking the wrong question. It's not "at what price profit" but "at what price not making a profit?" Take away the profit motivation and Ms. Maynard's union members won't be dealing with higher health benefit costs, they'll be out of a job.

I agree. Employees are last in line for profits because they are last in line for risk. If you inverse the profit scenario ("Why don't Wal-Mart's employees get to share in some of that amazing profit?") you can see the answer clearly. If Wal-Mart incurs a $10 billion loss in one year that loss is allocated among the shareholders in terms of declining share prices and loss of dividends. Now I can already hear the arguments from the bleeding hearts among the group that will say that a 5% drop in the stock probably has less effect on a fat-cat shareholder's income than the loss of jobs of employees that will probably also result from the loss the company incurs. 5% loss vs. a 100% loss of personal income seems a little skewed therefore the employee is taking as much...nay more risk than the employer.

Unfortunately this argument relies more on a tug of the heartstrings than logic. If you look at the total societal cost and who bears the brunt of it, the shareholder always bears more. The loss to the shareholder in terms of a bankrupt company is typically 100% of invested capital. The loss to the employee is typically 0% (because all their invested labor capital is paid for up front). Unemployment represents the loss of future income off of future labor. The shareholders, meanwhile have lost value off of invested capital, the results of past labor on their part that was once a riskless asset (cash) and has been transferred into a risk bearing asset (equity). As the bearers of the risk they deserve compensation.

If the employees want to share in the corporate profits they should become owners. Many companies offer stock purchase programs that allow employees to purchase stock (sometimes at a discount to market).

via [ProfessorBainbridge.com]

Fri, 21 Nov 2003 15:08:53 GMT

Hartford Is No Longer the Insurance Capital. Within two years, Hartford, once known as the insurance capital of the world will be the home office of just two major insurance corporations. Just look at the horrors that the insurance industry has wreaked upon Hartford! :)

According to the 2000 census, 30.6 percent of Hartford's 125,000 residents live below the poverty line. Forty percent of the adult population is functionally illiterate, and more than half the city's students drop out of high school. The per capita income is $13,428.

via [New York Times: Business]

Thu, 20 Nov 2003 15:50:05 GMT

Now Greenspan is warning about growing trade deficits. Actually, he's been warning about them the whole time. Now he's saying that they haven't hurt the economy yet. Of course the way the headline reads it seems to imply that trade deficits mean jack squat in the grand scheme of things. So now we have Buffett and Greenspan tag teaming current business trade deficit growth. I'm still out to lunch on the trade deficit issue. Obviously, at an extreme level where you are buying everyone elses crap and they are buying none of yours it is a bad scenario but I'm not exactly sure what is the difference between a good deficit (i.e. short term inefficiencies) and a bad deficit (chronic misappropriation of funds at a macro level). Still, I know that these are two guys who know the economic ramifications of things alot more clearly than I do so I'm going to postpone lining up on the opposite side of them on a bet as long as I can.

Greenspan said that throughout history domestic industries have sought government help to fight off foreign competition, only to find that these efforts were eventually overwhelmed by free market forces.

``The costs of any new such protectionist initiatives, in the context of wide current account imbalances, could significantly erode the flexibility of the global economy,'' Greenspan said.

``Consequently, it is imperative that creeping protectionism be thwarted and reversed,'' he said.

...

Greenspan said that the current account deficit, the country's broadest measure of trade, is running at a level equivalent to 5 percent of total U.S. economic output. That is far above the previous record level of 3.5 percent set in 1986. In dollar terms, the current account trade deficit hit a record of $480 billion last year and is on track to be well above that mark this year.

I do agree with Greenspan that chronic protectionism is not the solution. We as a country can no longer have the attitude that we can take our ball off the court and go home. Isolationism is not a viable political philosophy. We must assault the problems of globablization head on. Any good biologist or chemist or economist can tell you that any attempts to disrupt equilibrium will eventually fail. If you have a plan that will decrease the short term pain and eventually lead us out of the problem then I'm all ears. If you simply want to build a wall to fend off the oncoming hordes and stick your head in the sand on the other side of it and wait for the problem to go away then I'm afraid I don't consider that a solution.

Thu, 20 Nov 2003 15:37:46 GMT

A Plan to Postpone Pension Financing at United. First come the airlines, soon to be followed by Big Auto, then the old telecom companies. Welcome to the new golden age of retirement! And you felt pity for the people who get screwed when Enron went under? Most of them at least had stock that rose sometime in the last decade. via [New York Times: Business]

Thu, 20 Nov 2003 14:51:35 GMT

U.S. Textile center Burlington, N.C. is trying to combat the flood of textile jobs to China. Unlike the tech job flight, this is not a new phenomenon. The textile industry in the U.S. simply cannot compete with foreign labor and has been unable to for decades. Our healthcare, Social Security, union and pension costs are just too high. In order for us to be competitive in this arena we would have to subject the workers to abject poverty. This is a no-win situation.

And even as textile companies lose business to China, the country has emerged as the fastest-growing export market for American cotton farmers.

So we stymie one commodity industry to save another, that is our Catch-22. Really the most obvious solution to me would be for U.S. Textile companies to open up plants in China. Of course what is glaringly simple in statement is enormously complex in execution. Still, at least the profits would flow back to the U.S. and we would own the land and equipment, which puts us measures ahead of the alternative.

Welcome to the new global economy. The good news is that everyone will soon be equal and judged purely on value added. The bad news is that we (the U.S.) have been making money off of these inefficiencies for years and we're the ones who will suffer the most in the short-term. Now when I say "us," I mean the U.S. labor force. U.S. companies stand to prosper enormously as they take advantage of lower wages and drive costs down, then turn around and sell their products to a global marketplace hungry for American premium brands. In this month's Fortune there is an article that talks about all the kids in India who are working tech support. They spend their money going to clubs, buying cars, purchasing liquor, throwing parties, etc. The author makes the comment that it reminds him of Silicon Valley back in the heyday.

I think the main point to take away from these examples is that U.S. citizens are no lazier, on average than anyone else. It's just that when you are worried about feeding your family or yourself, you tend to be hungrier for success. The average U.S. worker hasn't had that problem for quite some time. Even the unemployed are able to purchase food in most cases due to unemployment insurance, etc.

As the other countries build themselves up they will start demanding the trappings of success that we take for granted. Of course while all this gets sorted out we will have some growing pains. But I think we are already finding out that borders and tariffs are a relic of a bygone age.

In response to the tariffs, China Protests U.S. Limit on Textiles. Beijing issued a statement expressing its regret and its opposition to the United States action, but stopped short of threatening trade retaliation. via [New York Times: Business]

Mon, 17 Nov 2003 14:32:35 GMT

2 Insurance Giants to Combine in $16 Billion Deal. In a deal that will form the second-largest U.S. commercial insurer, St. Paul Companies today agreed to buy Travelers, a larger rival, for about $16 billion in stock. via [New York Times: Business]

Tue, 28 Oct 2003 16:10:42 GMT

Interesting article at Fortune.com about the worldwide loss of manufacturing jobs thats been underway for the last decade. I like Geoffry Colvin's articles a lot. Of course I also agree with most of what he says, maybe that has something to do with it.

Fri, 10 Oct 2003 20:19:34 GMT

Great summary page of Cialdini's "Influence: The Psychology of Persuasion", one of the greatest psychology books ever written. If you haven't read it you need to run to your bookstore and get a copy.

Fri, 10 Oct 2003 15:23:03 GMT

Apparently, holding the Shift key bypasses CD copyright protection and puts technology vendor's panties in a wad.
Buried in this article about corporate stupidity at its finest ("sure our products got bugs, but what were you doing using our product, anyway?!?") is a much deeper societal trend bubbling its way to the surface:

"Halderman and Princeton University have significantly damaged SunnComm's reputation and caused the market value of SunnComm to drop by more than $10 million," the company alleges.

Somewhere along the line people have begun to use stock market fluctuations as a proxy for corporate reputation. The statement above was thrown out as a starting point for assessing reparatory legal rewards and that scares me. If you think I'm overblowing one statement and making it a trend you ought to think again. In the last few years companies have begun to see their "reputation" and "goodwill" within the community as a valuable asset of the business. And insurers, quick to take advantage of a money making opportunity, are rushing to create a coverage to protect this valuable asset. Already, several insurers are looking at ways to compensate companies for the fallout from a tarnished reputation.

Their proxy of choice? Market capitalization. Besides limiting this coverage to public companies, this proxy has the potential to work a significant amount of havoc on the financial markets as well as the average enterprise. There are a number of issues insurers face in putting together this coverage that they are well aware of. Do you compare the fall in value to an industry index or the market as a whole? What about companies like WD-40 that operate in a protected niche and don't have competitors? Do you base settlements on the date of loss or for several weeks of market fluctuations? How do you assess the related damages caused by weak market capitalization (availability of credit options, etc.)?

What I don't think they have considered is the fact that a myriad number of things play into market capitalization. What happens when a sell side analyst releases a report on behalf of a short selling investment firm, which drives the price down? Is that "reputational damage"? Sure it is. Is it illegal or unethical? I don't think so, as long as the analysis is based on facts and data. Should it be covered? Probably not.

But knowing the courts ability to expand insurance coverage and the perception by the public of the "deep pockets" of insurers, it is not inconceivable that it would.

What about a situation like Johnson & Johnson's Tylenol scare in the 80's? There are already product recall coverages available that pay for the expense of taking bad products off the market. But how much of the resulting market share decline do you pay? Though there was an immediate drop in the stock following announcement of the crisis, Johnson & Johnson's actions were a reputation enhancer over the long run. How do you recognize that when assessing claims damages?

The stock market is a mechanism to provide equity capital to corporations. It is a mechanism for the individual to fuel corporate growth and reap the rewards of that growth. For some reason we seem to be shifting our beliefs that the market is the creator of the value and the unbiased assessor as well. It is becoming the judge, jury, and executioner of fiscal health. That somehow in the midst of all these stock swaps, and options, and derivatives, and other esoteric activities money is made. This is inherently untrue.

Money is shifted from one individual to another but it is not made. The market in aggregate is a zero-sum game. The only thing that causes the increase in value is the growth of the companies that it tracks. I think to use the market is an arbitrator of damages incurred, or assessment of corporate health is a dangerous game to play.

Link found via [drunkandretired.com]

Fri, 10 Oct 2003 14:41:27 GMT

Hotel Owner's Suit Accuses Marriott of Mismanagement. The owner of a Midtown Manhattan hotel operated by Marriott International filed for Chapter 11 bankruptcy protection yesterday, contending that Marriott's hotel-management practices forced the move. via [New York Times: Business]