Should you buy YHOO now?

I recently asked this question on my Google+ page. I got some comments there and a few good ones privately emailed to me or in other forums. Here's the wisdom of the crowds, colored with my own perception and understanding.


  • Traffic. YHOO still attracts a lot of eyeballs. It's one of the top 3 destinations on the web where people spend time. So, the potential is there for more revenue.
  • Valuation. About $1B in earnings expected this year, which would put the forward P/E at a reasonable 15.
  • Leadership. Shakeup could provide new steam for company.
  • Low expectations. $3B in cash, $14B in total equity and a total market cap of only $18B. Market expects little of this company going forward.
  • Buyout. Private Equity companies are already negotiating a buyout, which could lift the shares.

  • Downward trajectory. YHOO has been declining in traffic, revenues and pretty much everything else for a while now. This is hard to reverse.
  • Lack of innovation. Enough said.
  • Talent. Outflow of talent is certainly higher than inflow. This is a chicken-and-egg problem: it's hard to attract talent when the company is sinking, but hard to turn it around without new talent joining the workforce.
  • Limited upside. Any buyout will probably not pay a lot of premium for YHOO, given that they have few other options at this point. 
  • Risky. Since YHOO is not exactly a super-bargain, risking real capital to hold the stock just to watch it go lower is, well, risky.
What do you think?

I decided to pass. Mostly because I think the turn around story is flawed and the buyout one is more likely, but with limited upside. However, buying some call options could be a good strategy, depending on valuation. I'm still to look at those.

Disclosures: No financial interest in YHOO (neither long or short) at the time of writing.


Is GM a Buy?

I recently had a discussion about investing in General Motors (GM). I thought I'd share that discussion succinctly here.

  1. GM is now profitable.
  2. Trading close to book value. Buy the assets, get the income stream for free.
  3. Car sales are up year-to-date.
  4. Car manufacturers are stepping up ad spending, so this could spur even more sales.
  5. The government has taken an interest in the company (the taxpayer still owns about 26% of GM). This could put a floor under the stock.
  6. GM has experience in alternative ("green") fuels and electric vehicles, which is the current trend these days. 
  7. Insider buying is positive. The CEO keeps buying shares.
  8. Internal organization is very different now than it was before bankruptcy. 
  9. The company is making progress towards fully funding its pension plan. The "hole" came down from $17 billion to just around $10 billion in the last six months.

  1. The "free" income stream from the pros reason number two above can easily be destroyed by a downturn, poor management or more government intervention.
  2. Government still owns about 26% of the company. History shows that government is terrible at handling companies (see Post Office and and Amtrak for examples).
  3. Alternative fuels and electric cars are not the specialty of GM. There are better-equipped competitors out there that, albeit smaller, could eat GM's lunch in this growing sector  (think Tesla,  BYD).
  4. GM does not yet pay a dividend.
  5. The company's pension plan is still underfunded by a non-trivial amount ($10 billion).

Overall, I thought I'd take my chances and started a small position in GM.

Disclaimers: I own GM at the time of writing.


Notes from Berkshire Hathaway Shareholder's Meeting

Once again, as became known as "Woodstock for Capitalism", Warren Buffett and his partner Charlie Munger fielded questions from shareholders and journalists from all around the globe. With an audience north of 17,000 people present in the Qwest center in Omaha, Buffett, 80, showed he's still in decent shape and perfect wit by withstanding a grilling session that lasted for about 6 hours.

David Sokol

Buffett started clarifying his mistake at publishing a press release about David Sokol, the Berkshire manager who bought shares of Lubrizol in the days leading Berkshire's offer to purchase the company outright, pocketing an estimated three million dollars. 

Buffett explained why his much criticized press release was too positive on Sokol. Buffett felt like publishing a press release only criticizing David for his "inexcusable" mistake would be diminishing all the great work Mr. Sokol's done for Berkshire. Mr. Sokol did great things and Buffett didn't want them to be lost because of this one mistake. 

Buffett also said he does not believe a man who was paid handsomely over many years (last year his compensation was US$ 14 million) would act in bad faith to earn another 3 million. He believes Mr. Sokol's lack of proper disclosures were an oversight, not an act of bad faith. But that nonetheless, they were inexcusable. 

He then went on to mention Mr. Sokol's altruistic personality.  When Berkshire first bought MidAmerican, Buffett offered a $50 million package to Mr. Sokol and $25 million to Greg Able (another executive at MidAmerican). But Mr. Sokol refused to accept such split and suggested a 50-50 split between the too.

