Saturday, January 14, 2012

Capitalism & Inflation

This post is for all the Austrian, gold hugging, inflation fearing bears who have no idea how or why capitalism continues to increase our standard of living.

Below is a photo I borrowed from Carpe Diem of a nice color TV set taken from the 1964 Sears catalog. The price of the top two TV sets were $750 in 1964 which equates to $5300 in 2010 dollars.  The bottom TV set was $800 in 1964 which equates to $5650 in 2010 dollars.

So, what can you buy with the same purchasing power today? Well, to put it in perspective this is what you can purchase with $5300 in today's dollars.

Since I can’t say it any better, I am going to quote Prof. Mark Perry,

"Bottom Line: For a consumer or household spending $750 in 1964, all they would have been able to afford was a console color TV from the Sears Christmas catalog. A consumer or household spending that same amount of inflation-adjusted dollars today (about $5,500) would be able to furnish their entire kitchen with 8 brand-new appliances (refrigerator, freezer, dishwasher, range, washer, dryer, microwave and blender) and buy 9 state-of-the-art electronic items (laptop, GPS, camera, home theater, plasma HDTV, iPod Touch, Blu-ray player, 300-CD changer and a Tivo recorder). And of course, even a billionaire in 1964 wouldn't have been able to purchase many of the items that even a teenager can afford today, e.g. laptop, GPS, digital camera. 

As much as we might complain about high unemployment, a sub-par recovery, a dysfunctional Congress and a huge deficit, we have a lot to be thankful for, and we've made a lot of economic progress since the 1960s as the example above illustrates, thanks to the "magic of the marketplace."

Now I’m not saying we couldn't be doing even better with lower inflation but seriously, we live better today than ever before.  At the end of the day does it matter if we only pay income taxes or a combination of income taxes and inflation? 

For those unaware, inflation is simply a reduction in the purchasing power of a dollar via theft by the government.  The cost of goods and services rise because the value of our money decreases.  Think of it this way, if the government deposited one million dollars into every persons bank account overnight would we be any richer?  Perhaps the first guy to the store would benefit but that would be about it.  Because we haven't increased our physical production of goods and services the prices would rise to reach a new equilibrium.  These higher prices are what we call inflation.  The government does this every year a little at a time because they own a printing press and dilute the purchasing power of your money every year.

Real wealth comes from production or as economists call it supply side economics.  We are a wealthy country not because of money, banks, stock markets or anything of the sort.  Those things are byproducts of a free market economy.  We are wealthy because we produce a lot of stuff.  We can do far more work with a track hoe or wheel loader than with a shovel & wheelbarrow.  We can move far more goods with a train than with a horse.  These things (capital goods) aren't going away anytime soon.  Every year companies seek to become better, faster and to produce more goods and services with less cost.  If you have ever watched the TV show "How It's Made" you will understand what this looks like. 

So the next time you hear some gloomy news, you can just smile and say life will go on. 

Please allow me to stop here for a little rant to explain what I mean.  US Retail sales numbers for December were just announced on Thursday.  If you simply read the headline at the Globe & Mail you would have gone away with the impression that December was a total disaster.  It said something like "Retail Sales gains slowed in December... missing analyst expectations." 

The reality is retail sales were up, despite what some twenty something analyst in New York feels the number should be.  Secondly, retail sales (the largest part of US GDP) have been up 17 of the last 18 months.  This point shouldn't be taken lightly.  Retail sales typically fall three to four times a year, even when the economy is health and growing.  Lastly, retail sales for October/November were revised upward by 0.2%. 

So despite what the pouting pessimist pundits may say, the economy is on the mend.  Now it may not be as fast as some would like it to be but does it really matter what the artificial "target" is.  The truth is we will live better ten, twenty and thirty years from now because of capitalism (or "the miracle of the marketplace"). 

Best Regards,

Kevin Graham

Click here to read the full post at Carpe Diem

Wednesday, January 11, 2012

Globe & Mail - When to Rebalance

I was quoted in an article about portfolio rebalancing.  For the complete discussion I had for this article and some additional discussion, see below.

When to rebalance, and when to avert your eyes

How do I monitor my portfolio?

I monitor my investment portfolio by active reading.  I read the financial news each day.  I also read a number of “good” financial blogs/websites.  Many of these provide raw economic data with minimal spin.  Most everything else on the internet is not worth reading.  Lastly I read the quarterly and annual reports of all of the companies I own and a number I don’t own.  I also read the financial reports of companies that I might buy. 

I also enjoy reading the Annual Information Form (AIF) for Canadian listed companies.  The AIF is a valuable source of information about a company’s business model, their recent history, and business risks. 

