David Einhorn of Greenlight Capital wrote a book called Fooling Some of the People All the Time, John Wiley & Sons , 2008. Mr. Einhorn runs a hedge fund called Greenlight Capital and it has longs – expects stocks to go up and shorts expects stocks to go down. In theory, everyone should look how to make money going short or buying puts,  in reality most of us focus on the upside. In part, investment companies make money bringing shares to market for their future growth. The issues Mr. Einhorn writes about in his book do not go away which makes the book an excellent read.

Greenlight Capital along with others did a great deal of research about how a company called Allied Capital was valuing its investments. Allied Capital was (no longer exists) in the business of making loans to small businesses (which is a great thing) and a US agency would return 75% of the loans if the company failed. In theory, it was taking a 25% risk. There were a number of issues – the government agency sets up a program expecting lenders to lend money to small business because often they can not receive loans from the local banks (high risk), the agency expects the contractor in this case Allied to be honest and ethical and has limited capacity to determine if they are. In all likelihood Allied started as honest and ethical, but Mr. Einhorn and others determine they were not. Mr. Einhorn determined Allied had many examples of approving loans and keeping the value of the loan at 100% even though the small business was in bankruptcy and not paying the loan. Under normal circumstances – when a company does not pay the value of the loan falls to less than 100%. When the company is in bankruptcy the bonds are worth cents on the dollar. The effect of not writing down the debt was to make Allied’s balance sheet look good and allowed them Allied to pay dividends or a regular income. As long as the income was paid, many choose to believe Allied’s story. When the income was cut, the end of Allied was near.

The book is written from Mr. Einhorn’s perspective which means Allied Capital for many years had a different story. Part of their story was Greenlight Capital was only interested in the company because it sold short, otherwise made money when the stock fell. Their story was the good people of Allied were trying to help the US economy grow by investing in small businesses. To be against Allied was to be against small businesses.That is a powerful argument. In all companies there is likelihood of some fraud, but how much? is it rotten to the core? Does the government, if it believed in Greenlight Capital arguments, remove Allied from the preferred list of small business loans? The answer was for many years no. (in part because the preferred list did not track fraud, but how well the paperwork was done) (what is measured is what will be received).

Linking to dividend paying stocks – how does your company value its assets? When does the company write down and off its assets which no longer produce income?

There are more questions than answers, till next time – to raising questions.

There are a number of books written about Lehman Brothers – most focus on the executive suite for very good reasons. Lawrence McDonald a former VP of distressed debt of Lehman Brothers wrote a book called A Colossal Failure of Common Sense The Inside Story of the Collapse of Lehman Brothers , Crown Publishing, NY, 2009.

The executive suite wanted to be at any cost to be a top tier company, for Lehman was traditionally seen as second tier company. Second tier is similar to the old Avis car rental company – we try harder. Second tier allows for a culture to exist of us against the establishment, meaning there is some resentment against the first tier companies.

In terms of his job, Mr. McDonald and group had to understand the companies he would short in terms of what value would the company be worth if it went into Chapter 11 bankruptcy – 5 cents on the dollar? 30 cents? 50 cents? When a company moves to the path of reorganization through Chapter 11 bankruptcy, there are funds which are not allowed to hold them in their portfolio. The companies have to sell and the issue is what price is good while the company works to come out of Chapter 11? There is a buying opportunity if you know what the assets should or could  be worth. To know the answer means a doing research.

Linking to dividend producing stocks – just about every President says they want to be world class or ranked number one – what does that mean? what type of growth does that imply? what type of debt does that carry? is it feasible in your eyes?

In every organization, there are people who understand what is happening, what needs to be done and if listened to would have made a difference.However getting to the executive suite and listening to different view points are often two different skills, which skills does the executive suite in your companies have?

There are more questions than answers, till the next time – to raising questions.

There are a number of books written about Lehman Brothers – most focus on the executive suite for very good reasons. Lawrence McDonald a former VP of distressed debt of Lehman Brothers wrote a book called A Colossal Failure of Common Sense The Inside Story of the Collapse of Lehman Brothers , Crown Publishing, NY, 2009. The perspective is interesting because Mr. McDonald’s job was to find companies whose stock should fall because of debt and other reasons and short the companies. The other part of the job was to examine the debt of companies which had declared or expected to declare bankruptcy and determine how much value is left in the company and make bids for the debt.

In the book, Mr. McDonald says his group understood what was coming in the housing market, was shorting the mortgage companies but the executive suite was driven to become the leader on Wall Street which meant they did not understand what was happening and wanted growth at any cost. While Mr. McDonald was shorting companies in the airline and real estate mortgage business, other parts of Lehman were going into overdrive to bulk up on both commercial and personal real estate mortgages bonds. They were doing it because money was inexpensive, the credit lines existed, they relied on the assumption that the real estate prices rise and people paid back mortgages (although when someone is given a mortgage with no down payments, little income and very low mortgage payments for the first two years, it is not surprising in year three and beyond thousands of people stopped paying), and the fees to bundle the mortgages or securitize and sell them as bonds was too much of an incentive not to do.

