The Mother of all bailouts

Even after committing $285 billion over the past couple of weeks to bail out mortgage lenders Fannie Mae and Freddie Mac and insurer AIG, the Federal Government is now looking to fork over more — much more.

The Treasury Department and Federal Reserve now are making plans to buy troubled mortgage securities en masse from banks and other financial firms. This would amount to moving from ad hoc loans and bailouts to a more systematic approach to resolving the bad-debt problems at the heart of the current financial crisis. Systematic apparently sounds good — the Dow jumped 400 points after CNBC first reported Thursday that such an effort was in the works, and on Friday, markets around the world opened sharply higher. But the price tag could be steep. "We're talking hundreds of billions," Treasury Secretary Hank Paulson said at a press conference Friday morning. "This needs to be big enough to make a real difference and get at the heart of the problem." The more alarmist economists are saying the cost of resolving the current crisis will exceed $1 trillion. To put that in context, total U.S. government spending in 2007 was $2.7 trillion.

* * *

Speaking in Green Bay, Wisc., Republican presidential candidate Sen. John McCain said Friday that the Federal Reserve should stop bailing out failed financial institutions.

The Republican presidential hopeful said the U.S. central bank must get back to "its core business of responsibly managing our money supply and inflation." He laid out several recommendations for stabilizing markets in the financial crisis that has rocked Wall Street and taken over the presidential campaign.

McCain renewed his call for tighter regulation of financial markets, even though he has generally championed deregulation throughout his career in the Senate and as chairman of the influential Commerce Committee.

AIG booted from Dow, replaced by Kraft

A week of pain and ignominy for American International Group Inc. (NYSE:AIG - News) took another hard turn on Thursday when it got booted from the Dow Jones industrial average, ending the shortest term any company has spent in the blue-chip index since the Great Depression.

Taking its place come Monday's opening bell is Kraft Foods Inc. (NYSE:KFT - News), the first pure food company in the index in 23 years. Emblematic of the current market turmoil, the maker of such comfort foods as Oreo cookies and Kraft Cheese was apparently seen as a better fit for the world's most-watched stock index than another risky financial company.

AIG, which required an $85 billion government bailout to avert bankruptcy earlier this week, was added to the Dow in April 2004 and was touted at the time as representative of the growing importance of financial services to the U.S. economy.

[via chucks_angels]

a crazy day at the markets

An early rally in stocks that pushed the Dow up by 215 points soon after the open, fell apart by noon. Forty-five minutes later, the Dow was suddenly down as many as 150 points. But the situation reversed again, largely on news that the United Kingdom's securities regulator said it would ban short-selling of all financial stocks until Jan. 19.

Then, a huge rally erupted in American stocks this afternoon on reports that the Treasury Department was working on a plan to take bad assets off the books of financial institutions.

News of the plan was first reported by CNBC around 3 p.m., and stocks immediately shot higher. A At the close, the Dow Jones industrials were up 410 points, or 3.9%, to 11,020. The Standard & Poor's 500 Index was up 50 points, or 4.3%, to 1,206, and the Nasdaq Composite Index was up 100 points, or 4.8%, to 2,199.

The idea, as reported by CNBC, would involve creating a federally-chartered company that would take over the bad assets of banks, investment banks and others. The financial institutions would then be able to raise new capital and lend money and finance new ventures.

It's been that crazy.

financial crisis

Here's what currently in-vogue economist (and NYU professor) Nouriel Roubini posted to his popular blog back in August, and again the day after Wall Street's latest Black Monday:

This is by far the worst financial crisis since the Great Depression, not as severe as the Great Depression but second only to it. ... We are only barely midway in the meltdown of U.S. and global stock markets.

Professor Roubini is currently in vogue for good reason. The guy has basically been right about everything since the financial crisis began to unfold in earnest, penning a paper back in February that scripted (per its subtitle) "The Twelve Steps to Financial Disaster" -- steps that, alas, have indeed been taken.

* * *

The Biggest Financial Story of the Past 50 Years

Wow.

That about sums up the events of this past weekend, which saw the following events transpire:

● After failing to finagle a government bailout, Lehman Brothers (NYSE: LEH) filed for bankruptcy protection.

● Bank of America (NYSE: BAC) spurned Lehman Brothers and instead agreed to acquire Merrill Lynch (NYSE: MER).

● Insurer AIG (NYSE: AIG) begged the Federal Reserve for as much as $40 billion of assistance.

This is bigger than either JPMorgan Chase's (NYSE: JPM) buyout of Bear Stearns or the government bailout of Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE). Our colleague Bill Mann, in fact, has deemed this weekend's credit-crunch-inspired string of bailouts, buyouts, and bankruptcies "the biggest financial story of the past half century."

Bigger than the dot-com bust? Yep. Bigger than Black Monday in 1987? Yep. Bigger than the oil shock of the 1970s? Mmmhmm.

NYU economics professor Nouriel Roubini, George Soros, and the International Monetary Fund have all called the overall credit crisis the worst since the Great Depression.

money fund breaks the buck

Extraordinary events are piling up on Wall Street so fast, it's hard to know where to focus. Forgetting the prospective bailout of AIG for a moment, since every media outlet is on that one, the most shocking development of the day for me is news that a $60 billion money market fund "broke the buck" on Monday due to losses in Lehman Brothers paper that it held. So much for the safety of "cash".

The Reserve Primary Money Fund (RPFXX) has become the first money-market fund in more than a decade to lose money because its board was forced to write down $785 million worth of LEH debt to zero. The fund has reportedly seen assets plunge by 60% to $23 billion in the past two days after holders got wind of the fact that it would have to cut its net asset value to less than its usual $1 per share.

[9/25/08] Help is on the way for some money market investors: TD Ameritrade says it's going to put up $50 billion to make sure its brokerage customers who have money in the Reserve Primary Fund suffer no losses. A drop in the fund's net asset value last week left investors with less than $1 for every dollar invested. Meanwhile, Ameriprise Financial says it'll backstop losses with up to $33 million. The firms said those amounts represent the cost of making up the 3 cents per share their customers stand to lose (the fund's net asset value dropped to 97 cents a share last week).

Dow 8360?

A market that falls below its 200-week (3.8-year) average usually heads straight for its 200-month (16-year) average. I learned this concept from Belkin during the past bear market, and it was great guidance to the then-shocking deterioration in Intel (INTC, news, msgs), Cisco Systems (CSCO, news, msgs) and Oracle (ORCL, news, msgs). Lest you think that's a crazy idea, the Philadelphia KBW Bank Index ($BKX), which encompasses Bank of America and Wachovia, already is well below this level. So are General Motors (GM, news, msgs), insurer American International Group (AIG, news, msgs), International Paper (IP, news, msgs) and Merck (MRK, news, msgs). General Electric (GE, news, msgs) is close. Moreover, you should know that the 200-month average was the exact spot where the plummeting Nasdaq Composite Index ($COMPX) finally bounced and recovered in 2002. The 200-month averages for the big indexes now are 981 for the S&P 500 Index, 1,771 for the Nasdaq and 8,360 for the Dow industrials.

The average bear market of the past century has lasted less than a year and generated losses of 30%. But ones that lasted more than 12 months showed an average loss of 42%. All of these figures are averages with relatively few examples, however, and thus deceiving in their exactitude. The current bear market was caused by a perfect storm of trouble: a real-estate collapse, a credit disaster, an oil price mega-spike, recession and inflation. Will it persist for only an average amount of time and decline by only an average amount? That's an open question. Put me down as doubtful. For your score card, this bear market has so far lasted 12 months and generated a loss of 17%.

A reversal higher can be swift and big, and it is usually disbelieved at the start. Eventually, all bear markets end -- very often with a roar and when least expected. The only statistical measure that I have seen work effectively in the past 20 years to signify the end of a major bear phase is a one-two punch in which the market experiences a session in which 90% of prices and 90% of volume is to the downside, and then, within three days, the opposite occurs: a 90% upside day. Most recently, this measure -- invented by the nation's oldest technical research firm, Lowry's Reports -- kicked in to signify the end of a 3-year-old bear market in late March 2003. When that massive buying occurs, most investors don't believe the inflection point is really occurring and consider it just one more rally to sell into or short. But in reality, that has been the signature of the end of a bear. Despite recent highly volatile up-and-down trading, this combination has not yet occurred.

[via doctorm_33139]

Dow drops 500

Stocks tanked Monday, as investors reeled amid the fallout from the largest financial crisis in years after Lehman Brothers filed for the biggest bankruptcy in history and Bank of America said it would buy Merrill Lynch in a $50 billion deal.

Treasury prices rallied as investors sought the comparative safety of government debt, sending the corresponding yields lower. Oil prices tumbled, falling well below $100 a barrel on slowing global economic growth. The dollar rallied versus other major currencies and gold prices spiked.

