Category Archives: Accounting

Negative Equity Companies



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.


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


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


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 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.


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:   (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:    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?


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.

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)


We last posted the Case Study of Cisco (CSCO) here:

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.


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.


PS: Low future returns for stocks:

The Best is yet to come?

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


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:

Current Conditions


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:

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….


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

What is a balance sheet:

Signs a company is in trouble:

Why does a profitable company go bust?

A Ponzi on top of a Ponzi:  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:


Prof Selgin on sound money

Dr. Judy Sheldon on the origins of our money:

Money in crisis part 1:

Money in crisis, part 2:


Readers’ Questions


In the second decade of the twenty-first century, America is faltering under the weight of a dual crisis. Its public sector teeters on the ragged edge of political dysfunction and fiscal collapse. At the same time, its private enterprise foundation has morphed into a speculative casino which swindles the masses and enriches the few. These lamentable conditions are the Janus-faces of crony capitalism–a mutant regime which now threatens to cripple the nation’s bedrock institutions of political democracy and the free market economy.

….Once the Fed plunged into the prosperity management business under Greenspan and Bernanke, however, the subordination of public policy to the pecuniary needs of Wall Street became inexorable. No other outcome was logically possible given Wall Street’s crucial role as a policy transmission mechanism and the predicate that rising stock prices would generate a wealth effect and thereby levitate the national economy. — David A. Stockman (former Budget Director under Reagan and a former Partner of Blackstone Group) from The Great Deformation, The Corruption of Capitalism in America.


Reader Question #1:  What Accounting Books Do You Suggest? I want to improve my intermediate level of understanding so I am ready for my investment analyst internship.

My reply:

Buy and work through the problem sets. Accounting problems must be done rather than reading texts because then the concepts will sink in.

Also, to combine that with analyzing financial statements, read

Interview of the writer:

Companion website for the book:

Also, look at: Go download several research reports then obtain the particular annual report and study the numbers. Do you agree with the analyst’s report on the company? Study cases.

Financial Shenanigans by Schillit. His books are great for practicing your financial statement skills to undercover weaknesses and strengths.

Also, view short seller blogs like

Reader Question #2: How to begin?

My reply: Investing for beginners:

Obtain a few of these books on the cheap to get a perspective. Then find an industry like beer, soda or trash hauling (one that you can easily understand) and order the annual reports, then pick a company and go through the numbers with your books at your side to look up what you don’t understand. Go back and forth and note your questions. Try to find answers for those questions.

Wall Street on Sale by Timothy Vick (A good book but perhaps out of print?)

The Little Book of Value Investing by Christopher Browne

The Little Book that Builds Wealth by Pat Dorsey (A good intro to franchises)

Reader’s Question #3: How Do you Invest in Gold Mining Stocks?

My reply: Very carefully………….


Dr. Ron Paul was interviewed by Fox after the U.S. Federal Reserve confirmed it will continue its QE program highlights the importance of gold as money.

On July 13, 2011, when Dr. Paul was a U.S. Congressman he asked U.S. Fed Chairman, Ben Bernanke, “Do you think gold is money?” and Bernanke replied, “No, it’s a precious metal.”

Dr. Paul countered, “Even though it’s been used for 6,000 years?” But Bernanke denied gold was money and said, “No, it’s an asset. Just like T-Bill’s are not money.”

The Fox News interviewer then commented, “Cyprus has taught us that governments can confiscate money that you’ve earned or even paid taxes on. Rampant quantitative easing and price fixing by governments may prop up the stock markets but it doesn’t keep unemployment down. The U.S. Fed is going to continue its QE program which is good for gold.”


First, I do not want this subsection to be more than 35% of my portfolio, then I want 12 to 15 companies for maximum specific company risk diversification, then I have a range of low cost producers like Yumana, Eldorado then Streamers (Royalty Companies) like Royal Gold and Silver Wheaton, then more obscure, smaller companies that are beginning their production.

I suggest visiting Listen to all the audios and videos. Read: GSA_2012_User_Guide and GSA_sanfranpresentation  

Also, a book, Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks by Adrian Day

Go to and listen to the investors, miners and analysts of the mining industry.