Buffett also clarified that he didn't fire Mr. Sokol on the spot because he wasn't sure of the involvement of Sokol at first, but that when Sokol resigned Buffett decided to accept the resignation which is cheaper than firing an executive and less prone to law suits.

I think deep inside Buffett didn't want to let Mr. Sokol go, but was forced to act this way to keep his image clean and Berkshire's reputation pristine.

Investing in Gold

When asked about investing in gold, Buffett said gold "doesn't do anything". He said people can stare at gold, climb a ladder on top of a pile of gold and sit on it and claim to be the king of the hill. One can even fondle gold and rub it. But it doesn't generate any wealth. 

He then proceeded to tell the same funny story he's told before: suppose Martians were watching the Earth. They would be quite confused by seeing people dig up gold from the ground in South Africa, transport it to New York and then bury it again in vaults.

Buffett simply prefers to invest in things that create economic value and tend to grow over time, such as well-managed companies with competitive advantages that require little re-investment of capital to maintain sales and grow, such as See's Candies.

I very much agree with this. In fact, I wrote about it very recently on my discourse on how to fight inflation.

Investment Vehicles

When answering a question about money, Buffett mentioned that there are three types of investment vehicles: currency-denominated investments, things that only have value because of prices people pay for them and businesses. 

Currency-denominated investments are poor investments over the long run. All fiat currencies tend to go to zero over time. Even shorting currencies is not a great investment because one still needs to know which one will go to zero faster, but in the long run, they all go, because of inflation. So Buffett prefers to stay away from these, which include bonds, loans, IOUs and currencies. He did, however, short the dollar a few years ago for a handsome profit. But he doesn't believe he can consistently predict which currencies will lose value faster.

Things that depend on others to pay up later include gold, oil, and precious metals in general. Even though some metals have utility and oil is a finite resource, he doesn't have any edge on predicting what the demand is for these things. So he doesn't invest in them.

The third category is his favorite: well-managed companies that require little re-investment of capital to function. He cited an example of See's Candies which went from $30 million to $300 million in sales with just a $31 million investment (from $9 million in assets when he purchased it to $40 million now). So, a 10x gain was obtained with less than 10x investment, which is a property of great businesses.

Again, I agree completely with Buffett. I also classified different types of investments recently. Although not exactly like Buffett, my categories are similar.

Investing in Oil

When an investor asked if she should short oil or go long, Buffett answered that instead she should teach us how to do it, because he didn't have any insight. He simply said he has no edge on picking the direction of commodities and as such he doesn't get involved in doing it.

Too Big To Fail

An investor and small business owner asked whether there should exist a business that is "too big to fail", which was the case of many US banks in 2008 and 2009 and also AIG, Freddie and Fanny as well as General Motors.

Buffett said that these businesses do exist and in fact, there are now countries that are too big to fail. This is simply unavoidable, in his view. However, he doesn't believe in free bailouts either. He suggested a policy where shareholders should get wiped and the CEOs and their families should lose all their money, certainly all their money earned when at the helm of such big institutions. Such treatment would protect investors and the population by discouraging CEOs from taking huge risks.

In the case of GM, Buffett said he was on the fance on whether it should have been bailed out, but he said that in hindsight it was a good move by the government. I disagree. GM was not too big to fail and it sucked up resources and market share that could have gone to more efficient players. 

In the case of banks, I'm sympathetic to Buffett's view, since a run on banks and massive unemployment could have destabilized the country and generated massive domino effects elsewhere. However, it's clear more responsibility is necessary on the part of executives. The trick is to achieve this without too much regulation and without stifling innovation and competitiveness -- if other countries can do it, then the US will lose out by not allowing their banks to do it too. Balance is the key.

Expanding the Circle of Competence

A shareholder asked: "if given another 50 years to live, which new circle of competence would you like to develop?" Buffett first answered with "I really like the preamble", and the crowd laughed. He then proceeded to say that he would learn about tech, because it's a very large field and there will certainly be a few big winners in it.

Charlie agreed and also said that energy would be a good area, because with enough energy all problems of civilization are resolved, such as clean water. Charlie mentioned having read "In the Plex", a book about Google, which he certainly enjoyed reading and learned a lot from it.

Best Businesses To Invest

A shareholder asked Buffett whether an asset-heavy business would perform well during periods of inflation versus a business with fewer assets. His theory was that tangible assets such as factories, machinery, power plants, etc would work as a store of value.

Buffett was unequivocal about this: no, the best business is the one that doesn't depend on too much capital invested in it and can generate profits with minimal capital reinvestment. He again  cited the example of See's Candies and compared it with Lubrizol and utilities, which can be lucrative, but are not as good as businesses with moats and low capital requirements.

