Category Archives: Accounting

Don’t Spare the Rod: Critique of Investment Research Reports

Time WarnerA beginning analyst sent me a research report to discuss: Ensco PLC Write-Up

Now before I start, realize that when I was beginning, my idea of a research report was to mimic Cramer.  Buy because the “chart” looks good and I gotta feelin’.  One time my hedge fund boss said his time was worth $1,000 an hour so the six minutes he took to read my incoherent report meant that I OWED HIM, $100.  Well, we all have to start somewhere.  The point of this exercise is to learn.

Buffett’s punch   idea may apply. If you only had twenty investment ideas over a lifetime–one every two to three years–would this be it? Would you put all of your money and family’s money into the idea and why?

Or, you pretend that you have a 45-second ride in the elevator to the top of the Time Warner building with Carl Icahn while selling your idea.

Bill Miller once said that money managers had the attention span of knats. You had to summarize your thesis and then give three or four supporting reasons within thirty seconds.

My critique of Ensco PLC

Instead of four paragraphs to tell me what Ensco does, perhaps you can be more succinct while putting forth what is compelling about your investment thesis.

ESV (Ensco, PLC) is an owner/operator of offshore contract drilling rigs/services that is trading at X% under tangible book value.  This is a cyclical, asset-intensive business subject to swings in natural gas and oil prices. Over a fully cycle, the company earns normal returns on capital of XX?

The price: Enterprise Value

Returns: over several prior cycles?

Capital structure and terms of debt?

Bottom line: this is a non-franchise or asset-based investment that is currently and cyclically out of favor.  OK.   But if this is an asset based business what are the assets worth?  You would need to dig into tangible book–what is there?   What is the current and expected replacement value of their assets? Liquidation value?  Is their fleet of rigs unique? Who are their competitors?  Any hidden assets or potential assets like, say, NOLs or assets outside their core business for example?

What is their cash flow and owner earnings?   I would like to see enterprise value over EBITDA-MCX over the past decade to get an idea of how the market priced ESV over a cycle.

Who is management? What skin do they have in the game? Are they good operators and capital allocators? Insider buying?  Who owns this company?  I don’t have much to go on in the above report so I jump to my handy VL: ESV_VL.  Whoa!  I see debt has jumped about 35% from 2013. How does their capital structure compare to competitors?   It seems like there isn’t much free cash flow. Capex eats up most of the company’s cash flow.

Where is the margin of safety? Book value has been growing but during an up-cycle in drilling. What happens in a prolonged down-cycle?  What are the risks?   You mention a DCF? Where did that come from? Your assumptions?

I will let others in the Deep-Value group chime in, but for a first-ever research report I give a D- which isn’t bad. At least the writer has good instincts to look at an out-of-favor company, but the core analysis of the assets needs to be provided. Also the competitive landscape.  Obviously, it is a business without a competitive advantage due to the low and cyclical nature of the returns, so how does this business compare operationally, financially and value-wise to their main competitors? Who are their customers and how are they faring?

The only way to improve is to write, practice and look at other reports. Go to www.valueinvestorsclub.com and sign up. Then look at the highest rated ideas and study those along side the 10-K of the company mentioned.

Study Other Examples of Research

Or The_Security_I_Like_Best_Buffett_1951  Warren Buffett on Geico.

https://sumzero.com/sp/bc_winner (you may have to paste into your browser) and as reference, Rockwell Automation Inc and ROK_VL from a Deep-Value member, Thomas Harris. We can critique this next if you wish.

Carl Icahn paid $500,000 for an investment bank to furnish a report on breaking up Time-Warner: lazard_twx (worth a look!) and Icahn was right about Time Warner

Analyzing Debt

Sell ABX

ABX Sombull along with Barrick Annual Report 2014 and Barrick 1 Q 2015

https://www.coursera.org/learn/learning-how-to-learn

http://en.wikipedia.org/wiki/How_to_Read_a_Book

Stay with it………writing is hard and finding great ideas even harder.