From GSA:

Investors must choose from two major groups: Explorers, of which probably 1,000 are publicly owned and Producers, of which only about 50 trade in North American stock markets.

To this latter group, we can add near-Producers, miners that have taken a deposit through the bankable feasibility stage and an independent engineering firm’s analysis has shown that:

1)      drill holes are close-enough spaced to have high confidence about the ore grades in-between the holes and thus justify the Proven and Probable Reserves (P+P) classification, and

2)      that the capital investment required to put the site into production will yield a profit, or economic return. Just as an independent auditor’s sign-off on a company’s financial statement is critical for investors, so too is an independent engineering firm’s sign-off on the deposit’s economics, and it’s required by the US SEC for a miner to be able to call its ounces in the ground P+P Reserves.

Gold Stock Analyst only follows producers and near-producers as they are the only miners with data confirmed by 3rd parties and thus have solid numbers that can be analyzed.

The Gold mining industry is unique. All the miners produce exactly the same final output, ounces of Gold. Unlike Coke and Pepsi, they spend nothing trying to tell consumers that their Gold is the best. The miners simply accept the current Gold price when they sell. With all ounces the same, and selling for the same price, one might think the stock prices would reflect similar valuations for Miner A’s ounces versus Miner B’s ounces. But, in fact, the stock market is not efficient and the valuations can vary widely. This gives an opportunity for investors.

The gold stock analyst uses three filters:

  1. Market Cap/oz P + P Reserves
  2. Mkt.. Cap/Oz Production
  3. Operating Cash Flow Multiple

Essentially, you can use his filters to pick your own gold and silver stocks. I monitor some of the well-known gold and value investors like Sprott, First Eagle Fund, Van Eck, Tocqueville and note some of their holdings, then I run the numbers and compare. I want to buy the cheapest ozs of gold (producing or in the ground) that I can with management that has been successful before and with a decent balance sheet or highly probably access to the capital markets.  Many junior gold mining companies are going to go bust due to the prior boom creating over-capacity (too many mining promoters or two guys and a mule with pick and shovel) and to tight financing conditions today. Great conditions for those companies that survive.

By the way, here is one gold bug who will not hire MBAs:   (see 4 minute 30 second mark)

Interviewer: Do they need a good degree to work at your shop (

Doug Casey, “We don’t care if someone has an MBA or college. We don’t care whether they went to college. We ask, “Do they have good character, intelligence, diligence, are they hard working and do they want to improve themselves? I don’t see how a college degree has anything to do with that, especially what they are teaching today—gender studies, etc. If someone comes to work for us today with an MBA, we look at them and say, What’s going on in your head that you allocated $100,000 and two years of your life to get more theory instead of doing in the real world.

….be careful.

Hitler’s SS and Investing; Jim Rogers’ Interview; What Is Inside Banks?


Daniel Kahneman on Life and Investing (Interview)

Buffett’s Favorite Valuation Metric:

Quant. Value:


What is Inside Banks? What is inside Americas Banks

An excellent article by The Atlantic. The article explains why some banks trade under tangible book value. Investors do not trust the balance sheets of the banks and therefore do not trust the reported earnings.  If the banks had truly cleansed themselves of rotten loans and assets, our economy would be growing faster but thanks to intervention, we slog on.

Yet, don’t let that stop you from studying WFC: Wells Fargo Notes

and visit The Brooklyn Investor

Legendary Jim Rogers: Brokers Going Broke, Farmers Will Become Rich – Very Rich!

Jim Rogers is a renowned international investor. In 1973, he co-founded the Quantum Fund with George Soros. After a fantastically successful decade, he retired to travel the world. He is the author of Investment Biker: On The Road With Jim Rogers and A Bull in China: Investing Profitably in the World’s Greatest Market, among other books. He also runs the Rogers Global Resources Equity Index. Recently Rogers sat down with Steve Forbes to talk about why the global economy is moving to Asia, where he’s putting his money and what the U.S. can do to right the ship. Video and a transcript of their conversation follows.

Steve Forbes: Jim Rogers, thank you for joining us.

