David Milstead of the Globe and Mail recently wrote a column which was called How to separate wealth creators from wealth destroyers. As long term buyers, you want your wealth to grow rather than slowly erode and that is why this column was wrote. Often times the easy metrics are used because they are easy to do. However, Mr. Milstead was reviewing information about companies that have the best return on capital, versus their capital cost. His question was which companies have the worst return on capital versus their capital cost? If you know which ones are the worst, then you can avoid them, unless there is really really good reason. Maybe they are a mining company and the commodity price is low, but if you took a 5 year average it might be better picture If you avoid the worst, then you can be better on the markets. Any company that is losing money is not earning more than its cost of capital.

The other strategy is to find out which companies have a really low capital cost that allows them flexibility and even if they just do relatively normal and they will do well. Those companies have a built in advantage. Remember companies make money through its investments or its return on invested capital needs to be greater than their cost of capital.

To create a high economic performance – divide the companies’ return on capital by their cost of capital. or Return on capital equals net operating profit after tax (NOPAT).

The cost of capital is cost of debt plus equity. The debt is the interest rates the company pays plus an assumed cost of the equity a company issues. The result is called Weighted Average Cost of Capital or WACC. Companies do not disclose the number so analysts have to determine it which means sometimes is more art than science.

Linking to dividend paying companies, one of the great advantages of companies which consistently making profits is the ability to raise capital by issuing debt or shares at low cost. If things are normal in the marketplace they will continue to do well. If you buy a company which has a high cost of capital they have to make an even higher cost of return to be make money, which is a risk. It can be well worth it but if one thing goes wrong, then with the high cost of capital, you will likely lose money. The strategy is then to find companies will a low cost of capital and make the most of those investments it is making.

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

The Inquisition was used by the Catholic Church (the dominant religion of the Europe) for 300 years and the subject was to ensure all of Europe was 100% believer in the Catholic Church so their minds and souls would go to heaven. If you were not a 100% believer you would be accused of being a heretic and likely found guilty unless you confessed. Over the years, what may have been a reasonable thing because an increasingly hard to justify for how do you know what the person is thinking because you are concerned about their thoughts. Are the thoughts daily? are the thoughts once a year? What is a good result? The book The Inquisition of the Middle Ages – its Organization and Operations by Henry Charles Lea published by Eyre & Spottiswoode, London, UK, 1963 focuses on how the Inquisition worked.

The Inquisition started because there was more than one method to look at the life of Christ. Peter and others helped institutionalized the church and the dominate religion was set as Catholic Church and over the years the Popes decided they made a monopoly on people’s beliefs. As an institution some subjects are left out, some subjects were changed to reflect the organization. There were and are many reasons why people may act according the universal values of being a Catholic, but could question the organization. The inquisition wanted no questions to be raised, you were supposed to accept on faith the interpretations of the Catholic Church or face the punishment.

In the book, Mr. Lea focuses on the organization and operations and given the task of a success is so loosely defined, many different methods were tried. One good thing about an institution is they all like to have policies and procedures and paperwork or documentation about the Inquisition is easily to be found in the church’s records. It also means someone had to approve what was going on and since the Inquisition reported directly to the Pope – it was his responsibility. Popes typically serve 10 years and some saw the threat of heresy as more important than others. In the beginning the leaders of the Inquisition wrestled with the policies and procedures and what punishments were to be given out? No one ever figured out how to determine if they worked or was the idea just to put a fear of the organization in the eyes of the faithful, for that it did. If you watch a movie such as the Hunchback of Notre Dame it is easy to see in the background.  Think about the secret police – trying to get neighbors to watch neighbor and report anything that was not perfect. In all communities there are people who do not like others, who want to change their relationship, who want to get ahead of the line. If you read the book from the aspect of do the policies and procedures make common sense? you may find yourself looking for something more. The fact that the Inquisition lasted 300 years meant the Church and the local population gave support to the process or for the upper leadership the Inquisition was a valued part of the church.