On Inflation

Buffett dislikes inflation like everyone else. He said that the dollar from when he was born is only worth six cents today. But despite that, he and Charlie did well over time. So inflation is bad, but not as bad as it sounds. 

I suppose he was trying to say that controlled inflation is not a very big deal. But that somehow goes a little against his disdain for cash-denominated investments. I guess what he meant by this all is that inflation is only a problem if one is not invested in great businesses and instead holds cash or cash-denominated investments.

Jamie Dimon

Like two years ago, this year again Buffett praised the CEO of JP Morgan, Jamie Dimon, and said it's worthwhile reading his shareholder's letter. Maybe again this year, like two years ago, yours truly will read it and summarize it here. Stay tuned.

On BRK Dividends

This year again, as is common for several years now, people ask when Berkshire will pay dividends. Buffett thinks it's best not to, as long as a dollar retained produces more than one dollar of economic value for the stock. So far this requirement has been met. 

The day Berkshire pays a dividend, says Buffett, is the day they admit defeat and can no longer invest money profitably. On this day, the stock price should go down, according to him.

Buffett joked that he wishes his friends live until BRK pays a dividend.


Many other topics were debated, including a charitable giving program that was discontinued several years ago; Charlie's love for Costco; Ajit Jain's workaholic habit of flying to London on Thanksgiving to continue on working; and the one diploma Buffett has on his wall: "Dale Carnegie's Course on how to communicate effectively".

Buffett also commented that the government not raising the debt ceiling would be the biggest asinine thing it could do. That the debt capacity of the US is larger than it was when the ceiling was instated and that, in his opinion, there should be no limit.

All told, it was worthwhile flying to Omaha to see the Sage. (Even better, on a private jet with a couple friends of mine). I expect to repeat this again in the years to come. Long live Buffett.

Disclosures: I own BRK at the time of writing. I do not own an airplane.

You can follow me on Twitter @pinhe1ro.


What To Do In The Current Inflationary Climate?

It's no secret that the dollar is turning into dust. It has been depreciating since it went off the gold standard over 40 years ago. And it is now depreciating faster given current government intervention. Just check out the news and expert commentaries:
Of course, there are those who believe the opposite is true, such as Mish and Vijay Boyapati. The argument pro deflation is that the government won't have the political will to allow rampant inflation and their means to trickle down newly-printed money within the economy is limited, barring political suicide.

The truth is that no one on the deflation camp believes the dollar is getting any stronger nor that inflation will not return in the future.

Inflation is the tried and true method that works to reduce government debt. It's what's been going on for decades ever since we've had fiat money. And it will continue in the future,  in spite of short periods of deflation.

Becoming Inflation Agnostic

Regardless of what will happen in the next six months or a year, the fact is that investing is about the long term. And long term we will have inflation, like we've always had, plus more, given the increasing deficit this country is running.

So, what's the best way to protect hard-earned money? 

There are many ways of doing this, and they all have pros and cons. Here are the ones I know of. I'll break them down into smaller categories, even though everything eventually rolls up as either "cash-flow positive assets", "limited supply entities" or "mixed".
  • Business Interests (stocks, private businesses)
  • Precious Metals (gold, silver)
  • Commodities (gas, oil and agriculturals such as corn, wheat and cotton)
  • Collectibles ex-precious metals (art in general, rare objects)
  • Real Estate (land, houses)
  • Paper Instruments/Derivatives (TIPS, bonds, futures)
  • Other income-producing assets (patents, royalties)
For simplicity, I will ignore the bottom two classes. I'll just say this about TIPS: while an interesting asset to have some exposure to, its inflation-protection comes from the people creating inflation (i.e. government), so in the long run TIPS are unlikely to offer much real purchasing-power protection.

Business Interests

I believe this is the best way to generate wealth. Having businesses generating income for me is the most scalable way to attract money. After all, I can't have ten day jobs to generate 10x my income. But by owning businesses (or their stock) not only is this realistically achieved, but even more is possible. 

And having multiple sources of income is, in my mind, the best way to offset inflation. After all, profitable businesses want to stay profitable, so they increase prices with inflation when they can (unless they are airlines, in which case just don't invest in them, like I did and regret).

But stocks are unpredictable in the short-run and they can be at times grossly over-valued. 

The other way is to create businesses from scratch or invest in them privately (private equity) or very early (angel investing). I've tried my hand at all of these. Results will vary and these are hard things to do well. So, if you're not in this camp yet, start to learn or move on to the next one.

Precious Metals

There is no way to value precious metals. And they don't pay a dividend either. 

Nonetheless, precious metals have historically more or less retained purchasing power relative to fiat currencies. They can be especially useful in times of crisis when a race to the bottom in currency debasement is in effect, like it is right now.