The Dow Jones industrial average (INDU) lost 500 points, or 4.4%, according to early tallies. It was the biggest one-day point decline for the Dow since Sept. 17, 2001, when the market reopened for trading after having been closed in the aftermath of 9/11 terrorist attacks.

Lehman files bankruptcy

Stocks plunge as worries now mount about AIG's future. Lehman Bros. files for bankruptcy. Bank of America will buy Merrill Lynch.

The fate of Lehman Bros. (LEH, news, msgs) and Merrill Lynch (MER, news, msgs) is sealed, with Lehman filing for bankruptcy and Merrill agreeing to be sold to Bank of America (BAC, news, msgs).

Wall Street is now watching and wondering what will happen to insurance giant American International Group (AIG, news, msgs), whose stock plunged $6.16, or 50.7%, to $5.98 this afternoon.

Shares of Lehman plunged $3.44, or 94.3%, to 21 cents per share after the company this morning filed for bankruptcy protection.

Wall Street is now left with two brokerages: Goldman and Morgan Stanley.

Asia stumbles

A 3.3% slide in the Shanghai Composite Index in China led a sell-off in Asia, sending shares to the lowest level in 21 months. Worries about asset quality at some of the major banks in China and fears growth is slowing were responsible for the latest slide. According to the Financial Times, Beijing is coming under increasing pressure to enact measures to stop the slide in stock prices, but so far, authorities have done little to signal any actions to prop up the market. Since peaking in October, Chinese shares have lost an astonishing 66%.

-- Charles Schwab, Morning Market View, September 11, 2008

gurufocus stock performance

It has been a very tough year in the market. The S&P500 is down about 15% as of Sept. 10. Here we like to review the performances of our model portfolios. Each model portfolio consists of the top 25 stocks top ranked with its criteria. How did the model portfolios do in such a market?

All four model portfolios were rebalanced on Jan. 2, based on the close prices of Dec. 31, 2007 . Although all four model portfolios are down for this year, they all outperformed the S&P500.

* * *

In case you were wondering if there is any stock on all four lists, yes there is one. That stock is SHLD which has gone down from 116.01 to 99.09 (-14.58%) since being bought on 1/2/06. There are two stock on three of the lists. C has gone from 47.87 to 18.61 (-61.12%) since being bought on 1/2/06. CMCSK has gone from 17.3067 to 21.42 (+23.77%) since being bought on 1/1/06. Stocks that are on two of the lists are AXP, BRK.B, BSX, CNQ, HD, KO, LOW, MSFT, PENN, TGT, UNH, WB, WFC, WMT, XOM.

large cap value down again

According to Fama & French, large-cap value stocks have fallen for two consecutive years only five times in the past 100 years:

Great Depression: 1929-1932
World War II: 1939-1941
Arab oil embargo: 1973-1974
Collapse of the Internet bubble: 2001-2002
Collapse of the housing bubble: 2007-2008

It's rare, but this kind of marketwide value depression is a golden opportunity.

buying low p/e stocks

While it is not the end-all-be-all metric, the beauty behind the P/E ratio is its simplicity. Logic would argue that a stock trading at a lower P/E than its peers could be mispriced and therefore a potential value. Finding mispriced stocks is a fundamental principle of value investing, and there is plenty of evidence that low-P/E stocks outperform higher-P/E stocks over the long haul.

Despite the evidence that low-P/E stocks outperform their high-P/E counterparts, it's not enough to simply pick stocks with the lowest P/E ratio. It is important to look a company's risk and growth potential along with the quality of its earnings.

raising and cutting dividends

Remarkably, Schwab research has found that stocks that have raised their dividends in each of the past five years have underperformed all other dividend-paying stocks by almost 3% annually since 1990! What's more, stocks that cut dividends in the prior year have outperformed all other dividend-yielding stocks by about 2.5% per year over the same time—possibly because investors view dividend cuts as a signal that management is serious about addressing financial difficulties facing the firm.

institutional selling

At Legg Mason (NYSE: LM), for instance, there was $18.4 billion in net redemptions in the quarter ending in June. Amazingly, that was an improvement from the $19.2 billion in the previous one. The fund run by Bill Miller, whose legendary 15-year streak of beating the market was unparalleled in recent times, represented around $2.4 billion worth of Legg Mason's first-half redemptions.

As investors' money leaves an institution's control, fund managers can be forced to sell stock to meet those redemptions. When billions of dollars flow out of a fund, its manager is left with no choice but to sell some of the stocks it holds to come up with the cash. Since many of these funds share the same holdings, all of that forced selling drives their prices down.

In a perfect world, a fund manager would be able to pick which shares to sell based on valuation. The more expensive a stock relative to its true worth, the more of it the fund manager would sell, thereby minimizing the long-term damage to the fund. In the real world, however, a fund manager facing huge redemptions will sell whatever stocks happen to be liquid enough to support it.

There aren't all that many stocks with enough trading volume to support a sell-off of that magnitude. Over the past month, for instance, there have only been 69 individual company stocks across the U.S. and Canada with at least half a billion dollars' worth of average daily trade volume. They're virtually all names you know.

If a single fund manager needs to sell tens of millions of dollars in a single day just to meet redemptions, these highly liquid stocks are about the only ones that manager can easily sell. Multiply that impact by all the fund managers who face redemptions in a generally declining market, and you can see how stock prices can quickly plummet.

... As an individual investor managing your own money, you're not beholden to the redemption pressure that massive mutual funds feel. On the contrary, you can do what those fund managers only dream of doing: buy into an irrational, forced sell-off.

Are the banks cheap?

Since the beginning of the credit crisis last summer, bank stocks have been absolutely murdered -- the KBW Bank index, which tracks 24 of the most prominent U.S. commercial banks (including Bank of America (NYSE: BAC), Citigroup (NYSE: C), and JPMorgan Chase (NYSE: JPM)) is down more than 40% from a year ago, at levels not seen in almost a decade.

Prior to 2008, the last time the Bank index was at this level was the fourth quarter of 1998. Russia had defaulted on its debt over the summer, precipitating the meltdown of hedge fund LTCM. In response, the Fed organized a private rescue of LTCM by a consortium of 14 banks and broker-dealers -- the fund’s massive positions were thought to threaten the stability of the financial system.

If that sounds familiar, it should -- the summer of 1998 offers direct parallels with the current environment. In March, for example, the Treasury facilitated JPMorgan Chase’s rescue of Bear Stearns on the assumption that the troubled broker’s failure posed an unacceptable risk to the financial system.

As serious as the current problems are, when a bubble deflates, it’s common for sentiment to shift from unbridled optimism to exaggerated pessimism. That spurred my curiosity: What is a fair value for the KBW Bank Index?

* * *

[9/8] Which banks to buy?

Fannie and Freddie

The government has formulated a plan to put troubled mortgage giants Fannie Mae and Freddie Mac under federal control, dismiss their top executives and prop them up financially, federal officials told the two companies yesterday, according to three sources familiar with the conversations.

Under the plan, which could prompt one of the most sweeping government interventions in the workings of financial markets in U.S. history, federal officials would place the firms under a conservatorship, a legal status giving the government the option and time to restructure and revive the companies, the sources said. The value of the companies' common stock would be diluted but not wiped out; while the holdings of other securities, including company debt and preferred shares might be protected by the government.

[9/8] What's all this mean to shareholders?

The BMW Method

Jim Schout believes he's uncovered a trick to finding long-term winning stocks that have temporarily stumbled -- and he needs the potential for 25% annual returns before he becomes interested in a stock.

Granted, the investing industry abounds with prophets touting "winning systems" -- for a price -- but what grabbed my attention at a recent conference was that Jim doesn't charge a penny for his system. He's happy to exploit it for his own gain. We'll get to several stocks Jim likes -- and doesn't like -- shortly.

From its beginnings 13 years ago, Jim's "BMW" method has steadily gained adherents, blossoming into a self-propelled mini-industry of message boards (the BMW Method board is a staple of the Fool community), websites, conference calls, annual meetings, and T-shirts. Not to mention what seem to be great investing returns.

Invited to the 2007 BMW method conference to both speak and listen, I came away intrigued -- and armed with an interview from Jim Schout, the man who scoffs at 24% returns. (Note: This interview was first published Dec. 14, 2007.)

James Early: In a nutshell, what is the BMW method?

Jim Schout: The BMW method is about exploiting something in plain view, yet something the market seldom looks at: the really big picture. In the short run, the market may be very irrational, but the market is always correct in the long term. Like a band in formation, or sports fans collectively spelling out enormous words at a stadium, investors often don't see the big picture -- but with a bird's-eye view, it's easy to spot.

I achieve this by applying lines of constant growth to a stock's long-term price data. Let's say a company's stock price has average growth of 12% annually over the past two or three decades. I might apply lines representing 10%, 11%, 12%, 13%, and 14% growth to the chart. What often jumps into view is [that] the share price continually rises after reaching the 10% CAGR line. The price tends [to] "bounce" up from that low growth line over and over again. That is the BMW method in a nutshell. It is quite simple to spot underpriced equities this way.

