Money and Financial Business

I received this fantastic site on email today. If you are the type of person who hates talking to and keying in numbers to a computer on the phone, this is for you.

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Back from a Thanksgiving weekend today (left early to avoid NY-bound traffic from central PA). Three family dinners left me full of turkey, laughter and some sage advice from my wife's aunt Janine.

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My word of mouth network sent me a new client a few weeks back. Basic stats are couple, mid-50s, GI of $400K. I give them credit for realizing they needed some help. They are the perfect examples of what I call "Too Rich To Be Rich".

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Busy pre-holiday week has kept me out of the blogosphere but I have gotten some interesting comments this weeks. One of them came from "Guest" regarding my personal policy of holding all of my money at Fidelity for simplicity of record keeping.

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TECD reported this morning with results ahead of expectations and above the high-end of mgmt guidance. Both Americas and EMEA were strong sequentially. Gross margin was little weaker due to mix of products and where the product was sold and internal issues. Guidance for January quarter is for growth of 4-7% sequentially and 5%-8% Y/Y, which is on top of US Dollar appreciating about 10% from last

"The price you pay determines (your potential) rate of return"
"The price you get determines (your actual) rate of return"

A hypothetical situation:
Consider 2 equally intelligent investors buying stock of 'Pendulum, Inc' for $50, which they both know is worth $100. As all of you might agree that there is very little chance that they both will sell out at the same time (ie) end up with the same rate of return. Why? The possible answer could be the varying levels of emotional discipline. This is brilliantly explained by Warren Buffett as,

"Only when you combine sound intellect with emotional discipline, you get rational behavior"

Emotional Discipline:
When to sell is as important as when to buy. Because once we buy a security it becomes, "I own Pendulum, Inc ","I think it will do this & this"... The psychology that comes into play here is similar to how a mother feels of her child to be the best in the world. That psychology helps life flourish on earth but that tendency can wipe us in the markets.

The puspose of this write up is to share with you all my basic understanding of 'What causes fear & greed?' & 'How can we deal with them?'

Understanding Fear:
As a human being we might not expect the unexpected. But as an investor we cannot afford to not expect the unexpected. I think Ben Graham's emphasis on diversification is based on this notion (ie) expect the unexpected & be prepared for it.

"Emphasizing once again the element of diversification as a safeguard in all such operations, we express the view that a number of purchases of this type will in all probability turn out quite satisfactorily in the aggregate. That some losses will occur goes without saying, but the proportion of such losses should undoubtedly be much lower than the favorable outcomes in a normal period"--Ben Graham.

Also as Buffett has said, "If you cannot stand 50% paper loss on your stock, stay away from the markets."

We all think we can stand such a situation, simply put, it is not just that simple. Moreover the logic is simple, 'It's not a one way road to Rome'. One might have done everything right about picking up a stock but who knows tomorrow UFO might come up and carry away the management team of the firm & keep doing it every time shareholders replace them... We never know. What I am trying to say is, there are things over which we have no control and when somehow they happen we have to live with it. This is why diversification makes sense as far as I am concerned.

Understanding Greed:
"Content makes poor men rich; discontent makes rich men poor"--Ben Franklin.

I think of greed as 'Somebody expecting to have what he desires rather than what he deserves, provided that the desire is more than what he deserves. If it were other way around it will make him a satisficer.'

As human we all at various times end up being greedy to varying degree. But when it comes to investing we should train ourselves to be desirious of what the stock price deserve to be. It reminds me of beautiful quote by Ben Franklin,

"There's none deceived but that he trusts"

Conclusion:
The bottomline is buying a stock is much like one sided affair. "The stock does not know that you own it. Even if it does, say somehow, it does not care." Stock does not understand the word 'emotion'.

We should rather train ourselves to be respectful of the feelings of stock, if she does not like being loved, we better be good people and reciprocate that by not loving her. Moreover she(stock) might say thank you for being nice to her. We all know in what denomination does stock say 'Thank you'...