CSInvesting Editor: I like his cantankerous, contrary nature.

Jim Rogers: My pleasure.

Forbes: Let’s go through a little bit of history. You teamed up in the early 1970s with George Soros. Had a great fund, got out in the early 1980s. Quickly recapture what you did and how you did it at such a young age.

Rogers: Well, we had a successful ten years. I didn’t want to wake up at 75 and still be looking at a computer screen. I’d always wanted to have more than one life, so off I set to have more than one life. And I’ve had more than one life. I retired. I was 37. And set off to have more than one life.

Forbes: Any motorcycle trips in the offing? Any more books on the exotic places of the world?

Rogers: No. I went around the world in a car, 1999 to 2001, and I really haven’t been on a motorcycle much since then. It grieves me that you ask, because some of the finest times of my life were on motorcycles, including the trip around the world on the motorcycle. But now I’m doing other things. I’ve got two little girls. I’m living in Singapore, which is not a great motorcycle place. Now I’m doing other things.

Forbes: I can’t imagine you speeding there.

Rogers: No, no. I mean, the speed limit is 90 kilometers an hour! It’s not a great motorcycle place.

Forbes: Not to be negotiated.

Rogers: Right, and not negotiable. You’re right. Exactly.

Forbes: Talking about Singapore, when you moved there you decided to have three dates:  1807, you’d move to London. 1907, you’ve got to go to New York. 2007, you’re in Asia, specifically Singapore. Why?

Rogers: Well, the 20th century was the century of the U.S. The 19th century was the century of the U.K. The 21st century will be the century of Asia, and it’s becoming more and more evident. And especially of China. I wanted my children to grow up knowing Asia and speaking Mandarin. I think the best skills that I can give two girls born in 2003 and 2008 is to know Asia and to know Mandarin. So there we are. I couldn’t do it in New York. I tried. I tried doing it in New York. But it was not possible. So there we are.

Forbes: What do you see as the problem with the U.S.?

Rogers: The main problem is the staggering debt. We are the largest debtor nation in the history of the world, Steve, as you undoubtedly know, because you probably read Forbes. It’s amazing how high the debt is, and it’s going up by leaps and bounds. It’s just mind boggling how fast it’s going up. Nobody seems to understand or care what the significance and the consequences will be. It’s not good. It’s not good news.

Forbes: In the past, we’ve had some rough periods – I remember the malaise of the 1970s – and the U.S. has come back. You don’t see that happening again? Are we just digging the hole so deep we’re not going to be able to get ourselves out?

Rogers: There will be rallies. The U.K. in 1918 was the richest, most powerful country in the world. There was no number two. In three generations, they were bankrupt. Now in that period of time, they had some rallies, as you well know. They won the Second World War, for instance. So they had some big rallies. But basically, they were in decline.

I would like to think that there’s something which is going to save us. I can think of some things which will give us rallies. But I cannot see anything – I mean, look at Japan. Japan has staggering internal debt. They still are externally a creditor nation. They still have a balance of trade surplus. We’re the largest external debtor nation in history and the largest internal debtor nation in history. We’ll have rallies. But Steve, I don’t see what can cause us to repeat, perhaps, the ’70s. We’re in relative decline. Maybe you would like to debate that. I don’t think so. I don’t see that that relative decline will stop.

Forbes: Now in terms of investing, commodities. You have the Rogers Global Resources Equity Index. You don’t see the dollar eventually getting strong again? Do you think commodities replace –

Rogers: I actually own the dollar. I actually own the dollar, as we stand here. I bought the dollar 15-16 months ago. 17.

Forbes: That’s just a bear market rally?

Rogers: It’s a bear market rally, yes, in my view. Although when I walk out of here, I may buy more. No, I don’t see it as anything more than a bear market rally. But I own several currencies around the world. There may be a time, Steve, in the foreseeable future, when all of us are going to be getting rid of our paper money, because it’s being debased all over the world. One reason I own the dollar is because everybody’s panicked about the debasement of these other currencies. Paper money is suspect.

Forbes: So it’s just the best house in a bad neighborhood?

