The Problem With Investing in High-Tech

As a high-tech engineer and a value investor, I'm often caught in the middle of what might be seen as a conflict between the two: should value investors shun high-tech?

Hardcore value investors often quote Warren Buffett's reasons for not investing in technology companies: Buffett admits he does not understand the world of high technology well enough to be sure of which companies will still dominate their core area in 10, 20, or even 30 years from now. Despite being friends with and admirer of Bill Gates, Buffett has never invested in Microsoft nor any other high-tech company. The closest he got to high-tech was investing in Chinese fuel-cell maker BYD.

The Case in Favor of High-Tech

Predicting dominant position in 20 or 30 years is not really what value investing is all about. There's plenty of money to be made by companies that don't fully dominate their markets. After all, not every company can be a dominant player in its market, and there are way more profitable companies than markets out there.

Moreover, being the dominant company in the next 10 to 30 years is probably asking too much of tech, where many of its fields did not even exist 5 or 10 years ago. Fortunes can be made in a short span of time in technology, since consumer preferences change quickly, specially for online services (think social networking, search, micro-blogging platforms, etc).

Also, high-tech is where a lot of attention is. And following attention, many times is reward. And attention should be there in case of tech. With simple changes millions of lives can be changed (typically for the better, but not always).

Think of how people found addresses until recently: physical maps. Then printed maps online, GPS devices and now phones and watches can guide you from Timbuktu to Kathmandu.

Or how many expecting mothers couldn't see if their babies had any problems before they were born because ultrasound imaging technology didn't exist.

The Case Against High-Tech

That said, there are real criticisms for investing in tech that are not related to the difficulty in predicting dominant positions in the future.

The problems are many.

Need for constant innovation. How can one ever be sure that the next product to come out of Apple will be a blockbuster? Motorola all but disappeared from the market after its success with the Razor phone. One day the Apple's iPhone is all the rage, the next day, Google's Android is outselling it. High-tech companies need to invest a lot of effort into innovative new products to keep people buying new ones. And that entails spending money on research and development and also retaining talented employees. Compare Apple or Nokia with Coca-cola and WD-40. Which ones haven't changed their product in 20 years?

High-tech companies are typically young and without a solid track record. That's just the nature of their businesses. While this is not true for some more mature companies such as Microsoft and Intel, others are still not exactly on Value Line's 10-year index either.

Most tech companies don't pay dividends. And the few that do typically don't pay meaningful dividends. They keep the cash around for making deals, acquiring smaller upcoming companies and defending their positions, which can typically be attacked very quickly by faster, more nimble smaller competitors.

Repeat business. While not all tech companies are single-sale business, some are. How many times can someone buy a new video game, laptop, cellphone, etc? Having repeat customers can often yield superb results. Think Starbucks coffees and Gillette razors. Warren Buffett once said about his investment in Gillette that he takes comfort in knowing that 2.5 billion males will be shaving in the morning.

Too much attention. As discussed before tech draws a lot of attention and it's harder to find inefficiencies and mispriced securities when everyone is dissecting these companies. Value investing has a lot to do with discovering hidden gems in balance sheets.


All told, I love innovation and the occasional high-tech gadget. And I do reserve a small pool of money to invest in promising new technologies and solid high-tech companies when they fit my investing criteria.

But when it comes to investing the bulk of my money, it goes into companies that are simple, have been established for long, draw less attention, don't require a lot of innovation to maintain and, of course, pay out lots of dividends.

Disclosures: I own shares of PG, KO, GOOG at the time of writing.


Starting Your Own Business

I want to apologize. It's been quite a while since I last wrote here. You'll know why in a moment. But first, I want to recap what I consider to be "the" formula for getting financially independent.

The Get Rich Constantly Formula

Long time readers of this blog will know what I consider to be the formula to get rich. It boils down to constantly building cash flow that gets reinvested into more cash-flow-generating investments.

To get there, the formula goes like this:
  1. First, invest in yourself with whatever means you have.
  2. Get a job where you can get raises often.
  3. Save money and invest. Focus investments on...
  4. Dividend-paying stocks.
  5. Real estate, for the rent and proceeds from sales by building it yourself.
  6. A small part should be invested in a mix of bonds (municipals or corporate preferred), commodities (gold, oil, agricultural), foreign currencies, and to a lesser extend speculative capital gains opportunities.
  7. Private equity (angel investing, small startups).
  8. Building a business.
The last one, Building a Business, I have alluded to a few times, but haven't discussed in detail. So, today I'd like to focus on it.

Starting a Business

Starting your own business is a big decision. One that needs to be fully thought-out before embarking on the entrepreneurial ship.

On the other hand, a business, if built right, can help one grow cash flow. The idea is to leverage resources -- money, hard assets, other people's time and effort -- to solve a problem that people are willing to pay money for. With the proceeds from sales (of service or goods) one reinvests in the business to make it grow to its full potential. As an entity, a business lives forever and if profitable, that theoretically infinite stream of income can generate salary for many as well as dividend to shareholders (you, the business owner).

Fallacies of Starting a Business

Note that I suggest starting a business as yet another source of cash flow, similar to buying dividend-paying stocks. The idea is to leverage "the system", which is the sum of assets (patents, machinery), employees, and a plan (the business plan), to generate this cash flow.

But many people confuse working on your business with working in your business. One's goal should not be to create a new job for oneself. That you already did on step 2.