If a stock is presently priced at its historically low CAGR, what's wrong? I'll dig deeper here with due diligence to determine if I think the problem is temporary. It's essential to see if there has been a fundamental shift in the company's ability to add value. Maybe a law changed, or a technology became obsolete. More often, Wall Street has decided to act irrationally and undervalue the shares. I love it when that happens.

At the end of the day, if I believe that the underperformance is temporary, or it exists for reasons that make the downturn irrational from an investing sense, then I will buy that stock.

Where have we heard this before?

Here's a couple of predictions I recently came across:

"We are in the early stages of a long cycle of generally accelerating inflation."

"If we do not solve the energy crisis, the American Dream is over."

Where'd I find these bearish remarks? They weren't part of a Jim Cramer rant or a Barack Obama speech. In fact, they weren't made by anyone contemplating recent headlines.

Nope -- these are from the pages of Howard Ruff's 1981 book, Survive & Win in the Inflationary Eighties. These eerie predictions -- which sound like they were stripped from the front page of a recent Wall Street Journal -- are nearly 30 years old!

Charlie Munger quotes

Had Warren Buffett never been born, there's a good chance we'd award the "world's greatest investor" honor to his right-hand man, Charlie Munger. Not only is Berkshire Hathaway's (NYSE: BRK-A) co-chairman a phenomenally talented investor, but he'd probably school almost anyone in a debate about philosophy, biology, physics, or just about any other topic. The man's disturbingly smart.

I'd continue this introduction, but as Munger might bluntly say, "Nobody would listen." Without further ado, here are five Munger quotes you should study before making another investment decision.

[9/5/08] Five more Munger quotes

Da Bear

If we exclude the two most extreme bears -- the grinder of 1973-1974 and the dot-bomb bear of 2001-2003 -- some fairly consistent patterns emerge. The total market declines from top to bottom ranged from 21.5% to 36.1%. Yet while the typical length of bear markets ranged from just over three months to more than a year and a half, they usually ended within six months after hitting that 20% decline.

Compare with where we are now: about 1.5 months past the 20% marker, almost 11 months of bear-dom so far, and the low point so far (as of this writing) was 22.4% off the high, set on July 15. All of which is right in the historical ranges -- so far, this bear isn't extraordinary by any means.

bearish sentiment

A recent New York Times article pointed out that bearish sentiment, as measured by the Conference Board, has hit an all-time high. Fully 55% of the people questioned in July expect the stock market to decline over the next 12 months.

Why is this important today? Because each time the bearish sentiment has exceeded 35% over the past 21 years, the market has confounded that sentiment by gaining ground over the following year, at an average pace of 20.5%.

10 Things Millionaires Won't Tell You

7. "I was a B student."

Mom was right when she said good grades were the key to success — just not necessarily a big bank account. According to the book "The Millionaire Mind," the median college grade point average for millionaires is 2.9, and the average SAT score is 1190 — hardly Harvard material. In fact, 59 percent of millionaires attended a state college or university, according to AmEx/Harrison.

When asked to list the keys to their success, millionaires rank hard work first, followed by education, determination and "treating others with respect." They also say that what they absorbed in class was less important than learning how to study and stay disciplined, says Jim Taylor, vice chairman of the Harrison Group.

How are oil prices set?

Crude is a commodity, a raw material like natural gas, corn, wheat, gold, coffee, and cattle used to produce other goods. The costs of extracting oil from its source could vary widely from $5.26 a barrel in the Middle East region to $63.71 for U.S. offshore crude, based on 2004-6 averages from the EIA. Petroleum is bought and sold under exotic names like Nigerian Bonny Light, North Sea Brent Blend, and West Texas Intermediate on a variety of futures markets -- where traders deal for the rights to buy and sell product at a specific price on a future date -- around the world and governed by the rules of a particular country.

"The energy markets are among the largest and most liquid," says Timmer. "The oil market is no different from the stock market in that oil futures are traded on exchanges where buyers meet sellers." For an outsider, however, locating precise figures to explain how crude is currently priced is harder to unearth than a gusher in Central Park.

Generally, there are two ways to trade commodities: either market trading or over-the-counter trading (OTC). Market trading takes place through the New York Mercantile Exchange (NYMEX) and is self-regulated with oversight by the Commodities Futures Trading Commission (CFTC), the government agency charged with regulating the commodities markets. In contrast, OTC trading is conducted without any such regulatory controls.

Only about 25%-35% of all energy trading occurs on the NYMEX,4 which means up to 75% of all oil contracts go unchecked by the federal government. Because OTC trading is unregulated, the exact volume of trades -- not to mention the legality -- is unknown. To compound matters, despite growing activity in the commodities markets, the CFTC has a staff of less than 500, compared to 3,700 for the Securities & Exchange Commission.

Other legal escape routes allow energy trading on so-called "dark markets," exchanges not subject to the transparency and accountability laws governing U.S. exchanges. For example, the "foreign markets loophole" lets investors buy and sell millions of barrels of U.S.-bound oil multiple times overseas before ever reaching American shores, thereby driving up the price with each change of hands.

The standards for trading crude oil and setting prices should be, theoretically, consistent among different international market regulators. However, recent U.S. congressional hearings have introduced terms like "dark markets" and "swaps loopholes" used by some investors to skirt largely toothless government controls. Oil speculators -- typically hedge funds and investment banks -- have come under a spotlight amid allegations of exploiting gaps in the regulatory system.

According to the CFTC, the government agency charged with regulating the commodities markets, the percentage of petrol contracts controlled by speculators has surged to 71% in 2008 from 37% in 2000.

The International Monetary Fund has concluded that speculation has played a significant role in the run-up of oil prices, according to testimony at a June 23 House Energy & Commerce subcommittee. Also at that meeting a Lehman Brothers analysis suggested that more than half of the price of a barrel of oil may be attributed to speculation. Even the Saudis, the world's largest oil producer of 9.7 million barrels a day as of July, contend that supply-and-demand seems to be in balance and that there is no substantive basis for current price levels.5

At this stage, however, no one knows for sure if any improper oil transactions have been executed. In part, that's because American authorities can neither fully police nor gain access to data in most overseas commodities markets.

dividends and growth

In 2003, Rob Arnott -- former editor of the Financial Analysts Journal, a publication of the CFA Institute -- and Clifford Asness, managing principal at AQR Capital Management, looked at dividend yields and subsequent 10-year earnings growth. Their findings? Amazingly, earnings growth increased with dividend payout, right up to the highest payers having the highest next-10-year earnings growth.

a long bear

From 1959 to 1974, the Dow Jones Industrial Average gained precisely 0%. It has gone down as one of the longest and most painful bear markets of recent history.

The Nasdaq is currently in what is shaping up to be an even longer bear market. It's down around 50% from its peak of more than 5,000 in March 2000, and I would argue that it's likely to take another 12 years -- until 2020 -- to reach that level again. That would mean a roughly 20-year period of 0% returns for the index. Like the 15-year bear market from 1959 to 1974, it will go down as one of the biggest bear markets of all time.

But the truth is, there's still money to be made in bear markets.

... the first thing about making money in this bear market is clear: Don't buy and forget. Monitor your existing holdings, sell if your thesis has radically changed, keep cash ready to pounce on new opportunities, and put that money to work on a regular basis. It may seem obvious, but an individual investor would have made far more money by investing throughout the bear market than during the irrational exuberance of the bull.

The Secret of Dividends

Between January 1926 and December 2006, 41% of the S&P 500's total return sprang not from the price appreciation of the stocks in the index but from the dividends its companies paid out.

That's right -- a cool 41%. Annualized, that amounts to 4.4 percentage points. To put it in dollars-and-cents terms, consider this: An investment of $10,000 over that stretch would have grown to $1,013,000 without dividends. With dividends kicked in and reinvested, however, that same sum would have been worth a whopping $24,113,000 by the end of the period.

Talk about the miracle of compound interest!

300 Point Rallies

We're in a very confusing atmosphere. People didn't really know what to make of a 300-point rally in the Dow the other day, but my main message was that 300-point rallies from the Dow don't happen in bull markets. In fact, they never happened in the bull market from October '02 to October '07, but it has happened 6 times in this bear market and happened 12 times in the last bear market. You don't get moves like that in bull markets. As Rich Bernstein has said time and again, "This is the hallmark of a recession and a hallmark of a bear market."

Mauldin not bullish (surprise)

I think we are likely to stay in recession for perhaps the rest of the year and well into 2009 before we start a very slow recovery. It is not time to get bullish on stocks, as I have been writing for the past few months. Earnings are going to continue to come under pressure, and earnings are what drive the stock market over the long term. We could see total S&P 500 as-reported earnings drop below $50. You do the math. Even with a 20 multiple, that does not yield a pretty picture.