Measuring Financial Distress Chapter 4 of Quantitative Value

nq150415

 

The corpse is supposed to file the death certificate. Under this “honor system” of mortality, the corpse sometimes gives itself the benefit of the doubt. -Warren Buffett, “Shareholder Letter,” 1984

Cryin’ won’t help you; prayin’ won’t do you no good. –My Ex.

We take up from Chapter 3 and move to Measuring the Risk of Financial distress: How to Avoid the Sick Men of the Stock Market in Chapter 4 of Quantitative Value (which you have if you are in the Deep-Value group at Google Groups).   I will email Financial Shenanigans as a supplement to this chapter of uncovering distress/fraud.

Can one predict financial distress from the outside of a company BEFORE bankruptcy. Obviously, the first place to look is at the balance sheet for the quality of the assets vs. the terms and amount of the debt. Then look at the competitive nature of the company’s industry. Airlines tend to go bankrupt more than cola companies.

I think you must practice your skills as a financial analyst. When you read about a bankruptcy like Radio Shack, then download the financials for your records and look back for what signs you might have noticed.  I will have other tips below.

Several research papers and case studies mentioned in Chapter 4 below. Especially look at the WorldCom case.

JOIM

_predicting_financial_Distress Risk 2010

Forecasting Bankruptcy More Accurately

Predicting Bankruptcy for Worldcom Final

WorldCom1 Ethics Case Study

Litigation against WorldCom for Fraud

Enron CS

WorldCom_Case_Study_April_2009

WorldCom Accounting Fraud

WorldCom

Practice your skills

You can look at these research reports from Off Wall Street and then download the financials of the companies mentioned and see if you can recreate the analysis.

NEW_EXAM_7-4-11

NEW_HGG_7-5-10

NEW_WHR_5-4-10

NEW_STRA_3-15-09

NEW_PBI_1-19-09

Blood in the streets!

CRB-Index

Gold Mining a Crappy Business

Why Gold Mining is a Tough Business_Pollitt (An interesting insight into this industry)
SEE YOU NEXT WEEK as we go into Chapter 5 in Quantitative Value.

Practice Like Jonah!

Screening out Earnings Manipulators; Quality of Earnings

budget cuts

Accounting shenanigans have a way of snowballing: Once a company moves earnings from one period to another, operating shortfalls that occur thereafter require to engage in further accounting maneuvers that must be even more “heroic.” These can turn fudging into fraud. (More money, it has been noted, has been stolen with the point of a pen than at the point of a gun.)” –Warren Buffett, Shareholder Letter, 2000.

We pick up from the last lesson and read Chapter 3 in Quantitative Value: Hornswoggled! Eliminating Earnings Manipulators and Outright Frauds.

This is an important chapter for improving as an investor. Your goal might be to understand accounting up to the intermediate level so as to adjust accounting principles into economic reality. What story are the numbers telling you?

Think of this chapter as a way to build an early-warning system for companies with weak accounting.

The authors propose three ways to detect aggressive accounting that lead to poor quality of earnings:

  1. Scaled total accruals (STA), which uncovers early-stage earnings manipulations
  2. Scaled net operating assets (SNOA) which captures a management’s historical attempts at earnings manipulation.
  3. The third is the probability of manipulation, or PROBM, a tool that identifies stocks with a high probability of fraud or manipulation.

When the growth in cumulative accruals (net operating income) outstrips the growth in cumulative free cash flow, the balance sheet becomes “bloated.” Stocks with balance sheets bloated in this way find it difficult to sustain earnings growth.  When managements take the low road in aspects that are visible, it is likely they are following a similar path behind the scenes. There is seldom just one cockroach in the kitchen.

A warning sign is high accruals that show much higher income than cash flow. See pages 64 to 68 in Quantitative Value.