Instead, one should focus on working on the business.  This means building a rock-solid plan that is so simple anyone could execute. Why? Warren Buffett once explained why: "I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will".

Hence, your goal should be to come up with a simple system that can be applied repeatedly to generate money as a business structure. Of course, this is not to say that there is no work involved in the business at first. If it were that easy, anyone would do it. The goal though, is to make it simple to operate and free yourself to work on it -- that is, generating improvements, new ideas, closing deals -- instead of doing all the jobs that can be outsourced like accounting, paper filing, greeting customers (if that's not what you're good at) or talking to suppliers (unless you're a good negotiator and enjoy doing that).

Take, for example, a restaurant. Many people can cook. Many people can cook well. But cooking well doesn't mean being able to have a restaurant. In fact, cooking well can easily get in the way of building a great restaurant. Why? Because as a restaurant, one needs to be able to provide fresh and tasty food in a short amount of time to many people. Even if you have a small restaurant that only serves four to five tables at a time, you still need to cook their meals within 15 to 25 minutes. No one will wait an hour until you roast that pork and no one will want yesterday's pork either.

In this case, cooking like your grandma used to may be a detriment to the business. The trick, so I'm told by a friend who owns a great restaurant, is to develop recipes that are fresh, delicious and can be prepared relatively quickly in a consistent and repeatable manner. Pre-cooking that pork will not work unless you know how to keep it fresh and moist and ready to serve while your customers wait.

My New Business

Okay, so you got the message. You may still be wondering why it took me so long to post something new here.

The reason is that I've been busy working on one of my passions outside of investing: nutrition and fitness. And as an investor and entrepreneur I decided to follow my own formula and turn this passion from a hobby into a business.

Today, I'm proud to present my new venture: Entropy Energy Replenishment Drink. Entropy is an anti-aging drink that helps the body's own mechanisms turn fat into mental focus (these statements have not been evaluated by the FDA. Entropy is not intended to treat, cure, prevent or diagnose any disease). Entropy was developed after many years of experimentation and studies. You should try it out. To boot, you get a 10% discount by using coupon code EPINV2010X.

Besides creating it out of passion, I partially did this to learn the steps and later be able to tell others about it. With this new business, I've now executed on all steps of my Get Rich Constantly formula above.

So now you know why the long absence. Next time, I will discuss how I put the company together and how I plan on working on it instead of in it.

My goal is to slow cook that meal once and then find ways to make it repeatable in under 20 minutes. In the beverage world, it takes a long time to come up with a good formula and flavor, but once that's done, you as a consumer get to drink it right away. And that's how it should be.


Investing in Real Estate in Emerging Markets

While the economy in the US and Europe continue to melt, savvy investors are turning their eyes to "alternative" investments, such as gold, venture capital, and foreign real estate. Today, I want to talk about one of these alternative investments, which readers of this blog are now familiar with: foreign real estate.

Every emerging country is different and the one I'm following more closely is Brazil. Just watching the stock prices of Brazilian home builders -- many of whom IPOed or raised more money in the last couple of years such as Gafisa, Mills and Rossi -- and their underlying fundamentals, it becomes apparent that they're making money, and a lot of it.

But there is no need to watch the stock market for this if one is attuned to what's happening with the real estate market. Brazil has a strong economy where the lower class is getting richer, thanks to a solid economic policy in the last couple of years and a myriad of government subsidies and protectionist laws (the latter two of which, by the way, have their many downsides in the long run, but that's another story).

Good deals don't last long, but they're happening everywhere. I'm aware of new high-end beach houses in gated communities in the south, commercial buildings in the financial town of Sao Paulo all the way to low-end popular apartments in Rio de Janeiro, right where the World Cup 2014 and the summer Olympic games 2016 will take place.

Out of these, the popular apartments in Rio caught my eye. One particular set of buildings is planned for 2012. The builder is offering very low financing, according to government rules to incentivise the low middle-class to buy their first home, and financing is eligible for such government credits. It's as sweet a deal as the cash for clunkers was in the US. These are modest two-bedroom, one bath small units about 10 minutes from the beach, right where the bulk of the Olympic games are supposed to take place.

The risks:
1. Too many investors and speculators driving up the price to the point they can only resell to other investors and not to their target audience. That's the basis to form a bubble.
2. Overbuilding. This shouldn't be a problem for at least the next two years or more, since Brazil has a shortage of homes and pent-up demand. But the market is local and each area has a given capacity for building and demand that are unique. Those with first-hand knowledge of their region will have the upper hand.

The benefits:
1. The upside is tremendous. Some investments are returning anywhere from 20 to 60% a year.
2. In the worst case, investors can rent their units. Demand exists.
3. Qualifying for credit in Brazil is tough, but when buyers are approved, they really are creditworthy and chances of investors getting the short end of the stick are low.

Unfortunately, none of the opportunities I mentioned above are available anymore. Good deals don't last long. But others will come up. Readers interested in finding out about upcoming deals and similar opportunities should get in contact through the comment section below.

Disclaimers: No shares in companies mentioned. I own real estate in Brazil.


Sources of Personal Income

This article originally appeared on The Div-Net on 2010-07-13.

Last time we talked about sources of income it was in the context of where companies get their income from. We discussed one specific company and how healthy and durable that source was.