Linking to dividend paying stocks, all companies have policies and procedures and they are there for good reasons or were in the start. In most organizations there were be some policies and procedures which tend to exclude something. an example is “We will serve high income individuals ” (which means we have a threshold of income needed for our services) or we do not serve low income people. If the company can gather the clients, there is a select high competitive marketplace for it and many companies are successful doing it. The policies and procedures to control the mind to believe in one form of religion so their souls will go to heaven are much harder to do because no had the ability to control beliefs and who knows where souls go? Do souls go to hell for a lifetime of wrong decision making or making one bad one? who knows – we still do not. As you studied the companies you invest in: a question to ask is what do the policies and procedures not allow the company to do or should not be doing?

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

In the Middle Ages, Catholic was the dominant religion in Europe. Being the dominant religion, the leaders of the Church had a desire to stomp out any other religion for in their eyes and minds – anyone not 100% Catholic or a believer in the true faith was a heretic. On a normal day it is hard to look into someone’s mind and consider their soul if they were not a true believer. The solution to this problem was to devise an organization which reported to the Pope called the Inquisition and similar to all large organizations, there were policies and procedures for the Inquisitors to go into a community to find out if the faithful were true believers. the Inquisitor could also here confessions and give punishment for those with the wrong thoughts. The book The Inquisition of the Middle Ages – its Organization and Operations by Henry Charles Lea published by Eyre & Spottiswoode, London, UK, 1963 focuses on how the Inquisition worked.

The Inquisition lasted over 300 years, which means both the Church hierarchy and those that followed the religion were supporters of the method. In some ways, the job of the Inquisitor was similar to that of a criminal attorney – trying to determine the innocence or guilty of those that come before him (the Catholic Church only employed male priests). At the time the Catholic Church had the resources of the Country (the police) on its side Unlike a court, the defendant had no one to help them, for if a person helped someone that was accused, the inquisitor would see that person as guilty and go through the process with him. There may had been good reasons to go after the other religions, the Catholic Church had set the rules and those are the lessons to be taught. They had decided what was important and what was left out of the teachings and about the person of Jesus. Even today, over 2,000 years after Christ, we still know very little about Jesus and we live in a more connected world than ever before. You can imagine what it was like in the Middle Ages with 90% of the population not being able to read and write and most people living in rural villages. The Inquisitors come into town in a large coach surrounded by guards, through the grapevine most know they are in town and maybe why?

The Inquisitors were trained in asking questions that went along this line:

I: Do you believe in the one God, the Father, and the Son, and the Holy Ghost?

A: I believe      (good answer)

I: Do you believe the bread and wine in the mass performed by the priests to be changed into the body and blood of Christ by divine virtue?

A: Ought I not to believe this?      (problem answer)

I: I did not ask you if you ought to believe, but do you believe?

A: I believe whatever you and other good doctors order me believe.

The Inquisitor was looking for the simple answer, never the complex. 99% of the time their training and education was much greater than the general public and they were suppose to report back results. The questioning could take hours and if the answers took longer, confinement in jails for a month or torture were regularly used. In the end, a sentence was given – sometimes to wear a X on your shirt or coat; sometimes it was jail and for a few burning at the stake.

Linking into dividend paying stocks, the Inquisition started off as reasonably good policy for similar to the Catholic Church there are trademarks which must be protected. Many people copy others it is not necessarily a bad thing to go after them. It can hurt profit margins but it is understandable if your company has a great idea, your competition will likely have something similar to it in the near future in order to stay competitive. The danger of the Inquisition was it was after a undefinable end – the minds of its people and their souls afterwards. Since no one knew what was the end result, all kinds of methods were developed over the years and there was remarkably few checks and balances at the senior level. The Inquisitors reported directly to the Pope, which Priest is going to challenge the Pope? Very few. As you research the companies you invest in, who says NO or this is wrong or I do not support and will not give my vote to it?

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

 

 

In the Middle Ages people were generally loyal to their community, state and faith for very good reasons. Their community is where they lived and since the average person never left their farming community they were loyal to where they lived. The loyalty to state because if the state went to war or had to be defended, young and old males were swept into the military. The loyalty to their faith for there often only one religious institution in the community and they taught when you died your soul will live on, if you followed the one true church. At the time most of the population could not read or write, which meant there was not a lot of discussions about the meaning of the words or alternatives. Also the majority of people were known as serfs and if the Lord of the Manor went to church you were expected to attend.  However if another religion came along and it seemed to make common sense then it might be practiced. The Catholic Church wanted a monopoly on faith in Middle Ages Europe – be catholic or you might as well be dead (at least to the church). Similar to every large institution some practices are better than others and considering the average person’s connection to the church was the local priest – some are better than others. In the drive to be the one true faith, the notion of heresy or being a heretic came forth. If you did not believe 100% of the time, if you questioned the basics of the religion, you must be punished.

The Inquisition took time to implement, it lasted for over 300 years and for many years the public was invited to the hearings (think about an outdoor court room) The hearings were  after the questioning and detention and sometimes there was torture for people to remember more details. The book The Inquisition of the Middle Ages – its Organization and Operations by Henry Charles Lea published by Eyre & Spottiswoode, London, UK, 1963 focuses on how the Inquisition works. On You Tube you can find videos about the Inquisition for the Catholic Church believed it was saving souls through the Inquisition and the Church was great record keepers. In addition you might want to view the movie In the Name of the Rose with Sean Connery to get a sense of what was going on. In the Vatican there is a great amount of information written down, for the leaders were saving souls.

The Inquisition started small – it went after those who were preaching a different version of the established Catholic Church. In Spain, after the Christians beat the Moors (Muslim) the King declared the country as a catholic country and issued rules against all religions that was not catholic. For some – rather than being killed they converted but were generally not really accepted. In terms of the Jewish population, Spain had limited the professions Jews could be employed at; after the forced conversion all professions were open to them. In Spain, it was at first easy to find those that were not 100% believers in the Catholic faith, but you can imagine over time it became harder to find people – for non 100% believers would practice in secret. As time went on, various Popes would see heresy as a bigger problem and issue orders to the bishops to pump up the volume to find more heretics in their area. The Inquisitor would come into town with guards (law enforcement) to round up those who secret thoughts and opinions were not in keeping with the 100% rule. Now days we have freedom of religion and thought so we do not worry as much.

Linking to dividend paying stocks, in some ways larger companies operate like the Catholic Church of the Middle Ages. When you question something about an established company, they are often not open to discussion except on a very limited basis. Typically nothing happens to you but the people are dedicated to their company and believe they are doing the right thing. While many companies particularly in the retail industry would love to control your thoughts so you will buy their items. the reality is they still do not. When you buy shares in the company, you are buying an ownership and you want the company to continue what it is doing – making profits and sending you money. In terms of ownership, you have an addition access to someone, the more shares you own the higher the person in the organization. How does your company deal with the competition? some companies do not like them and forbid people to deal with them including industry groups. Who is the enemy? and what does the company do about them? Answering those questions will tend you to consider if you wish to be a long term shareholder.

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

 

 

If you are interested in how the Marines are governed and work, then the book by Tom Clancy and Tony Zinni called Battle Ready published by G.P. Putnam’s Sons, NY 2004 is worth reading. In the book examines the career of US Marine Tony Zinni  from the Vietnam War in the 1960’s to 2000 and the Gulf War to mediation of the world’s problems. There are many great stories and leadership lessons in the book.

One fact which could be used to strengthen the country is after the first World War when the soldiers were discharged from duty they received citizenship papers if they were not already citizens. Mr. Zinni’s father received his.