The lesson is leverage – most companies and Individuals (it seems) operate on the use of leverage. In the error of inexpensive money it is prudent for a company to buy assets which produce returns. The question is how much, is too much? In the case of Lehman Brothers when they declared bankruptcy they were leveraged 44 times their capital or for every dollar of capital, they had borrowed 44.

Prior to their downfall, Lehman bought a large commercial portfolio at the top of the market price and the securitization of individual mortgages machine was at full production, but Lehman was keeping more and more of the inventory as it was harder to sell the bonds. This was acceptable as long as the bonds kept their value, the week the bonds started to fluctuate in price, the bonds were in a free fall and billions of dollars of assets became cents on the dollar. The investment business is based on credit, the credit is based on providing assets for collateral for banks to lend money. When the mortgage bonds became to lose their value, no bank wanted the collateral. No collateral, no business.

Linking to dividend producing stocks – what is the leverage in stocks that you own?  Second lesson is the common sense one – mortgage brokers selling the no income mortgages were operating in the grey area. It was legal, but not the same as the expected standard that the mythical average person operates in. As an individual if you saw the ads or articles or participated you have to ask yourself what is the outcome of the mortgage. What are the assumptions everything is based on? Is it good?  Mr. McDonald left NYC where Lehman is based and went on a field trip to where many of the mortgages were originated to see what was happening in the field, travelling in person is often a good thing.

There are more questions than answers, till the next time – to raising questions.

In one of the newspapers the writer looks at, a useful chart was seen. There are many methods to determine which is the best stock to buy. All methods have some validity but one way to start with is through the credit rating of the companies. The writer David Parkinson with the help of Jamie Hynes sales director of S&P Capital IQ examined stocks with the highest credit rating – in this case S&P credit rating.

The headings were

Stock Name    Price   Credit Rating   Dividend Yield % Payout Ratio  %  5 Year Growth %  and % Total Return

In this particular group of 20 stocks, all paid a dividend, the vast majority had raised their dividends in the past 5 years, most of the shares were up this year and of great interest the total return was more than twice the general stock index.

This chart provides a great starting point to to buy one or more stocks or to look for a index which has stocks which pay dividends and has A to AAA credit ratings. Knowing that high credit ratings of companies outperformed the general market is a good thing.The result should not be surprisingly for stocks that pay dividends and have great credit ratings are highly desirable features and indicate their business plans are working very well.

There are more questions than answers, till the next time – to raising questions.

The writer lives in an urban area with mature trees in the neighbourhood. In the fall, the trees lose their leaves and some of the leaves accumulate on the street. This week the  city’s crews finally made it to the street and cleaned it. The city collects the leaves to make compost which is then recycled onto gardens and parks around the city. The end result is something to be valued for it is a sustainable, usable product that the wonders of nature do all the work. However, on a urban street, which is used to being relatively clean, the streets were in need of the city’s cleanup.

Linking to dividend producing stocks – when you buy your shares, sometimes you want the company to do perform similar to all the growth stocks you read about or even follow. You know the dividend is coming, but you want an increase in stock price to. There is nothing wrong with the the want, however for most dividend companies, similar to nature doing its work,  the increase happens over time. The continued dividends with the great possibility of increases every year pushes up the stock price. The great advantage of dividend producing shares is you can buy for dividends and receive an increase in stock price to.

There are always more questions than answers, till the next time – to raising questions.

An interesting book on the story of Merrill Lynch is the Crash of the Titans by Greg Farrell Crown Publishing NY 2010. This post focuses on management style. Every President and CEO has a slightly different management style depending on how they were picked for the job. As long as the company makes money, it does not really matter on the style. When the company does not make money, style is critical. If you own dividend shares and the shares continue to pay money, for the most part style does not matter. If the company loses money, management style is a very important consideration.

The management style of Merrill Lynch varied over the years – from someone who genuinely loved the investment advisers to someone who considered them less important in their Presidency and focused on other parts of the business.

One of the Presidents to ensure he had no rivals “fired” anyone who he thought was a threat. Three or four years into the his Presidency, the Board looking to the future found the internal pickings for the next leadership to be thin. No secession planning existed under his reign.

A President who decided to talk first to other partners about mergers, then to the Board was removed. He was removed because Board of Directors need process. The first step is explain to the Board where we are and what the financial situation is. Then you go through the strategic options, whether it makes sense to stay independent or sell. And if you wish to sell, who is the right partner? It is then you begin to talk about who you favour. It is very important to remember as a President you report to your Board, your Board can rubber stamp your decisions, but every once in a while, if the process is not followed, they will exercise their authority.

A different President felt anytime someone questioned his authority or decision making, the person was let go. In the end, he has surrounded himself with yes men with less talent than himself. When he went, so did the yes men.

Another great lesson is for any company to remain prosperous it has to have great internal controls and know the potential liabilities of all its assets. Companies buy and sell assets as part of their business, how much are the assets worth? The best company says when in doubt offer to  sell some of the asset into the marketplace. What is the bid or offer price? If the price is lower than what the asset was bought at, mark the asset as such. If it is higher, so much the better.