Though you should read this chapter carefully and for the nerds, dig into the research papers below, but I highly suggest studying Chapter 8 in Quality of Earnings, Chapter 8 (sent via email to Deep-Value at Google Groups).   A gem of a book. and Defining Earnings Quality CFA Publication

Earnings Management, Fraud Detection and Adjusting for Accruals

How a group of Cornell Students sold Enron before the collapse

http://www.valuewalk.com/2014/10/beneish-m-score-earning-manipulators/

http://www.valuewalk.com/2013/06/red-flags-fraud-detection-2/

Information in Balance Sheets for Future Stock Returns

Earnings Mgt and LR Stock Performance of Reverse LBOs

Earnings Mgt and LR Performance of IPOs 1998

Can Forensic Accounting Predict Stock Returns

Analysts do not adjust adequately for accruals 2004

After a few days of digesting this post, we will tackle Chapter 4: How to Avoid the Sick Men of the Stock Market, in Quantitative Value.

How can we avoid bad news as investors through our knowledge of financial statement analysis and human motivations (incentives)?

Sound Money

The-Age-of-Inflation-Jacques-Rueff

A Banker for All Seasons John Exeter

An American Original: Voodoo Child

Have a Great Weekend!

 

Tawes Hockey

POP Quiz: Is a Rising ROE Good?

snowmen

I intend to live forever. So far, so good–Steven Wright

We will tackle Chapter 4 in Deep Value next week and I will find out the status of the forum for advanced students this weekend. I am swamped. 

POP QUIZ

If a company is increasing its Return on Equity (“ROE”) over time, is that an attribute of a good business?   

Since you are skeptical, you whip out your ROE diagrams:

400px-DuPontModelEng.svg

simpler

roe

Even better, you are hired as the investment banker to help advise the CEO how to enhance ROE (bonuses are based on rising ROE and increasing earnings per share).

Today, the company receives 0.00000000000001% on its money market accounts, while the CEO’s company stock trades at 34 times earnings and earns its cost of capital, 10%.   Remember, you work for JP Morgan and you have student (MBA) loans to pay off.  You sharpen your pencil and……………….?

My thoughts posted this weekend after I pass out grades.

Post: Feb. 16, 2015

Damn! I am unable to flunk anyone. There was a good discussion looking at the question from many sides because I didn’t give you much detail.  The key point is: “It depends.”  Context is key.  You could have a situation like Microsoft’s where its core businesses (Office, etc.) generate so much cash without incremental investment that cash builds up and in turn drags down ROE (equity grows without a high return on the cash). Then the issue becomes what will Microsoft do with its excess cash? Squander on new ventures and acquisitions or return it to shareholders?  Microsoft over the past six years has done a little bit of both. Perhaps low ROE means the company has no debt and thus a buffer during cyclical down turns?

Maybe this company’s ROE is suppressed by last year’s investment into new stores and more time is needed before the stores earn their expected return. Perhaps, like Costco or Philip Morris, future growth will be so profitable and persistent that buying in shares means reducing shares below intrinsic value–a long shot, how many emerging Wal-Marts, Costcos or Whole Foods are there?

The popular move which I, as a JP Morgan banker, would advise the CEO to buy back his stock with his low yielding cash (about a 0%) return and lather on low cost debt to buy stock back  to earn an approximate 3% return (1 divided by 34) despite being a mundane business (10% ROE). Even at inflated prices. You shrink share count and equity to drive up EPS and ROE. The CEO collects another bonus and you can chirp about your value enhancement strategies.  But when you buy an average company at 34 times earnings, you are paying over intrinsic value (let’s assume). Earnings and ROE rise but book value drops. Long-term wealth is reduced.   Look at tech and consumer good companies today where managements are buying in their stock near all-time highs after a six year run-up.  Few bought shares in the depths of the 2008/09 crisis.  Borrow money today at 3.5% to buy-in your stock at a 5% earnings yield. Brilliant–until the next economic downturn.

This is another lesson in incentives. CEOs are incentivized to get a short-term bump in their stock prices, long-term value be damned.

GOOD JOB to all who commented.

Negative Equity Companies

Investors_ENG

 

CLF-2014 Year End Earnings-Release  $7.5 billion write-off and thus $1.4 billion in NEGATIVE equity.  Headed to bankruptcy?  I wouldn’t bet on it, but there go the screens for low multiples of book value.   Investors typically run from stocks like this.