Today, I want to talk about your personal source of income. Like companies, you too probably want to make sure you have a diversified stream of income from reliable and durable sources. For most people, that source of income consists of salary, savings accounts, stocks and bonds and perhaps even a rental property. If you have any two of these you are already better than most people on this planet in terms of income.

But chances are you're a reader of this blog because you would like to have more income. And we do cover a lot of ground regarding stocks, dividends and even real estate. But the investment world is not limited to those and perhaps you should consider adding other income streams flowing directly into your pocket.

Let's take a look at some of the possibilities.


Adding more salary to your income stream is probably something you're already doing now. Getting a raise or a bonus is what you work so hard for. We even discussed the topic of return on salary previously. But once you get it, chances are that to get another one you have to work even harder or longer. And at some point this plan doesn't scale anymore -- it can't continue to grow and grow.

So, what should you do? Get another job? Well, that's always a possibility. One can work part-time or on weekends or after-hours or double shift. But again, this only goes so far.

Is all lost then? Not at all. Keep working on (and in) your job but start to look at other possibilities too. Have you considered...

Angel investing

We discussed that by looking to invest on small or startup companies that other investors cannot invest on (because they lack the personal connections), one can even beat Warren Buffett at his own game as well as big-shot venture capitalists who are looking for the next Google and will probably miss the next corner store, butcher shop or flower stand.

If you keep your eyes peeled and your ears tuned, perhaps you could even invest in the next Walmart before the big shots. But if not that, investing in your next neighborhood bar or local gas station might be a start and a solid plan, depending on your capital and expected return.

Investment clubs

Investment clubs are nothing new. But they can be overlooked by many investors because investing often feels like it should be a solitary activity. Nonsense! Investment clubs can actually scale better than solo investing because by pooling together people with similar goals, it's easier to benefit from each other's knowledge and time to analyze companies and find new opportunities.

Often times, investment clubs that are flexible enough may even want to pool their resources together to invest in private companies, do some angel investing or move into real estate.

The benefit is clear: leverage each other's time, money and all get to share the benefit of new ideas from others who may think alike but do so independently.

Start your own business

This is also a topic I've alluded to before but have yet to discuss further. Opening up your own business -- whether part-time or home-based -- can be easier and safer than one imagines.

First, there are many businesses that don't require huge upfront investments nor huge effort or high cost to operate. And while one may think these are easy to replicate and thus should return close to zero to their owners, think again. The trick is to do something you love or have a strong interest in or something you'd love to have but somehow is not available yet or is not easy to get in your area. Or you just need to do it better than the competition. In many cases, you don't need to do all of these, so long as you have the passion or interest.

Let's just consider a few examples that are close to me. I'm sure you can think of a hundred other example of small businesses that you could create easily and that are meaningful to you.

Growing escargot. Yeah, the slimy snails that some people love to eat (especially the french). Turns out my dad used to create escargot in our backyard when I was little. He had plans to sell them, but he never developed the business around it and chose to eat them all instead. Growing escargot is easy -- they reproduce faster than rabbits -- and extremely cheap -- they eat lettuce and other greens. If you have even a medium-sized backyard, you can build a little shed and grow escargot in simple to build boxes. Just make sure you have all the necessary sanitary and business permits and you could sell them fresh or frozen to your local specialty store, restaurants or even grocery shop chains.

Pizza dough. Growing up, I remember us buying pre-made pizza dough from a friend's neighbor. They made the dough at home and packaged them in four or fives and sold them to order. If I were to do this today I'd probably offer multiple options such as whole wheat, yeast-free, gluten-free, special multi-grains, vegan. All organic and natural and 100% preservative-free.

The pill. Yes, believe it or not I have a friend whose grandparents used to make women's anticonceptional pills at home. They had all the permits and licenses and sold them under their own brand name. They never felt much competition from the big brands because they had their local niche market. I would probably be more careful on this one given the risks, but with proper knowledge and insurance this just comes to show that one can get as entrepreneurial as one wants. The sky is the limit.

Homemade jewelry. I actually know two people (not related to each other in anyway) who used to make earrings, rings, pendants and other jewelry at home or at small local shops from cheap metals or semi-precious ones, with semi-precious stones or other good-looking materials. In one case, the person would sell everything she could make to big-name retailers who would sell under their exotic or one-of-a-kind departments.

There. Four small but very real ventures created and run by people like you and me, most of which had a job and a family to attend to.

Know how to cook? Love dogs? Can build children's toys out of stuff in your backyard? Can teach piano lessons over the internet? What are you waiting for?

This article was written by EPIC INVESTOR.


Building a Strong Dividend Growth Portfolio

When it comes to indexing I usually have two views: it's a great tool if one doesn't have the time or inclination to analyze stocks, but it's also a wide catch-all net that brings in the tuna along with the catfish.

So, what should a time-constrained investor do if one doesn't want to invest in the entire market or a sector at once and get the chaff along with the wheat? Answer: Buy the strongest dividend payers from selected industries. And to find out who these dividend payers are one can do their own detailed analysis or read this blog.

Selected pharmaceutical index

The list below is a non-diversified list of strong pharmaceutical companies that have a history of paying dividends. Not all are cheap, but the point of indexing a sector is to get the benefit of the industry as a whole without having to guess or investigate which company has the best pipeline, the best strategy or the best cash position to go after acquisitions.