"All is well that ends well"

Well, I am done with most of my shopping and thanks to a mix of practiced frugality, creative cajoling and natural inertia I am actually under budget. I traded in the white iPod nano I received from my fairwell for a black one my coworker just bought for himself and gave him a $50 iTunes gift certificate as a thank you for being my knight in shining armor. Guess this is what they call win-win. He

I was pleased to receive the first paycheck from my new promotion today. I'm bringing home about $250 more per pay period (2-weeks) which represents a nice increase. Beyond that I will receive a quarterly incentive package as well assuming our company makes revenue targets.

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I invited reader comment in my post Large Caps about a week or so back (the timestamps are wrong because of technical issues).

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Readers may notice a trend in my, and indeed in all, pfblog.com posts. That trend is the seemingly maniacal obsession with squeezing just one more point of interest or appreciation out of every single transaction. Clients often question my obsession with low mutual fund fees, extra points of interest, and ...

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I had mistakenly stated that Huawei was banned by BSNL due to its alleged ties with the Chinese government. That information was incorrect and came from a reliable source. It has come to my attention that the reason BSNL has banned Huawei is that because Huawei had earlier failed to deliver equipment on previously won contract for 1.05M CDMA lines. BSNL just rewarded ZTE contract for 2.85M

A comment by Puzo on my original 0% APR Arbitrage post reminded me I left something out when I made the original post. While I mentioned checking and rechecking the terms, I should have shared my method of doing so.

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Remember that great ad campaign Washington Mutual ran when they went fee-free on their ATMs? I thought it was quite clever - "The buck fity stops here." Looks like they fired that ad agency this week - starting 11/17 they will charge fees on all their ATMs for users from ...

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I'm often wary of the major credit agencies. They haven't won many points with me with all the lobbying they do to hold your personal information hostage and then charge you for access to "protection services". To me that's a bit like paying a cover charge to access your own ...

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Fans of Keyes will remember the famous quote. I was reminded of it while reading the most recent Selected American Shares Update that arrived in the mail. More on the Selected American Shares fund here.

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According to their site, Neat Receipts is "a portable scanner and software system that is guaranteed to dramatically reduce your paper clutter and simplify your business paperwork." I read about it in one of my wife's organization magazines. Sounded great, but too good to be true?

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I have been reading for at least 9 months that it might be time to move into large caps. I have started to do my research because I believe the market is finally bearing out the logic, especially in technology.

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I struggle to file this under the "Financial Planning" category, because this certainly isn't something I would recommend to a client, but... following the lead of MM (here and here), I decided to try my hand at leveraging my credit score in order to get money at 0% from a ...

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"So, why does Generation X seem to be so much better prepared financially than their parents?" asks Lisa Predella in Fidelity Investor's Weekly. Chalk some of the credit up to sites like our own pfblog.com says Jeffrey Carney, president of Fidelity Personal Investments, because "[Gen-Xers] are Web savvy and have ...

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Money is running a great piece this month called "Declare financial independence". As I consider this my ultimate goal I'd like to comment on these articles and how I have embraced some of these philosophies.

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"The officers of large corporations constitute a group of men above the average in probity as well as in ability. But this does not mean that they should be given carte blanche in all matter affecting their own interets. A private employer hires only men he can trust, but he does not let these men fix their own salaries or decide how much capital he should place or leave in the business"--Ben Graham.

Recently Prof. Sanjay Bakshi screened the movie, "Other People's Money" in his class to demonstrate why, usually, managements don't realise that their company may be going down the tube and keep on evading the reality by taking irrational decisions, thereby causing huge losses to owners(ie) shareholders. I will quote Ben Graham extensively, among others, from his Security Analysis(1934) throughout this post while discussing the issues where there is conflict of interests between management & shareholders.