Valueline Investment Survey is another tool I use to get a really good condensed financial report on a company.  Most public libraries & universities have access to Valueline. 

On average I would say I spend between 10-20 hours per week reading about investments.  My passion is really two things, reading and investing.  I have never met an intelligent person who didn’t read a lot.  For me, I would much rather read a company report or a book than watch TV. 

What I find is that most individual investors are more interested in trying to make a quick buck than they are in the actual process of investing.  The process must include a passion for reading and specifically reading company reports.  If you love the process of digging deep for value you will love value investing.  If you don't, I wouldn't recommend investing for yourself as it will be a disaster. 

Lastly, I don’t spend a whole lot of time worrying about the daily stock prices of the companies I own. If you own a good company, the daily price fluctuations really don’t matter.  For instance, I bought Johnson & Johnson (JNJ) and General Electric (GE) this past year (for a family member).  The dividend yield worked out to just about 4% on the purchase price for JNJ and over 4% for GE.  JNJ has increased earnings for the last 15 consecutive years.  The only thing you really have to monitor is how much the earnings and dividends will increase next year.

How do you rebalance your portfolio?

I tend to hold a very concentrated portfolio.  Some of the companies I don’t ever intend to sell while some have been purchased because I believe the price is cheap.  I hold the cheap companies until they reach intrinsic value or a fair price for the company.  When they approach fair value I sell and wait for another opportunity.  Sometimes you recognize a mistake in your thinking regarding a company or it’s prospects have changed and you have to sell at a loss. 

I am not driven to have a fixed percentage of my investments in a certain sector.  If I rebalance it is only to buy something that is relatively cheaper than a current holding.  Looking back, often when I  reduced a successful company in my portfolio it was a poor decision.  Good businesses are good for a reason.   

One Final Thought...

I know this is counter productive for me (a writer of an investment blog) to admit but I will say it anyway because it's true...   If you think you will find a good stock tip on the internet you are only fooling yourself.   What I find truly amazing is that the number one google/bing search term for traffic to this blog is "top canadian investments for 2012".   Let me be blunt... This type of search will never get you the results you are looking for.  

You may then ask why I bother writing this blog?  It is mainly to interact with people who like me have a passion for value investing.  I have met numerous investors, analysts and portfolio managers.  For those interactions I am truly grateful.   

Best Regards,

Disclosure - Long JNJ & GE.

Saturday, January 7, 2012

The Big Economic Picture

It's funny how the newspapers do not have a clue about economics.  Then again, neither does the average person on the street.  Many are fearful right now, and let me be very clear... That is the environment when you want to be buying stocks.  Check out this article on how the average Canadian believes we are in recession although the data doesn't say that at all.

Not to worry, main street will figure out that the world isn't coming to an end.  What will it take for them to change their mind?  Likely once the stock market has rocketed ahead a few thousand points.  Then main street will start buying their mutual funds again only to be disappointed that they are once again buying at the top.  And so the cycle repeats itself. 

What does the Economic Data look like?

What are economists seeing that main street doesn't?  Well lets take a look at some US economic graphs (with limited commentary).  Please note some of the graphs are from three of my favorite blogs: Carpe Diem, Califia Beach Pundit, and Calculated Risk.

US REAL GDP (click to enlarge)

Note: As of the forth quarter 2011, the US economy is now larger than every before. 

Retail Sales

Note: Real Retail Sales will eclipse the previous high in Q4 2011 also.  This is despite the labor market being 4.5% below its pre-recession high. 


Note: The ADP private employment report last week was the largest monthly gain in decades.  Construction jobs are still depressed. 

Commercial and Industrial Loans

Capital Goods Orders


Household Debt Ratios

Note: Americans have significantly lowered debt levels.  Household debt relative to incomes are at the lowest since 1993-1994.  North of the border, Canadians continue to pile on the debt. 

Auto Sales


What we step back and take a look at the big picture we can see that things are improving.  The only area of the US economy that isn't seeing any growth right now is in housing.  When the excess housing inventory that was built during the last boom has been worked through, the economy will rocket ahead.  As seen in the chart on construction jobs above, over 2 million jobs have been lost.  When you add in the jobs lost by companies that supply the construction industry the total is much larger.  These jobs will eventually come back and recently we have already seen small signs of improvement.  When housing officially turns the corner the US economy will grow at a rapid clip for a good while. 

Best Regards,


Monday, January 2, 2012

Top Investments for 2012

2011 Year in Review

2011 proved to be quite an interesting year to say the least.  Looking back, the games played by the US government over the debt ceiling seemed to put the fear back in the markets.  Add to that the debt problems in Greece and the markets just unraveled until early October.   Since then they have recovered somewhat with the S&P 500 ending flat and the Dow Jones up just over 5% for the year.  Here in Canada the TSX Composite index was down 11% for the year.  These results don't surprise me as large caps were definitely cheaper than small caps going into the year. 