Rogers: I’m not even sure it’s the best house in a bad neighborhood. But it’s a good house in the bad neighborhood, for the moment.

Forbes: Getting back to commodities, what makes you bullish on commodities?

Rogers: Well, there’s been a huge dearth of investment in productive capacity for 30 years now. The last lead smelter built in America was built in 1969. No gigantic elephant oil fields discovered since the 1960s. I could go to agriculture. Steve, you should start an agriculture magazine. Because the profits in agriculture –

Forbes: Share with us the observation you made about somebody majoring in public relations and agriculture.

Rogers: Well done. More people in America study public relations than study farming. We have no farmers. You went to Princeton; nobody you went to school with became a farmer. I went to Yale; nobody I went to Yale with became a farmer. The average age of farmers in America is 58 years old. In Japan, the average age is 66. In Australia, it’s 58. Hundreds of thousands of Indian farmers commit suicide every year. It’s a disastrous business. In the U.K., the highest rate of suicide is in agriculture. It’s been a horrible business for 30 years. Prices have to go up – have go to up a lot – or we’re not going to have any food at any price.

Unless you’re going to become a farmer.

Forbes: Then we truly starve. But you pointed out we have 200,000 PR graduates, 20,000 farmers coming out of our schools. And you have a wonderful phrase, “You can’t eat press releases.”

Rogers: That’s exactly right. You cannot eat press releases. It was actually 200,000 M.B.A.’s we have coming out. That’s even worse. We have more people doing M.B.A.’s than doing PR.

There’s going to be a huge shift in American society, American culture, in the places where one is going to get rich. The stock brokers are going to be driving taxis. The smart ones will learn to drive tractors so they can work for the smart farmers. The farmers are going to be driving Lamborghinis. I’m telling you. You should start Forbes Farming.

Forbes: In the 1970s, we heard the same thing, and it didn’t happen. Why?

Rogers: Well, farmers did make a lot of money in the 1970s.

Forbes: And then lost it all in the ’80s.

Rogers: Yeah, but it actually started before. That’s my point. These things go in cycles. There has never been any bull market which has lasted forever. No bull market in the history of the world has lasted forever. These commodity cycles come and go. On average, they’ve lasted 18 to 20 years in the past. I have no idea how long this will last. But it’s not over yet.

Forbes: Thoughts on gold? You were suspicious in the late 2011, not without reason. Where does that go from here?

Rogers: Well, I own gold. I’m not selling my gold. I’m not even hedging my gold, at the moment, although I’m thinking about it. Gold’s up 11 years in a row, which is extremely unusual, as you know, for any asset class. It’s correcting right now. I would suspect it’s going to continue to correct.

There are some things going on in the world. The Indians are coming down hard on gold, and they’re the largest consumer of gold in the world. So it may continue to correct. If so – if it goes down further – I hope I’m smart enough to buy more. To buy a lot more. The bull market in gold is not over yet, Steve.

Forbes: Now going back to Asia, China. You have not been a big fan of stocks. You are of the currency. How do you play China now?

Rogers: The best way to play China is commodities, because they have to buy commodities. If you’ve got cotton, they will take you to dinner, they will pay for your dinner and they’ll pay you on time. You don’t have to worry about corporate governance or any of that kind of stuff. They don’t care who the head of The Federal Reserve is if you have cotton. Because cotton is its own world. And many other commodities, as well.

I own the Renminbi, as well. It’s a good way to play China. I don’t buy Chinese shares, except when they collapse. They collapsed last in November of 2008. I bought more Chinese shares. If and when they collapse again, I’ll buy more. My Chinese shares are for my children. They’re not for me.

Forbes: Now looking at China itself, can they become (as the U.S. has been) an innovative economy instead of a catch up economy? Are they going to do the real value added stuff? Do you see the changes coming on that?

Rogers: The first time I went to China, 25 or 30 years ago, there was one radio, one TV, one newspaper, one way to dress, one everything. That’s changed dramatically, as you know. In China now, they produce something like, I don’t know, 20 times as many engineers every year as we do. They didn’t in the past. It was a very closed and traumatic society and autocratic society. That’s changing rapidly.