If one believes, like I do, in the future of the pharmaceutical industry -- which is home to great companies, many international, and robust dividend payers -- then buying the strongest companies is a wise strategy.

Dividend yield-based weighting

Should one buy an equal-weighted index of these companies? Well, first, if by equal-weight one means same number of shares, the answer is no. Share price is too dependent on number of shares, which is arbitrary and as such this index would be arbitrary as well. If one buys an equal number of dollars per company, that's a more suitable strategy but it would still assume that all companies are equivalent, which is not a good assumption.

A better way to index is to use a dividend yield-based indexing: buy more dollars worth of companies with higher dividend yields. This approach has two benefits: 1) one buys more of the higher-dividend companies which in turn boosts the yield of the portfolio and 2) higher yielding companies in the same industry are typically considered cheaper than peers since the yield is higher because the price is lower, so one ends up buying more of the cheaper companies.

However, this pure yield-based approach also has drawbacks: 1) high yielding companies can be cheaper for a reason, and a thorough investigation of these reasons defeats the purpose of this lazy indexing approach; and 2) high current yields could mean the companies have little growth ahead of them and as such the dividend may not keep up with inflation or growth elsewhere.

So, what's the alternative?

Dividend growth-based index

Factoring in current dividend yield as well as dividend growth should provide a much better index because current yield plus dividend growth equals total dividend returns. So, this indexing method is equivalent to saying "buy more of the companies that will return more money to you in form of dividends".

Of course, dividend growth involves making predictions about future dividends. However, armed with fundamental analysis and a long history of dividend growth one can make informed assumptions about future growth and thus minimize the risk of making a bad call.

With this, here's my dividend growth-based index of pharmaceutical companies based on 10-year historical growth rates and current yield and their respective weights.

Ticker 10-yr div. growth Curr yield Curr Price P/E Weight
NVS 13.74% 3.93% 49.55 12.07 2.36
JNJ 12.84% 3.57% 60.54 12.72 2.19
LLY 7.86% 5.57% 35.17 9.07 1.8
ABT 9.26% 3.66% 48.03 14.08 1.73
PFE 7.87% 4.87% 14.77 11.89 1.7
GSK 5.53% 5.28% 34.84 10.2 1.45
BMY 3.73% 5.00% 25.6 14.71 1.17
MRK 3.29% 4.19% 36.3 7.57 1
Putting it all together

The "weight" column in the table above indicates a dollar multiplier for each ticker. That means one should buy 2.36 times more Novartis (NVS) than Merck (MRK).

If one has a budget of $10,000 to allocate to this index, and rounding the number of shares to their nearest whole number, one should buy $1783.8 (36 shares) worth of NVS and only $762.3 (21 shares) of MRK.

The final portfolio worth approximately $10,000 in today's prices would look like this:

Shares Cost $
NVS 36 1783
JNJ 27 1634
LLY 38 1336
ABT 27 1296
PFE 86 1270
GSK 31 1080
BMY 34 870
MRK 21 762
Of course, one should only follow this approach if one doesn't have time to do a thorough due-diligence fundamental analysis and after consulting with their financial advisor.

Disclosures: Long JNJ at the time of writing.


Preparing a Shopping List for Bad Times Ahead

Several pundits online and on mainstream media are calling for another "leg down" or plain depression in the markets soon.

I don't react to predictions, forecasts, star readers or fortune tellers. I will see when it happens. However, it's always good to be prepared for anything -- up markets, down markets, neutral markets -- at all times. As such, I have my shopping list ready in case the forecasters turn out to be right.

Because it's a long shopping list and it's mostly still far from my entry prices, I will just pick those that have been approaching my entry price recently. Many of these are names I already own and am looking to buy more of. Some are new.

Shopping list for the next "leg down"

PAYX (Paychex) - Buy range: $25-21, Current: $25.47
COP (ConocoPhillips) - $47-38, Current: $48.82
PFE (Pfizer) - $13-11, Current: $14.14
RDS.A (Shell) - $48-42, Current: $50.01
CINF (Cincinnati Financial) - $23-21, Current: $25.53
ETR (Entergy) - $75-60, Current: $70.70

Note 1: These are all dividend payers that have been around for a while and paying dividends for a while.

Note 2: Entry prices were based on my model of discounted dividend analysis and a qualitative assessment of earning power. The entry prices typically entail a total return from dividend plus dividend appreciation to 11 to 12%. Any share price growth is extra icing on the cake (and was not factored in the price).

Note 3: There are two oil companies on the list. This is a good thing, because when governments in developed countries start to print money seriously, oil, gas and tanker and pipeline companies will benefit. It's best to own the companies behind these commodities than own the commodities outright for various reasons that are beyond this article's point right now.

Note 4: I started buying Shell a little ahead of my entry price and am looking into buying more significantly when it does enter the buy range.

Note 5: I haven't bought Entergy yet because I haven't had time to investigate their price drop and read their latest 10Qs. As soon as I find out they're still in as good a shape as when I first priced my buy range, I will pull the trigger.

Disclosures: I own shares of PAYX and RDS.A at the time of writing.


Return on salary

In this blog, we've been talking about investing and getting a return on your investment. However, as most readers tell me, besides being investors, they are also salaried workers. Do the same principles of investment apply to salaried workers? But of course.

One should look objectively at compensation, with an investor's eye to it. The concept of return on salary should be routinely checked to make sure one is not working in vain.