Looking back the recommendations from last year, they appears to be a mixed bag.

Return (w/div)
Citizens Republic Bancorp
Bank of America
Hardwoods Inc
Goldman Sachs
Fairfax Financial

Average Gain


Compared to the broader market indexes this is a decent result.  The financial companies have been hit hard due the issues in europe despite the fact that US financial institutions are well capitalized and have little exposure to the European sovereign debt crisis.  Hardwoods Inc. is back on track and has started to pay a dividend again.  Citizens Republic was priced for disaster but the economy in Michigan has bottomed and loan losses have stabilized.  Fairfax, a holding company, mainly owns insurance businesses but they started to diversify this year by purchasing a number of other companies.  They include William Ashley (fine china), Sporting Life (sporting goods), & Prime Restaurants (Eastside Mario’s, Casey’s, & Prime Pubs).  Fairfax made billions owning CDS swaps a few years ago and now are now putting that capital to work. 

I have a large portion of my net worth in Fairfax.  In fact if I wasn’t interested in actively managing my investments, I would put 100% in Fairfax and sleep soundly at night.  The company is worth considerably more than its current quotation.  As I have mentioned before I have read every single letter to shareholders going back to 1986.  Prem Watsa openly discusses the positives and negatives which is quite refreshing compared to the typical sales pitch you get from most annual reports.  What is remarkable is that Fairfax has made their fair share of mistakes over the years but despite those mistakes they were still able to grow book value and thus the intrinsic value at a very fast rate.  Since Mr. Watsa doesn't do any promotion, I don’t mind shamelessly promoting the company for him.

Top Investments for 2012

Bank of America (NYSE – BAC)

I have written several times about BAC in the past and despite the 58% decline in 2011, it is my top pick.  The facts haven’t changed only the emotions on this stock.  Compared to a year ago, the company is much more soundly capitalized.  Tier 1 common equity should be over 9.5%  in Q4 if you include the recent asset sales (Basil 1).  Despite what the pundits say the assets are not marked to fantasy.  Level 3 assets, the ones with the most assemptions made by management are 2.9% of total assets.  The company still has a lot of litigation headwinds but the company has already set aside a lot of funds to cover most of these expenses already.  It may takes years before the results of the numerous lawsuits are known.

Management has a lot of credibility issues because of the numerous promises not kept during the past couple years.  Despite this they are well on their way shrinking the balance sheet and reducing risky assets.

BAC sells for around 25% of book value and 40% of tangible book value.  The lower the shares go the better the bargain.  BAC could double or triple from here and still be undervalued. 

Goldman Sachs (NYSE – GS)

I’m going to keep this one short.  Despite all the hatred, Goldman Sachs is still a premier global investment bank.  As emerging markets develop and require access to capital, Goldman's business opportunities will likewise grow.  To be clear, financial uncertainty is the biggest problem hurting the company.  The success of both the company and the financial markets hinge on investor confidence.  When it returns Goldman will return solid results.  Goldman is soundly capitalized.

GS sells for just over net working capital, 68% of book value, and 75% of tangible book value.

First Niagara Financial Group (Nasdaq – FNFG)

I know, I know... another financial company.  I can't seem to help myself as there are so many cheap financial companies to choose from.  If you can't see that you must be blind.  Like the CRBC pick from last year, FNFG is a cheap bank but unlike CRBC they don’t suffer from problem loans and mortgage issues.  Problem assets are very low compared to almost any other financial.  Despite these strong points the shares have been sucked to the vortex of the euro crisis.

The key highlights for FNFG is that they selling for less than of book value (a reoccurring theme for this value investor), and problem assets are minimal.   Numerous insider buys over the past 12 months is another big sign that the shares are cheap.  

Another interesting note is that FNFG was profitable throughout the recession and because of that they have gone on an acquisition spree.   Which raises one problem I hate to see.  Management recently raised equity for less than book value to purchase 195 branches from HSBC.  I personally hate it when management does this sort of thing but I will give them the benefit of the doubt.  Despite the bad deal on the equity the acquisition should still be accretive by 10% in 2012 and another 12% the following year to per share earnings.   If you do take a deeper look at FNFG, keep in mind that merger and acquisition expenses are masking at least $0.25/shr in 2011 so far, so their GAAP earnings are understated. 

FNFG sells for 65% of book value, and buying today gives you a 7.4% dividend yield. 