A couple of stories from Vietnam is when Mr. Zinni was in Vietnam he was exposed to many fire fights, eventually he would be add to judge from the pop and flash of the guns  what was being shot and how far away they were. If you know that information you can prepare yourself and defend yourself. It is skill that likely should be taught before the recruits arrived in battle.

In the build up of troops – people were promoted to leadership at all levels – many should not have been and their actions were not productive. At the higher levels, what type of war and what the results need to be can easily be questioned. In retrospective, even though the US lost the war, the spread of communism stopped, perhaps that was a victory.

In the leadership of Marines and other organizations – future leaders are posted to various parts of the world to see how they perform. The postings typically run 2 years or so. Most of the time is spent drafting plans or strategies of what needs to be done and how it is going to get done. Plans are great but the only thing that makes them workable is the relationships between people to get them done. If the leadership has gone to the field to see what those that actually do and their needs, then when it comes time to implement people will take the extra steps (sometimes creatively to get it done). If they have not, then the plans will gather dust. The higher the post, the more the results depends on relationships and if the person has built and kept them up. If the person has built and kept them up, phone calls matter. When they have not, the letter of the law and self interest matters most.

Linking to dividend paying stocks, models are wonderful but it is the people that matter. Relationships that people build through the years, if management has a single focus and its people do not count, then do not expect too much from them. If the people believe they count, they will be more productive and creative. Mr. Zinni says values and leadership matter and if they matter, the people who follow will see and respond to it. Live words like integrity, ethics, honor and people will see them; do not live them but say them and no one will care except for your flunkies. Live the words and be honest to those closer the bottom and they will respond like wise. In the companies which you own stock in, how is the leadership or is the monopoly so good the leadership does not matter?

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

 

 

 

 

Earlier in this month of September Hanjin Shipping Co filed for bankruptcy. Hanjin was the 7th largest sea container shipping firm and the largest company in South Korea in controlled about 8% of the trans Pacific trade volume for North America. Think about your household or favorite electronics store – do you see South Korean goods in it? One of the largest accounts is LG (Life’s Good) who sent between 15 and 20% of their goods through Hanjin. What is important to know is retailers similar to everyone else try to have close to just in time inventories and know that the months between September and December have higher sales than other months. If the items are is transit being held up by bankruptcy courts, the items are not in the store and will not be sold. LG similar to other companies around the world ship using more than one firm and another South Korean shipper Hyundai Merchant Marine says it will add more vessels – but that takes time – a couple of weeks.

In the world of shipping, many of the ports are run by a few companies and the container ship company which pays the fee to the port company. The stuff that is inside the container the owner pays the shipping company and you can see what happens when a company can not pay their fees. A couple of days after filing for court protection, the ports blocked more than half of the container ships from docking to unload. If they do not unload they do not get paid and someone will need to sort it out. Sorting it out takes time.

Linking to dividend paying companies, all companies in the world are dependent on somebody or something. It used to be companies were vertically integrated or doing everything themselves but most companies contract something out because it is cheaper and it is very hard to be excellent in all areas needed. It is far easier to take a piece that the company lives and breathes and do that well. The supply chain works till it does not and ideally the supply chain is not dependent on one company for the most critical aspect of the business. When you investigate your companies – you will want to know about supply chains and what could be a weak link in the chain.

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

Warren Buffett has produced a number of papers which we sends to his shareholders and because his success has been great, various people have read and studied his writings. One of those people is Jeremy Miller who wrote Warren Buffett’s Ground Rules published by Harper Business, NY, 2016. One of the methods to promote the book is to do a lecture tour and Google Talks had him as a speaker. Mr. Miller found 3 things not to do:

1. Stay away from short term predictions
2. Try not to listen to the wisdom of the talking heads
3. Do not play someone’s else game

The 3 things to do are:

1. think long term in years allowing compounding to help you
2. Establish you own viewpoint – each of us has specialized skills in looking at the markets, accent yours.
3. Play your own game – why did you buy the stock? if the price goes down would you add more? if it goes up that is good.