Worth more dead than alive:
"We're dead all right. We are just not broke. And do you know what is the surest way to go broke? To get an increasing share of a shrinking market. Down the tube. Slow but sure"--Larry the liquidator (Danny Devito in the movie) on the consequences of management not facing up with the reality.

Management don't realise it, even if they realise they just don't act. Why?

"Complete liquidation means loss of the job itself. It is scarcely to be expected, therefore, that the paid officers will consider the question of continuing or winding up the business from the standpoint solely of what is in the best interest of the owners"--Ben Graham

Though a retail shareholder is rightfully the owner of a business, he cannot in anyway alter the way management work. So it will be much more prudent to try and avoid management that don't adapt to changing times

Capital Allocation:
This is one of the most important decision that a management makes. Generally capital can be allocated to 2 activities:

• Expansion (organic or inorganic)
• Buybacks

Expansion:
"Management are naturally loath to return any part of the capital to its owners, even though this capital may be far more useful-and therefore valuable-outside of the business than in it. Returning a portion of the capital means curtailing the resources of the enterpirse, perhaps creating financial problems later on, and certainly reducing prestige of the officer."--Ben Graham.

The problem is not expansion but unwise expansion as Warren Buffett explains:

“We test the wisdom of retaining earnings by assessing whether retention, over time, delivers shareholders at least $1 of market value for each $1 retained. To date, this test has been met. We will continue to apply it on a five-year rolling basis. As our net worth grows, it is more difficult to use retained earnings wisely. We continue to pass the test, but the challenges of doing so have grown more difficult. If we reach the point that we can't create extra value by retaining earnings, we will pay them out and let our shareholders deploy the funds.”

Yet managers having committed themselves to a losing project keep on pushing it. This is quite similar to an investor holding onto his losers. Peter Bernstein explains this in Against the Gods: The remarkable story of risk as follows,

"Investors(Managers) hate to take losses because a loss taken is acknowledgment of error. Loss-aversion combined with ego(reputation) leads investors to gamble by clinging to their mistakes in the fond hope that some day the market will vindicate their judgment & make them whole"

Buybacks:

“One usage of retained earnings we often greet with special enthusiasm when practiced by companies in which we have an investment interest is repurchase of their own shares. The reasoning is simple: if a fine business is selling in the market place for far less than intrinsic value, what more certain or more profitable utilization of capital can there be than significant enlargement of the interests of all owners at that bargain price?” – Warren Buffett.

But the desire to acquire the stock at lowest possible level, sometimes, pushes the management to manipulate the price to bottom out before announcing the buybacks. This is generally done by reducing or passing out the dividends even when the free cash flow may be sufficient even to carry on with the dividends,

"The desire to buyback shares cheaply may lead to a determination to reduce or pass the dividend, especially in times of general uncertainty. Such conduct would be injurious to nearly all the shareholders, whether they sell or not"--Ben Graham

He further adds,

"If the reason for passing the dividend as a desire to preserve cash then it is not easy to see why, since there was money available to buy in stock, there was no money available to continue a dividend."

In general, not only what the management does is important but also how and when it is done.

Compensation:
"Human nature what it is, such(managerial compensation) developments are not in the least surprising. They do not really reflect upon the character of of corporate managements, but rather on the patent un wisdom of leaving such matters within the virtually uncontrolled discretion of those who are to benefit by their own decisions." - Ben Graham

Also Warren Buffett has been since long advocating against the stock options & bonuses as compensations to employees.

Role of Directors:
"The role of individual directors are frequently joined by many close ties to cheap executives. It may be said in fact that the officers choose the directors more often than the directors choose the officers. Hence the necessity remains for the stockholders to exercise critical and independent judgments on all matters where the personal advantage of the officers may conceivable be opposed to their own"-Ben Graham.

Conlcusion:
Keeping with the style of the post I would like to end the post with quotes, whatelse,

"By failing to prepare, you are preparing to fail"--Benjamin Franklin.