Sears Canada (TSE - SCC)

This is an interesting pick and to be honest, I can’t say that a strong conviction about it.   With that said, the company will likely muddle through the current slow patch and result should be satisfactory given the margin of safety.  Historically Sears Canada has been a strong business with good returns on equity.  Canada is a very large geographical country so their model of having small stores has in many small towns has worked well until Amazon and other retailers showed up.  The question is can they retain their market share. 

Financially the company is sound with virtually no debt and it has a very small float.   Sears Holdings (SHLD) owns nearly 94% of the shares outstanding.   No investment analysts cover the company.  Both SHLD and SCC have been buying (or buying back) shares at and around $20/shr for the past several years.  If the management of SHLD and SCC thought it was worth $20/shr they must feel it's a bargain at $10/shr.  I wouldn't be surprised if SHLD were to take SCC private as it wouldn't take much more than $85 million dollars to do it (6.2 million shares at book value of $13.80/shr).  SCC could then borrow $85 million on their credit line and pay back SHLD. 

Some negative include; falling same store sales, increased competition from online retailers and the brand appears to be on the decline.  This is a similar to what happened at Eaton’s or The Hudson’s Bay Company.   Obviously investors are worried about these negatives but given the strong financial position, the company is worth more than the current quotation. 

Sears Canada sells for 75% of book value (and has no intangibles or goodwill).  The real estate was recently reappraised due to the transition to IFRS accounting so the book value for these assets should be good.  With that said, management has no incentive to inflate the asset values so I would guess they are on the books at the bare minimum.  If you add the cash, real estate, half of the inventory and subtract all liabilities, the company is worth at least worth a billion dollars.   Downside risk is very, very low.

Speedway Motorsports (NYSE – TRK)

TRK is a small cap company that operates NASCAR motor speed ways in the southern US.  I particularly like the brand appeal and significant insider ownership.  Officers and Directors own 72% of the shares outstanding.  How's that for having skin in the game? 

Since the recession in 2008 revenues have dropped around 16% and profits have dropped by over 50%.  That has caused the stock to fall and stay down for he past 3-4 years.  However, if you annualize their Q3 2011 results the company is selling for a 6.6 times earnings or a 15% earnings yield.  The dropping attendance at race events is largely due to the strength of the economy and unemployment rates.  As the economy improves, so will the financial results.  It is interesting to note that television viewership of the NASCAR Sprint Cup Series is up year over year. 

Despite the recent run up in the share price, the company still only sells for 73% of book value.  Pre-recession the returns on equity were quite consistent at 12.5% or better.  Since the recession they have dropped to around the 5% mark.  If you annualize the third quarter 2011 results, ROE is back to around 11%.  TRK is on its way back to normal profitability.

Safe and Very Cheap (New Category)

Wells Fargo (NYSE –WFC)

Although not one of my top picks for 2012, I had to create a new category for Wells Fargo called Safe and Very Cheap.   Anyone who knows me personally is likely tired of me singing the praises of Wells Fargo.  Wells is a premier large-cap bank that really deserves to be in a category all-alone. 

Wells Fargo is really a plain vanilla bank and doesn’t come with all the other baggage that many of the other large banks do.  They aren’t a hedge fund, don’t have a huge derivative book, and don’t have any exposure to the euro crisis.  They also don’t try to make extra money by writing CDS insurance.  They make money the old fashioned way, by focusing on the customer and meeting the customer's needs.  Their net interest margin, the spread between loans and deposits, dwarfs most other large banks.  They have been buying up financial assets on the cheap lately, probably because they are one of the few companies with the means to do so. 

Financially the company is well capitalized and will report record earnings per share for 2011.  If the company paid out 50% of earnings they would be selling for a 5.3% dividend yield.  Given that they are under earning their potential, earnings will continue to grow over the next couple years.  Within a couple years I wouldn't be surprised to be getting paid a 7.5% dividend yield on the current price.  The downside risk is very low.  Sit back and enjoy the dividends.

Wells Fargo also gets the approval of Warren Buffett.  It's his third largest holding, behind Coke and IBM.  He has been consistently buying for the past couple years at prices up to and greater than $30/shr.  Given the current low price of $26.50/shr, take advantage of the bargain while it’s still available. 

Some Honorable Mentions – Intel (INTC), K-Swiss (KSWS), Pacific Sunwear (PSUN), Research in Motion (RIM), SunPower (SPWR).

For these stocks you will have to do your own homework.  All I will say is that they all have wide appreciation potential but results will depend on the operating results of each company.  Many of these companies have their own issues or problems that make the near future cloudy.  That is why people avoid them but without uncertainty they wouldn't be cheap.  Remember fear is your friend. 

Cheers to another great year!

Best Regards,


Disclosure – I own BAC Class A warrants, WFC, FFH and GS.  Don't worry I own more than financial companies...