In Search of the Perfect Investment

You can smell it. You can feel it. You can almost touch it. We’re getting to the point that the Feds (including Bernanke) are talking about easing their Quantitative Easing (aka money printing) and maybe, in the not too distant future, letting interest rates edge up.

Now they may want interest rates to edge up. But I think it will be a lot more violent than that. They’ll jump – and jump big-time.

This could be devastating for bonds.

Take a simple example. Let’s say you have a bond paying you 4%. Let’s say the bond is selling for $100. Now let’s say the bond now has to yield 6% because that’s what interest rates have risen to. That means the price of your bond will fall to $66.6667. Figure it out. You’re getting $4 in a cash dividend. But it now has to be a 6% dividend yield. That means a price of $66.6667 for your bond.

A small rise in interest rates yields a huge drop in the value of  bonds– in this case 8.5 years of dividends.

There’s only one case where this logic doesn’t apply — when you’re planning on holding your bonds to maturity. That’s when you’ll get your $100 back.

VWALX has done great for us. But it’s now yielding 2.%%. Enough already.

So, where’s the market going? No one knows. Trust me. But staying out can be expensive — as we’ve seen from recent months. I personally believe the market will run some more — especially if we’re very careful about picking stocking the right stocks. (I love HD today.)

Picking the right stocks is what I try and do in the column on the right. 

Here’s one of my favorite financial reporters, writing  on the future of the stockmarket in this week’s New Yorker:

The Financial Page
Boom or Bubble?

With the stock market setting new highs on a nearly daily basis, even as the real economy just slogs along, there seems to be one question on everyone’s mind: are we in the middle of yet another market bubble? For a growing chorus of money managers and market analysts, the answer is yes: the market is a house of cards, held up by easy money and investor delusion, and we are rushing all too blithely toward an inevitable crash. Given that we’ve recently lived through two huge asset bubbles, it’s easy to see why they’re worried. But in this case the delusion is theirs.

The bubble believers make their case with a blizzard of charts and historical analogies, all illustrating the same point: the future will look much like the past, and that means we’re headed for trouble. Smithers & Company, a London market-research firm, says that, according to a number of market indicators, stocks are, by historical standards, forty to fifty per cent overvalued. The bears admit that corporate profits are high, which makes the market’s price-to-earnings ratio look quite normal, but they insist that this isn’t sustainable. They think that earnings will return to historical norms, and that, when they do, stock prices will be hit hard. Today, after-tax corporate profits are more than ten per cent of G.D.P., while their historical average is closer to six per cent. That’s a vast gap, and it’s why bears believe that the market is, in the words of the high-profile money manager John Hussman, “overvalued, overbought, overbullish.”

It’s certainly unusual for corporate profits to soar during a slow recovery. But the argument for a stock-market bubble is flawed: when it comes to the role that corporations play in the U.S. economy, the present looks very different from the past, which means that historical comparisons to the nineteen-fifties, let alone the thirties, tell us little. The four most dangerous words in investing may be “This time, it’s different.” But this time it is different.

Take taxes: one big reason that after-tax corporate profits are much higher than their historical norm is that corporations pay much less in taxes than they used to. In 1951, corporations had to pay almost half of reported profits in taxes. In 1965, they had to pay more than thirty per cent. Today, they pay only around twenty per cent.

Then, there’s globalization. Many of the “American” companies in the S. & P. 500 are multinationals: a study of two hundred and sixty-two of them found that, on average, they got forty-six per cent of their earnings from abroad. This is a relatively new phenomenon. As late as 1990, foreign earnings accounted for only a small fraction of corporate profits in the U.S. Today, they account for almost a third of corporate earnings, and they’ve nearly tripled since 2000. So comparing corporate profits only to American G.D.P. yields a false picture of how companies are doing. The global economy, even with its current woes, is projected to grow more briskly than the U.S. economy over the next decade, so corporations will continue to benefit.

Finally, the decline of unions and the sluggish labor market have enabled corporations to cut payrolls, thus keeping profits high. The result is that labor’s share of the economy has fallen steeply. Skilled workers are still in demand, but most workers have little bargaining power. This could change if there is another economic boom-during the tech bubble, in the late nineties, wages did rise briskly-but, even in that case, corporate profits would likely stay high, as increased sales would make up for narrowing profit margins.

The underlying issue is that in recent decades there’s been a shift in the U.S. economy: it’s become far more congenial to businesses and investors. The fundamental trends that have driven the profit boom are unlikely to be reversed. That doesn’t mean that companies are going to be able to keep slashing their way to profit growth. As Doug Ramsey, the chief investment officer for Leuthold Weeden Capital Management, told me, “It’s hard to see how companies can get profit margins much higher, unless they want to see massive labor strikes across the country.” But keeping profits where they are doesn’t look all that difficult, which makes stocks today quite reasonably priced. It’s still possible that investor hysteria could eventually inflate stock prices, or that investor panic could send them crashing, but there is no profit bubble and, for now, no stock-market bubble, either.