Return on salary is simply the annualized rate of change in total compensation. For example, if one gets a pay raise on year 2 of 10% and then again on year 3, and no more raises until year 5, then over five years, this person has had a return on salary of about 3.8% (assuming salary of X at year 1, this person ends up with a salary of 1.21X on year 5 because a 10% raise applied twice is 1.1 x 1.1 = 1.21 and that annualized over five years is equivalent to 1.21^(1/5) = 3.8%).

So, this fellow would be in practice a little ahead of inflation, assuming inflation is 3% per year -- but not much more than that.

On the other hand, someone who gets a 20% raise twice would fare much better than inflation at the end of the same five-year period: 7.5% per year.

Of course, we are not advocating that people focus on a salaried job to get rich. Very few people manage to do that. But if that's your biggest source of income, then watching your return on salary every so often is important to make sure you're not losing to inflation or effectively staying behind on pay given your added responsibilities as you progress in the job.

If you're only getting raises that match inflation or you're only getting promoted every so many years, you may effectively be making no progress on the financial aspect of the job.


How bad is "excessive" debt?

Investing and accounting books everywhere say that too much debt is bad. One can resonate with this mantra. After all, debt holders are the real owners. They are the ones who dictate the terms of the loan and how the loan will be paid back. Many loans even have special clauses that force payback if certain ratios exceed given thresholds -- that is, exactly when the situation is bad for the company. In other words, debt holders are those who lend you an umbrella when it's shining but demand it back the moment the rain shows up on the horizon.

There is no hard and fast rule about how much debt is bad. Certainly, a debt-to-equity ratio of 100 to 1 is pretty bad, no matter how one tries to spin it. But then there are those who think that 2:1 is already pretty bad. These are the likes of Warren Buffett and similar conservative investors. "The least the best" they say. I don't recriminate them. After all, I too don't appreciate gratuitous debt or companies that must take on debt because they have heavy fixed expenses or need too much reinvestment into fixed assets just to stay afloat (case in point: airlines, car manufacturing and some mining companies).

But there's a subtle kind of debt that is not at all bad. That is private debt with the owners.

A common way to fund a startup is by giving it equity -- owners put in cash in exchange for shares. Another common way to do it is to lend money to the company. In many ways, an owner lending money to his or her company is a smart way to fund it and yet keep first dibs on any cash left over in case the company goes under.

I currently hold a tiny cap company that has a 4:1 debt-to-equity ratio and is about to take on more debt. And yet, I'm not at all worried about it because the only reason this debt load is high is because of accounting reasons -- the owners prefer to fund the company that way, but are otherwise convicted of its success and so am I.

So, there you have it. There's bad debt and there's just accounting debt. Differentiating them can provide investing opportunities that are typically overlooked by even the deepest of the value investors.


Final Update on Real Estate Investment

This is my last update on my much discussed foreign real estate investment. The final return on this investment is now about 33%.

We started with an expected return range from 40 to 98% in mind. We assumed something in the middle of the range was doable. There were unforeseen costs and a surge in supply in the area, which made the sale difficult and thus brought the price down. In the end, 33% over about a year is still a very strong return (construction started this time last year, but the land had been purchased six months prior -- the land, though, was cheaper than the construction itself).

The lesson here is to have a margin of safety, as we did, and to watch out for hidden costs, which eat into the profit margins.

All told, this was a successful investment in two fronts: a successful learning opportunity for three first-time real estate developers and a nice return to go along and set the bar high from here on.

Now I'm preparing for the next one. Or two or three.


Invest in ethics

It seems like an obvious thing to say "be ethical, be honest" and yet there are so many people and so many companies out there that are not. Some make money, some don't. But in the long run, there is no other way to run a sustainable business without these qualities.

While a simple comparison between the returns of the FTSE KLD social index ETF with those of the S&P 1500 over 1, 3 and 5 years shows a small advantage to the socially responsible group, the jury is still out on who ultimately wins. There are academic studies that both support this theory and some that show no difference in returns.

Regardless of who wins, there's no doubt in my mind that there is one major pre-requisite to being in business and that is being honest, transparent and ethical (socially responsible is just a part of these qualities).

Instead of engaging in over analyzing why people and companies behave unethically, a much better question is "why would anyone invest in companies or people who behave unethically?".

A few stories to illustrate

I know this small business owner who operates in the service industry. He hires service providers to deliver services to a third party, the third party pays him, he pays the service providers the bulk of the earnings and takes out a small percentage, for coordinating the team and assuming all liabilities for the services rendered. His percentage goes down as his team grows.

It just happened that over a short few months last year his team started to flock to a competitor who offered slightly higher rates. His business suffered. But he remained honest and insisted on paying his team fairly and timely as always while his competitor had to make up for the higher wages by delaying payment and "accidentally" misplacing people's paychecks.

So what happened? The honest small business owner soon saw his business flourish again as his competitor started to lose people due to dishonest and unethical behavior.

Moral of the story: honesty pays, dishonesty is not sustainable.

A personal story

I recently hired a team of contractors for a small project of mine. The candidates who seemed the best had done work in advance of being awarded the project. They had updates and demos for me even before I agreed to hire them. Their turnaround time was impressive, sometimes answering my concerns within a few hours. So I hired them, expecting nothing short of great results. I was promised a new update the next Monday.