I would advise people to have some small amount of physical gold or silver with them, such as 5% of their net worth. Timing the purchase of these metals is tricky.  I wouldn't hurry to buy right now that they've gone up by record amounts. If you haven't exhausted other alternatives yet, hold off on buying metals until no one is talking about them again. However, if you buy as a contingency reserve and never sell otherwise, then almost any time is a good time to buy.


With commodities I see roughly two classes that mostly only exist in theory: those that should go down in price over time, such as agriculturals, and those that should go up, such as oil and gas.

The reason why agriculturals should go down in price over time (all else equal) is because agriculture is becoming more efficient and mechanized -- we produce more food per acre than we've ever did in the past. Oil and gas, on the other hand, are being depleted and we'll eventually run out of them.

However, theory and practice are very different. While oil is going up in price due to depletion (and also instability and speculation), reserves of natural gas are a lot bigger. Natural gas prices have been all over the place and can remain like that for a long time, depending only on supply and demand, both variables which I cannot predict.

Meanwhile, agriculturals have gone up in price, mostly because oil has gone up and the dollar is losing value.

So, what's an investor to do? I believe a diversified portfolio needs some exposure to commodities. However, the vehicles for that exposure are complex and time-consuming. Pure commodities ETFs and ETNs such as OIL, USO and DBA, are not ideal. In fact, they are harmful, because traders take advantage of them in ways I don't want to delve into right now.

My recommendation: if you have the inclination, time and stomach to use futures, go for it. Setup a small account and keep rolling some exposure to grains.

If you don't want to go into the futures market, then get some exposure to the agricultural commodities sector by buying stock in companies such as ADM. Or, for a more diversified (and more expensive) exposure to agribusinesses, try MOO or PAGG.

The disadvantage of having stock in agribusiness companies is that it increases one's exposure to stock market and hence this may offset some of the benefit of being invested in commodities.

As for oil and gas, I believe it's best to own exploration and pipeline companies instead of futures. The reason is that owning oil futures or oil in the ground is very similar: the stock price of companies like XOM should go up as oil goes up (with agriculturals, the wheat and corn are not there all the time, they must be grown, so owning the business is not a great proxy for owning the commodity). So for oil and gas, there's no need to forfeit getting the juicy dividends these companies pay just to offset the stock market risk. But again, if you have the inclination to do futures, that's a fine option too.


Owning a Picasso painting or a Rodin sculpture is a great way to store wealth. It seems to be a trick the rich know and that the poor don't usually understand -- many people think buying art is squandering money, a vain waste of resources. But the value of these rare objects should go up over time. So it serves a dual purpose of decorating the home and storing wealth.

However, the drawbacks are obvious: they are illiquid, non-fungible and extremely hard to deal with.

During times of extreme distress (wars), good luck trading your Rembrandt for food at a decent exchange rate. You may have better luck with a Patek Phillippe, but you first need to find an original item and a qualified buyer.

Finally, this leads us into another category.

Real Estate

Real estate was the darling of the easy-money policy era. Until 2007.

And then it became taboo to even talk about a "recovery" in real estate prices.

Real estate cooled in America and became hot in other parts of the world such as China, Australia and Brazil. In fact, the last two seem to be nearing bubbly conditions, though the make up of these conditions are very different than those in the go-go years of free-houses-to-everyone-with-a-pulse in America.

That's exactly why real estate is now the right place to invest -- because no one is talking about it other than saying how bad it is and how slow it will be for a long time.

What most are missing though is that price appreciation is only part of the equation. Income is the other. Even though prices can continue to tumble into the near future, they must eventually find a floor on rents. Especially in desirable and growing areas.

It is now possible to own real estate essentially for free in many desirable zip codes across America. Right now. For example, in Silicon Valley, companies are hiring, builders have slowed down and yet there are houses on the market that after a down payment can generate enough rent to cover mortgage, closing costs, insurance, taxes and even HOA fees (in case of condos).

Now, depending on the terms, it might even be possible to generate a 6% annual return on investment. Plus any future price appreciation. And that with almost full immunity to inflation, since rents will keep pace with inflation. Add to this equation a fixed-rate mortgage and I see not better inflation protection right now than a cash-flow positive rental property.

Of course, there are drawbacks: the market is not very liquid, tenants are not all the same and managing rentals can be a time-consuming and headache-prone activity. If you're not up for it, the alternative is to go the ETF route, such as RWR or IYR.