For investors, that’s obviously good news: there’s nothing wrong with profits, and the rebound of the stock market has helped restore many Americans’ battered finances. Still, it’s unsettling that companies and investors are doing so well while the economy as a whole is stuck in the mud. Throughout the postwar era, high corporate profits were coupled with rising wages and strong economic growth. Today, there’s a growing divide between the fortunes of corporate America and those of the majority of Americans. You might hope that people could make back as investors some of what they’re not getting as workers, but in fact only about half of Americans have any money in the stock market, and most of those who do have only small sums. What’s more, the crash of 2008 scared many ordinary investors out of the market, so they haven’t benefited from the recent profit boom at all. “There’s a lot of residual shell shock at work, and that’s made investors still pretty gun-shy,” Ramsey said. The stock-market boom is real, but most Americans have been left on the outside looking in. 

Still staying short on Best Buy. From Seeking Alpha on BBY’s latest financials::

Comparable store sales dipped 1.1% during the period, although the retailer did get a strong bounce (+16.3%) from online sales. If the shift of the Super Bowl and the impact from the decision to cut back on certain non-core businesses is backed out, comp sales were flat. Gross profit was down 190 bps to 23.4% due to the retailer’s increased investment in pricing and higher promotional stance. The company notes Samsung Experience shops will be a focus in Q2.

Best Buy’s shops remain dreary and unexciting — not the place you want to pop into and check out the latest and greatest electronics. There are a thousand places on the web to do that that are more exciting. Further, if best Buy really ever does bring down its store prices to compete with Amazon’s, profit margins will fall through the floor. Meantime, the much-vaunted “Samsung Experience Shops” suck big-time. Don’t believe me. Go check one out. What really got me was the Samsung phones were locked down. You couldn’t experience them in your own hands. And the “helpful”, “knowledgeable” salespeople were from Best Buy, not Samsung, which made them useless. And the phones kept locking.

BBY is a long-term short.

So, what is Tumblr and why did Yahoo spend $1.4 billion for it?

+ Tumblr is way for you and I to have a blog that others can read. This daily column is a blog. It’s done on WordPress. I could use Tumblr but it wouldn’t have all the features of this one — like the stock quoting on the right and ability to go backwards and find previous columns. You should use Tumblr if you want to make a big announcement to your friends — say one including photos, videos, an invitation to a wedding, etc. Tumblr is very easy to use, and free. and your final result is handsome — containing no irksome ads (at least, for now).

+ Yahoo bought Tumblr because Yahoo is desperate and because it had the cash. It should give a temporary pop to Yahoo’s stock. But ultimately Yahoo will destroy Tumblr and probably close it down as it has with other pricey acquisitions.

I’m not a Yahoo fan, since I find their site gives boredom a whole new meaning. Yahoo Finance is a redeeming feature, but doesn’t have the excitement of a Business Insider or the insightfulness of the New York Times financial section — from which comes this piece today by Andrew Ross Sorkin:

But Wait. Didn’t Yahoo Try a Deal Like This Before?

When Yahoo announced its headline-grabbing acquisition, it boasted that the deal gave it access to an “unduplicated” audience of users and that its target was a “popular personal publishing” platform.

“Yahoo will be able to integrate and distribute a powerful set of state-of-the-art editing tools and content published through personal home pages in an array of services,” the company declared.

But Yahoo wasn’t talking about Tumblr. Those quotes came from a news release Yahoo issued in 1999 when it acquired GeoCities, which allowed users to create their own Web pages – not unlike Tumblr – for $3.6 billion in stock. The site was closed in 2009.

As investors and analysts size up Yahoo’s latest $1.1 billion acquisition, it is worth reflecting on the GeoCities deal, which has many similarities. Both companies were money losers when they agreed to be acquired. Tumblr had just $13 million in revenue last year, according to reports.

Both companies had loyal followers that quickly left in droves. According to Matt Mullenweg, the founder of WordPress and a competitor, Tumblr users were moving their posts over to WordPress at a rate of 72,000 an hour amid speculation of an impending deal this weekend. (Usually, he said, Tumblr users migrated 400 to 600 posts an hour). Still, for perspective, Tumblr users generate tens of millions of posts a day.

And GeoCities and Tumblr had at one point been averse to accepting advertising. Tumblr’s 26-year-old chief executive (and now multimillionaire), David Karp, said three years ago, “We’re pretty opposed to advertising,” adding that “It turns our stomach.”