CLF

Revlon VL has had negative equity for over a decade, but increased cash flow is what has driven this stock higher.

Revlon

Negative shareholder equity–at least from a securities perspective–is not a problem in and of itself generally in the U.S. It can result from any number of corporate histories. Corporate valuations tend to vary widely from their shareholder equities. I am not aware of any state’s corporate law that considers it a problem, in and of itself, either. In Delaware, the measure that matters is “surplus,” which is drawn from a corporation’s market value rather than its book value. Delaware corporations, for example, can pay dividends, borrow money, issue new securities to investors, etc. notwithstanding a negative s/h equity, so long as they have adequate “surplus” meet minimum capital and other legal requirements. I would say s/h equity, while important, is seen more as an accounting function that can-but does not always-track the actual value of a company. The only time I have ever seen it come up as a legal matter is in the case of one company that wanted to self-insure itself for workers compensation liabilities. The state denied the company’s application to self-insure on the basis of negative shareholder equity–notwithstanding its market capitalization was in the hundreds of millions. It was just a requirement buried in the state’s regulations that used s/h equity as its measure of a corporations value (and, thus, its ability to pay worker’s comp claims).

Jun 2, 2013

Oscar Varela · University of Texas at El Paso

Look at Revlon. Here is a firm with about 1.2 bil in assets and 1.9 bil in debt, giving it negative equity of 0.7 bil. This is less than it was a few years ago, when its equity was about negative 1 billion. Yet it survives, and is an NYSE firm.

Timothy R. Watts · University of Alaska Anchorage

Your example is very good because it shows that a change in stockholders’ equity can be a good measure of performance. Revlon’s increase in s/h equity shows that it is performing well, even though it is negative (and will probably be for years to come). Although, like book value, there are plenty of other reasons s/h equity change absent a valuation change. A general example is companies that have (from prior years) built a huge bank of net operating losses (NOLs), which can shield a company from tax liability for a long time. These NOLs, while having value cannot be booked as assets unless the company is showing, according to accounting standards, that it will actually use them. Once a company that has been losing money (and accumulating NOLs as well as, likely, shareholder deficit) becomes consistently profitable, these NOLs can be booked as an asset. The asset is the value of future tax savings. That can turn a company’s negative book value into a positive book value overnight–even though the company’s market value hasn’t changed at all. This can also happen the other way. I recall this happening to Ford around the time of the financial crisis. They booked a massive loss in one quarter largely on the basis of the elimination from their balance sheet a tax asset based on the value of their NOLs. It was a bad quarter for them to be sure (like everyone else), but the accounting loss magnified it several times in a way that didn’t track performance. Ford, after all, was the only major car company in the U.S. that avoided bankruptcy during the crisis.

Jun 7, 2013

How_long_can_a_company_survive_with_negative_equity_and_how_long_is_this_state_permitted_in_the_USA

I bring the negative equity to your attention because it seems like a good search strategy to find mis-valuation.  First, many screens wouldn’t pick these companies, second most investors would shun them, investors often fixate on accounting convention rather than underlying economics, and finally it seems very counter-intuitive.

Note the article from an early post in this course: Behavioral Portfolio Management

If anyone wants to study this further, let me know.

Question on ROE vs. ROCE; Comprehensive Look at EBITDA

EBITDA

http://greenbackd.com/2014/04/28/median-stock-at-all-time-high-valuation/ and an interesting look at margins here:

Respecting the Reality of Change

The following chart shows CPATAX divided by GDP from 1947 to present.  The black line represents the average from 1947 to 2002, and the green line represents the average from 2003 to 2013.

cptxa

As you can see in the chart, CPATAX/GDP is wildly elevated at present.  It currently sits 63.3% above its average from 1947 to 2013, and a whopping 75.0% above its average from 1947 to 2002.