Final Thoughts

When fighting inflation there is no silver bullet. It's important to be broadly diversified. And that doesn't mean having many mutual funds. One needs to think in terms of assets that tend to retain value. My favorites are those in the category of income-generating assets, especially business ownership and real estate rentals.

I think now is a good time to buy real estate in America, particularly in areas with positive job growth. Prices may continue to slide, but timing purchases perfectly is tricky. Plan on buying properties that can generate enough income to at least pay for the mortgage. In 2-3 years they will likely turn cash-flow positive and in 5-10 years you'll get price appreciation on top of that.

In the end, you get inflation protection, income and price appreciation. It doesn't get any better than this.

Disclosures: I own RWR at the time of writing.


Never Fall In Love

Falling in love with a company, its services or its products is well-known to cause its stockholders more financial harm than good. Avoiding this trap is a common advice. And it's a good one.

A Concrete Example

As a real past example, let me tell you about when I invested in Jamba Juice (JMBA), the smoothie shop that is so ubiquitous and keeps expanding. I thought the concept was great. After all, being from Brazil, I know how popular freshly-squeezed fruit juice and smoothies are over there. The fact that Jamba was aggressively expanding outside of its home state of California was a big plus.

This was back in 2005, and I had just discovered Jamba Juice. I immediately fell in love with the idea and wanted to invest in it. But Jamba was a private company back then and all they gave me was a discount coupon when I offered to invest some money into the company. Silly me.

So I waited for its IPO and then waited some more for the post-IPO hype to die down. In 2007, I finally decided to buy, based on its expansion plans, and a lot of excitement about its products and business model. After all, who wouldn't want to buy a Jamba Juice smoothie?


Price paid: $6.49 per share in 2007.
Current price: $2.37.
Maximum price in the last two years: $3.83.
Dividends paid: $0.

Now you do the math.

What went wrong? First, I didn't stop to analyze the market. I assumed everyone must love smoothies. But it turns out that outside of California, Hawaii and Florida people don't care as much about smoothies. Moreover, only during the summer months do people care enough to look for Jamba's colorful stores. Also, Jamba's expansion plans were so aggressive and it expanded so quickly that it had to close some poorly-performing stores, hurting the bottom line.

And how could this business model be so popular in Brazil? Despite the weather differences, juice and smoothie shops in Brazil typically freshly squeeze their fruits in front of customers, while Jamba mainly freshly blends fruit concentrate with a sugary "dairy base", according to their own in-store information.

I took my losses on JMBA today, after keeping a shred of hope for the last 3+ years.

Conclusion: it pays to look beyond products and services before investing. Look at the market, management quality, financial situation and company expansion plans.

Avoiding a Current Trap

With the lesson learned from Jamba Juice, I recently avoided a similar trap.

I'm a big fan of Vitacost, my supplier of vitamins, herbs, protein, etc. Their products have the lowest price, they ship super fast and their customer service is great. In fact, over the many years I've been using them, I've only had two minor problems with shipping, which they resolved so quickly and satisfactorily that I even wonder if they caused the problem on purpose so that I would fall in love with their speedy customer service.

Sounds like an ad for them, right? But I'm in no way affiliated with them. And that's for the betterment of my pocket.

You see, I wanted to invest in Vitacost for a while and like with Jamba Juice, it was still private when I first thought about investing in them. Today, I discovered that they've been public since 2009, ticker VITC. So I started looking into a possible investment.

Even before turning to their financials I find a slew of terrible news about the company. First, it failed to file for the required paperwork with NASDAQ and it is at risk of being delisted. The CEO has left recently, and it is postponing its shareholder meeting. Worse, it's being sued by not one, but three law firms for security irregularities. Something about its executive team having allegedly lied about its products, services and financial strength to mislead investors into a higher valuation.

Of course, all the bad news could mean that the stock price is depressed and when things are resolved this could be a terrific opportunity to buy. However, for a company with such short track record and with so many problems accumulating right out of the gate, I can't even start considering an investment in it.

I will continue to enjoy Vitacost's good product selection and quality service. But I'm not buying any piece of the company any time soon.


The advice "don't fall in love with your stock" is a good one. Treat all your investments as anonymous machines working for you. If they fail to work for your best interests, it's time to replace them. There's a large pool of good ones out there. All you have to do is do your due diligence, look at the fundamentals and choose carefully.

Disclosures: No position in any of the above mentioned securities as of the time of writing.


Why Abbott Looks Cheap

The pharmaceutical juggernaut Abbott Laboratories looks reasonably cheap these days. Its shares have been going down for the past few weeks and it's a good buying opportunity in my opinion. Here's why.