I suspect, yes, some of these engineers are going to turn out to be hotshot engineers. I don’t know when. I don’t know where. But China has a long history of entrepreneurship and capitalism. They’ve been disastrous, at times, in their history. But they’ve also been spectacularly successful, at some times in their history. So teach your children Mandarin, teach your grandchildren Mandarin.

Forbes: You’re not a fan of India?

Rogers: No, no, no. I’m short India as a matter of fact. I love to go there. If you can only visit one country in your life, Steve, for whatever reason, I would urge you to go to India. There’s nothing quite like it from a tourist point of view. But as far as a bureaucratic maze, it’s the worst bureaucracy in the world. They don’t like foreigners. They don’t like capitalists. They don’t like people making money. It’s a fabulous country to visit, but I wouldn’t try to do business there.

Forbes: So what’s happening in high tech is just an outlier?

Rogers: Yeah, very much so. You can probably name four or five companies – I doubt if you could name four or five, I could probably name two or three high technology companies. Steve, there are a billion people in India. We hope that somebody’s successful. And most of the outlying outliers that are the successful Indians that you know live in Europe or America. There are very few great success stories in India itself. There are. They exist. Out of a billion people, of course.

Forbes: Japan? Are they ever going to get out of this rut?

Rogers: I own the currency. And when they had the tsunami, I bought shares, as a matter of fact, as they collapsed. It’s always been a good thing to do when there’s a huge natural disaster. It’s usually a good thing to do, to buy into the market. I doubt in five years I will own them. I doubt if I’ll own the currency or the shares. Japan’s got staggering problems. They’ve got the highest internal debt in the world and they’ve got a declining population. They’ve got serious problems.

Forbes: Talking about debt, India’s piling on debt, too.

Rogers: I know. That’s why I’m short India. That’s one reason I’m short India – because they’ve got this huge debt. For some reason there are all these bulls walking around that don’t seem to understand that India has a debt to GDP ratio of 90%. They’re still bullish. They don’t do their homework.

Forbes: You going into Myanmar?

Rogers: I’m extremely optimistic. If I could put all of my money into Myanmar, I would. I cannot, because you and I are citizens of the land of the free. In the land of the free, we cannot invest in Myanmar. Everybody else can. The Japanese, everybody’s pouring into Myanmar, except all of us from the land of the free.

It is so exciting. It is like going to China in 1978; it’s exactly the same place. It might be more exciting, because it’s been such a disaster for 50 years and now they’re opening up. They’re right between India on the left, China on the right – huge natural resources, 60 million people, disciplined, hard work, educated. Oh my gosh, it’s such an exciting opportunity. But all you and I can do is I can read about it in Forbes. I can’t do anything.

Forbes: Where else are you doing things?

Rogers: Well, the other place that I see wildly exciting things is North Korea, but we can’t do anything there. There’s no market in North Korea either. But there’s going to be a merger soon of North and South Korea and that’s going to be a very, very exciting place. Then you’ll have a country of 75 million people, right on the border of China, huge labor pool, lots of natural resources in North Korea. They’re going to run circles around the Japanese. The reasons the Japanese don’t want it to happen is because they don’t want a huge new competitor. They got their own problems.

North Korea, I wish I could find – I’m looking for ways to invest. I have a couple of ways. But they’re not of great interest. These are the places that I find the most exciting. But as far as stocks, for the most part I’m short stocks. I don’t own many stocks in the world. I own commodities. I own currencies.

Forbes: Vineyards?

Rogers: Not in vineyards. No, that’s a good idea. I don’t own any. No, I don’t own any vineyards. No, I drink the stuff, I don’t grow it. It takes too long to grow it, so I’d rather drink it.

Forbes: So to sum up, the U.S. – long term, secular decline.

Rogers: Certainly relative secular decline. There’s no question about that. We may have a lot of oil. When the U.K. had a big rally, went bankrupt in the ’70s, it had a big rally because the North Sea oil started flowing. I know Margaret Thatcher takes credit for it – it was the North Sea. North Sea oil started flowing in 1979, the same year Margaret Thatcher came to power.