As readers of this blog have probably inferred by now, I’m not very patient when it comes to waiting for “mean-reversion” to occur.  In my view, when a variable deviates for long periods of time from a reversion pattern that it has exhibited in the past, the right response is to expect something important to have changed–possibly for the long haul, such that a predictable reversion to prior averages will no longer be readily in the cards.  The task would then be to find out what that something is, and try to understand it. Go here:

http://philosophicaleconomics.wordpress.com/
http://www.millennialinvest.com/   (Interesting blog)

Reader Question:

Can you help me understand one aspect of ROE? In Indian companies, some of the companies have ROE < ROCE.

Isn’t that a violation of the observation that ROE ~ ROCE times Leverage.

I define ROCE as Return on Capital Employed.

ROCE = EBITDA (1-Tax Rate)/Total Capital Employed (=Debt+Equity)

I use ROCE as a measure of the attractiveness of the industry and the company. High ROCE is good, implying a moat, low ROCE is not.

Some of the reasons I could think of are:

  1.  Exceptional losses, which lead to Net Income << EBIT(1-Tax) *Leverage
  2.  Extremely high interest charges. ( higher than return on the        debt portion) which leads Net Income << EBIT(1-Tax)* Leverage
  3.  There is a slump sale of a division, and thus suddenly huge            amount of profit has come in increasing inordinately the            average shareholder equity. So suddenly the effective leverage        has dropped.

Update May 1: 

I made a mistake in describing ROCE.  In my defense, I dont exactly calculate ROCE and merely use the numbers from screens.
ROCE = EBIT(1-Tax Rate)/ Total Assets and not EBITDA as mentioned before.

Does someone want to have a crack at this? I see issues whenever you use EBITDA without understanding maintenance capex. Please read this: Placing EBITDA into Perspective

More on WMT: A reader posted this in the comment section: http://www.fool.com/investing/general/2014/04/28/why-is-wal-mart-failing-in-emerging-markets.aspx.    Does that article even touch upon the ture nature of WMT’s competitive advantage?  No wonder the obvious is overlooked.

What Is Behind The Numbers?

510y1Ll7csL._SL160_PIsitb-sticker-arrow-dp,TopRight,12,-18_SH30_OU01_AA160_

With sentiment high and stocks in general having rallied for five years, be very careful about the financial numbers in your companies. A strong review of financial shenanigans is worth your time.

John Del Vecchio and Tom Jacobs, the authors of What’s Behind the Numbers?, are giving a presentation at the New York Society of Analysts. See sample chapter:WBTN_DelJacobs_samplechapter

Attendees will learn:

  1. How companies hide poor earnings quality
  2. Repeatable methods for uncovering what companies don’t tell you about their numbers
  3. Reliable formulas for determining when a stock will get hit

Whether you’re a number cruncher or just curious, you’ll greatly benefit from this seminar, given by two people who combine investment chops with crowd-pleasing stories. So what are you waiting for?

Date: January 13, 2014
Time: 6:30 – 8 pm
Place: NYSSA Conference Center
1540 Broadway, Suite 1010
(entrance on 45th Street)
New York, NY 10036
Price: Nonmember $55 ($10 surcharge for walk-ins)

Advance registration is encouraged in order to avoid the additional charge for walk-ins. Also, space is limited by the size of the room.

https://www.youtube.com/watch?v=G-YYwz9oSPM

The above video is worth viewing. Just remember that the authors do not understand the causes of inflation, but you will learn more about individual investor psychology. Jacobs provides plenty of excellent advice for individuals in terms of search and strategy. Go small and look for wholesale emotional selling.

If you don’t want to invest in stocks, then go here:

A Reader Seeks Guidance

I appreciate your feedback and willingness to guide me in the right direction. I wanted to go over my current situation and get your feedback.

By trade, I’m a computer engineer. But it seems my passion now lies in investing and creating a more balanced and comfortable life for myself where I can control my outcome, not some company where my best interests aren’t exactly aligned.

I consider myself a buy and hold investor. I don’t try to beat the market in the short term. Most of my holdings are aligned with the motley’s fool’s picks (stock advisor, rule breaker) and I have had very good success with them (high fliers such as chipotle, netflix, but also steady picks such as berkshire b shares, costco, etc). But I also want to learn to do better and be able to pick from the right ones and ultimately be able to do my own research. I enjoy the gardner brother’s research and can align with their philosophies but I also try to learn about Buffet’s and Pabrai’s philosophies.