"We can evade reality, but we cannot evade the consequences of evading reality"--Ayn Rand.

Having just read Jim's skewering of Uhaul, I figured I'd take him up on his offer to relate a moving story. While I haven't been screwed by Uhaul this year, I am moving (also in NJ) and can explain why I refused to give them the chance.

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As I had speculated last week about IBM starting to do more acquisitions in India, IBM bought a small outfit in India fews days back. IBM has announced that it has acquired Network Solutions Pvt. Ltd., a Bangalore-based infrastructure services company. Network Solutions will allow IBM to augment its networking and managed services portfolio. Network Solutions seems to be a network implementation

This reminds me of that scene in SATC where Miranda and Carrie go shopping for pregnancy tests and Miranda grabs one and says, “Here, get this one. This is half off.” As Carrie puts it back on the shelf she says, “Sweetie, I just spent $365 on a new pair of shoes last week. This is not the time to be frugal.” When is the time to be frugal? I know some people’s answer to that is never just as

Recently a reader asked what age I thought was ideal for buying long-term care insurance. In this post I share my thoughts on the pros and cons of buying at a younger age vs. waiting until retirement. The majority of people hold off shopping for LTC insurance until their late ...

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I am weak, don't blame me. I just ordered a grande caramel frappuccino, light, with whipped cream and extra caramel topping. Not sure what the point of the "light" was since the extra caramel canceled out any calorie savings but it was so, oh so, good. I was at a traffic light in my car sipping my drink and thinking "Please, please don't turn green!" This was one of those moments that get frozen

“In a speculatively capitalized enterprise, the common stock holders benefit—or have the possibility of benefiting—at the expense of the senior security holders. The common stockholder is operating with little of his own money & with a great deal of the senior security-holder’s money; as between him & them it is a case of “heads I win, tails you lose.” This strategic position of the common stockholder with relatively small commitment is an extreme form of what is called “Trading on the Equity.” Using another expression, he may be said to have a “cheap call” on the future profits of the enterprise.”—Benjamin Graham.

A “Cheap call” on the future earnings. How?
I will use a hypothetical example to illustrate Graham’s assertion. Consider a steel company “Cyclical Business Inc” with the following financial statement numbers (I have for the sake of simplicity used only the numbers which are important in this case)

Debt	$75 m at 8%
Equity	$25 m
OPM	12%
No of shares	1 m

Scenario A: Bad year of a typical cyclical business.
Scenario B: Good year of a typical cyclical business.

$ m	A	B	% Increase
Sales	100	200	100
EBIT	12	24
Interest	6	6
PBT	6	18	200
EPS	$ 6	$18
P/E	2	3
Market price	12	54	350

What is relevant in above table is the sensitivity of the EPS as compared to sales growth and the prospective markets returns. Having said that I would like to clarify that the sensitivity holds even on the downside (ie) if earnings drop we can expect that the drop in market price will be more as compared to drop in the sales. So it is all about where you catch the pendulum when it is swinging.

Leveraged Buyouts (LBO):
Apart from the advantages of speculative capitalization structure and sensitivity of EPS, LBO comes with an added advantage. Will use pie charts to illustrate,

(Table below represent the capital structure of a LBO company at the start of the buyout and after a few years)

	While buying	After reducing debt
Equity	$ 10m	$ 10m
Debt	$ 90m	$ 40m
EBITDA	$ 20m	$ 20m
EBITDA * 5 (Value)	$100m	$100m
Market Value of equity	$10m	$20m

The advantage:
Generally it is the free cash flow from operations or sale of non productive assets that is used in paying off the debt. Thus we can probably expect that the EBITDA is atleast same even when the debt is down to $40m. Suppose we can sell out the company at the same multiple of EBITDA at which we got into it then our profit is atleast 100% (non-annualized)

LBO & Leveraged Arbitration:
We can apply the concept discussed above in increasing our return substantially from arbitration opportunities. Again will use a simplified example:

Expected return from arbitration	20 %
You have (equity)	$ 100
You can borrow (900% of your equity)	$ 900 @ 10% (say)
Total Profit after interest on leverage	$ 110
Return on your Equity	110 %

I am not saying that whenever an arbitration opportunity comes up we should borrow money and play the game, rather, only when the odds make it sensible enough to do so.