Books such as the history of Merrill Lynch is a good read, with lessons to be learnt – see what type of management exists in your dividend producing companies.

There are more questions than answers, till the next time – to raising questions.

From the book The Big Investment Lie by Michael Edesess published by Berrett-Loehler Publishers, San Francisco, 2007. If you go to a financial planner, at some point there is a fee involved and similar to every other sales, sometimes the smart thing for a financial planner is to sell you the expensive items. There is value in the financial planner, but deal with them in the understanding part is a sales process.

Mr. Edesess has come up with 10 Commandments for Smart Investing.

6. Don’t pay anyone to pick stocks for you; there is no reward for the cost and risk. If you pick stocks, which can be a very good thing, the other person should be asking how does the stock fit into your comfort level and is the position relative to your holdings within reason.

7. Avoid hedge funds like the plague.You likely have read some of the owners of the hedge funds have made lots of money. Part of the reason is the high fees they charge the clients in both up and down markets. Are the clients making more money to justify the fees? If you pay fees which are near credit card interest rates, how much are you making?

8. Know the risks of investing; take only the risk you are comfortable wth. Most companies that deal with financial planning will have you sign a form about what investments you are comfortable with. Your investments should stay in that category, for most people relatively low risk, low fees is best.

9. Keep fees and taxes as low as possible; they can swamp your investment returns. The purpose of investing is to gain more, however fees and taxes have an influence. It is entirely possible to keep fees low as well as to ensure whatever the politicians decide – the method of earnings should be weighted in that direction. Dividend income is taxed less than interest income, if you have more dividend income you keep more of your money.

10. Invest only in true low-cost index funds. Index funds work because the stock exchange removes the “losers” and replaces them with “winners”. Over time, the winners will do better than the losers. The big issue with index funds is time has to go by, which means if you need to sell on a regular basis index funds are not ideal. However, if you are in the work place, they can be be one of your major holdings – ensure you check out the fee, it should be near 1% for the cost of managing the fund is low. Many companies offer mutual fund matching investments for their pension plans, ensure the options include an index fund.

There are more questions than answers, till the next time – to raising questions.

From the book The Big Investment Lie by Michael Edesess published by Berrett-Loehler Publishers, San Francisco, 2007. If you go to a financial planner, at some point there is a fee involved and similar to every other sales, sometimes the smart thing for a financial planner is to sell you the expensive items. There is value in the financial planner, but deal with them in the understanding part is a sales process.

Mr. Edesess has come up with 10 Commandments for Smart Investing.

1. Follow a wealth-building strategy, not a gambling strategy  – be similar to the turtle, not the rabbit. Long term horizon making compound interest work for you. If you keep your debt low and most of your money in your home and in dividend producing stocks that have paid consistently over the years, you will do well.

2. Stop searching for the Holy Grail – give up the futile quest to beat the market. Some years you will, most you will not, due to the market fluctuates. Refer back to number one.

3. Stop believing that past performance predicts future performance. If you look at a mutual fund, the best number will be highlighted – it is good marketing. Look at the 5 year or 10 year number. Last year’s star fund is not likely to repeat again because of simple math. If you have 1 penny in your pocket and find a penny on the street, you have doubled your money. If you have $ 50 in your pocket, and find a penny, you have more, but not much.

4. Don’t be duped by the false claims of investment manager and advisers. In every sales or client meeting, someone is trying to find what sales pitch works. The old rule whatever works, works.

5. Fire managers and advisers who charge more than bare bones fees. All organizations charge fees of one sort or another, some fees are higher or lower, you should pay a fee. The concern is how much is reasonable for both parties. Remember if you own a fund and the fee is 2%, your fund has to make greater than 2% before you start to make money. Is it?

The other 5 commandments will be in tomorow’s post.

There are always more questions than answers, till the next time – to raising questions.

In Baseball this year, a number of players are on the ballot and eligible to voted into the Hall of Fame. Their careers produced consistently exceptional numbers and awards, however part of it was cloud with drug abuse to keep their performances at their peak, even as their age increased. Typically in baseball as a player ages, his performance begins to drop. Steroids helped a number of players retain their edge. Should the voters vote in the Barry Bonds and Roger Clemens? What if the players played on teams you followed? If you say no, do all the players in the Hall of Fame match your standards or should somebody be removed?  Sometimes the answers are not black or white.

Linking to dividend paying stocks – depending on how you answered the above questions, would you own a company that consistently pays dividends but has many lawsuits? In the world of billion and trillion dollar corporations, there will be lawsuits. Lawsuits are part of doing business, most companies try to operate with the fewest lawsuits possible. It would be great if all the companies had no lawsuits, but the reality is many companies are being sued, but most lawsuits are not material to the overall operations of the company. An exception was BP Oil which had to sell off large portions of its assets to pay its fines of the oil spill in the Gulf coast.

There are more questions than answers, till the next time  – to raising questions