Consistent Dividend Growth

Abbott has grown dividends consistently for over 25 years. It's part of the Dividend Aristocrats index maintained by S&P. Not only that, but ABT has grown dividends an annualized 9.33% over the last 11 years. On average, the year-over-year dividend growth has also been around the same ballpark, 9.45% (the average and the annualized 11-year return can differ in case most of the growth was in one or just a few years as opposed to consistent over time. When they match, it's a sign the growth has been sustained over time).

Consistent Earnings Growth

A consistent dividend growth needs to be accompanied by a consistent earnings growth too or the dividend is not sustainable. Over the same last 11 years, ABT has had an annualized earnings growth of 9.31%, which comes in very close to its annualized dividend growth. This means that dividend growth is supported by earnings growth directly, which is a good sign. It means the company is passing through all of its extra earnings back to shareholders via dividend increases.

Some people prefer to see earnings growth slightly surpass dividend growth to be on the safe side. But by doing so, it means the company is increasing its cash reserves and I would want to understand why. It could mean an acquisition is coming up or the company is expecting to have higher expenses going forward (patent disputes, lawsuits, etc). So, higher earnings growth per se is neither good or bad, but must be understood. In the case of Abbott, for the past 11 years earnings and dividend growth have matched, which can only mean the company is growing smoothly and not becoming lopsided in anyway, neither increasing cash reserves nor depleting it, hence a very good sign in my opinion.

Consistent Sales Growth

Just because earnings growth have been consistent during this time does not necessarily mean the company is actually generating more cash since earnings can be so easily manipulated. However, 11 years is a long time, especially when the earnings can be seen in form of dividends during this time (it's a lot harder to fake real cash in your pocket than it is on an income statement). Nonetheless, let's see how Abbott fares in sales growth, which is a more direct way of assessing where growth is coming from.

For the past 10 years, sales have grown an annualized 8%. This is only slightly less than the 9% earnings growth, which indicates that for the most part sales have kept pace with earnings. It also indicates that the company has been aggressive at cutting costs at a rate of 1% per year. In the long run I'd expect earnings and dividend growth to slow down to catch up to sales growth. Still, 8% is a good growth rate to have.

Dividend Yield is Moderately High

At a price of approximately $45.50 and with an annual dividend of $1.76, ABT sports a dividend yield of 3.8%, which is pretty decent in today's market. When factoring in a 8-9% growth, it means investors can expect a return of 11-13% on their investment going forward, minus inflation and plus any share price appreciation.

Implied Price using Dividend Discount Model

Treating a share of ABT as a bond and investing in it just for the dividend using the Dividend Discount Model, I came up with a price range for ABT of between $59 and $44. This means that ABT is undervalued at the time of writing. My assumptions were a 10-11% discount and 7% dividend growth, which, given the track record of sales growth of 8% is still a little conservative.

Other Considerations

Other things to consider before investing: why is ABT going down in the past several weeks? No single news piece accounts for this decline, but a more thorough investigation is warranted.

One a price-to-earnings basis, ABT looks fairly valued with a tailing P/E of about 15. However, its forward P/E is only 10, since ABT expects to earn between $4.54 and $4.64 per share in 2011.


All things considered, ABT looks cheap to me. I'm buying shares of Abbott (ABT) at the time of writing. Please do your own analysis before buying.

Disclosures: I own shares of ABT at the time of writing.


Are Muni Bonds Cheap Again?

Back in 2009 Munis got a lot of attention because several states were in trouble, meaning they couldn't service their debt loads. The situation is not much different now and still most muni issues are still being serviced.

So, what has changed?

For one, their credit ratings. Specifically, two California issues I own (one of which I discussed back in 2009) are now back in investment-grade camp. Both 13062TPU2 and 13062TSB1 started 2009 as A+ issues and were downgraded to BAA1 (or BBB as Fitch calls it). Both are now back to A-, as of late 2010. And yet, their prices have fallen recently, probably in anticipation of more ugliness ahead.

However, these two issues are still paying their coupons and both are fully backed by the state's taxing authority. No disclosures of other material events have been filed with the MSRB.

In this case, should a California-based investor buy more?

I can't see why not, at least in the short term. Even if inflation picks up, it's unlikely to pick up so fast as to obsolete these papers, whose coupons are 4.5%, but are yielding now about 6.2%, tax free, at approximately $78 per issue.

Therefore, I'm officially adding to my position. The only trick is that the market is so illiquid now that these bonds are not being offered on a daily basis. Investors must request offers, which are hard to come by. Patience shall be rewarded.

Disclosures: I own both bond issues mentioned above. Consult your financial advisor before making any investment.