If you give me the largest oil field in the world, I’ll show you an extremely good time, as you can imagine. We may have the largest oilfield in the world, with all this oil shale and natural gas, shale gas if they can solve the environmental problems. That would cause a huge rally in the U.S. We’re very good at agriculture or have been. That could cause a big rally in the U.S.

So don’t give up on the U.S. I own the dollar. I’m a U.S. taxpayer, U.S. citizen. So don’t give up on the U.S. But I’m afraid it’s nothing more than a secular rally, because we’re the largest debtor nation in the world and nobody cares, except me and you. I know you care. But other than the two of us, nobody seems to care.

Forbes: So why aren’t you running for president?

Rogers: No, no, no.

Forbes: Might do better than I did.

Rogers: No, that’s why I’m not. Because I know I wouldn’t. And second of all, you think I want to spend my time being nice to people I don’t want to be nice to? You tried that. I can’t imagine it’s a lot of fun, going out day to day being nice to people you don’t want to be nice to. I don’t want to do that.

Forbes: Jimmy, thank you.

Rogers: Thank you, Steve. Good fun, as usual.



A Reader’s Question on Case Studies

Fall from Grace

On my good days, I think of Wall Street as one large promotion machine and on my bad days, I think of Wall Street as a den of thieves.–Jean-Marie Eveillard

Capitulation everywhere (risks rising):

A Reader’s Question on Cases

Hi John: Do you have a compilation of case studies that you’ve found extremely instrumental in learning from, that you’ve collected over time?

I got a lot out of reading your notes on Greenblatt’s classes, so thanks for
that. Last night I read a great small case study from Einhorn and I realized
that the few pages I read was far better than all the time spent studying for my CFA exams. Any good compilation you have would be amazing.
My reply:  Good question. Besides a relentless curiosity, learning how to learn is critical for your development. I believe subscribing to Grant’s Interest Rate Observer then downloading ALL 30 years of his letters while also downloading the SEC filings of any company he mentions over the past 30 years will repay you many times more than any MBA, CFA–if YOUR GOAL IS TO BECOME A BETTER INVESTOR.  You will learn financial history, valuation, about market psychology, business cycles. This is what I am currently doing. I have downloaded 1983 to 1993 newsletters. Now I just need the time to finish reading them!
OK, you don’t want to do that–shell out $990 or whatever–then go here:

Take the first link. Download a research report, look at the name of the company and date, then download the financials for the company mentioned and try to analyze the company BEFORE reading the report.   What do you see? If you don’t understand something, look it up in your finance or accounting textbook that you keep by your side. Then read the report–what did you learn or miss?   Note what you need to learn, then learn it, then go on to the next report.

Yes, this takes hard work, doggedness, and discipline, but you can do it. Not many will, so there is your chance to become great.

Spend time doing this rather than listening to CNBC. Yes, we all laugh when we hear Icahn call Ackman a loser (I was appalled and saddened), but how will THAT help you become a better invesstor?

I will post a link to more case studies tomorrow.   Good luck.

PS: I haven’t forgotten my reply to an investor seeking an answer on what to do with his/her money.

Solution to Earnings Quality CS; Reading Hayek; Learning

Scarlet LEtter

Solution to Earnings Quality Case Study (Manufactured Housing)

The case was introduced here: Try it now if you haven’t. What jumps out at you? Red flags should be flying when you read the chilling lines (at the bottom of this post so as to not give you the answer now.)

Stirling Momex Supplement and Enron Too Shall Pass and GAAP Games_Stirling Homex

Learn more about reading Hayek. What books you should focus on:

How to learn (Refine your questions)

Learning Begins From Within

by Butler Shaffer

Don’t ever let school interfere with your education.~ Mark Twain

Education is an ongoing confrontation between those who want to help children learn how to think, and those who want to teach them what to think. While there are numerous variations on these themes, the contrast can most clearly be found in the distinctions between child-centered Montessori systems, and teacher- and test-centered schools. Government schools usually fall into the latter category. Homeschooling, religious schools, un-schooling, and other forms tend to emphasize either the “how” or the “what” in their efforts with children.