The lesson of GeoCities raises this question about Tumblr: How can a company with zero profits (actually, multimillion-dollar losses) and just $13 million in revenue be worth $1.1 billion?

Inside Yahoo, officials dismiss the comparison to GeoCities. Instead, they compare the Tumblr deal to Google’s purchase of YouTube – that is, Yahoo’s management believes that Tumblr is one of a rare few transformative sites on the Internet. Google paid $1.6 billion for YouTube when it too made no money. At the time of that deal, it seemed heretical. Now, it seems genius.

To Yahoo, Tumblr is the equivalent of beachfront property. With more than 100 million user-generated blogs on Tumblr, there is no question that it brings Yahoo a younger audience. It adds a sense of hipness to a company that had lost its sense of cool.

According to Marissa Mayer, Yahoo’s chief executive, who drove this deal, Tumblr brings Yahoo a possible growth engine for the future.

But that’s a big if. It requires Ms. Mayer’s team to execute brilliantly and online users to continue to want to establish ways to communicate outside of places like Facebook and Twitter.

And then there is the pesky issue of selling ads on Tumblr’s pages without upsetting the site’s finicky users. (One user began a petition to block the deal.)

“It is difficult to justify the premium acquisition price for Tumblr given its low levels of revenue,” wrote Doug Anmuth of Barclays Capital in a note to investors. “In addition, we believe Yahoo needs to be careful about the manner in which it monetizes Tumblr, as a significant ad load and the perception of a large corporate owner could potentially alienate Tumblr’s core user base. Though we believe Tumblr’s model does have switching costs for users, we do not view its actual barriers to entry as particularly high.”

If you want to do the math on what it would take for Yahoo to justify the price tag, Brian Pitz, an analyst at Jefferies, has sketched it out. By his count, Yahoo will need to figure out a way to make $127 million a year in profit from Tumblr, meaning the site would have to bring in an additional $950 million annually in advertising revenue.

That’s a big challenge, especially considering that Ms. Mayer pledged that while she planned to add more ads to Tumblr, she would do so mostly on the site’s “dashboard” or newsfeed.

“We would like to look at them and understand how we could introduce ads – in a very light ad load – where the impact is really created, because the ads really fit the users’ expectations and follow the form and function of the dashboard,” Ms. Mayer said.

She said she might add advertising to user pages, but only with the permission of the blogger. That means a lot of Web pages will not be monetized.

And there is the issue of porn. Yes, porn. At least some of Tumblr’s users post images that are not exactly “work safe.” Indeed, Tumblr’s own terms of service allows for such content. Such content could make Tumblr a challenging environment for advertisers.

Tumblr’s users also regularly post copyrighted images and other content Yahoo will have to find a way to police. When Tumblr was just an upstart, content owners were unlikely to pursue claims against the company, but now that it might be owned by a big public corporation, you can bet that copyright owners, some of whom compete with Yahoo, will be contacting their lawyers.

Given all of that, you might expect me to say that Yahoo should have never proposed acquiring Tumblr. But I won’t.

It may actually turn out to be the right bet. The key is recognizing that it is a shoot-the-moon gamble. It might work out. It might not.

And even if it does not work out, analysts note that Yahoo can afford to experiment given the billions of dollars it has in cash.

As Jordan Rohan, an analyst at Stifel Nicolaus, wrote: “Even a squandering of $1.1 billion in cash, however unlikely that might seem to Yahoo management, would only move the sum-of-parts slightly.”

Favorite recent New Yorker cartoons:

Is God great or what?
A woman received a call that her daughter was sick. She hurried to the pharmacy to get medication, got back to her car and found that she had locked her keys inside.

The woman found an old rusty coat hanger left on the ground. She looked at it and said “I don’t know how to use this.”

She bowed her head and asked God to send her some HELP.

Within 5 minutes a beat-up old motorcycle pulled up, driven by a bearded man who was wearing an old biker skull rag.

He got off of his cycle and asked if he could help.

She said: “Yes, my daughter is sick. I’ve locked my keys in my car and I must get home. Please, can you use this hanger to unlock my car?” He said “Sure.”

He walked over to the car, and in less than a minute the car was open.

She hugged the man and through tears said “Thank You SO Much! You are a very nice man.”

The man replied “Lady, I am NOT a nice man. I just got out of PRISON. I was in prison for car theft.”

The woman hugged the man again sobbing, “Oh, thank you, God! You sent me a professional!”

Harry Newton who marvels at how the economy must be coming back. Up in Columbia County. New York, where we have a country house, it’s increasingly difficult to find contractors and to get a quote for work to do. They’re overwhelmed with work. Good for  them.

David Karp, Tumblr founder,  announced its acquisition thusly: