Sunday, January 26, 2014

Willie and his chocolate factory

There are many ways to value a company and none of them are incorrect. The more valuation tools you have in your tool chest the better. Just understand the company you are looking at and use the most appropriate valuation technique.

Wednesday, January 15, 2014

10 lessons from elderly Americans

Karl Pillemer is a gerontologist and a self-described person who "goes directly to the self-help aisle in the megabookstore." He combined these two passions and interviewed more than 1,000 elderly Americans -- most in their 80s and 90s -- seeking out advice on how to live a good life. He calls them "the experts." His book, 30 Lessons for Living, is wonderful, and I'd recommend it to everyone.

The experts give advice on everything from raising kids to a proper diet. But I found their advice on money and work the most fascinating, because it goes against so many maxims younger Americans live by. Here are 10 from Karl's book.

1. Young people obsess about making a lot of money. Older people wonder what they were thinking.
When asked about their prescription for happiness at work, what wasn't mentioned spoke the loudest. And fancy statistics aren't necessary because the results are so clear.
No one -- not a single person out of a thousand -- said that to be happy you should try to work as hard as you can to make money to buy the things you want.
No one -- not a single person -- said it's important to be at least as wealthy as the people around you, and if you have more than they do it's real success.
No one -- not a single person -- said you should choose your work based on your desired future earning power.
2. Money is often at war with time. Balance them appropriately.
The view from the end of the life span is straightforward: time well and enjoyably spent trumps money anytime. They know what it means to make a living, and they are not suggesting that we all become starving artists. But they also know firsthand that most people who decide on a profession because of the material rewards at some point look back and gasp, "What have I done." In their view, we all need a salary to live on. But the experts concur that it's vastly preferable to take home less in your paycheck and enjoy what you are doing rather than live for the weekends and your three weeks (if you get that much) vacation a year. If doing what you love requires living with less, for the experts, that's a no-brainer ...
If you are willing to accept a lower income level, you can gain enormous benefits by choosing part-time work as a lifestyle. Imagine if you suddenly had more leisure than work time. Some experts made this decision: living on much less money, renting rather than owning a house, and forgoing expensive consumer goods to pursue a job and a lifestyle they enjoy.
3. Independence at work is crucial.
When the experts discuss their work lives, two themes go hand in hand: purpose (beyond making a salary) and autonomy. Neither one can be found in every job, every time, but without them work can become a miserable burden...
Career satisfaction is often dependent on how much autonomy you have on the job. Look for the freedom to make decisions and move in directions that interest you, without too much control from the top.
4. You'll spend 40+ hours a week at work for half a century. Make sure you enjoy it.
[Expert:] "No amount of money is worth more than having a job that you're glad to get up and go to every morning, instead of one you dread ... I have learned many lessons, but there are only a few that in the long run are meaningful and which I have tried to pass on to my children and students. If you can't wake up in the morning and want to go to work, you're in the wrong job ..."
You know those nightmares where you are shouting a warning but no sound comes out? Well, that's the intensity with which the experts wanted to tell young people that spending years in a job you dislike is a recipe for regret and a tragic mistake. There was no issue about which the experts were more adamant and forceful.
5. Jump at new work opportunities.
I've seen people who turned down a promotion for fear it would be too time-consuming or taxing, or who rejected a chance to spend a year or two abroad because they were "not the adventurous type" ... The experts' view? This approach to life is a huge mistake. Their advice is to embrace new challenges at every turn, saying yes as often as possible. The most frequently reported regrets about work in particular involved times when opportunity knocked and they kept the door firmly closed. According to our elders, the greatest reward you can receive in your career is the opportunity to do more.
6. Not traveling enough is a key source of regret
I learned that whether [the experts] had visited dozens of counties or stayed put in one place, the experts had one thing in common: they wished they had traveled more.
I came away from my interviews with the realization of the profound meaning travel has at the end of life. To sum up what I learned in a sentence: when your traveling days are over, you will wish you had taken one more trip. Often, after a long narrative about trips taken, I heard an elder say wistfully, "But I always wish I'd visited ..." 
7. To succeed at work, you need to be more than talented. You need to be nice.
The experts come from hundreds of different occupations and employers. They have observed people who succeed at work and those who crash and burn. It is on such experiences that this lesson is based. Their consensus: no matter how talented you are, no matter how brilliant -- you must have interpersonal skills to succeed. Many young people today are so focused on gaining technical expertise that they lose sight of this key to job success: traits like empathy, consideration, listening skills, and the ability to resolve conflicts are fundamental in the workplace.
8. Be frugal, but live a little.
[Expert:] "Don't worry so much. There is not enough time in our lives to trade off the gold of our existence for the dust of what-ifs or what-if-nots. I had my first job before I was twenty and saved everything I could from my paychecks. I closed my ears to good advice from a dear woman who told me that I should enjoy my days and not become so absorbed with thrift. I did not understand what she said. Although I used money to attend plays and concerts, I did so knowing that each ticket for a performance meant less money in my savings account. As I grew older, people I knew and loved died, and I began to see how very precious each moment of each day is."
9. Stop worrying about things you can't control.
It seemed reasonable that people who had experienced the Great Depression would want to encourage financial worries ... the reverse is the case, however. The experts see worry as a crippling feature of our daily existence and suggest that we do everything in our power to change it. Most important, they view worrying as a waste of time. They see time as our most precious resource. Worrying about events that may not occur or that are out of our control is viewed by them as an inexcusable waste of our precious and limited lifetime.
10. Long-term thinking is a great way to live as an investor. It's a terrible way to live as a person.
[Expert:} "It seems to take a lifetime to learn how to live in the moment but it shouldn't. I certainly feel that in my own life I have been too future oriented. It's a natural inclination -- of course you think about the future, and I'm not suggesting that that's bad. But boy is there a lot to be gained from just being able to be in the moment and able to appreciate what's going on around you right now, this very second. I've more recently gotten better at this and appreciated it. It brings peace. It helps you find your place. It's calming in a world that is not very peaceful. But I wish I could have learned this in my thirties instead of my sixties -- it would have given me decades more to enjoy life in this world. That would be my lesson for younger people."

Ray Dalio

Warren Buffett once said, "It's never paid to bet against America." The same could have been said for the United Kingdom before World War I or Rome before Commodus' reign. While extrapolating the historical trend line is actually a pretty good prediction strategy, it's not the way to make money. Fortunes are made (or preserved) anticipating big economic shifts, and successful prediction requires good theory. Buffett admits his expertise is not in timing macroeconomic shifts. Ray Dalio's is. And he thinks the United States is an empire in relative decline.

Dalio is probably the best macro investor alive. He has made a fortune anticipating once-in-a-generation shifts, such as the financial crisis, the subsequent bull market in bonds, and the eurozone crisis. His hedge fund Bridgewater Associates is now the world's biggest, and its Daily Observations newsletter is devoured by policymakers and investors alike (your faithful editor included, when he can get his hands on a copy).

Dalio's model is generational. Each stage lasts about 30 years, progressing when the older generation either dies off or retires, allowing the younger generation to set the country's direction. To understand the U.S.' place in the arc of Dalio's model, let's look at each stage in turn.

Countries in the first stage, called early-stage emerging countries, "are poor and think that they are poor." For most people, staying alive is a struggle. Investment usually comes from abroad. Investors demand high returns on their capital as compensation for the big perceived risks. Foreign investors don't trust these countries to maintain the value of their currencies, so the countries peg them to gold or a reserve currency, or even adopt another country's currency wholesale. Much of Africa and parts of Asia and Latin America are in this stage and have been stuck there for decades.

Countries in the second stage, called emerging countries, "are getting rich quickly but still think they are poor." Productivity and income soar, but savings remain high and work hours long because people remember what it was like to be poor. They export more goods than they import and they undervalue their currencies to keep exports cheap. However, the currency peg keeps interest rates too low. As a consequence, debt/income and inflation rise. A country in this stage must eventually break the peg. When a big country goes through this stage, it typically becomes a world power. China is undergoing this transition.