Conclusion:
A conservative capital structure is a must for a good business, I used to think, but when it comes to making a good investment “Price changes everything”. In other words,

“Safety does not reside in titles, or forms, or legal rights, but in the values behind the security issue”—Benjamin Graham.

CELL reported results ahead of expectations on both revenues and EPS. For those of you who do not know what CELL does, a quick introduction is in order: CELL is a distributor of handsets for various carriers throughout the world. CELL also distributes accessories for handhelds. CELL usually has great visibility into the end-market demand. Overall it seems as though handset demand remains strong

IDTI reported after market today and the management sounded positive than the pessimistic market expectations. Top line and EPS was better, guidance is inline for revenues but EPS guidance is higher-just what I want. Company is already 80% booked for the quarter, 10% ahead of typical seasonality- is it demand or are people double ordering? Inventory in the channel and at OEMs seems to be a

MTZ provided more details on the results for the quarter. The top line was slightly weaker than guidance due to the natural disasters during the quarter top line guidance for Q4 is little weaker also but EPS is higher due to continued margin expansion. Gross margin was higher than expectations even with negative impact from the hurricanes in Gulf Coast and Florida and lower margin from DOT work,

MTZ reported results after market and as I had pointed out earlier margins are starting to move up. Gross margins increased nicely from 11.4% to 14.8% sequentially, very tough to see margins increasing in this increasing cost environment. G&A expense was higher but operating margins improved as well. MTZ is a play on not only better spending by carriers on specific projects like FTTx, it's also a

Each weekend, I hold at least one Open House.  As the weeks have progressed, Buyers at my opens seem much more relaxed about their searching; they know there’s a lot of houses for sale and they know that the houses that are for sale probably will still be for sale next week, or the week after.While Buyers are calm, Sellers are a little more tense. Showings are continuing to drop off, and Open House activity is going down as well.  In addition, more and more Sellers are reducing their asking price, which puts added pressure on other sellers to follow suit.  Between Thanksgiving and Superbowl Sunday has historically been the hardest time for Sellers, but the best opportunity for Buyers.  Based on what I am seeing in the market now, that appears to hold true again this year.

NT in its 10Q (filed 11/3/05) has revealed that its BSNL business might not be as big as it has once anticipated. NT has raked up losses of approximately $263 million on recognized revenues of $288 million. Not really a profitable endeavor in my opinion. Company expects to build the remaining revenues “profitably, progressively”. That remains to be seen as the size of the deal might not be as

My saving spree seems to have worked somewhat. My net worth increased $441 from 9/29-10/28/05. And that's even with a large wedding purchase (airline tix), a bad month for the 403(b), and a rapidly decreasing in value automobile (we're putting 2000+ miles on it each month).

I did cheat a bit more than I should have on my rules. Like how I played poker again last weekend. And made $550 (not included in net worth calculations). So in this case, cheaters do prosper. :) But I did establish one very good habit - staying in for lunch. I even got my fiancé on board and we are eating out for dinner significantly less than September and before. Now we're even trying to replicate our favorite Thai dishes at home, and had some initial luck with a basic peanut sauce.

So I have $1600 of expenses left for the wedding, $400 saved up already, and about 3 months to save the remaining $1200. My poker winnings are going toward a "poker fund" or mini-bankroll so I don't have to feel guilty next time I play, and toward Christmas presents. I'm doing okay.