So a few days went by and on Tuesday I decided to check on the status of the job. The contractor said the team was on holidays for a few days but that the next day, there would be updates. Another day went by and this time I was told that the team was actually busy working on another project, but that within a day or two they'd be taking on my job. They had lied to me. Of course, the next two days went by and the team was "getting started very soon now".

Had they told me upfront that they were busy, I might have taken my project to someone else or I might have chosen to go with them anyway. But now, not only I'll never hire them again, I won't let anyone I know hire them either. That's worse than losing one single job -- they lost a customer, possibly a repeat customer, and who knows how many more customers they've now lost.


These are just simple illustrations of why I believe that being ethical in the long run is the only way of operating. As such, I don't hire or invest in businesses that can't or won't operate in the most ethical way possible.

No investor should. Do your homework before investing (or hiring).

Disclosures: No interest in the above mentioned securities.


Beat Warren Buffett

Warren Buffett likes to remind us that he likes easy one-foot hurdles he can step over rather than having to jump over the higher ones. He's referring to companies that are easy to understand and provide a lot of downside protection. It's easy to make money if we can find these easy-to-step-over hurdles!

However, for us non-Buffetts, finding these safe money-making investments is not that easy -- and Buffett admits it's getting tougher for him as well. Investment is about taking risks and, of course, managing them.

So how can you and I beat Warren Buffett at his own game? Not by doing better research than him on public companies. Nor by buying big, private ones either.

Be where Buffett cannot be

Both you and I have an advantage over Buffett: we live in different places, buy different products, surf different websites, have different tastes and most importantly, we come in contact with new, small, local businesses that Buffett cannot cover!

What does this mean? Should I be buying small start-ups?

Why not?

Be an angel to small businesses and start-ups

I'm not advocating you go door to door trying to buy your local landscaper or butcher shop. But you can be a small angel investor in small businesses if you simply ask them. Many business owners will be happy to take your money. All you have to do is find one that you believe in. And you have the tools for that, and Warren Buffett doesn't: you already buy their services or goods or know about their future products or services first-hand, by word-of-mouth and local publicity.

Angels don't have to be those who can offer multi-million dollar deals or even hundreds of thousands. I once read a short biography of a successful entrepreneur named David Portes, who started out by selling candy on the streets, with borrowed money -- ten dollars. By the time I read about him, he was already making more than a hundred thousand a month from teaching marketing seminars and his candy-selling business. Those ten bucks came from an angel -- who, given the circumstances, didn't think of himself as an angel. But he effectively was.

You too can be an angel investor to perhaps someone in your family or a friend. Yes, investing in start-ups and small businesses can be a huge risk. But if you do your due diligence as you would do on a big business(*), you have an edge over Buffett and over Wall Street that not very many people have.

Think about it, how many people knew about Bill Gates when he was just a kid with a computer? It's true that for each Bill Gates there are thousands of Broke Bobs and Bankrupt Sams out there. Your job is to find the ones that are competent, that have a great product or service, a lot of energy and integrity and most importantly, whom you trust.

Being an epic investor is about looking where others aren't.

* Remember, in this blog, we never recommend you invest blindly in anything, big or small, new or established -- you still need to do the scuttlebutt to find a suitable business that qualifies for your investment.

Disclosures: None.


Current Short Interest

I thought it would be time to revisit the NYSE list of short interest. We've last talked about it in April 2009.

The NYSE table is interesting, but as it is it doesn't say much, because it's sorted by absolute number of shares sold short. But companies have different number of shares, so the sheer amounts correspond to vastly different percentages of their total shares.

To put things in perspective I like to look at the percentage of shares sold short, out of the total number of shares issued (column H in the spreadsheet). Too high and it means short sellers are aggressively shorting the stock and are probably very confident about it. Ignore numbers higher than 100%, these are ETFs for which the number of shares issued is simply a matter of market demand for the shares, which are created upon request.

Another interesting metric to look at is the number of days to cover (column G). This takes the number of shares sold short and divides by average daily volume. This tells us how long it would take for short sellers to unwind their positions. The larger the number the riskier it is for a short seller should a stock move against him/her. But it's also interesting from the perspective of a speculator trying to catch a short squeeze.

Finally, I like to combine both days-to-cover and percentage-short in one metric, where the product of the two gives us a number that "combines" both metrics equally. That is, the higher the number the highest the combination of both metrics together where both are equally important. Again, some numbers are skewed due to ETFs going above 100% shares sold short. Disregard those.

Here's the final table. Use it with care.

Disclosures: Long PG, BAC, GE, HD, EEM, KFT, SPY.


Bracing for Inflation

I'm no economist. Neither I have a crystal ball. Nonetheless, all I hear is talk about inflation. I don't know where it is, but from all I've read and thought about, one thing is clear: the US dollar will continue to lose value (as has been the case in the last 40 years or so since coming off of the gold standard), and it is likely to lose value faster than in the last ten years.

Again, I'm no economist. I don't know that there isn't a perfectly acceptable magic way out of this. But economists too have predicted seven of the last three recessions...

Anyway, it doesn't take much understanding about money to figure out that the USD is toast. With 30% of GDP compromised as debt and with the Greenspan-Guidotti rule out-of-the-whack the picture doesn't look rosy for Uncle Sam.

So what's an investor to do?