Those who focus on learning how to think have in mind helping children develop their own methods of questioning and analyzing the world around them; to control their own inquiries and opinions; to the end of helping children become independent, self-directed persons. The role of the teacher in such a setting is to provide new learning situations (e.g., open up new subjects of inquiry when the student is ready to do so) and to facilitate the processes of questioning so as to help the students get to deeper levels of understanding.

People who have developed the capacity for epistemological independence are not easy to control for purposes that do not serve their interests. Institutions – which have purposes of their own that transcend those of individuals – require a mass-minded population that has been conditioned to accept outer-imposed definitions of “reality.” Any deviation from this systemic purpose – as would derive from students questioning how the arrangement would benefit them – would be fatal to all forms of institutionalism.

The established order has, from one culture and time period to another, insisted on educational systems that train young minds into what to think. “Truth” becomes a set of beliefs that conform to an institutional imperative, and it becomes the purpose of schools to inculcate such a mindset. Whereas “how to think” learning that finds its purpose and focus within the minds of self-directed, independent students, “what to think” education derives from outside the students’ experiences and analytical skills. As Ivan Illich so perceptively expressed it, “[s]chool is the advertising agency which makes you believe that you need the society as it is.”

To this end, the established order has helped generate – with eager assistance from academia – a belief that all understanding is a quality requiring phalanxes of self-styled “experts” who, by virtue of their prescribed status, enjoy monopolies to offer opinions about their respective fields of study. Plato’s designation of “philosopher kings” has been sub-franchised into categories of “experts” to be found in “history,” “physics,” “psychology,” “economics,” “law,” and seemingly endless sub-groupings that negate the role once respected for those who had received a “liberal arts” education.

Entry into the sanctum sanctorum of the upper floors of this pyramidal high-rise is determined by a process of certification usually reflected in a graduate school degree provided by those already recognized. Of course, given the logic of any vertically-structured system, there is a hierarchy of certifying agencies, wherein Ivy League universities are presumed more capable of identifying and recognizing expert genius, than would Boll Weevil State University. Nor is tolerance exhibited toward any interloper who might dare to offer an opinion outside his or her area of certification. (When my book, In Restraint of Trade was first published some fifteen years ago, one reviewer – from a history department at a highly-respected university – spent the bulk of his time criticizing not the substance of my book, but the fact that I taught in a law school!)

The assumption is often expressed that, in a complicated world we must rely on “experts” to navigate through the turbulence and uncertainties that abound. But the study of “chaos” and “complexity” challenge this thinking, reminding us that complex systems produce unpredictable outcomes; that the most effective action occurs when decision-making is decentralized closest to the source of such turbulence. In a world currently being destroyed by centralized state systems of “economic planning,” “military planning,” misnomered “intelligence agencies,” “health-care planning,” among others, it is increasingly evident to people that the certified “experts” tend to supply answers to problems that their epistemological arrogance has helped to generate.

Systems premised upon outer- rather than inner-directed learning – training students what to think rather than how to think – turn children’s minds into so much “mush” as to deplete their inherent creative energies. People become neutralized by a system that trains them to accept the inadequacy of their own minds to make empirical and analytical judgments about the world. The outer-directed approach, in which “truth” is presumed to be found within the opinions of the certified intelligentsia, is self-sustaining as long as students’ minds remain in the default mode. Expertism is a circular process that makes it difficult for people to break the circle unless they have a sufficiently independent mind.

The method of learning I have found essential for encouraging the inner-directed (i.e., how to think) approach is found in the use of the Socratic method, which used to be used in most law schools. My all-time favorite professor was Malcolm Sharp, a law professor at the University of Chicago, one of the loveliest persons I have ever known; but who frustrated most of his students with his insistence on getting us to keep refining the quality of our questions. This was done through an ever-deepening level of inquiry encouraged by the creative us of the word “why?”