I think we are going to test the recent lows and then watch the market go lower as the market gets disappointed in the earnings from the third quarter, and re-test those lows again. We are in for an extended period of Muddle Through, while we wait for the housing market to find a bottom and the credit crisis to abate. Banks and other institutions have written off about $500 billion. There is at least another $500 billion to go. The amount of capital that is going to need to be raised is astronomical, and it is going to be very dilutive to current shareholders.

gurufocus financial data and charts

About two months ago, we informed our users that we have licensed 10-year financial data. The data is now available to all users. Here we like to introduce the features in the new page.

The Accidental Billionaire

About 10 years ago, Forbes Magazine ran an article about an "accidental billionaire" named Franklin Otis Booth Jr.

In the early 1960s, Booth tried to buy a printing company that contracted with The Los Angeles Times. The deal fell through, but he became good friends with the lawyer working on the case.

After discovering they had similar investment philosophies, they partnered up to build a 40-unit condo complex in Pasadena, Calif. -- and managed to double their money in just two years.

Booth decided he wasn't up for pursuing further real estate development, but he did agree to put $1 million into an investment partnership the lawyer put together. Thirty-five years later his stake was worth $1.2 billion.

The cynics and risk-takers among you will undoubtedly chalk Booth's success up to "luck."

Granted, his is a case of being in the right place at the right time, but the actual process that grew his fortune had very little to do with luck.

He didn't dump his money into penny stocks that took off. He didn't get in on the ground floor of Oracle (Nasdaq: ORCL) or IBM (NYSE: IBM). He didn't make smart options trades.

What he did do was hand his $1 million over to that lawyer and a "clever young fellow." They, in turn, made big bets on unexciting businesses with wide moats that were selling at a discount to their fair value. These businesses all had strong brands, outstanding returns on capital, consistent or improving profit margins, and substantial cash profits.

That's all -- big bets on great companies selling at good prices.

Of course, by now I'm sure you know that the lawyer was Charlie Munger and the clever young fellow he teamed up with was none other than Warren Buffett.

* * *

The Accidental Billionaire

yields are high

It's looking gloomy out there. The S&P 500 is down 12% year to date, led by the financial sector, which has lost one-fourth of its valuation.

Amid all the doom and gloom, one silver lining has drawn little attention: Dividend yields are the highest they've been more than a dozen years.

The recent market plunge has increased the S&P 500's dividend yield to 2.2%, its highest level since December 1995. Not even during the aftermath of the tech bubble collapse in the fall of 2002 -- when the S&P 500 traded at a paltry 815 -- did the yield break 2.0%.

But high dividend yields aren't the only reason this is a great time to be in the market -- stocks are also cheaper than trusty bonds.

The 10-year Treasury bond currently yields 4%. The equivalent measure of return for stocks is the earnings yield (earnings divided by price) -- and it currently stands at 5.5% for the S&P 500.

This divergence is unusual -- and a potential boon for investors. According to renowned value investor Arnold Van Den Berg of Century Management, (whose firm returned 13% net of fees vs. 6% for the S&P 500 over the past 10 years):

The usual difference between a bond yield and stock earnings yield is about 1%. For example, if investors can get 6.3% on a guaranteed bond they are willing to accept 1% less, or a 5.3% earnings yield on a stock. The reason for this is that if you have a 5.3% stock earnings yield and it is growing at 7%, it will equal your 6.3% bond yield in about 3 years. Anytime thereafter, the stock earnings yield will increase by 7% per year.

Investors are usually willing to accept a lower yield in stocks, because of the presumption of future growth. Right now, however, investors can get that growth at a better price than bonds -- and with the added bonus of high dividend yields.

Earnings yields like this suggest the market thinks earnings are likely to fall. But I would counter that even if earnings fell, the S&P 500 still would yield almost equal to the Treasury bond rate.

The combination of high dividend and earnings yields relative to bond yields means that this is a great time to buy dividend stocks.

quote of the month

"Wouldn't it be great if we could buy love for $1 million. But the only way to be loved is to be lovable. You always get back more than you give away. If you don't give any, you won't get any. There's nobody I know who commands the love of others who doesn't feel like a success. And I can't imagine people who aren't loved feel very successful." Warren Buffett

-- Warren Buffett Monthly Newsletter Issue #27

what is growth and income exactly?

Generally, a Growth and Income play will have healthy balance sheets, consistent dividend payments, quality products and services and experienced management teams. Usually Growth and Income companies are industry leaders, displaying steady earnings growth.

Companies that continually exhibit stable earnings growth, more than anything else, are ones that should hit the radar screens of Growth & Income investors. After all, companies exhibiting all of the characteristics mentioned earlier should have no problem producing a steady stream of profit growth, right? Analysts will subsequently grow more optimistic about the future earnings potential of the company and adjust their estimates up accordingly.

Growth & income investors get a dual benefit from following earnings estimate revisions. First, positive estimate revisions help investors buy shares in the companies with the best chances to outperform the market. Second, positive estimate revisions provide the easiest means to monitor the health of companies, providing a rather clear signal when the time has come to abandon ship. Companies experiencing upward estimate revisions will generally enjoy positive momentum going forward. Rarely will a stock suffer a significant price decline in the face of improving fundamentals. Add it all up and it’s clear that Growth and Income investors should only buy shares in companies enjoying upward earnings estimate revisions.

[says Zacks]

The bear market is official ... now what?

One of the saving graces to having officially entered a bear market (a >20% drop) in mid-July is that we no longer need to debate whether we're going to get one or not. Based on long-term averages, we may have more to go with this bear both in terms of damage and duration but, as always, we caution investors about full-scale bailing out of the market at this point.

History has shown that typically, once the –20% threshold has been hit, the majority (two-thirds) of the decline is in the past. [The median bear market lost 33.5% and lasted 250 days.] And, of course, timing the bottom is nearly impossible.

The bible talks business sense

Invest systematically: “He who gathers money little by little makes it grow.”—Proverbs 13:11

Pay tax: “Give to Caesar what belongs to Caesar...”—Luke 20:25

Avoid debt:The rich ruleth over the poor, and the borrower is servant to the lender.”—Proverbs 22:7

Save: “The ants are a people not strong, yet they prepare their meat in the summer.”—Proverbs 30:24

Diversify: “Divide your portion to seven, or even to eight, for you don’t know what misfortune may occur on the earth.”— Ecclesiastes 11:2

[from livemint.com via Chirag@investwise]

who's blog?

While googling around, I noticed there's a blog by veryearly1 called Finance and Philosophy Blog. At first I thought this was the blog of veryearly1 of chucks_angels. After all, there is a lot of information pertaining to investing, in particular on Buffett and Munger. And the guy who's writing it is reflective and sounds quite intelligent.

But now, I don't think it's actually THE veryearly1. The guy writing the blog is a software engineer, while VE1 has a financial background and worked at a hedge fund or something. Also I believe VE1 is a now a full-time private investor whereas this guy works for some engineering (or some such) firm. Also it seems that VE1 apparently used to live in Japan. No mention here of that. (It's kind of scary that I seem to know this much about VE1. :$

In any case, the blog is still pretty interesting and thoughtful.

rating CAPS ratings

despite all of the recent market turmoil, five-star stocks outperform the market by 12%, while one-star stocks underperform by roughly 11%. According to this data, investors would do well to look for new ideas among five-star stocks, while potentially unloading one-star stocks.

what is Morningstar good at?

A couple of clear trends emerge from this data. The first is that we're pretty darned good at picking wide-moat stocks--the wide-moats in the Buy at 5 Stars, Sell at 1 Star portfolio have outperformed our wide-moat coverage universe in all trailing periods, and in every calendar year but one. This conclusion is also supported by the performance of our Wide Moat Focus Index (WMW), which consists of the 20 cheapest wide-moat stocks. The Wide Moat Focus Index was off only about 5% in the first half of 2008--compared with a 12% loss for the market--and it has posted returns of about 11% annually over the past five years.

The second trend is that we have not been very good at separating winners from losers among the no-moat companies that we cover. Our performance in this area leaves much to be desired, and (so far) 2008 is the first year in which our no-moat 5-star stocks have outperformed our no-moat stocks as a group. Narrow moats are a toss-up--we have added value over some time frames, but not overall.

We've thought a lot about the causes for this divergent performance, and while it's a complex issue, I think a lot of it boils down to the simple fact that no-moat companies are more difficult to forecast and value. They're more volatile, they often have weaker balance sheets, and they are more frequently affected by tough-to-forecast external factors like commodity prices.

Estate-Planning Pitfalls

H. Susan Jones, a top estate-planning attorney based in the Chicago suburbs, discusses some of the most common pitfalls of estate planning and how to avoid them, as well as some underutilized estate-planning maneuvers.