Countries in the third stage, called early-state developed countries, "are rich and think of themselves as rich." Their per-capita incomes are among the highest in the world, and their priorities change to "savoring the fruits of life." They are seen as safe-haven investments. This describes the British Empire during the 19th century and the U.S. after World War II. These countries tend to have big armies to expand and defend their global empires.

Countries in the fourth stage, called late-stage developed countries, are becoming "poorer and still think of themselves as rich." In this stage, debt/income rises in a self-reinforcing cycle. Debt stimulates income and asset price growth, which in turn stimulates even more debt. However, research and development and capital spending decrease; budget and trade deficits increase. Infrastructure is old and less well-maintained. In other words, late-stage developed countries eat the seed corn, setting themselves up for slower growth. In the last few years of this stage, bubbles are frequent because investors extrapolate from recent trends. This stage ends when debt/income can no longer rise; incomes can no longer support bigger debt service.

In the final stage, "countries go through deleveraging and relative decline, which they are slow to accept." The self-reinforcing debt cycle now kicks in reverse: Private actors begin paying down or defaulting on their debts, leading to falling income and asset prices, encouraging more defaults and faster debt repayments. The first phase is dominated by defaults, what Bridgewater calls an "ugly deleveraging." Stocks do terribly; safe-haven bonds soar. Depending on how much monetary and fiscal stimulus is applied, the deleveraging can transition to a "beautiful" phase, where debt monetization, austerity, defaults and wealth transfers from the haves to have-nots are well-balanced. Typically, governments run deficits to make up the slack; central banks slash interest rates to both stimulate the economy and ease the burden of debt service.

It's clear the U.S. from at least 1980 to 2007 was in stage four. Look at our total debt/GDP over time. Since 1980, it rose in two steep jags: first, in the mid-1980s, when the government deregulated financial markets and ran massive deficits and the Federal Reserve began lowering interest rates to bring us out of the Volcker recession; and second, in the 2000s, when the Fed once again aggressively lowered interest rates to prop up the post-dot-com-bubble economy, and the government once again ran massive deficits.

The massive amount of debt the U.S. economy is laboring under will likely take decades to pay off. With more resources going back to paying off creditors, growth will be slower than it otherwise would have been. PIMCO calls it the "New Normal." Dalio calls it a "deleveraging process." Economists call it a "balance-sheet recession."

Dalio's model predicts a decades-long period of relative decline for the U.S. as it deleverages and the eventual graduation of China and other emerging markets from stage three to stage four. Because the U.S. is so rich and China is so big, chances are China will not catch up to the U.S.' average income during this process. The U.S. is not going to turn into a banana republic, either.

The deleveraging phase can be quite graceful, in fact. The U.K. was even more indebted after World War II than the U.S. is today. The British borrowed massively to fund nonproductive (but necessary) goods: guns, boats, tanks, and airplanes to fight the Nazis with. Its total debt/income ratio reached over 400%. How did they pay everything back? They didn't. The U.K. devalued its currency, suppressed real interest rates, and let inflation run a bit. It didn't liquidate its debt with a hyperinflationary bang, but rather let economic growth outpace debt growth over several decades.

I expect the same from the U.S. Not a big bang, but a long slog of low real interest rates and slow debt growth. Investors scared of the debt worry too much about the wrong things: vivid, hyperinflationary scenarios, in which the government's machinations ruin the economy. We have to account for the incentives and the knowledge of our policymakers. Our central bankers do not benefit by driving the economy into the ground. They also know that the debt problem can be slowly defaulted on without throwing the economy into turmoil, so that's likely the policy they'll continue to pursue.

