The Daily Reckoning - Margin Of Safety (James Boric)

verfasst von Firmian, 26.11.2003, 19:51

-->Margin Of Safety

The Daily Reckoning

Paris, France

Tuesday, 25 November 2003


----------------------

*** Don't worry about the current account, says
Greenspan...

*** When they fire the bears... sell stocks!

*** Gold backs off... hold the Trade of the Decade... poor
Edward... and more...

---------------------

Huge current account deficits are nothing to worry about,
says Alan Greenspan.

He might have saved his breath. For no one in America was
worried, anyway. Trade and current account deficits have
been rising for many years. People have begun to believe
they go in no other direction. It is as if an economist had
put his hand into a jar 15 times in a row and pulled out a
red candy every time."They are all sweets!" the scientist
proclaims. Taking the last few years as data points, a dim
economist finds nothing to contradict the hypothesis:
current account deficits are no problem.

Investors, even dimmer, bet on more red candies. They bid
stocks up to levels they have seen only 4 times in the
entire 20th century - in 1929, 1972, 1987, and 2000. Only
in 2000 - in terms of peak earnings - were they more
expensive than they are now. And never did they escape a
major adjustment downward.

"During the past year or so," Greenspan pointed out,
looking on the bright side,"the financing of our external
deficit was assisted by large accumulations of dollars by
foreign central banks."

What a marvelous world, we keep noticing. We spend more
than we earn. And then nice folks we've never met lend us
back the money so we can spend some more. And if things get
a little tight... our own financial authorities knock down
interest rates to make it a little easier for us to keep
spending.

Now, it is true that a current account deficit in itself is
not a bad thing. Fast-growing economies - like start-up
businesses - often run current account deficits; they need
to import capital to build new factories and
infrastructure. But the investments made by foreigners have
to be productive ones.

America's current account deficit is another variety. When
you see construction in the U.S., it is almost always
either residential or retail; rarely do you see new
production facilities of any sort being built.

When foreigners fund America's deficits, they do not
contribute to additional U.S. production, jobs, and
profits. Instead, the current account deficit does little
more than allow Americans to continue spending more than
they can afford - which has the effect of stimulating jobs,
production and profits in the foreigners' home economies,
not in America.

Seventy percent of the U.S. economy is consumer spending.
When Greenspan says the economy is 'recovering,' does it
mean Americans are getting richer? Does it mean that the
economy is healthier? Alas, what it really means is that
spending has resumed... and that consumers are ruining
themselves at a faster rate.

But watch out. The whole thing is a charade on both sides
of the transaction. Americans spend money... thinking they
are getting richer. Foreigners lend, thinking they will get
it back. We don't exactly know how this will end. But we
are fairly sure the final act will be accompanied by tears
and regrets.

"Something troubling has happened in the past few months,"
warns yesterday's Financial Times."Despite the falling
dollar, which should make U.S. assets more attractive,
there has been a noticeable acceleration in the pace at
which foreign investors are selling U.S. bonds.

"According to the Treasury's international capital system
report for September, net inflows into U.S. markets fell to
$4.2bn in September, the lowest since September 1998, when
the near-collapse of the Long Term Capital Management hedge
fund sparked a brief panic. The drop since May has been
steep - from $110.4bn then, to $90.6bn in June, to $73.4bn
in July, to $49.9bn in August."

At some point, American consumers are going to reach into
the jar and pull out a bitter pill. Maybe soon. Maybe late.
But sooner or later.

Over to Eric Fry, with the latest happy news from Wall
Street:

--------------

Eric Fry, writing from New York...

- The Dow Jones Industrial Average raced into Thanksgiving
week with a swift 119-point rally to 9,748, and the Nasdaq
Composite advanced 2.8% to 1,947. The dollar drifted behind
the sprinting stock market to gain nearly 1%, ending the
New York trading session at $1.17 per euro.

- The twin rallies in stocks and the dollar buffeted the
gold price, as waning demand for the safe-haven metal
knocked $4.50 off of its price to $392.00 per euro. Bond
prices also slipped, sending the yield on the 10-year
Treasury to 4.23% from 4.15% on Friday.

- Safe-havens like gold and Treasury bonds are not so safe
when the stock market is soaring. On the other hand, stocks
can be dangerous things to own when investors are shunning
safe havens. Excessive investor optimism often signals the
beginning of major market sell-offs.