Investment Decision Checklists

One of Charlie Munger’s most elementary pieces of advice for investors and thinkers is to utilize checklists when ever possible, as a way to improve cognitive ability and minimize errors. In a 2003 speech to UC Santa Barbara Economics, Munger put it thusly:

You don’t have just a hammer. You’ve got all the tools. And you’ve got to have one more trick. You’ve got to use those tools checklist-style, because you’ll miss a lot if you just hope that the right tool is going to pop up unaided whenever you need it. But if you’ve got a full list of tools, and go through them in your mind, checklist-style, you will find a lot of answers that you won’t find any other way.

Gurufocus started a thread discussing investment checklists. We will create a page where users can set up their own checklist, and data in our databases will be used for users to verify each item in the checklist.

This is what they come up with.

First of All
Is this a good business?
Is this a simple business? Is there something that cannot be understood in the business operations, financial instruments?

Business Climate
Is this a cyclical business?
Where is it at the business cycle of the industry?
What are the macro-trends affecting the company?
What is the economic outlook for the companies industry?
What will recession do to the business?

Growth and Competitiveness
Will the company be around in 20 years?
Will (will, not should) earnings and sales and the dividend grow over 5 years?
What's their competitive advantage and moat?
Have sales historically increased annually?
Is the company doing something that is unconventional for their business? Does the company focus on short term profit and forget the long term viability of the business? (sub-prime loans are examples)
Where is the company at in its growth cycle?
Does the company have a moat or durable competitive advantage?

Management
Who are the founders/BOD, what other companies have they been involved in, what are their credentials/biographies?
Are they shareholder oriented?
Are they buying shares lately?

High Quality?
Good return on equity?
Recent Guru buying
What is the downside risk
What is the debt level of the company? Is it increasing or declining?
Is the business predictable? What is the predictability of the business?
Does the business have enough moat to maintain its profitability?

Valuation
What is the earning yield? Is it undervalued?
What is the valuation of the company? What is the margin of safety?
If DCF applies, what is the valuation?
Why is this company undervalued? Is this reason likely to get worse before it gets better?

Level of Confidence
If the share price went down by 50% the day after I bought, would I immediately worry about having made a mistake, or would I buy more shares?
Is this a speculation? What percentage of speculation is there with this idea?
What is the level of confidence we have?

[basically, my checklist boils down to: is it a good company? And is it selling (reasonably) cheap?]

Obama selloff in November?

says Tobin Smith.

If Barack Obama is leading by 10 points over John McCain going into November, I guarantee you that you’re going to have a sell-off purely for locking in capital gains. I mean, Obama said he wants to go to 28%. Don’t fall for the trap that Obama really thinks he’s going to become president of the United States on a platform. Right now, everybody is pimping for John Edwards’ delegates— they need 235 delegates from Edwards. So right now, Obama sounds like he’s a socialist. You have to assume that when that’s done, whenever Obama is the one who’s the leader in the clubhouse—because Edwards hates Hillary Clinton—once he gets the delegates, then you’ll see that rhetoric move back to the middle.

Alternative energy is going to kick ass. The other thing is you’re going to assume that the Fed is going to be at 2% to 2.25%, which means that financials will do well as soon as they make the turn. And the turn is that you will have clarity on Citibank and the real big guys, we’ll have real transparency. We still do not have transparency.

EQUITIES: Is there one rule of thumb regarding investing?

Smith: You have to understand that there’s no free lunch. If you want a bond rate of return, then buy the bond. If you’re looking for superior return, you have to come to grips with the idea that you’re getting paid extra because you’re willing to ride out the bumps in the road. Many times, investors sort of miss that part.Usually, themost powerful psychological ingredient is the fear of not being greedy enough. The other part is that it’s not profitable, nor is it prudent, to always own growth stocks. The thing about an S-curve change that nobody realizes is, if something’s growing rapidly, it’s also getting to satiation rapidly. If it’s slow growth, it’s going to take a long time.

[roundabout link via Mauldin, who is now appearing in Equities Magazine]

Have financial stocks hit bottom?

Investment strategist Barry Ritholtz wrote in his blog that one reason to doubt that the bottom is in for bank stocks is that The New York Times, The Wall Street Journal and Barron's (the latter two sharing an owner with this newswire) all produced prominent articles on Saturday suggesting the worst was over for financial stocks.

"Can you recall the last time three major media players all picked the bottom in a market or sector on the exact same day -- and were all proven correct?" he asked.

taxing the rich

Washington is teeing up "the rich" for a big tax hike next year, as a way to make them "pay their fair share." Well, the latest IRS data have arrived on who paid what share of income taxes in 2006, and it's going to be hard for the rich to pay any more than they already do. The data show that the 2003 Bush tax cuts caused what may be the biggest increase in tax payments by the rich in American history.

The nearby chart shows that the top 1% of taxpayers, those who earn above $388,806, paid 40% of all income taxes in 2006, the highest share in at least 40 years. The top 10% in income, those earning more than $108,904, paid 71%. Barack Obama says he's going to cut taxes for those at the bottom, but that's also going to be a challenge because Americans with an income below the median paid a record low 2.9% of all income taxes, while the top 50% paid 97.1%.

... If Mr. Obama does succeed in raising tax rates on the rich, we'd also wager that the rich share of tax payments would fall. The last time tax rates were as high as the Senator wants them -- the Carter years -- the rich paid only 19% of all income taxes, half of the 40% share they pay today. Why? Because they either worked less, earned less, or they found ways to shelter income from taxes so it was never reported to the IRS as income.

The way to soak the rich is with low tax rates, and last week's IRS data provide more powerful validation of that proposition.

[via john/chucks_angels]

Zacks Rank is wrong

.. 44% of the time. Which means it's right 56% of the time.

Steve Reitmeister explains (video) how this short-term (1 to 3 months) strategy beats the markets despite being wrong nearly half the time.

The Bear is Back

If any of us needed further confirmation that things are bad out there, we got the signal right before the July 4 holiday -- the markets officially dipped into bear-market territory. The Dow Jones Industrial Average, Nasdaq Composite, and the S&P 500 Index are all down more than 20% from last fall's highs.

A lot of investors have lost a good chunk of their portfolio since those highs. And with a black cloud hanging over the financial sector, home values continuing to plummet, and gas prices resting comfortably above $4/gallon, the economic outlook is murky at best.

No one will deny that seeing the market fall 20% or more is unsettling. But if you're a truly long-term investor, does it really matter?

The market has endured bear markets before -- 33 of them since the Dow Jones Industrial Average was created. Since 1896, then, the market has dropped more than 20% on 33 separate occasions -- and each time, it recovered to reach new highs.

Sure, the length of time it took the market to recover those losses varied, but in most cases, the year or two directly following the end of the bear market saw a considerable jump in average share prices.

[Then again, the times it didn't jump back in a year or two were the ones that really hurt.]

market sentiment hits bottom?

Financial market turmoil has returned with a vengeance, weighing on the dollar and pressuring global stocks to distressing lows. However, an extreme in negative investor sentiment, a break in oil prices and some better-than-expected bank earnings spurred a rally in stocks this week—led by an impressive comeback in financials.

Stresses in the short-term funding markets are elevated once again, but not to the extent seen in mid-March. The Federal Reserve's aggressive rate cuts and lending facilities appear to be working. The latest market riot revolved around worries about the stability of the broader financial system—specifically the fate of government-sponsored entities (GSEs) Fannie Mae (FNM) and Freddie Mac (FRE).

Together, the GSEs own roughly $1.5 trillion in mortgages and guarantee $3.7 trillion. According to BCA Research, a failure would expose $4.3 trillion in mortgage-backed securities (MBSs) to losses, as well as $1.5 trillion in agency debt to potential default. Of course, the government cannot allow this to happen: An emergency weekend meeting July 12–13 of the Federal Reserve and the U.S. Treasury Department resulted in a plan to keep the GSEs in the "current form," assuaging concerns that they will be allowed to fail.

However, in one of the largest bank failures in U.S. history, the FDIC was forced to take over IndyMac Bancorp (IDMC), which was a large player in the Alt-A and subprime mortgage market. Although the majority of IndyMac's deposits are insured, the bank's failure sparked concerns that many other regional banks could potentially see the same fate.

With many financial institutions scheduled to report second-quarter financial results, investors became increasingly concerned that banks would not be able to raise fresh capital to cover losses—particularly because sovereign wealth funds (SWFs) could potentially shy away after seeing their investments during the past year lose value.

This dour outlook on the financial sector, in combination with still-high oil prices, pressured nearly all investor sentiment measures to below the March-low levels and close to the lows seen in the 1998 Long-Term Capital Management crisis (an infamous Fed-orchestrated bailout) and the 2002 tech bubble. Volume and volatility measures have not registered capitulation levels, but the depressed market and economic sentiment set the market up for a significant bounce. Although more banks and thrifts are likely to fail, calamitous failures (like IndyMac) have historically occurred near market lows.