I’m currently diversified into a basket of 50 picks in my IRA and about 20 picks in my regular account. I would like to learn to concentrate more into the better picks and have a portfolio of only 20 picks each. Throughout the past 10 years, I have seen returns upwards of 15% compounded annually in each account so I’m very happy with the results as they also include the 2008-09 recession and of course the subsequent runup. I would be very happy maintaining above 15% returns but aspire to hit 20% some day with better knowledge and understanding the business, financials, and the competitive advantage you mentioned. I’m in search for my first 10 bagger, I’m close with Chipotle around 8 bagger. I aspire to hold companies for decades.

I don’t know much about valuing companies or reading the balance sheets / cash flows / income statements so I use the motley fool’s picks to vet the financial side and then try to align my understanding of the industry to pick the stocks I’m comfortable with and can relate to. For instance, I shop at costco, use linked in, buy apple products due to their convenience and reliability compared to previously owner android and windows products, etc.

What advice would you have for a person like me? I’ve read through all of the buffet’s letter to shareholders, and have just recently started going through Pabrai’s.


My Response
Why don’t you take an accounting course online or at a school near you or get a programmed text with problem sets and the solutions. Then take Graham’s book on reading financial statements found in book folder (Use Search Box on this blog). Then go through Chipotle and find out what owner earnings are, how much they invest to grow and try to value the company based on different growth assumptions. Be conservative.

Look for companies with fairly consistent and moderately high return on capital or a return on assets over 12%. Look for strong companies and set up a watch list.

Google: Merrill Lynch’s How to Read a Financial Report.

Study how companies develop competitive advantages–read Strategic Logic (Search Blog)

Keep your expectations reasonable. Wait for my Analyst Handbook which will take you from beginning to end.  Many investors will be lucky to SURVIVE the next five years.   Red lights are flashing–Klarman returning cash, Tesla, Netflix roaring, IPOs on fire, and the belief that markets will never decline due to perpetual non-taper.

Good luck

Update on CSCO Analysis (Sales and Accounts Receivable Case Study)

RATS

We last posted the Case Study of Cisco (CSCO) here: http://wp.me/p2OaYY-1YL

My analysis: This case forces you to compare the year-over-year change between sales and accounts receivable. The reason why you should focus on it is because the market was happy that Cisco “met” its 5% growth target for sales.

Cisco’s revenues were up 5.4% year-over-year and met management’s guidance, but accounts receivable jumped 25.2% year-over-year ($4.9 billion versus 3.9 billion–you need to look at Cisco’s prior year’s 2012 quarterly announcement to find the comparable figure for account receivable).

A small yellow flag should fly in front of you. Normally the discrepancy would  indicate potential “channel stuffing,” in order to meet quarterly revenue and earnings estimates. However, if you listened to competitors of Cisco, you knew that the market for Cisco’s products were quite weak. Another explanation might be that Cisco gave generous credit terms to generate sales. Either way, there are slight concerns for future growth. In other words, the quality of Cisco’s growth may not be as high as it appears.

Of course, you need to be aware of Cisco’s valuation and take other information into consideration.  If Cisco’s price is near full value (and I think it is) then this accounting information adds to my inclination NOT to own Cisco any longer.

djia19201940s 

Chapter 8: Two Key Ratios : Accounts Receivable and Inventories by Thornton L. OGlove in The Quality of Earnings

In 1931, when stocks continued their dizzying plunge during the nation’s most spectacular bear market, Bernard E. Smith, better known as “Sell ‘Em Ben,” was the king of the district. As the sobriquet indicates, Smith was  a short seller who, as legend had it, ran from brokerage to brokerage on Black Tuesday, 1929, screaming, “Sell ‘Em All! They’re not worth anything!” Two years later, this former longshoreman out of Hell’s Kitchen was taking in more than $1 million a month, scorching the few remaining bulls.