Indian newspapers are reporting that IBM has purchased land in Bangalore. IBM CEO Sam Palmisano was recently in India on a not-so-well-publicized visit. Unlike CSCO recent announcement of spending $800M in India, IBM likes to keep things quiet for now. As IBM has been on the firing binge in Europe and America, the expansion in India would not sit well with some. Given that IBM services bookings

As human we are programmed to tackle physical risk instinctively but as an investor we have to learn to manage risk in every investment decisioin we take.

Understanding Risk:
"Price & probability are not enough in determining what something is worth. Although the facts are same for everyone, the utility is dependent on the particular circumstances of the person making the estimate. There is no reaon to assume that the risk anticipated by each individual must be deemed equal in value"--Daniel Bernouli in Peter Bernstein's "Against The Gods: The remarkable story of Risk"

Reflecting upon the above paragraph I found a relationship between understanding risk and portfolio management. I would serve the learnings in the form of a game to make it more reader friendly & easy to understand. (I myself learnt the lesson by putting myself in the scenario that follow)

Game:
Simple game of Coin toss. You have to bet on either head or tail. You win if you are right.

Scenario 1:
You bet Rs. 10 & if you win you will get Rs. 100. Will you play? Mathematically the expected value is Rs. 50, so one can easily conclude that you should play. I will.

Scenario 2:
The rules remain the same, only change that comes about is all you have is Rs. 10. If you win you become 10 times as much richer as you are now, on the other hand if you lose you go broke. Will You play? I won't.

Anomaly:
Scenario 1 looks like a very favorable bet but scenario 2 looks like a very risky proposition. Mathemetically nothing has changed to make scenario 2 more risky than scenario 1. What is that has made Scenario 2 more risky (or atleast make it look more risky)? The answer is fear of consequence. Hence we can conclude that, risk is sum of probability of an event happening & price you pay for it & fear of consequence.

Risk = Probability of the Event & Price paid & Fear of consequence

What makes this so important is that the facts are same for everybody it is the fear of consequence that differs for everybody & that in effect changes risk factor from person to person. (Think of a person who has Rs. 1,000 and what do you think he will do in scenario 2)

Scenario 3:
In the same game, you can bet Rs.1 from your total of Rs. 10. If you win you get Rs. 10 for your Rs. 1. That is you can play the game 10 times with the money you have. Will you play? I will.

Reflecting on Scenario 3 & relating it to Investing:
Mathematically speaking, the expected value is same for Scenario 1, 2 & 3, Rs. 50. But I think we will be attracted towards scenario 3. Why & what does that mean?

Diversification:
The reason is bounded rationality. We have no expertise as to predict the outcome. All we know is that probability is 50% and the more times we play the game the more the chances that the result will be near the mean(regression to mean). But still we can go broke, 10 tails or 10 heads in a row is not an improbability, just that it is highly improbable. (I remember reading somewhere that the probability of that is around 0.1%). It reminds me of beautiful quote by Ben Franklin,

"In this world nothing is certain but death & taxes"

Satisficing:
In scenario 1 & 2, if you win you make 900% return on your portfolio(from Rs. 10 to Rs. 100) & negative 100% if you lose. And the probability of that happening is good 50% on either side. But in the scenario 3 you cannot think of making 900% return, but you will hopefuly come out a winner, because you need to win once from the ten chances to take your principle back. But the probability of winning 10 times is around 0.1% (getting 10 heads or 10 tails simultaneously). So you have to be a satisficer in giving up some probable extra return for much needed safety.

Conclusion:
All said & done, this quote by Warren Buffett is even more important to understand and could find nothing better (a satisficer, that I am)

"Risk comes from not knowing what you're doing"

Kiplinger's Personal Finance mentioned this blog in their November issue. Forbes had picked this site as one of the Best of the Web also. I want to thank all the readers and the editors of the magazines for including this site. This site has been up and running for a year now and there are a lot of articles that are archived. Take a moment and read through some of them, my favorites are 1)Eddie