- The UBS Index of Investor Optimism surged 24 points in
November to a 20-month high of 93 in November. According to
the survey, a joint effort of UBS and the Gallup
Organization, 60% of those surveyed consider the economy to
be in a sustained expansion or recovery, up from 48% last
month.

- Surging investor optimism - as all self-respecting
contrarians are well aware - is an ominous sign for the
stock market. Investors tend to become extremely hopeful
and confident before steep market declines... and become
extremely pessimistic before market rallies. Which brings
to mind a related phenomenon, variously known as the"Pink
Slip Indicator" or the"Sell Side Indicator."

- Here's how it works: major Wall Street firms fire their
bearish strategists immediately before major sell-offs
begin, and fire their bullish strategists immediately
before major rallies begin. According to this indicator,
the stock market may be approaching the end of its year-
long rally... The Pink Slip Indicator is flashing yellow.

-"Amid a rising tide of complaints," Reuters notes,
"Merrill Lynch & Co.'s chief U.S. strategist, Richard
Bernstein, is seeking to defend his bearish view of the
stock market from investors who believe he is hopelessly
wrong... Bolstering critics' argument that Bernstein is off
the mark is a 17.5 percent rise in the Standard & Poor's
500 Index so far this year. The benchmark index closed at
1,033 on Thursday - significantly above Bernstein's year-
end target of 880."

- Merrill has not fired Bernstein... yet. But we are holding
a vigil - and are readying our sell orders - for the day
that Merrill replaces him with a strategist that voices a
staunchly bullish outlook.

- Poor Merrill Lynch... the white-shoe firm just can't seem
to get it right. Back in the late 1990s, strategists like
Abby Joseph Cohen and Joseph Battapaglia were making daily
headlines with their incessantly bullish forecasts. Abby
Cohen became a minor celebrity and brought accolades, fame
and fortune to her employer, Goldman Sachs. Meanwhile,
Merrill Lynch employed the habitually cautious Charles
Clough as its chief strategist.

- While Abby and the other bullish seers were cheering from
the sidelines, Clough urged restraint. Eventually, the top-
brass at Merrill could no longer stand the humiliation of
endorsing Clough's bearish posture during the greatest bull
market of the 20th century... Early in 2000, Merrill urged
Mr. Clough to"pursue other interests."

-"Just before the bubble popped in 2000," Bull & Bear
Investor recalls,"several Wall Street brokerage houses
fired their most bearish strategists and economists... Chuck
Clough was shown the door at Merrill Lynch. His doom and
gloomster colleagues who suffered the same fate included
J.P. Morgan's chief strategist Douglas Cliggott, Salomon
Brothers' market strategist David Shulman and Oppenheimer's
renowned chief strategist Michael Metz. With the benefit of
hindsight, all were fired for being correctly bearish."

- Merrill replaced Clough with uber-bull Christine Callies.
The new chief investment strategist tried to make up for
lost time by urging Merrill Lynch clients to buy stocks
aggressively throughout 2001, even as the stock market was
collapsing.

- Merrill was twice chagrined. The firm fired Callies in
December of 2001, replacing her with the bearish Bernstein.
Callies was the first of several high profile bulls to
receive pink slips as the stock market headed toward its
bear market lows of October 2002."During the go-go years,"
CNN/Money observed one year ago,"nobody pounded the table
quite as hard as Lehman Brothers' Jeff Applegate and Credit
Suisse First Boston's Tom Galvin. Both had replaced bearish
predecessors and both became progressively more bullish as
the rally wore on. When the market hit a top in March 2000,
they were each recommending that clients keep a whopping 80
percent of their portfolios in stocks."

- Alas, Applegate and Galvin both drew pink slips in the
fall of 2002, just as the stock market was embarking on a
massive, new bull market rally.

- Today, investors are very optimistic and bearish
strategists are fighting off angry mobs... Hmmmm... maybe
it's time to hold a mirror beneath the nostrils of this
bull market.

--------------

Bill Bonner back in Paris:

*** Poor Richard Bernstein. Merrill is out to get him, Eric
notes above. He's bearish on stocks; they want him bullish.
He's cautious; they want him to be reckless.

"It's hard to find risk aversion in the marketplace right
now," writes Bernstein."We see considerably more
speculation as the market goes up." The longer a trend
remains in place, the less people imagine that it will ever
change. Thus, the riskier the marketplace becomes, the less
risk investors perceive.