According to one of many sources about him, Smith was monitoring the stock of a medium—sized industrial company which supposedly was bucking the trend and doing quite nicely. Because of this the stock was setting new highs almost daily, while the rest of the list was hitting bottom. Smith was puzzled, and one day motored to the factory where he asked to see management, only to be turned away at the gate. Undeterred, he walked around the plant, and noticed that only one of its five smokestacks was belching forth smoke. Smith took this to mean the other furnaces were not operating, and so business was bad. Rushing to a telephone, he shorted the stock which plunged several weeks later when poor earnings were reported. This was how Sell’Em Ben made part of that Month’s $1 million.

The investment world is far more sophisticated today, but such simple ploys still work better than the most baroque equations cooked up in the business schools for use on computers.

One of the these simple ploys—the best method I have every discovered to predict future downwards earnings revisions by Wall Street security analysts—is a careful analysis of accounts receivable and inventories. Learn how to interpret these, and you will have today’s equivalent of Smith’s smokeless smokestacks.   In fact, had old Ben been able to go through that company’s books, he probably would have found two things: a larger than average account receivable situation, and /or a bloated inventory. When I see these, bells go off in my head telling me to analyze that particular stock in a devil’s advocate manner.

END

PS: Low future returns for stocks: http://www.hussmanfunds.com/wmc/wmc130610.htm

The Best is yet to come? http://www.gold-eagle.com/editorials_12/lundeen060913.html

The Great Deformation; Current Conditions; Is Bitcoin Money? Ponzis; Watch the Balance Sheet; Sound Money

Sundown

This freakish central bank accumulation of dollar liabilities, in turn, was the result of the greatest money printing spree in world history. In essence, we printed and then they printed, and the cycle never stopped repeating. In this manner, the massive excess of dollar liabilities generated by the Fed were absorbed by its currency pegging counterparts, and then recycled into swelling domestic money supplies of yuan, yen, won, ringgit, and Hong Kong dollars.

As the US debt-based global monetary system became increasingly more unstable in recent years, central bank absorption of incremental Treasury debt reached stunning proportions. Thus, US publicly held debt rose by $6 trillion between 2004 and 2012, but upward of $4 trillion, or 70 percent, of this was taken down by central banks.

I could be truly said, therefore, that the worlds’ central banks have morphed into a global chain of monetary roach motels. The bonds went in, but they never came out. And therein lays the secret of “deficits without tears.”

David Stockman from The Great Deformation (2013)

Read an interesting article on crony capitalism: Sundown_in_America

Comments on the article: http://www.zerohedge.com/news/2013-04-01/guest-post-stockman-liquidation

Current Conditions

wmc130401a

The chart is based on data through the end of 2012. Smithers notes “At that date the S&P 500 was at 1426 and US non-financials were overvalued by 44% according to q and quoted shares, including financials, were overvalued by 52% according to CAPE. With the S&P 500 at 1552 the overvaluation was 57% for non-financials and 65% for quoted shares.”

Unfortunately, that seems about right. Let’s translate this into an estimate of prospective 10-year total returns, assuming underlying nominal economic growth rate of about 6.3% (which may be optimistic, but is a robust peak-to-peak norm across economic cycles, and is unlikely to be pessimistic), and a dividend yield of about 2.2% on the S&P 500. With that, a 65% overvaluation in quoted shares, reverting to fair valuation a decade from now, would imply a 10-year annual nominal total return on the S&P 500 of 1.063*(1/1.65)^(1/10) + .022 – 1 = 3.3% annually. That’s right in line with the estimates we obtain from a wide range of other historically reliable approaches (historically reliable in italics, because the “Fed Model” is not).

Notice that in 1982, the -0.7 reading on Smithers’ log-scale chart implied that stocks were undervalued by exp(-0.7)-1 = -50%. At that point, with the dividend yield on the S&P 500 about 6.7%, one would have estimated a 10-year prospective total return for the S&P 500 of 1.063*(1/0.5)^(1/10)+.067 – 1 = 20.6% annually. One would have been correct.