Well, by and large, nothing much one wouldn't do in normal times: buy undervalued, dividend-paying stocks. In the long run, if anything is going to hold value, it's a well run company with valuable assets (physical or intellectual) with a strong franchise.

Ok, but there might be something else investors can do to tweak their portfolios a bit: they should move their cash away from the USD and bonds and into:

  1. Diversified baskets of foreign currencies
  2. Physical assets (commodities, oil, gold)
  3. More stocks, favoring global companies with business presence in large foreign markets.

TIPS is not an unreasonable option, but being a taxable security and being tied to the official inflation rate (which is computed by those devaluing the currency), I tend to leave them as a distant fourth option.

Foreign currencies

I've discussed the role of foreign currencies before. So I'll just add that there's no reason to completely avoid emerging markets. The Brazilian Real is old news. But the Mexican Peso (FXM) pays a reasonable interest and I don't see it defaulting or going into hyper inflation anytime soon.

Physical assets

My beef with commodities and physical assets in general is their lack of dividends, lack of internal growth rate. Nonetheless, it doesn't hurt to have some as a backup plan.

My favorite commodity would be oil, given its importance as an industrial raw product and its finite production. Also, gold tends to do well in uncertain times like now.

But my favorite physical asset is really real estate. With real estate, one can obtain dividends (rent) and increase its value over time, through proper maintenance, and upgrades.

More stocks

As you may have guessed, investing in businesses is still my favorite option, be them your own business (assuming you're competent and are in a good industry) or someone else's, under the same assumptions, plus the condition that these companies trade for a discount and/or pay juicy, growing dividends.

However, there's no telling what will happen with the US or the USD. If the country defaults, we lose. If we go to war, we lose (as Phillip Fisher said in his book, "War is always bearish on money. To sell stock at the threatened or actual outbreak of hostilities so as to get into cash is extreme financial lunacy. Actually just the opposite should be done") and if do nothing, well, nothing will be resolved.

Disclosures: Long brazilian Real and global real estate.


Be a Zen Investor

A friend brought to my attention a very interesting article by blogger Leo Babauta, of Zen Habits titled "How Not to Hurry".

In the article, Leo exposes the benefits of taking life slower and doing things with more quality, more time and in a more relaxed manner. After all, being productive is not a function of how many things we do at once, but of how many things we complete orderly. "Nature doesn't hurry", says Lao Tzu, "yet everything is accomplished".

That got me thinking about how I practice stock-picking and how any form of investing should be taken: just as lazily, if not more.

Slow to buy, slower to sell

One should be slow to buy. A stock or bond purchase can be planned sometimes for years. Warren Buffett admits having wanted to buy Coca-cola for the better part of his adult life. But it wasn't until 1988 that he got the opportunity. Of course, when the opportunity arose, he was fast to pull the trigger. But being fast in 1988 pales in comparison with his 20+ years of waiting to buy.

Likewise, when selling, one should not hurry either, despite what most "common sense" out there might be. A quick sale would only make your slow buy seem contrived and ill-timed. If you spent time studying what to buy and when to buy it, it makes no sense to turnaround and sell it for a small profit or just because things deteriorated a bit. Most good buys never deteriorate this fast. The kinds of company that are associated with financial scandals and overnight bankruptcies are those you will avoid by buying slow and having a plan.

So, no need to sell anything fast. The slower you sell, the more dividends you collect and the better your tax rates will be.

The zen plan in action

Here is my zen plan that has been working for quite some time (since mid 2008 or thereabouts) with no change and close to zero effort. (Prior to this zen plan I had a somewhat similar strategy that required more effort -- subject for another day.)

  • Make a list. I made a list of good, solid companies that pay dividends and have a history of increasing them (these are also called Dividend Achievers and Dividend Aristocrats).
  • Determine fair value. I worked out their fair value by looking at various metrics, but mostly I valued them as bonds -- how much money will they pay me if they keep on raising dividends at a reasonable clip, comparable to their past history but not faster than growth in EPS and not much faster than their industry. This can be done with the help of the dividend discount model.
  • Apply a discount to fair value. This is to protect from errors in the assumptions. This is the price one should pay for an asset when time comes. Twenty percent sounds reasonable.
  • Wait. I sat and waited. And for a very long time -- a really tedious time -- I didn't buy much, but just waited for my price to be reached. Around November 2008 and then again in March 2009, the market panicked, the financial world was coming to an end and some good stocks traded at or below my target price. That was the time to be fast and hurried and I pulled the trigger many times.

Some of the good stocks I bought then include Gerdau ADR for $4.96 (it's now above $13), Visa for $45.40 (it's now above $80), Pepsi for $47 (it's now approaching $60), 3M several times for an average of $58 (it's now close to $79) and others like PAYX, KFT, HD and KO.

Some of these aren't really dividend achievers, but they all pay a dividend and I had fair prices established for them. (In the name of full disclosure, I also bought GE and a few US banks, which are underwater. I still have faith in GE, and the banks, while anemic, still pay a token dividend.)

Now it's a matter of waiting to collect the dividends and not being in a hurry to sell. If it really leads down the road to riches I will know many years from now.

No hurry.

Disclosures: I own every stock mentioned above plus others that I'm Zenfully holding for the time being.


Notes on Foreign Exchange

A reader recently asked my opinion on foreign exchange (forex). It depends, really. Banking on short-term fluctuations or active trading is financial suicide. But as a mechanism for parking a portion of one's excess cash not needed in the medium term (6 months to a year) it's not a bad idea and I actually encourage it.