Investment Implications
Intriguingly, it turns out that a deleveraging country's stocks can do quite well. Bridgewater notes British equities returned 13.3% annualized from 1947 to 1959, a period of "beautiful" deleveraging.[1] On the other hand, Japan's equity markets struggled for over two decades since their bubble popped and they entered an "ugly" deleveraging, which they haven't exited yet (though this may be changing with Shinzo Abe's shock-and-awe campaign of fiscal and monetary stimulus coupled with structural reform).

And even with low yields, bonds can do well. If you can leverage up bonds to match the volatility of stocks, you would have received midteens returns in both ugly and beautiful deleveragings because of capital gains from rolling down the yield curve and deflationary surprises[1]. This analysis was why Bridgewater was bullish on Treasuries after the financial crisis, a time when everyone else thought yields would rise. However, if you can't leverage up bonds, they don't offer much return.

Finally, regardless of the type of deleveraging, gold did well against the deleveraging country's currency. Unsurprisingly, Dalio is a big fan of gold. He argues it's a form of money. Many rich-world central bankers don't agree, but, according to data from the World Gold Council, Russia has been a net buyer of gold every quarter since 2007, and both China and India dramatically increased their gold reserves in 2009.

*** [2/16/14]

In many respects, Dalio is the anti-Warren Buffett. Buffett makes big bets on a handful of companies. Dalio makes many small bets on currency pairs, commodities, bonds, and, to a much lesser extent, equities. Buffett grants his subordinates plenty of autonomy and lets them figure out their own way. Dalio imposes a set of principles that his subordinates are to live by and heavily monitors them. Buffett doesn't give much thought to economic cycles. Dalio's investing style is based on identifying and navigating them. Buffett doesn't like gold. Dalio thinks everyone should own a little bit of it.

*** [8/13/14]

Some  billionaires hold onto the secrets to their money-making success with a tight fist. But Ray Dalio is worth $14 billion and is more than happy to share.

Although he isn't a household name, he should be, as he's revealed the secrets to his success in a 123 page paper simply entitled Principles, that is chalked full of great investment advice. And there are five things we should remember when making our own investment decisions.

*** [9/24/14 Grahamites]

One of my all-time favorite readings is “Principles” by Ray Dalio (Trades, Portfolio). I think everyone should read it, whether or not you are an investor. Mr. Dalio stated in the forward that he wanted us to think for ourselves – to decide 1) what you want, 2) what is true and 3) what to do about it.

Among all the principles Dalio generously shared, the principle truth – “more precisely, an accurate understanding of reality” is the one that has the most impact on me. In this article, I’d like to share with the readers a few quotes I jogged down while reading this principle.

Among all the principles Dalio generously shared, the principle truth – “more precisely, an accurate understanding of reality” is the one that has the most impact on me. In this article, I’d like to share with the readers a few quotes I jogged down while reading this principle.
  • Truth is the essential foundation for producing good outcomes.
  • I have found that observing how nature works offers innumerable lessons that can help us understand the realities that affect us. For example, I have found that by looking at what is rewarded and punished and why, universally – i.e., in nature as well as in humanity – I have been able to learn more about what is “good” and “bad” than by listening to most people’s views about good and bad.
  • I believe that we all get rewarded and punished according to whether we operate in harmony or in conflict with nature’s laws, and that all societies will succeed or fail in the degrees that they operate consistently with these laws.
  • Understanding what is good is obtained by looking at the way the world works and figuring out how to operate in harmony with it to help it (and yourself) evolve. What is bad and most punished are those things that don’t work because they are at odds with the laws of the universe and they impede evolution.
  • I believe that the desire to evolve, i.e., to get better, is probably humanity’s most pervasive driving force. Enjoying your job, a craft, or your favorite sport comes from the innate satisfaction of getting better. Though most people typically think they are striving to get things (e.g., toys, better houses, money, status, etc.) that will make them happy, that is usually not the case. Instead, when we get the things we are striving for, we rarely remain satisfied. It is natural for us to seek other things to seek to make the things we have better. In the process of seeking, we continue to evolve and we contribute to be evolution of all that we have contact with. The things we are striving for are just the bait to get us to chase after them in order to make us evolve, and it is the evolution and not the reward itself that matters to us and those around us.
  • Self-interest and society’s interests are generally symbiotic: more than anything else, it is pursuit of self-interest that motivates people to push themselves to do the difficult things that benefit them and that contribute to society. In return, society rewards those who give it what it wants. That is why how much money have earned is a rough measure of how much they gave society what it wanted – NOT how much they desired to make money. Look at what caused people to make a lot of money and you will see that usually it is in proportion to their production of what the society wanted and largely unrelated to their desire to make money. There are many people who have made a lot of money who never made making a lot of money their primary goal. Instead, they simply engage in the work that they were doing, produced what society wanted, and got rich into it. And there are many people who really wanted to make a lot of money but never produced what the society wanted and they didn’t make a lot of money. In other words, there is an excellent correlation between giving society what it wants and making money, and almost no correlation between the desire to make a lot of money and how much money one makes. I know this is true for me – I never worked to make a lot of money, and if I had I would have stopped ages ago because of the law of diminishing returns. I know that the same is true for all the successful, healthy people I know.
  • Some of the most successful people are typically those who see the changing landscape and identify how to best adapt to it.
  • It is extremely important to one’s happiness and success to know oneself – most importantly to understand one’s own values and abilities – and then to find the right fits. We all have things that we value that we want and we all have strengths and weaknesses that affect our paths for getting them. The most important quality that differentiates successful people from unsuccessful people is our capacity to learn and adapt to these things.
  • However, typically defensive, emotional reactions – i.e., ego barriers – stand in the way of this progress. These reactions take place in the part of the brain called the amygdala. As a result of them, most people don’t like reflecting on their weaknesses even though recognizing them is an essential step toward preventing them from causing them problems. Most people especially dislike others exploring their weaknesses because it makes them feel attacked, which produces fight for flight reactions; however, having others help one find one’s weaknesses is essential because it’s very difficult to identify one’s own. Most people don’t like helping others explore their weaknesses, even though they are willing to talk about them behind their backs. For these reasons most people don’t do a good job of understanding themselves and adapting in order to get what they want most out of life. In my opinion, that is the biggest single problem of mankind because it, more than anything else, impedes people’s abilities to address all other problems and it is probably the greatest source of pain for most people.
  • Aristotle defined tragedy as a bad outcome for a person because of a fatal flaw that he can’t get around. So it is tragic when people let ego barriers lead them to experience bad outcomes.

Monday, January 13, 2014

printing money?

The government really doesn’t “print money” in any meaningful sense.  Most of the money in our monetary system exists because banks created it through the loan creation process.  The only money the government really creates is due to the process of notes and coin creation.  These forms of money, however, exist to facilitate the use of bank accounts.  That is, they’re not issued directly to consumers, but rather are distributed through the banking system as bank customers need these forms of money.  The entire concept of the government “printing money” is generally a misportrayal  by the mainstream media.

[I don't get it.  So what this about hyperinflation and precious metals?]

So to "create" money, the government buys bonds (from banks?).  So the government gives cash to banks in exchange for a promise to pay it back with interest.  So where does the cash come from?  Haven't they run out of cash yet to buy bonds with?

So how does inflation occur?  I always thought it was because there was more and more money in circulation, causing the value of money to go down (so prices go up).

I guess not.  But I don't really understand these explanations.  And another one.

Saturday, January 11, 2014

payback in 2014?

After a great year for equity markets in 2013, investors are looking to next year and wondering whether there will be a "payback" coming, as described in the Schwab Market Perspective. 

We expect the US market to experience a decent pullback at some point during 2014, but still believe stocks will end the year higher. 

Despite the strong returns in 2013, according to our friends at ISI Research, there have been 11 years since 1950 that the S&P 500 has posted 25% plus gains, and with the exception of two recession years, the S&P posted positive results in the following year.