The rules are simple, how you do it is the complex aspect.

Mr. Buffett typically favors a 15% rate of return as a risk factor. He has a wide variety of stocks he is looking at, not necessarily buying but looking at. When the stocks meet his price,he nibbles and then buys bigger allocations. The reason you need to have a variety of stocks you are looking at is as the markets go up and down (and they will) you can buy good quality stocks at lower prices and see them go back up. The trick is therefore to know which are the good quality stocks and why they are good quality stocks then you will know when to begin to buy, based on your plans and follow through with your decisions and live with them for a few quarters.

Linking to dividend paying stocks, if you are a small investor and expect to hold stocks for a long period of time, getting the perfect price is not that important. What is important is the company will be in business and making profits for a number of years. One method to do that is start with dividend companies and make your list. The companies and industries that are easy for you to follow and as they reach the price you think is good, buy and hold. The reason you want profitable companies is they will continue to pay a dividend and in a bullish cycle the multiple on your stock will be higher than other stocks. If the market declines, the dividend continues and you can buy more. As the cycle changes profitable stocks will rise faster, then the rest of the market catches up to go through another cycle.

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

 

 

There is great information to be found and some of it is on You Tube – today will be some takeaways from Aswath Damodaran who teaches Business Valuation. If you have not seen the You Tube they are worth the time to watch and learn.

Mr. Damodaran gave a talk to Google Talks on 4 Lessons To Take Away on Valuation

1. Valuation is a Simple

Similar to all things, as long as you start with the fundamentals, it can be simple. Valuation is not accounting.

Accountants look backwards to what has been done. They are necessary for that, the numbers they end up with is used for analysis and accounting works best for mature companies.

Valuation is forward looking – what could happen in the future? Which means it deals with unknowns.

A Balance Sheet works best for companies with tangible assets. The problem for young companies is Goodwill – the difference between what a company is worth and what it paid for on the asset side. On the liability side Shareholders Equity only increases if you have bought a company. If the growth is organic, then low shareholders equity.

Most of the tools for valuing companies are based on mature companies for  the estimates are relatively easy to make and involve less risk. Mr. Damodaran and a partner have a tool  on iTunes called You Value – plug in the numbers and you have a valuation.

Evaluation Balance Sheet

Assets in Place – what are they?                                           /            Debt

Growth Assets – expectations for the future                  /               Equity

Key question to ask – what are you buying when you buy this company.

Growth companies finance themselves through equity as it is tough to payback a loan based on the good ideas of the people in the company. Mature companies generate cash and do either equity or debt – whatever is more advantageous at the time.

2. Do not mistake modeling for Valuation

Valuation is about the cash flows:

1. What is the cash flow from existing operations?
2. What is the value created by growth?
3. How risky is the cash flow?
4. When will the company become mature? ideally it is going to be in business in the future. All companies go through the cycle.

95% of you research should be on the cash flow; 5% on which discount rate to use.

To answer the above questions regarding cash flows, you have to determine a story for the company. The narrative of the story will tell you what the company is and what the company is not – then the numbers reflect the storyline.

Rule: whatever number you come up with – the offer for the company should be less.

Analyst Reports are an important part of the sales business, however they must be read with a grain of salt. For sometimes they are meant to justify the client rather than justify the price offered. Mr. Damodaran calls buzz words Weapons of Mass Distraction – control; synery; brand name; strategic considerations; China or BRIC.

Remember:

1. If it does not affect the cash flow or alter risk, it can not affect the value.
2. For an asset to have value the Expected Cash Flows have to be positive sometime before the life of the asset
3. Assets that generate cash flow early in their life will be worth more than assets that generate cash flow later – they have to financed.

How to value Growth Companies?

Mr. Damodaran uses a program called Crystal Ball which attaches to his excel sheets. The program allows for a distribution model or you can say there is a 90% probability the results will fall with the parameter, 10% chance they will not. Remember the only time you have perfect information is looking back, you are trying to look forward.