Short Term Speculation

Anyone engaged in day trading or active trading in forex is losing money, necessarily. Forex is a zero-sum game for investors -- one side must lose in order for another one to win. But there's more: spreads, taxes, and commissions make it necessarily a losing game.

Not only that, but foreign exchange rates are thought to be even harder to predict than short-term stock movements. If you thought it was hard to value a company, imagine a country or a group of countries as is the case with the Euro. There's just too much going on -- policy setting, politics, lobbying, international interference, international trades, changing laws and even wars and natural disasters.

Stay away from short-term speculation on forex.

Medium-term cash parking

If you have excess cash (and you should, for your emergency funds), then diversifying away from your local currency is like buying insurance against three things:

  1. Government actions (jurisdictional diversification)
  2. Inflation
  3. Major catastrophes (natural or man-made)

Government action protection only works if you pick currencies from countries with a reasonable political history. It protects you from arbitrary actions taken by a governments that could adversely affect the currency, such as import taxes, interest rates, or even outright confiscation.

Inflation is listed again separately from government action because it's such a common threat. It's the invisible tax. A basket of currencies can help mask the effect of a single inflationary country devaluing your hard-earned cash.

And of course, if something terrible happens to a country, having some exposure to other currencies can mitigate some of the negative effects.

I currently don't put a lot of faith in the US dollar, so I believe it makes sense to have some exposure to other currencies (gold was discussed here).

Guidelines for investing in foreign currencies

So, what do I recommend? First, when possible, tilt your allocation towards currencies that earn some real (after inflation) yields. The Swiss Franc right now yields 0%, while the Australian dollar yields over 3%. You might as well get paid to wait.

Second, pick countries with a history of maintaining their stability and buying power. In this case, the Swiss Franc is a good option and it is also partially-backed by gold.

Third, choosing currencies whose countries have lots of varied natural resources may provide some comfort about the currency's attractiveness in international markets. Some options that come to mind are Australia, Canada, Brazil and South Africa.

Current opportunities

My current cash diversification is pretty bad and I don't recommend anyone follow it. Given what I just wrote, I will follow my own advice and diversify further. But just because you asked, my cash reserves are currently split as follows: 12% in Brazilian Reais, 6% in Australian Dollars, 4% in Canadian Dollars and another 4% in the South African Rand. The other 74% are still shamelessly in US dollars (in my defense though, I do have international stocks traded directly in foreign stock exchanges in their native currencies).

Until recently I was recommending CDs backed by a basket of foreign currencies, but I found that option to be cumbersome and not very fee-friendly or transparent so now I'm sticking with currency ETFs such as FXA or direct investment in the target countries (to take to the extreme the jurisdictional diversification).

FXA, by the way, is down 3% from last year's averages and yielding more than 3%.

Disclosures: Long FXA.


Infrastructure Opportunities in Brazil

To spur economic activity in Brazil, the government decided to do something unique: it opened up basic infrastructure projects (railroads, energy, roads, ports, etc) to private investors to use their retirement funds.

Explaining the deal

Let's go in parts: in Brazil, employers must contribute a fraction of their workers' salary to a tax-free account, which such workers can only use in very specific circumstances (buying a house, involuntary unemployment, etc). The money in such retirement funds are typically restricted and can only be invested in a few investment vehicles tightly regulated by the government, such as savings accounts and CDs. Therefore, it's no surprise they don't earn a huge return compared to all the options that would be available were such restrictions inexistent.

Now, in order to heat up the much needed area of infrastructure development, the government is allowing workers to invest part of their retirement funds into selected infrastructure projects.

What does this have to do with non-brazilian workers, you ask? Everything. Why? Because the companies poised to gain from these government-lead efforts are many and if brazilian investors join the bandwagon these companies should ring nice profits in the next few years.

The bad news

The bad news is that many of these builders and engineering companies are private and as such are very hard to invest in directly. They are the likes of Grupo Votorantim, Queiroz Galvão, Camargo Correa, and Odebretch.

The good news

The good news though is that some are public and even the private ones sometimes hold smaller subsidiaries that are publicly traded. For example, the financial arm of Grupo Votorantim, Votorantim Finanças, emits bonds from time to time, while Queiroz Galvão's subsidiary Braskem is publicly traded under the symbol BRKM3 -- though, Braskem is in the plastics and recycling business.

Camargo Correa also holds several companies, some which are public, such as ticker CCRO3, which is in the business of maintaining roads and commercially exploiting their toll booths. With more roads, toll booths are sure to boom too.

Finally, there are is one company left that is publicly traded and directly into the construction business: Andrade Guitierrez, which trades under the ticker CANT3B.

Sadly though, none of these are available as ADRs in the US. However, a strict ADR investor can still get some fringe benefits by investing in basic materials and exploration companies, such as chemicals company Braskem (ADR symbol BAK), Steel companies Gerdau (GGB) and Siderúrgica Nacional (SID), mining company Vale do Rio Doce (VALE) and homebuilder giant Gafisa (GSA). A far away alternative would be ETF EWZ.

None of these investments though are sure things, of course. These are just starting points. It's possible that these companies are overvalued and that the boon due to the new government-sponsored infrastructure projects have already been factored into their prices. Do your own homework before investing.

Disclaimer: I own GGB at the time of writing.