Remember, it's not just fundamentals that drive stocks and markets but the relationship between fundamentals and expectations. At market lows, the expectations bar has usually been set sufficiently low for fundamentals to hurdle them, even if those fundamentals remain weak in absolute terms.

As panic gives way to the reality that the financial system and federal regulatory bodies are well-equipped to deal with this crisis, and/or if oil prices continue their descent, we see the potential for additional sharp rallies like those we witnessed this week. However, we remain skeptical that an enduring rally is in the offing until inflation pressures ease significantly and the U.S. housing market stabilizes.

Bombay near capitulation?

[7/13] Indian ADR's got the hammering of their life at the Nasdaq/NYSE Friday last, slicing 13 per cent off the market cap of Infosys, 7 per cent for ICICI Bank and 4 per cent for HDFC Bank. Banks, Real Estate and Technology stocks should be the key contributors to a possible enmasse selling this Monday, as investors move out in droves towards the EXIT gates.

-Conditions are now set for a mass capitulation beginning July 14, 2008 and getting close to a situation where the Buyer's side will become non-existent.

[via Maverick@investwise]

To the rescue of Fannie and Freddie

The Bush administration hastily arranged the dramatic Sunday evening rescue of Fannie Mae and Freddie Mac after Wall Street executives and foreign central bankers told Washington that any further erosion of confidence could have a cascading effect around the world, officials said on Monday.

Treasury Secretary Henry M. Paulson Jr. and other top officials were warned, after Fannie and Freddie lost nearly half their stock market value on Friday morning, that any more turmoil threatened to reduce the value of trillions of dollars of the companies’ debt and other obligations, which are held by thousands of domestic and foreign banks, pension funds, mutual funds and other investors, government officials said.

The warnings of a potential systemic failure led to the resulting rescue package, and one of the most striking — though unspoken — regulatory shifts in modern times. For decades, Treasury secretaries and Federal Reserve chairmen have insisted that the government did not stand behind the debt of Fannie and Freddie. But the safety net Mr. Paulson announced on Sunday sends the opposite message: that the government is determined not to let either one fail.

The plan calls on Congress to give officials the power to inject billions of dollars into the beleaguered companies through investments and loans. Until the plan is adopted, the Federal Reserve has agreed to let the companies have access to its so-called discount lending window, a move that most regard as a symbolic gesture intended to show the markets that the government stands ready to help the companies if they need cash.

Six in a row

It's clear that the "crisis of confidence" in Fannie Mae (FNM) and Freddie Mac (FRE) was a prime factor in driving the stock market down this week to its sixth weekly loss in a row (Standard & Poor's 500 index).

Losing streaks of this length are rare. In fact, the last run of six down weeks ended at the major market bottom in October 2002. However, I still firmly believe that we're due for a bounce any day now, although the market will probably come back and "test" today's lows later in the summer.

-- Richard Band

Freddie and Fannie in Freefall

The dike might be cracking on the U.S. financial system and U.S. regulators are trying to figure out how to make sure it doesn't burst.

Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE), the behemoth caretakers of U.S. home ownership financing, are looking increasingly unstable. Their demise would spell disaster, and the U.S. cannot allow that to happen.

The market went nuts this week as former St. Louis Fed President Albert Poole suggested that Freddie Mac is technically insolvent. What does the market think? As of Friday morning, Fannie and Freddie stock were down 53% and 64%, respectively ... just this week!

IndyMac fails

WASHINGTON (Reuters) - U.S. banking regulators swooped in to seize mortgage lender IndyMac Bancorp Inc on Friday after withdrawals by panicked depositors led to the third-largest banking failure in U.S. history.

California-based IndyMac, which specialized in a type of mortgage that often required minimal documents from borrowers, became the fifth U.S. bank to fail this year as a housing bust and credit crunch strain financial institutions.

The federal takeover of IndyMac capped a tumultuous day for U.S. markets that saw stocks slide on a surging oil price and renewed fears about the stability of the top two home financing providers, Fannie Mae and Freddie Mac.

IndyMac will reopen fully on Monday as IndyMac Federal Bank under Federal Deposit Insurance Corp supervision, but tensions ran high as customers at a branch at its Los Angeles-area headquarters read a notice in the window saying it was closed.

upgraded broker ratings

I'm sure a lot you have experienced the pleasure of waking up and finding that a covering broker upgraded their rating on one of your stocks.

I'm also guessing that you probably experienced the opposite, and found that one of the brokers downgraded your stock.

While nobody can perfectly guard against downgrades (or forecast all upgrades), it's important to know how the market reacts. Therefore, you can stay in your upgraded winners (or buy if you're on the fence) and consider getting out if a downgrade comes your way.

When I'm screening for new stocks, I like to look for companies that have recently seen a broker rating upgrade. Tests have proven that stocks with broker rating upgrades outperform those that don't get upgraded and really outperform those that get downgraded.

-- Kevin Matras, Zacks.com

Reinvigorating the PEG ratio

Marc Gerstein ran a series of backtests to examine different strategies using the PEG ratio.

Even the gurus are down

If you haven't been having a great time in the market since last spring, you may take some consolation by seeing how many 'fund managers of the year' and other top-notch investors have been faring over the recent past. Even Warren Buffett is now in negative territory for both the 6 and 12-month periods just ended.

[via g66k]

Sir John Templeton

Sir John Templeton, a Tennessee-born investor and philanthropist who amassed a fortune in global stocks and gave away hundreds of millions of dollars to foster understanding in what he called "spiritual realities," died on Tuesday in Nassau, the Bahamas, where he had lived for decades. He was 95.

His death, at Doctors Hospital in Nassau, was caused by pneumonia, said Don Lehr, a spokesman for the Templeton Foundation.

The foundation awards the Templeton Prize, one of the world's richest, and sponsors conferences and studies reflecting the founder's passionate interest in "progress in religion" and "research or discoveries" on the nebulous borders of science and religion.

In a career that spanned seven decades, Sir John dazzled Wall Street, organized some of the most successful mutual funds of his time, led investors into foreign markets, established charities that now give away $70 million a year, wrote books on finance and spirituality and promoted a search for answers to what he called the "Big Questions" — realms of science, faith, God and the purpose of humanity.

Along the way, he became one of the world's richest men, gave up American citizenship, moved to the Bahamas, was knighted by the Queen of England and bestowed much of his fortune on spiritual thinkers and innovators: Mother Teresa, Billy Graham, Aleksandr Solzhenitsyn, the physicist Freeman Dyson, the philosopher Charles Taylor and a pantheon of Christians, Jews, Muslims, Buddhists and Hindus.

* * *

Templeton's 16 Rules to Investment Success

Neglected stocks

Last week, Mark Hulbert reported on a new study in The New York Times that found that from 1962 to 2003, stocks that could go at least a day without trading any shares -- like Brazil Fast Food -- outperformed stocks that traded every day by more than 8 percentage points annually. And that was the case even though the "neglected stock portfolio," as researchers Athanasios Bolmatis and Evangelos Sekeris called it, contains "a disproportionate number of stocks that underperform the market by a dramatic margin."

Good To Great

Jim Collins, already established as one of the most influential management consultants, further established his credibility with the wildly popular Good to Great: Why Some Companies Make the Leap...and Others Don’t, originally published in 2001. The book went on to be one of the bestsellers in the genre, and it is now widely regarded as a modern classic of management theory.

Collins takes up a daunting challenge in the book: identifying and evaluating the factors and variables that allow a small fraction of companies to make the transition from merely good to truly great. ‘Great,’ an admittedly subjective term, is operationally defined according to a number of metrics, including, specifically, financial performance that exceeded the market average by several orders of magnitude over a sustained period of time. Using these criteria, Collins and his research team exhaustively catalogued the business literature, identifying a handful of companies that fulfilled their predetermined criteria for greatness. Then, the defining characteristics that differentiated these ‘great’ firms from their competitors were quantified and analyzed.

[via gfs1354@chucks_angels]

price anchoring

Price anchoring is a mental mistake that can be very costly to your long-term returns.

As soon as your intuition seizes on a number -- any number -- it becomes stuck, as if it had been coated in glue. That's why real estate agents will usually show you the most expensive house on the market first, so the others will seem cheap by comparison -- and why mutual fund companies nearly always launch new funds at $10.00 per share, enticing new investors with a "cheap" price at the beginning.

Share prices are complicated things -- they account for not only the underlying quality of the company, but also public opinion, assumed earnings growth, and investor enthusiasm.

Anchoring to a price means you'll ignore the more important trait -- value.

financial stocks are cheap

says Richard Pzena.

In brief, the subprime mortgage and liquidity crisis has sent investors into panic mode about financial stocks, driving their prices far below their underlying value. Major firms with strong franchises have fallen precipitously, despite their historical records.