To the proposition “government is necessary in order to protect the lives, property, and liberty of people” the following questions could be asked: “how is property being protected if the state must forcibly take property from people (taxation) in order to support its activities?” “Can liberty be protected if the state can compel people to act – or refrain from acting – in ways contrary to how they would otherwise choose to behave?” “How can lives be protected if the state is able to engage in deadly wars?” “If the war system generates restrictions on human action, including the forced conscription of people as soldiers, how is individual liberty being defended?” “If it is our purpose to protect the lives, liberty, and property of people, can such ends be served by a system that regularly contradicts such ends? Are there alternative ways to accomplish such purposes?” As each question is asked, the response might generate additional sub-questions to be explored (e.g., is it possible to support a system through voluntary payments? Is the marketplace an example of accomplishing these ends without violating them in the process?)

Most of my students experience frustration over my methods of providing them with cases and materials, and then playing around with hypotheticals – and the factual modification of hypotheticals – to explore the ramification of case holdings and rules of law. “I came to law school to get answers, one student raged, and all you’re giving me is more questions!” “How do you propose to deal with legal questions once you are in practice?” I asked him. “And if you think I am such a fount of understanding, how do you think I got that way; and do you think you might be able to develop such a skill?” It is encouraging to find some students who grasp, at the outset, that their success in the classroom and as lawyers depends upon this process of learning how to think. I often receive favorable responses from students years later. I had one student tell me “when I was a student of yours, I hated your guts. Now that I’ve been out in practice for ten years, I think I learned more from you than from anyone else.” Just a few months ago, a former student wrote me – thirteen years after graduation – to thank me for what she learned from my classes.

Perhaps the most pleasant experience I had with a first-year law student came on the first day of class a few years ago. We had discussed a particular case, and I began playing around with the facts to see how the students might follow the process of discovering the boundaries of legal concepts. At this stage, most students are able to give a one-line answer, but can go no further. This young woman, however, took the inquiry to greater depths: “how does this square with what the court said in the earlier case?,” and similar inquiries. I knew, at once, that she was a real “keeper;” that classes were going to be far more interesting with her ability to use the Socratic process to discover the kind of understanding one never gets from answers; that it is the endless pursuit and improvement of one’s questions that makes for real learning.

I asked this young woman about her educational background: “I was homeschooled up to high school,” she responded. “The best teachers I ever had were my parents.” I suspect that she was the beneficiary of parents who knew that how to think was of greater importance to a creative and successful life, than being conditioned into what to think! The former approach allows men and women to develop, within their own minds, the skills not only for understanding the nature of the world, but to act competently. The latter method reduces people to the task of seeking the opinions of others – particularly the “experts” – to be informed of what they are expected to know.

After working through a series of hypotheticals, I still get a few students who ask “but what is the answer?” “Who cares?,” I respond. “It is going through the process of constant questioning that is the purpose of what we are doing here? I don’t know how the courts would rule in this situation, but I do know what noises to make were I representing one of the parties.” The Socratic method helps students grasp the meaning of Milton Mayer’s observation that “the questions that can be answered aren’t worth asking.”

Our world is being torn apart by men and women who naively try to integrate into some manageable whole their confusions, contradictions, conflicts, lies, evasions, corrupt and violent dispositions, and other destructive behavior. We live at a time when people become righteously indignant over the heinous murder of another, but wave flags and cheer for those who conduct wars against the millions; when Nobel Peace Prize grantors cannot distinguish Mother Theresa from Henry Kissinger as worthy recipients of such an award. Perhaps when our well-organized, expertly-run world finally runs out of answers to the destructive conditions it has created, we may – as Malcolm Sharp urged – undertake the search for improved questions.

December 12, 2012

Copyright © 2012 by Permission to reprint in whole or in part is gladly granted, provided full credit is given.

Butler Shaffer Archives

RED FLAG on Earnings Quality Case Study (Thanks to a reader)

Note 3 on receivables says revenues are recognized when units are
manufactured and assigned [at the company’s discretion] to specific
contracts. (What the F%^&!)  Then it says contracts provide for payment upon completion.  (Expect a massive difference between GAAP accruals and CASH FLOW–lots of room for funny stuff!) 

[not manufacture/assignment] and receipt of all approvals necessary
[which is not in Homex’s control]… Ergo revenues are booked when the
customer doesn’t even have to pay.   BINGO!

That note to the financials (Revenue Recognition) should have you reaching for the barf bag.