Giving with purpose

OMAHA, Neb. (AP) — A free online course that starts Monday will offer students the chance to learn about giving from Warren Buffett and help decide how to spend more than $100,000 of his sister's money.
More than 4,000 people have already signed up for the course that will also feature philanthropic advice from baseball legend Cal Ripken Jr. and the founders of Ben & Jerry's ice cream, Ben Cohen and Jerry Greenfield. Boston Red Sox Chairman Tom Werner and journalist Soledad O'Brien are other featured guests. The amount being given away could grow if more students sign up.

Buffett and his older sister, Doris Buffett, will be featured in the first class to talk about their motivation for philanthropy. Warren Buffett is gradually giving away all of his $58 billion Berkshire Hathaway stock while Doris Buffett has already given more than $150 million away en route to her goal of redistributing all her wealth before she dies.

"The trick is not to have her give it away faster than I make it," Warren Buffett joked because his family's wealth is tied to the Berkshire Hathaway conglomerate he runs.

Each one of the big-name givers will be featured in videos at the end of each of the six class sessions discussing an aspect of philanthropy.

But everyone involved with the course agrees that the fact students get a chance to give away real money may be more important than the famous speakers because it makes the lessons more powerful.

"It's an experience that gives profound insight into deciding how we meet the needs of our society," said Rebecca Riccio, the Northeastern University professor who will teach the course.

The Giving With Purpose online course is modeled after a class that has been taught at more than 30 universities that allows students to give away $10,000 after evaluating several nonprofits and learning about effective giving. This online offering allowed Doris Buffett's Sunshine Lady foundation to expand the classes without adding staff to manage the program.

"Giving With Purpose allows us to extend the classroom walls to include any individual passionate about philanthropy," Doris Buffett said in a statement. "There are thousands of people with the energy and ideas to make a difference."

simple financial tips to follow (30 years ago)

Sadly, we can't turn back the clock and do things right. We can, however, teach the younger generation to avoid making our mistakes.

Here is a handy, one-page financial checklist that will allow everyone to build their wealth over the long term. If you follow this simple advice, you'll be on the road to financial freedom.

1.  pay yourself first
3.  create a portfolio for all seasons

Thursday, January 09, 2014

market valuation

What a great year it was! The market was up 30%, the best year since the go-go years of 1990s.The good news is that our account balance is higher, investors are more bullish. The bad news is that we will see lower future returns.

So where are we with the market valuation and the expected return starting 2014?

The ratio of Total Market Cap over GNP, Warren Buffett’s “the best single measure of where valuations stand at any given moment,” is standing at 115%. This ratio is already higher than the pre financial crisis peak of 107% and is higher than any time except for the go-go years of late 1990s, when it reached 141%. Its historical mean is around 85%.

Shiller P/E, the cycle adjusted P/E ratio, is now at 25.6, 55.2% higher than the historical mean of 16.5.

If we assume that the ratio of total market cap over GNP (Buffett’s indicator) and Shiller P/E will reverse to their mean over time, which they always did in the past, the future market returns do not look good. Using 8 years as time the market will reverse to its mean, both Buffett’s indicator and Shiller P/E suggest that the stock market will average 1% a year (2% dividends contribution included) over the next 8 years. At 1% of total market return, the market indices will be lower than they are now after 8 years.


Howard Marks, one of the smartest investors from Oaktree Capital, describes the three stages of a bull market:

· the first, when a few forward-looking people begin to believe things will get better
· the second, when most investors realize improvement is actually underway, and
· the third, when everyone’s sure things will get better forever

He also wrote the three stages of a bear market:

· the first, when just a few prudent investors recognize that, despite the prevailing bullishness, things won’t always be rosy,
· the second, when most investors recognize things are deteriorating, and
· the third, when everyone’s convinced things can only get worse

In May 2012, he thought we were at the first stages of bull market: a few forward-looking people begin to believe things will get better. In May 2013, he thought that we were somewhere in the first part of stage two.

After a gain of 30% in 2013, investors are more bullish. We don’t know which stage of bull market Howard Marks thinks we are now, but we believe that we are either at late second stage or early third stage.