A bubble not unlike that seen with internet stocks in the late 1990s seems to have formed, with energy, commodities, and industrial cyclicals being bid up with little regard to earnings. Indeed, the spread in valuations between commodity and financial stocks is wider than at any time in the past 55 years, and financials represent one of the most compelling investment opportunities we have ever seen.

bubblin' crude

June 13 (Bloomberg) -- The rally that drove oil to a record $139.12 a barrel last week surpassed the gains in Internet stocks that preceded the dot-com crash in 2000.

Crude rose 697 percent since trading at $17.45 a barrel on the New York Mercantile Exchange in November 2001, and reached 28 record highs this year. The last time a similar pattern was seen in equities was eight years ago, when Internet-related stocks sent the Nasdaq Composite Index up 640 percent to its highest level ever, according to data compiled by Bloomberg and Bespoke Investment Group LLC.

The Nasdaq tumbled 78 percent from its March 2000 peak, erasing about $6 trillion of market value, as investors concluded that prices weren't supported by profits at companies such as Broadcom Corp. and Amazon.com Inc.

Billionaire investor George Soros and Stephen Schork, president of Schork Group Inc., say oil is ready to tumble because prices aren't justified by supply and demand.

"There's nothing different between this mania, the dot-com mania, the real estate mania, the Dow Jones mania of the 1920s, the South Sea bubble and the Dutch tulip-bulb mania," said Schork, whose Villanova, Pennsylvania-based firm advises the Organization of Petroleum Exporting Countries, Wall Street firms and oil companies on the outlook for energy prices. "History repeats itself over and over and over again."

A Warning from the Royal Bank of Scotland

The Royal Bank of Scotland has advised clients to brace for a full-fledged crash in global stock and credit markets over the next three months as inflation paralyses the major central banks.

"A very nasty period is soon to be upon us - be prepared," said Bob Janjuah, the bank's credit strategist.

A report by the bank's research team warns that the S&P 500 index of Wall Street equities is likely to fall by more than 300 points to around 1050 by September as "all the chickens come home to roost" from the excesses of the global boom, with contagion spreading across Europe and emerging markets.

Such a slide on world bourses would amount to one of the worst bear markets over the last century.

[via chucks_angels]

Why John Montgomery invests

[Austin Edwards] remembers when John Montgomery, founder, CEO, and fund manager of Bridgeway Funds, came to Fool HQ to give us some insight into why -- not how -- he runs his funds.

Granted, I would've loved to learn more about how he invests. His Bridgeway Aggressive Investors 1 Fund (BRAGX) has returned a jaw-dropping 19.1% annualized since he started it in 1994, and currently owns market superstars Intuitive Surgical (Nasdaq: ISRG), Mosaic (NYSE: MOS), and Potash (NYSE: POT).

Nonetheless, it was refreshing to see that Montgomery has never lost sight of why he's investing. See, Bridgeway donates a whopping 50% of its after-tax profits to charities -- most notably to foundations dedicated to stopping genocide in Africa.

Bill Miller Deja Vu?

In 1991, financial markets opened the New Year with significant weakness, weighed down by a lingering recession in the U.S. housing market, soaring oil prices and fallout from war in the Middle East. Markets were also contending with a major crisis in the financial sector that arose from junk bond investments in the savings & loan industry.

Sound familiar? It should, as we face similar challenges today -- only this time, the turmoil in the financial industry stems from the subprime lending collapse.

Reflecting on his [poor] recent performance, Bill Miller noted that 2007 was "the first time since 1990 the Value Trust has lagged the S&P 500 in two consecutive calendar years. Perhaps, not surprisingly, that was also a time of panic due to a housing market recession, soaring oil prices, plus huges losses in the banking and financial sector. We took advantage of lower prices back in the 90s, which ushered in a pretty good period of excess returns.

-- from Legg Mason's empower Magazine, Spring 2008

Consuelo Mack

Consuelo Mack has a TV show called WealthTrack that only now I found out about from a link at gurufocus.

Listening to her show, she sounds like the spiritual successor to Rukeyser (without the bad puns). And in fact, she's actually a real successor to Rukeyser having hosted Rukeyser's Wall Street in its final months.

The latest show (6/6/08) features Bruce Berkowitz.

Some notable (to me) past shows include

Chris Davis (1/18/08)

Jean-Marie Eveillard (12/28/07)

Dan Fuss (12/14/07)

Whitney Tilson (12/7/07)

Robert Hagstom, Steve Leuthold (10/19/07)

Bill Gross, Jean-Marie Eveillard (10/14/07)

Ron Muhlenkamp (9/21/07)

Jason Zweig and Whitney Tilson (9/7/07)

Ben Stein and Jason Zweig (7/6/07)

David Winters and Rob Arnott (5/25/07)

Keith Trauner (3/16/07)

Ben Stein, David Winters (2/23/07)

is this the bottom?

With stocks down sharply from their bull market peaks, Forbes compiled a group of four prominent analysts and asked them to share their viewpoints on whether the markets had truly reached bottom. Here's what those experts had to say:

"Stocks are down, expectations are down, valuations are down, fear is up and the money supply growth has already started to take off along with the Fed cuts. Those are all positives for the market. The significant volume of selling, or panic selling, over the last few months is commensurate with a bottom."

-- Stuart T. Freeman, A.G. Edwards

"We're in a transitional area, but the trend looks like we're at or near the bottom. We're probably going to move up from here, but the question is how quickly."

-- Holly Gustafson, Legg Mason

"We should see a sustainable upturn from here."

-- Joseph Kalinowski, Thomson Financial/IBES

"In March a bottom occurred."

-- Daniel Peris, Argus Research

Will the experts' predictions prove correct? I wouldn't bet on it.

You see, those quotes were taken from early May. May 2001, that is.

After an extended bull rally, the S&P 500 dropped sharply in late 2000, characterized by sudden price swings and sharp volatility. In the spring of 2001, the market temporarily rebounded, and Forbes' experts all agreed: This was the bottom.

They were wrong.

Over the next four months, the S&P 500 fell 24%. It rebounded briefly, then dropped another 30%.

They weren't just wrong -- they were spectacularly wrong.

Soros on oil

Soaring oil prices are increasingly the result of speculation, financier George Soros said in an interview published Monday.

The billionaire investor said the money pouring into the oil market increasingly had the look of a bubble, but that it would not burst until both the United States and Britain were knocked into a recession.

"Speculation ... is increasingly affecting the price," Soros was quoted as saying by The Daily Telegraph. "The price has this parabolic shape that is characteristic of bubbles."

But the cost of oil — which briefly reached new record highs of more than US$135 a barrel in trading Thursday — was unlikely to fall dramatically until the U.S. and Britain economies began contracting, the paper quoted Soros as saying.

Ken Fisher is bullish

I'm getting a lot of hate e-mail these days. This onslaught is not entirely a bad thing. It reassures me that my bet against the crowd is a wise one. I'm bullish and have been steadily since the July 8, 2002 issue. In my Jan. 28 column I reiterated the upbeat outlook and reminded you that the fourth year of a presidency only rarely delivers losses to stockholders. Now, with stocks globally (as measured by the Morgan Stanley All-Country World Index) down 8.6% so far this year, people are telling me I'm an idiot. Someone posted to FORBES Web site, "Hi Ken. It's been an absolute pleasure watching you vie for the 2008 Henry Blodget Award. Keep up the good work!"

Gloat for now, but please note that 2008 isn't over. I still think the year will end in the plus column. And I'm never happier than when I'm alone.

My critics call me a perma-bull. They forget I called the last three full-fledged bear markets right here in FORBES--reasonably well and better than most--and mostly alone (June 15, 1987; Nov. 27, 1989; Feb. 19, 2001). I know I may be wrong now. But I see what's happened since Jan. 1 as just a major correction, very comparable to 1998, with a few things flip-flopped, as described in my Feb. 25 column.

On Mar. 13 Goldman Sachs demoted market strategist Abby Cohen for having been bullish too long. That day marked the bottom of the back half of what I think is a double-bottom whose first bottom was in January. I see Goldman's move as bullish. That once famous market timer Joe Granville materialized out of nowhere saying that we are beginning a bad bear market. I'd bet against Joe any time. Gloomy people are saying that we are in the midst of the worst financial crisis since the 1930s. They said the same thing in 1998. Bullish!

You can't find a time in the 20th century when, less than five months into a real global bear market, people were talking bear market and recession in any visible numbers. But they always talk disaster during corrections. Check out "Russian Financial Crisis" on Wikipedia. The second sentence says 1998 was a "global recession … which started with the Asian financial crisis in July 1997." Wrong. There wasn't a global recession then. There isn't one now.

An old saw says, "You should be fearful when others are greedy and greedy when others are fearful." Clearly folks are fearful now. So you should be greedy. Another saw: "Buy when there is blood on the streets." There's plenty of blood, or at least depression, on Wall Street. So keep buying.

