The Freedom Factory

Sen. Rockefeller proposes bill that would give government sweeping powers to control, monitor, and regulate the Internet, ACLU demands public schools stop blocking gay web sites on public computers, Rep. Jane Harman calls incriminating NSA wiretap “abuse of power,” National Service legislation signed into law that will cost $6 billion over 5 years by hiring “paid volunteers,” government will need to issue $2.4 trillion in new Treasury securities in 2009 to meet budget shortfalls and bailout program requirements, and U.S. to give another $5.5 billion to automakers… Continue Reading

The stock market hit and then furiously bounced off a low on March 9th. Since then it has shot up about 30% nearly uninterrupted. Hope abounds that we may be emerging from one of the worst economic disasters in 20+ years. By many measures the frantic chaos of the last year appears to be subsiding, particularly when looking at the resurgence of corporate earnings, stock prices, and declining value of the CBOE Volatility Index (VIX). Yet it is at times like these when it makes most sense to buy insurance, and it just happens to be cheaper than it has been in a long time. Continue Reading

With financial markets disintegrating, housing devastated, unemployment nearing double digits, and our incoming president warning that things will get worse before they get better, it is tough to see better times on the horizon. One simple observation should inspire some bit of hope, however: stocks go up the more government borrows and spends. Continue Reading

The people who know the company the best are the people who work there.  So their actions can give you information you may not otherwise be able to get.  I’m going to discuss what you should look for and where to find it.

1) Insider Trading

The easiest way to tell what bosses think is look at their buys of company stock.  You can find this information on Yahoo Finance by clicking on ‘Insider Transactions’ once you’re on a stock’s main page.  You can also see it on MSN Moneycentral by clicking ‘Insider Trading’.  Both of these pages will show you recent transactions of CEOs and other executives/insiders.

Big purchases are what you want to focus on.  And if they are big purchases at a smaller company, that is even better.  As a rule, you want to find purchases of more than $100,000 in a 3 month period.  For example, if you look at DELL, Mr Dell bought $100,000,000 worth of shares in Sept of this yr.  That’s an impressive buy.

2) CEO Compensation

If the CEO is paid like a king, he is likely to underperform.  That goes contrary to common thinking, but its been proven true.  You can find Executive compensation on Yahoo Finance by clicking on ‘Profile’ once you’re on a stocks main page.  The payroll will be on the bottom right side of the page.

Its hard to tell how much is too much though.  I have heard of a couple of rule-of-thumbs.  The first, is that the CEO shouldn’t make more than the rest of the top 10 on his staff combined.  The reasoning behind this thinking is that one guy cannot run a company on his own.  So if Mr CEO is making $10M and the rest of the top ten on his management team are making $100K each, then something is likely out of whack.  Also, many times in the past, if the CEO was paid a huge sum, it worked out very well in the beginning, but then very badly in the end (Lee Iacocca of Chrysler).  The hypothesis behind this thinking is that his ego will swell as his paycheck swells and he will think himself invincible, conceited and unable to make a bad decision.  You do not want your leader to possess those qualities.

The second rule-of-thumb is that the CEO should be making what other CEOs for similar sized companies make.  Last year, large cap CEOs averaged $12M.  Mid Cap CEOs averaged $6M.  And small Cap CEOs averaged $2M.

Another thing, I don’t think CEOs should make loads of cash during years of underperformance.  Their pay should be commensurate with their performance.  So if the stock or earnings are up 100% in a given fiscal year and the CEO is paid much more than other CEOs, that is probably alright.  But if he is paid $50M in a year in which the stock or earnings are down by 50%, that seems unacceptable.

Also, make sure you lump stock options into the compensation equation.  Many CEO’s stock options account for a larger portion of their compensation than does their normal paycheck.

3) Letters to Shareholders

You should always check out the annual report of a company before buying its stock.  And somewhere in the Annual Report should be the CEO’s letter to shareholders.  This part should include goals and strategies for reaching those goals.  It should be written in a manner that shareholders can understand.

If you want to read great examples of Shareholder Letters, you should check out Berkshire Hathaway’s letters here.  Warren Buffett has great business acumen, sense of humor, and a way of explaining complex things so anyone can understand them.

To fully appreciate what is occurring in the financial markets, I recommend reading two articles: Deleveraging: A Fate Worse than Debt from The Economist and The Question of Our Age by Tony Crescenzi.