S&P 500 Fair Value: What to Expect in 2011

About two years ago I posted my mathematical assessment of the market's fair value. It's still a widely-referenced article. Given your interest and my own curiosity as I prepare my investment route for 2011, I thought I'd repeat that study using more recent data.

But this time, I'll use both a dividend discount model and an earnings growth model.

S&P 500 Fair Value from a Dividend Perspective

Using the Dividend Discount Model here's a quick summary of the market today and what is in store for 2011, if history helps.

If we treat a stock as a bond and nothing else, we're expecting to get in the future our model for dividends  that we got in the past, plus some growth. This is one of the most conservative ways I know to value a stock and hence why I'm using it here to value the index.

Here are the numbers:
  1. All-Time Dividend Growth. Since 1960, the S&P 500 has grown dividends an average of 5.04% per year (note: variance is large, meaning some years this number is much higher, others much lower).
  2. 10-Year Dividend Growth. The last 10 years have seen a lower dividend growth, just 3.58% annually.
  3. Today's Fair Value. Assuming a 5% growth ad infinitum a 7.5% discount rate based on an estimated dividend for 2011 of $24.28, today's fair value is 971, meaning the market is overvalued by 33%.
Modeled value vs. real value for S&P 500 using DDM.

S&P 500 Fair Value from an Earnings Perspective

Earnings provide another way to assess the fair value of an index. By looking at historical growth and current earning yield, we can put a fair price on the index. However, earnings are a secondary measure of what one can get out of an index, since not all earnings flow to the investor as dividends. 

While earnings can give us a good feel for how the market is doing, it can't tell us what the companies will do with their earnings nor how they will return them to us investors. Dividends can be cut, but earnings are flakier, given that they're not usually thought as belonging to shareholders, which is a shame, but quite true of most companies.

Here are the numbers:
  1. All-Time Earnings Growth. Since 1960, S&P 500 earnings have grown an annualized 6.81%.
  2. 10-Year Earnings Growth. For the trailing 10 years, earnings have grown 4.07%.
  3. Today's Fair Value. Assuming 2011 earnings of 87.84 and applying a P/E multiple of 15, the S&P would be valued at 1318 today, meaning the market is undervalued by 1.7%.
Modeled value vs real value for S&P 500 using earnings.


Whether you choose to believe the DDM is more accurate or the earnings approach is more accurate, both currently indicate that the S&P is anywhere from fairly-valued all to the way to grossly overvalued.

However, this numerical assessment assumes a smooth continuation of history without taking into account all that is going on with the economy, international affairs and expectations of inflation/deflation.  Use this to help you make informed decisions, but do not rely entirely on it.

The source of raw data is still here (no affiliation with the authors or their institutions).

Disclosures: I own SPY and many other whole market-tracking indices at the time of writing.


Portfolio Returns for 2010

2010 is now history and it's time to update my portfolio returns to check on my progress so far.

In 2010, my US portfolio, which excludes real estate and foreign accounts, returned (including dividends) approximately 11.3%. Comparing with the S&P 500, which returned (including dividends) approximately 15.1%, my returns are not great.

But my results don't bother me at all, because my portfolio has less risk than the S&P and does better than the S&P in down years. Let's see why. But first, let me define risk.


I don't consider risk to be equal to beta or the Sharpe ratio. That's because I don't mind price swings (which increase beta) as long as I believe that in the long run, my buying power will be maintained or increased versus inflation.

In other words, I consider risk to be the degree with which I may lose principal, either via loss of capital (due to bankruptcy, long-term loses in the underlying companies, etc) or inflation.

With that, let's dissect my portfolio a bit to understand where I trailed the market and why I should not worry about it.

Portfolio Drag

Looking at my holdings and the weights they play on my overall allocation, I found out that the main reason for underperformance in 2010 was due to my bias towards large value companies. These are mainly blue chips that pay steadily-growing dividends such as HD, WMT and JNJ.

Let's look at a couple of those:

Johnson & Johnson (JNJ). The BandAid maker opened the year at $64.41 and closed it at $61.55, hence returning -4% in share price appreciation. When adding the 3.2% dividend, JNJ's total return was a negative 0.8%.

Walmart (WMT). The world's largest retailer opened the year at $53.45 and closed it at merely $54.09, thus returning 1.19% in share price. When adding its dividend of 2.2%, WMT's total return was 3.39%.

Home Depot (HD). The home-improvement retailer opened the year at $28.93 and closed at $30.21, thus returning 4.4% in share price. Adding its 3.3% dividend, HD's total return was 7.7%.

Therefore, my over-reliance on these big names caused my portfolio to lag behind the larger market.

However, as I've mentioned before, I believe my capital will be preserved better if I stay with these stocks for the long-run, as opposed to rotating in and out growth or "story" stocks throughout the year.