[via investwise 5/13/08]

Memorial Day

According to Martin Zweig's Winning on Wall Street, the day before Memorial Day (and holidays in general) is supposed to be bullish, "the odds of the market rising on the day before a holiday was about seven out of eight." However if the market is down on that day, then one should short the market for the day after the holiday.

So this means we should expect the market to go down further on Tuesday.

Of course, the mere fact that we know this affects the pattern. The book uses data thru 1985 and was published in 1986. Since then, the tendencies may not as strong.

[6/3/08] The market finished positive on May 27. In other words, wrong again.

How has van den Berg done it?

Although he is not quoted as frequently as master value investor Warren Buffett, value investor Arnold van den Berg's long-term investment returns at Century Management are nearly as impressive.

Since its 1974 inception, the firm has delivered more than 16% annual returns to investors before fees, and nearly 15% annual returns after fees. As Century points out, that means the firm would have doubled your money every 4.8 years.

How has van den Berg done it? Mostly by concentrating on buying stocks that are out of favor with other investors. At a presentation he gave in 2006 (which was transcribed in an excellent issue of Outstanding Investor Digest), he described four psychological states investors experience that he takes advantage of in order to earn those outsized returns.

• Apathy: The stock price has gone nowhere for a number of years, and people are just tired of it.
  
• Disgust: The stock has done nothing; earnings and sales might be down. People might have lost money holding on to it and can't bear to own it any more.
  
• Fear and panic: The bad news hits, the company runs into trouble, and the price drops off a cliff. Sell! Sell!
  
• Anger: Nothing's gone right while holding it, lost a lot of money, it will never turn around! Just dump this piece of garbage!

Those conditions, especially the last two, lead investors to "buy high, sell low." It's from those same people that Van den Berg buys his stocks. "People, acting as a herd," he said, "do some very foolish things because of emotions that block out reason and intelligence. ... So don't let your emotions dominate."

a penny costs more than a penny

WASHINGTON (AP) -- Further evidence that times are tough: It now costs more than a penny to make a penny. And the cost of a nickel is more than 7½ cents.

Surging prices for copper, zinc and nickel have some in Congress trying to bring back the steel-made pennies of World War II and maybe using steel for nickels, as well.

Market Cycle Math

During bull markets, a vibrant, peaceful combination of P/E expansion (a staple of bull markets, a great source of return) and earnings growth brings outsize returns to jubilant investors. Prolonged bull markets start with below- and end with above-average P/Es.

P/Es are some of the most mean-reverting creatures, and range-bound markets act as clean-up guys: they rid us of the mess (i.e., deflate high P/Es) caused by bull markets, taking them down towards and actually below the mean. P/E compression wipes out most if not all earnings growth, resulting in zero (or nearly) price appreciation plus dividends.

Bear markets are range-bound markets' cousins; they share half of their DNA: high starting valuations. However, where in cowardly lion markets economic growth helps to soften the blow caused by P/E compression, during secular bear markets the economy is not there to help. Economic blues (runaway inflation, severe deflation, subpar or negative economic or earnings growth) add oil to the fire (started by high valuations) and bring devastating returns to investors.

A true secular bear market has not really taken place in the US, but one has occurred across the pond in Japan. The market decline caused by the Great Depression, though referred to as the greatest decline in US stocks in the 20th century, only lasted three years and thus doesn't really fit the traditional "secular" requirement of lasting more than five years. Japan's Nikkei 225 suffered through a true secular bear market: stock prices declined over 80 percent from their 1989-1991 highs until they bottomed in 2003 (the market seems to be coming back now). For more than a decade the country struggled with deflation caused by its banking system coming to a near halt on the heels of a collapsing real estate market and the bad loans that came with it. Of course, all this took place on the heels of a huge bull market, and thus very high valuations.

Sell in May?

Numerous studies show that since World War II, as much as 99% of stock market returns have been generated between November 1 and May 1. Good friend and fishing buddy David Kotok of Cumberland Advisors sums it up nicely:

"According to the Ned Davis (NDR) database, starting in 1950, $10,000 invested in the S&P 500 Index every May 1st and then liquidated every October 31st would only be worth $10,026 today. That's right: had you stayed out of the stock market from November through April and only been in the market from May through October, you would have had no change during the last 57 years. 21 of those years would have been negative; 36 were positive. Thi s happened during the same period that stock prices were rising about 75% of the time and markets made extended upward moves.

"Consider the results of the reverse strategy. Buy the S&P 500 Index on November 1st and sell all your stocks on May 1st. The outcome is dramatically different. Your original $10,000 would now be worth $372,890 as of April 30th closing prices in 2008. Out of the 58 periods you would have had positive results in 45 of them and negative results in only 13 years."

*** 4/30/12

I'm perfectly willing to believe that there is a seasonal component to stocks' price appreciation that is inconsistent with efficient markets, but these data aren't enough to judge the efficacy of a seasonal switching strategy. In that regard, NDR's methodology suffers from several shortcomings: For one, it assumes that when the money isn't invested in stocks, it earns no return whatsoever instead of being invested in Treasury bills. Furthermore, their data do not account for dividends, a critical component of stock returns. Finally, there is no benchmark data corresponding to a straightforward "buy and hold" strategy.

In order to address these issues, I performed my own calculations, using data series from Ibbotson Associates (a unit of Morningstar) that begin in 1926.

There are two key observations here:

The "sell in May" strategy soundly beat the converse strategy, with a margin of outperformance that exceeds 3 percentage points on an annualized basis.

However, "Sell in May" underperformed buy-and-hold; in fact, the outperformance of buy-and-hold is understated because the returns in the table assume no transaction costs and no tax impact.

The Value Imperative

Dr. John Price (creator of ValueSoft and the Conscious Investor) has written a series of articles for gurufocus called the Value Imperative.

Here are the links to the articles:

Part 1: Setting The Scene
Part 2: Replacement Theory and Tobin's q theory
Part 3: Charting and Technical Analysis
Part 4: The Investment Methods of Benjamin Graham
Part 5: Intrinsic Value and Discount Cash Flow Methods
Part 6: Intrinsic Value and Dividend Discount Methods

What the Sydney Harbour Bridge Taught Me

He also has a number of informative articles at Sherlock Investing.

Buffett and Gates on FBN

Liz Klaman of Fox Business News interviews Warren Buffett and Bill Gates:

Buffett discusses the future of Berkshire Hathaway

Bill Gates discusses the failed Microsoft-Yahoo deal

Buffett and Gates discuss the energy industry and alternative energy

Buffett and Gates discuss the American economy

Buffett and Gates discuss their contrasting deal making methods

Emerging Markets are still going strong

Although industrialized economies in the U.S., Europe, and Japan are all likely to see slow growth in the next couple of years, emerging markets are still going strong.

Country   GDP Growth --  2008 GDP      2009 GDP
          Past 12 Months Growth Est.   Growth Est.
United States  2.5%          1.1%          1.7% 
Germany        1.8%          1.7%          1.6% 
Japan          2.0%          1.3%          1.5% 
China         10.6%          9.6%          9.0% 
India          8.4%          7.8%          7.2% 
Brazil         6.2%          4.6%          4.0% 
Russia         8.0%          7.1%          6.2%

By one simple measure -- the P/E ratio -- emerging-market countries have quite reasonable stock market valuations. And in some cases, they look downright cheap.

Country  Trailing P/E  Estimated
                       Forward P/E 
United States  19.2      14.8 
Germany        12.4      11.9 
Japan          16.6      15.6 
China          19.5      16.2 
India          22.0      20.9 
Brazil         16.2      13.2 
Russia         10.4      11.6

2008 Berkshire Hathaway annual meeting

There's a bunch of links regarding the Berkshire Hathaway annual meeting this year, thanks to brknews and chuck_angels and others. There's so many that, instead of cramming them in at WBIARD, I decided to list them here instead.

Warren Buffett to draw biggest crowd ever

The Buffett Madness has begun (Liz Klaman)

CNBC Live Blog Archive

Liveblogging the Berkshire Hathaway annual meeting (Justin Fox)

Joe Ruff's updates

Justin Fuller's blog

Peter Boodell's notes

iluvbabyb's notes

Liz Klaman blog

Buffett says Berkshire won't get indecent results

Buffett advice: Buy smart...and low

CNBC Video Gallery

LIVE BLOG ARCHIVE: Warren Buffett News Conference


Buffett explains his purchase of Berkshire

Adam Smith's Money World transcript 5/15/98 [via pohick2]

Earnings Estimates

A recent eye-opening study by Patrick Cusatis and J. Randall Woolridge of Pennsylvania State University looked at 20 years' worth of published earnings estimates made by Wall Street industry analysts. What they found was startling.

Cusatis and Woolridge found that Wall Street analysts -- supposedly among the smartest, most well-informed prognosticators -- consistently overestimated the future earnings growth rates of the companies they cover. By a lot. I mean by a whole lot.

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also