The theme of both articles is the same- cheap credit for the past 20 years has fueled economic growth. Now that credit has dried up, can the system deleverage without causing economic contraction? The coordinated effort of the U.S and other governments is meant to prevent (or at least slow) this deleveraging process. So far the governments have added liquidity to credit markets and injected capital to expand lending and revive economic growth. Continue Reading

Everyone seems to be asking the same question- is this the bottom? Personally, I don’t think so, but we are close. The basis for my conclusion is three-fold.

First, the credit market is still largely frozen and there is a lack of confidence between banks. Although LIBOR dropped significantly last week, the TED spread is still quite high. Until interbank lending and confidence is restored, I will continue to remain bearish on the market. Once the credit market thaws, I believe the market will rally significantly because sophisticated investors are using the credit market as a signal to reenter the market. Currently, the institutional money is sitting on the sidelines and is unwilling to risk money to ‘catch a falling knife’.

The second reason is based on technicals. During the Dot-com bubble, the S&P topped at 1,550 and dropped to about 800 two years later. The S&P topped out again at 1565 on October 9, 2007, and yesterday (October 15, 2008), it closed at 908. If one directly compares this situation to 2002, the S&P could fall another 10%, or about 100 points. Secondly, economic downturns typically last about 18 months, which means the market should suffer for another 6 months (or so). Granted, I do not place much faith in technical analysis because it is not correct to compare today to historical events. For example, there has not been a terrorist attack like in 2001. But, it does help to use history as a gauge for approximate price ranges.

Finally, the fundamentals of the S&P 500 appear appropriately priced. The current P/E ratio is about 13.5. If corporate earnings start to decline, the price must also decline to maintain this ratio. The big question is by how much earnings will decline? If you have knowledge about this, I encourage you to blog about this article. It would be great to know what the historical P/E ratio has been at ‘bottoms’, or the average amount that earnings have decreased in recessions. Either piece of info would give great insight into possible market behavior.

To play this market, my recommendation is to make three equally spaced purchases. (See my previous article here.) One thing is certain- you will never be able to catch the exact bottom. Over the coming months dollar cost averaging is the best approach to take advantage of these bargain-basement prices. The market has already lost a lot of its value. How much lower can it really go?

There are several reasons to wade back into the market this week – the Dow is down 20% for the year, the S&P 500 fell 8% on Monday, and Warren Buffet is buying.  Although there is blood on Wall Street, there is not yet blood on every street- especially Main Street.  In short, I think the economy will get worse before it gets better, but it’s time to start buying. Continue Reading

I highly encourage anyone invested in the stock market to read Fooling Some People All of the Time because it explains the value that ‘shorts’ provide in the stock market and highlights potential pitfalls to consider before investing in stocks.  At the very least, I would recommend watching David Einhorn’s speech, here, to find out if you are interested in the subject, and to get a flavor for the book’s content.  (Link: http://foolingsomepeople.com/main/ ) Continue Reading

Alcoa has been around for 120 years.  Its main business is in the production and sale of aluminum.  They have over 100,000 employees in 44 countries.  They are the world leader in production and management of aluminum.  They are very diversified.  This is important so that if one area of the world or one industry has problems then AA would be in trouble.  But if they sell products to many industries in many countries, then the risk is mitigated – if one country or industry has problems, it is only a mall portion of AA’s business.  Here are some of the locations they sell to and some of the people who buy their products:

–They sell to: N America (55%), Europe (25%), Pacific (14%), S Amercia (6%)

–They sell to many established companies: Airbus, Toyota, ExxonMobil, Lockheed Martin, Nissan

–They sell to many industries: Aerospace, Automotive, Building and Construction, Commercial Transportation, Industrial Markets.

They were also named one of Most Sustainable Corporations in the World at the World Economics Forum in Davos, Switzerland (2007).  Why is that important?  Because, many companies come up with something that gets them a lot of sales and a lot of profit for a few years.  One example is Crocs – you know those weird sandals that come in many different colors and cost $30.  I would say that their sustainability is very low.  A stock only goes up if they can raise their profits.  And I don’t think Crocs can raise their profits for too many years after their initial product push.  You already see spin off versions of their shoes for half the Crocs’ price.  And they are not going to be able to branch out their business very easily.  They can’t very well go into the food industry or the clothing industry.  There is just nowhere for them (and many other companies) to grow their profits.  Most companies are not very sustainable.  But AA is.  Continue Reading

July has been an extremely volatile month for nearly every asset class. The Fund had to employ all of its risk management techniques to minimize trading losses on certain positions, but we ended up 10.47% this week and 9.96% for the month so far. July options contracts expired today, so the Fund now sits on 100% cash, which will be incrementally allocated over the next few weeks.

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