Goals, Restated

For the largest part of my portfolio, my goal is on dividend growth and capital preservation. As such, I believe these companies will continue doing the job. All three have been increasing dividends over the years (HD did pause for a while though, but I believe they will resume soon) and as long as my capital is safe with them, I will reap the benefits of the increasing dividends over time.

To recap my investing approach: When I invest, I look for companies with a history of sustainable dividend growth. Then I factor in this growth and current share price to determine a price I should pay now that will yield at least 11-12% dividend return over many years, with a margin of safety of between 10 and 15% (depending on various fundamental and historical factors).

For this reason, I'm quite happy with my returns so far. I will lag the S&P in good years, but I will do better in the down years (like I did in 2008).

Disclosures: I own every stock mentioned above at the time of writing.


Two High-Yield Funds To Consider In 2011

In my quest for high returns, high yield is an obvious candidate. It's also a tricky one for the same reason: if it's so obvious, it probably won't last long or is very risky.

Nonetheless, a little bit of research can help mitigate these things a bit. Research won't guarantee anything -- nothing is ever guaranteed in investing. But I digress.

Here are the two funds that may help boost a small part of your portfolio the same way they're boosting a small part of mine (emphasis on small).

CEF Income Composite (PCEF)

The PowerShares* Closed-End Fund Income Composite (ticker: PCEF) is a fund of closed-end funds seeking high current income. It tries to achieve this by rotating in and out of closed-end funds when they offer a discount to NAV (net asset value) and good risk-reward prospects based on PowerShares proprietary trading technology. It currently yields  about 8% and pays out monthly dividends. It has a very steep  fee: 1.81% (0.50% for the ETF and the rest as per the underlying funds).

What I like about this fund is in part derived from what I like about CEFs (Closed-End Funds): they often trade at a discount to NAV and attract less attention than other funds. CEFs are often leveraged and they use long and short strategies to boost performance (and thus increase risk). The subject of closed-end funds is very interesting, but long. I'll reserve the details for another post.

With PCEF in particular, the yield and the monthly payouts are very nice. I looked at the top 5 funds that compose this ETF and they are reasonable funds with the typical risk profile of CEFs: some leverage (20-30%), a good diversifications of securities and most are not managed payout funds, which in my opinion are horrible funds (managed payout funds are those that make a distribution whether or not they have gains, which means that in lean times they will return capital to shareholders, which is a waste of time). Sadly, out of the top five funds, two are returning capital to shareholders.

Here is the breakdown of investment of PCEF, according to PowerShares:

(source: PowerShares.com)

High Yield Bond Fund (DHY)

The Credit Suisse** High Yield Bond Fund (ticker: DHY) is a simple CEF, not a fund of funds. It invests primarily on US corporate "junk" bonds. These are bonds rated "below investment grade" by the credit agencies. What this means is that these securities are less likely to re-pay their debts than the theoretically safest bond out there: US treasury bonds. In reality, no company wants to default on their bonds, which would imply having to file for bankruptcy protection and possibly liquidate the company. But in practice, this does happen, so the credit rating is important. Just keep in mind that low doesn't mean investors won't get paid. It means investors should demand higher yields.

DHY offers a monthly "dividend" (treated as regular income at tax time) that yields about 11% annualized. The underlying portfolio has a medium duration -- 4.75 years -- which means that the portfolio is not super sensitive to interest rate changes like, say, a 30-year bond. But it is not immune either.

The fund is leveraged, about 29% and has an expense rate that is very steep: 2.65%. Typically, I don't invest in funds with high fees, but in the case of CEFs I allow a few exceptions when I can get the funds at a discount.

This fund in particular is offering about 1-2% discount to NAV right now (it was 1.1% when I bought it). But it recently traded at a large premium (see graph below), which means that an attentive investor may capture outsized returns.

(source: CEFConnect.com)

It has, however, traded at significant discounts to NAV in the previous 3 years, which means this is a short-term play only.


I consider both of these investments to deviate from my value strategy. First, they are expensive and leveraged and second, at least DHY is a short-term investment only given its long history of premium/discount. So, consider yourself warned. However, the yields are decent and given that inflation is pretty much staying under wraps for a short while (at least until the Fed hits again with QE3), these two funds can offer a nice current yield.

Have a profitable 2011 everyone.

Disclosures: I own both of these funds at the time of writing.

* I'm not affiliated with PowerShares in anyway. Moreover, I usually don't endorse their dynamic way of portfolio construction and higher fees. This is one of the exceptions.

** I'm also not affiliated with Credit Suisse either.