As we pointed out last week, we don't know which hoss will
win dis race... but we'll take the long odds on the nag
named"Lazy Bear." He may or may not win, but if he does,
he'll pay off big. The downside risk is mis-priced.

*** Gold backed off yesterday. Conspiracy theorists believe
that somebody is trying to hold the price of gold below
$400. Well, more power to them. Let's hope they knock the
price back down to $370. We'll buy more!

It now takes 25 ounces of gold to buy the 30 Dow stocks. A
quarter century ago, an ounce of gold was about the same
price it is today. But the Dow was much cheaper - so cheap
that you could have bought the whole thing for only a
little more than a single ounce of gold.

During those 25 years was the biggest explosion of dollar-
based paper wealth in all history. Yet, the price of gold
went nowhere. We doubt that it is destined to go nowhere
forever. On the other hand, the Dow rose 25 fold against
gold. Likewise, we doubt that it is destined to go
somewhere extraordinary forever.

A couple of years ago, and in our book, we announced the
Trade of the Decade."Buy gold, sell stocks," we said. So
far, gold has risen nicely. Stocks have fallen. But we
suspect these trends have much, much farther to go before
they finally reach their end. We'll stick with the 'Trade
of the Decade' a bit longer.

***"Poor Edward," said Sylvie yesterday. Sylvie comes to
the office from time to time to try to correct your
editor's French. She struggles in vain against lapses in
the subjunctive mood and breaches in subject-verb
agreements. But she offers some gallic philosophy along
with the grammar:

"Yes, I know the mothers in the 16th arrondissement (a very
bourgeois section of Paris) are like that... but it is a
shame. They push the children to get into good schools. And
then, because not all children are cut out for top schools,
the poor children fail. So they put them in the next best
school. Well, they don't do well there either, because
they're just not well matched to the rigorous academic
environment. So the kid fails again. And so the parents
ratchet down, school by school, failure by failure, until
they finally end up at a level where he can succeed. But by
that time, the kid's confidence is destroyed and all he can
do is get a job in government... and feel like a failure all
his life."

***"Edward," we said to the boy last night, after his
tutor had left at 6PM... and after his back-up checker-upper
had left at 8:30PM... and after we had read a few pages of
the Call of the Wild. Edward has been quiet for the last
few days. We were worried.

"You know... school isn't everything," we began.

"I know..."

"It's not even the most important thing..."

"I know..."

"The important thing is just to do your best... and make
sure you are doing the right thing... I mean, you know
you're not supposed to take B-B guns to school, for
example..."

"Uh huh..."

"You just do your best... and don't worry, right?"

"Right..."

"And if you do your best and don't worry, I'll be very
proud of you..."

"Uh huh..."

"Goodnight, Edward."

"Goodnight, Dad."

---------------------

The Daily Reckoning PRESENTS: Small-cap sleuth James Boric
makes the case for investing in one of 26 undervalued
companies currently falling within the parameters of
Graham's 'Margin of Safety' rule. A sound strategy that
could work for the conservative investor... even during this
speculative rally.


MARGIN OF SAFETY
by James Boric

The year was 1947.

President Harry Truman was in office. Jackie Robinson, the
first African-American baseball player in the major
leagues, debuted with the Brooklyn Dodgers. The Academy
Award for best actor went to Ronald Coleman for his part in
"A Double Life."

And Benjamin Graham made the single best investment of the
20th century.

In a move slated for the investment hall of fame, Graham
bought 50% of a small company called Government Employees
Insurance Co. (now GEICO) for $720,000. That was a lot of
money in 1947. The average salary was $3,120 a year.
Minimum wage was 40 cents an hour. And you could buy a new
car for about $1,400. But Graham knew spending $720,000 for
a 50% stake in GEICO was an absolute bargain.

Founded in 1934 by Leo Goodwin, GEICO sold deeply
discounted car insurance via direct mail to federal
employees and noncommissioned officers with good driving
records. It was the first discount insurance company of its
kind in the United States.

By selling the insurance directly through the mail, GEICO
was able to cut out the commissioned insurance agents. That
was huge. By avoiding a large payroll, Goodwin kept his
overhead costs low, his profit margins high and the
competition at bay. No one else could offer comparable
service for such low prices. The business model was solid.
And Graham knew it.