3. Much of what passes as Evaluation is a Pricing Model

In his talk, Mr. Damodaran uses the example of house price listing. How does the number come up? The agent typically looks for comparable past sales, adjusts the price for special features and comes up with a number. That is the pricing model.

Price is based on supply and demand or mood and momentum

Valuation is based on cash flow, growth and risk.

In his talk, Mr. Damodaran discusses why price and value can diverge. It is often what the market is paying for. It used to website visits were worth something; at the present time it is the number of members ($100). Take the number of members x 100 equals the price of company. The problem is the market is fickle and one day will say – how do you make money from the members? what percentage do that? what would could that normally grow to?  The price might be different.

4. Do not mistake luck for skill

In the investment world, when you make money all is forgiven. There is no smart money there is stupid money and less stupid money.

Buying a company at the right price is good; buying it at the wrong price no matter how good the buzz words are the result will be losses in the future. Similar to all negotiations, they only work if you are willing to walk away from the table if you do not get your price.

Linking to dividend paying stocks, these tend to be the mature companies and the existing models work terrifically for them. The issue might be what price are you paying for the valuation when a tool such as You Value is in the marketplace. There is fewer reasons to discuss the estimates and how they are made. For growth companies there is need to focus on the story which allows you to focus on what the assumptions are made about cash flow, growth and risk.

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

 

 

 

 

 

 

We are all exposed to a variety of information all the time and some of it is interesting because we had not thought out it. One method to think about assumptions is from Aswarth Damodaran  who teaches Business Valuations at the Stern School of New York University. Mr. Damodaran has posted a number of his talks on You Tube and If you like buying  new companies reading Mr. Damodaran’s blog will save you money. Much of valuation of newer companies is based on assumptions and for each assumption there needs to be the Impossible, the Possible and the Plausible. This will save you money because when you read someone’s analysis you can see what that will mean in the future. It is safe to say many research reports are nearer impossible than the plausible. Besides the numbers, you can relate the story the person tells about the company to the numbers. The story means what business is the company in or what is it not in.

A fiction book titled the Columbus Affair by Steve Barry published by Ballantine Books, NY 2013 asks the question what religion was Christopher Columbus? Most of the history books do not tell us and most of us never asked, because it turns out Columbus never really told anyone and Columbus was not likely his real name. In the book the Columbus Affair, the assumption is Columbus was Jewish. At the time of his life the Spanish Inquisition was in full force. A brief background is Spain was run by those with a Muslim religion or the Moors. The Christians and Muslims fought wars and the Christians took control of Spain under King Ferdinand  and Queen Isabella. They decided anyone who remained in Spain had to be Christian or Catholic nation, the choice was to convert or die or leave. The conversion process is known as the Spanish Inquisition – in US terms think of the McCarthy hearings are you a communist or not? It was understandable that people converted at least in public. In the year 1492, Spain was not a rich country and the theory is some or most of the financing came from the formerly Jewish people because they were looking for lands that were not under Christian control. Eventually Spain brought back Mexican and Peru gold and silver to become the richest country in the world.

When Columbus went on his journey in 1492, there was no priest however there was a a rabbi. Why? no one really knows. Columbus wanted Jamaica for 150 years, why Jamaica?  except there are wonderful hints that Columbus had a past and did not want it to be known, but he was likely Jewish. The book is a exciting thrill ride, but is it impossible, possible or plausible?

Linking to dividend paying stocks, the results you receive had better be plausible or error on the side of caution. There are many challenges to a wide variety of companies and as an investor you have to decide whether they are impossible, possible or plausible. We have seen industries grow where many had not thought they would but with barriers to entry and the reason why the companies you own bring in cash, the answer tends to be clearer. We go through our days reading and absorbing information on all types of subjects – deciding whether it is impossible, possible or plausible will make your decisions easier.

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