In contrast, note that in 2000, the 1.0 reading implied that stocks were overvalued by exp(1.0)-1 = 172%. At that point, with the dividend yield on the S&P 500 at just 1.2%, one would have estimated a 10-year prospective total return for the S&P 500 of 1.063*(1/2.72)^(1/10)+.012 = -2.6% annually. Again, one would have been correct.

With due respect to Howard Marks and Warren Buffett

At present, we estimate a 10-year total return on the S&P 500 over the coming decade averaging just 3.5% annually, with zero total returns over a horizon of about 7 years, and expected losses for the S&P 500, including dividends, over shorter horizons.

…..The last four years of market advance have reduced FUTURE retruns.

While our estimates for 10-year total returns exceeded 10% annually near the 2009 market lows, the recent advance has, in effect, “eaten” most of those prospective returns. The well-admired bond manager Howard Marks is very correct when he notes “appreciation at a rate in excess of the cash flow accelerates into the present some appreciation that otherwise might have happened in the future.”

Where I differ from even Howard Marks and Warren Buffet here, is that if you are going to rely on a summary measure in order to value long-lived assets like stocks (both Marks and Buffett point to “forward operating earnings” today), that summary measure must be representative of the long-term stream of cash that investors can expect to receive over time. The hook today is that investors are using analyst estimates of next year’s operating earnings as if they are representative of the entire long-term stream, and that this one number can be used as a “sufficient statistic” for long-term corporate profitability.

Read More: http://www.hussmanfunds.com/wmc/wmc130401.htm

Profit MArgins

 

 Jim Rogers on when he was wiped out

 

 

Is Bitcoin money?

Money Diagram

 

No! Summary:

» Bitcoins can be hyperinflated in substance

» Bitcoins can never be the most saleable good

» Bitcoins cannot account for the regression theorem

» Bitcoins are the equivalent of token money

» Bitcoins are the opposite of anonymous

For context, Bitcoin is a newly formed digital currency which has rapidly grown in popularity (as well as in price) following the Cyprus banking system collapse. The chart below is the price performance of Bitcoins, which have seen a market cap expansion of almost 20x—from about $50mm to roughly $1B where it stands today—in less than one year.

Read more…. http://bullmarketthinking.com/bitcoin-bubble-2-0-from-a-monetary-standpoint-they-are-on-par-with-the-stuff-you-find-at-chuck-e-cheese/

 

Watch the balance sheet: Never ignore the balance sheet (Videos).

http://www.youtube.com/watch?NR=1&v=X-b62ZYXAyw&feature=endscreen

What is a balance sheet: http://youtu.be/DuKEcxVplnY

Signs a company is in trouble: http://youtu.be/lwp6i4Kd4RA

Why does a profitable company go bust? http://youtu.be/d0FY4xRT_yo

A Ponzi on top of a Ponzi: http://video.cnbc.com/gallery/?play=1&video=3000148493  This story is unbelievable. A young guy decides to create fake boat titles from fake invoices that he then obtains loans on from his local banker. The banker doesn’t have the brains nor the energy to make a 90 second call to the boat manufacturer to verify the make and model. Nor does the banker even wonder how his customer obtained the money to have 53 yachts.

As the court documents reveal, the con man said it was in the interests of the banker to believe the con! (This I believe). As a plea for leniency, the conman’s lawyer stated that his client ONLY defrauded FDIC INSURED banks! Expect many more ponzis to be revealed.   See: MichaelVorce_AmericanGreedStatement and Vorce_PleaTranscript

Another $600 million Ponzi:  http://www.huffingtonpost.com/2013/03/30/zeekrewards-ponzi-scheme-north-carolina_n_2984347.html?utm_hp_ref=business

SOUND MONEY

Prof Selgin on sound money http://youtu.be/U_0CNwgL8Rw

Dr. Judy Sheldon on the origins of our money: http://youtu.be/hdlZi2KPXhU

Money in crisis part 1: http://youtu.be/TQ4PGr0WBBc

Money in crisis, part 2: http://youtu.be/1mI8Lek60_w

www.moneyweek.com