But there was another reason Graham liked GEICO so much in
1947.

At the time of the purchase, GEICO's assets alone were
worth $3.3 million. If you divided them in half (to
represent Graham's cut of the company), he was buying $1.65
million of assets for $720,000 - 56% off the real price.
Not a bad deal. Even if the stock price fell, Graham could
sell the company's assets and make a profit. This
investment had what Graham called a"margin of safety"
built into it.

In other words, if GEICO only grew to be valued at 1 times
assets, Graham could cash out for a 56% profit - his
$720,000 would be worth $1.1 million. And his downside risk
was minimal.

GEICO had long-term profit potential growth. It was well-
managed. And the company had a viable market for its
services. It was unlikely to go out of business - which
meant the chances of losing money on this deal were small.
It was the perfect kind of investment for Graham.

As it turned out, Graham was right about GEICO. He did make
money on the deal. But instead of turning his $720,000 into
$1.1 million, he held on until his investment was worth a
cool $1 billion. That's billion - with a"B."

And GEICO was no fluke investment.

Using the same margin of safety rule, Warren Buffett and
John Templeton (both students under Graham) grew their
multibillion-dollar empires from the ground up - copying
Graham's bargain-hunting approach. Buffett bought shares of
Coca-Cola, American Express, Freddie Mac, Gillette, The
Washington Post, GEICO and others - all for deep discounts
to their real value. A $10,000 investment in Buffett's
Berkshire Hathaway in 1965 was worth $51 million in 1999.

Templeton, taking a slightly different approach, bought
undervalued stocks in emerging markets like Japan (when the
total market cap of all Japanese stocks was less than
IBM's), India, Russia, Argentina and Peru. Although the
return in Templeton's flagship fund, Templeton Growth,
wasn't as high as Buffett's Berkshire Hathaway stock, it
was still quite considerable. A $10,000 investment in 1965
was worth $5.5 million in 1999.

Graham, Buffett and Templeton were all successful because
they refused to pay market value for a stock. And that
meant they ignored the herd when it came to the hot stock
tip du jour. Instead, they bought stock in companies no one
else wanted - when a company was badly beaten down by the
market, overlooked by Wall Street or simply under-
researched.

But that was in the good old days when Coca-Cola and
Gillette were penny stocks. Let's be realistic - you and I
will probably never find a stock with that kind of profit
potential. Right?

Wrong. You can find the next GEICO, Coca-Cola and Gillette.
But you have to be willing to look places other aren't: the
small-cap stock market.

Of the nearly 9,000 stocks trading on an exchange (major or
otherwise), only 26 are worth investing in if you use a
modified version of Graham's margin of safety rule. Not
surprisingly, all but two are small-cap stocks with market
caps under $1.5 billion. And all 26 trade for $20 or less
and have the following similarities:

* They trade for less than 1 times book value and less than
1 times sales.
* They are growing their sales and net income quarter-over-
quarter and year-over-year.
* Their total assets exceed their market-caps.
* They trade for under 20 times earnings.

Will any of these stocks be the next GEICO? Who knows? If
the worst they do is simply trade at their market values,
anyone who invests in them will make money. Regardless of
the state of the U.S. or global economy.

And it is possible one or two could take off and not stop
for the next 20 years. Imagine if you happened to own that
stock. Fifty years from now, some young contributor to The
Daily Reckoning may start off his article like this...

"The year was 2003. President George W. Bush was in office.
Lance Armstrong won the Tour de France for the fifth
straight time. The Academy Award for best actor went to
Adrien Brody for his role in 'The Pianist.' And (insert
your name here) made the best investment of the 21st
century."

You never know...


Regards,

James Boric,
for The Daily Reckoning

P.S. Curious what the 26 stocks are that meet my"margin of
safety" criteria? E-mail me at psfortunes@agora-inc.com and
I'll tell you. Please understand, I am in no way
recommending these stocks. They simply fit the criteria I
showed you above.

Thread gesperrt

 

gesamter Thread:

• The Daily Reckoning - Margin Of Safety (James Boric) - Firmian, 26.11.2003, 19:51
  • Und zur Abwechslung mal wieder eine (fast) Vollversion Heimatsprache - Firmian, 26.11.2003, 19:56
    • Danke! Gruss (owT) - Tofir, 26.11.2003, 23:35