Harry Newton's In Search of The Perfect Investment
Newton's In Search Of The Perfect Investment. Technology Investor.
8:30 AM EST Monday, July 31, 2006: I
put $42 of gas into my 4-cyclinder Subaru on Sunday. I have never put that much
in. I freaked. Fortunately, I only drove it to the train station. Pity the poor
wretches who have to use their cars for commuting and visiting customers.
Oil has skyrocketed for six reasons:
1. Huge new demand,
especially from China and India.
2. Inability of the major producers to quickly ramp up production to meet that
3. Mideast political fears.
4. Fears we're running out of oil.
5. Hedge fund (and other Wall Street) speculation.
6. Slowness at finding new sources or developing large-scale viable alternatives,
like wind or solar.
Oil is critical
to us as investors because it's like a heavy tax on the economy. It hurts consumers
and companies, cutting expenditures and reducing profits.
Now comes word of a worrying new development in the oil biz. Ten members of
the Kuwaiti National Assembly last week tabled a motion to link Kuwait's crude
oil production with its oil reserve. After it is passed by parliament (and it
probably will be) it will become law. What Kuwait is trying to do is to hold
a little of its oil for future generations of Kuwaitis -- a totally admirable
goal. What it means for us that Kuwait will cut its oil production from
2.65 million barrels per day to 2.25 million -- about 15%. In and of
itself, this is not a huge cut. World production is 85 million barrels
a day. But, if every other oil producer got this weird idea of holding something
for their grandchildren, the price of oil is likely to skyrocket even further.
I smell $100 a barrel.
Each lift in oil prices means more profits for Canadian Oil Sands Trust (COS-UN.TO),
a big player up north developing reserves that allegedly contain almost as much
oil as Saudi Arabia. . The company recently reported its second-quarter profits
-- up 54 percent. As they say in Australia, that's better than a slap
in the belly with a cold fish.
My hope here is
that what I lose at the gas pump, I more than make up with COS-UN.TO's its rising
remains King (with exceptions)
Cumberland Advisors is a small money manager in Vineland, NJ , with
$800 million under management. This weekend, they put out a regular newsletter.
This one reinforces my "Cash is King" theme of recent weeks.
The Financial markets this week started to discount (with the present stock
and bond rally) the best possible outcome of the present situation in the
Middle East and in the US economy. We believe that was an error.
the best Middle East outcome as follows. 1. Hezbollah is quickly dispatched
and rockets stop landing in Israel. 2. Syria sues for a peaceful settlement
on its borders. This leads to 3. Syria joins Jordan & Egypt in a non-military
border with Israel. 4. Lebanon starts a rebuilding process with a true government
and without Hezbollah a part of it. 5. Some settlement occurs with the nutcase
leader in Iran. 6. The nuke threat is diminished. 7. Fatigue hits the Shia-Sunni
civil war in Iraq. 8. Iraqi oil reserves turn into real production.
In sum: for
the best outcome we will need to see that peace breaks out. Oil drops to $40-$50.
Stocks soar worldwide. Energy induced inflation heat subsides in the US. Interest
rates plateau. We all relax.
Not for me.
If you believe
this best outcome will arrive, stay fully invested in global markets. BTW,
see me privately and I have a bridge to sell you at a bargain price.
ignoring risk premia which have been rising. That is why they rallied on a
single and very preliminary GDP report and a Middle East trip by Condi Rice.
This was a relief rally from a deeply over sold condition in both stocks and
bonds. It may have a few more days. We are not betting that a new long term
bull market has been launched.
For the Middle
East, any scenario besides the one outlined above requires some wrenching
economic and financial outcomes. In the extreme scenario we will have contagion
because of the Iranian missiles being used by Hezbollah in Lebanon with Syrian
help as the conduit of supply. The newer and longer range versions are starting
to appear. They may be partially manufactured in North Korea. This is a dangerous
situation and may lead to a spreading war.
cannot stop its military action as long as there are rockets landing on her
soil. Therefore, Israel must have clear buffers AND iron clad diplomatic guarantees
before hostilities cease. Neither seems likely now. Israel has its back to
the wall. It has no choice but to persist until the Hezbollah threat is eliminated.
a metaphor that leads back to Carthage (modern Tunisia) and the Phoenicians
(ancient Lebanon). The Carthaginians religion and customs were based
on the Phoenicians. Carthages economy had its routes in the port city
of Tyre in Lebanon. That city now houses Hezbollah supplies; its seaport helps
child sacrifices were common. In the modern Eastern Mediterranean, the Hezbollah
hide their rocket launchers in civilian cover and care not about the causalities
they have brought on their Lebanese hosts. War is not pleasant. In the third
Punic War, Rome concluded that Carthage must be completely destroyed. In this
one, modern Carthage (the Hezbollah) must be eradicated. I must publicly thank
my friend, John Silvia, for this history lesson.
GDP is certainly in a downtrend. We do not know how far or how fast. We do
not know if the economy will have a soft landing or if it will get hard. We
recently wrote about the housing bubble and the risk it poses to the US economy.
See www.cumber.com for that essay.
And we have repeatedly discussed the impact of a high energy cost to the consumer
in the US. Now that natural gas prices are rising along with high oil, the
energy share of disposable personal income is approaching 7%. Coupled with
a housing downturn and this is where slowdowns become recessions. That is
up from a low of 4% just a few years ago.
It is too soon
to celebrate a new bull market in stocks and a permanent rally in bonds. Too
soon for certainty that this Fed is going to stop raising rates and start
cutting them. The Fed will have no credibility if it allows inflation to exceed
its Bernanke-stated targets. That is where inflation is right now. That is
also the present Fed forecast. Bernanke has no choice but to lean against
inflation and hope that the landing is a soft one. We hope so, too. But we
remember the warning that when investors need their hope to be realized in
order to succeed, they are flirting with danger.
We remain with
a cash reserve in our ETF accounts. Our bond accounts emphasize the highest
credit quality and are moving only to a more neutral duration after a prolonged
period of short duration as interest rates rose during the last three years.
We expect more rocky movement in financial markets during the rest of the
reason not to like tech stocks. Gretchen Morgenson
wrote "Options Fiesta, and Investors Paid the Bill" in the Sunday
New York Times:
and selling low is nobodys idea of a get-rich-quick scheme. But that
is precisely what companies do with their shareholders money
when they bestow stock options on executives and employees and then
buy back shares to offset the grants.
then backdate those option grants to secure a lower price for the lucky people
getting the options, they have essentially used stockholder money to buy high
and sell even lower than their filings had previously disclosed.
Much of the
recent discussion about backdating has centered on its inequity and its basic
cheesiness. Outside shareholders, after all, do not get to change the terms
of their stock purchases to manufacture the lowest possible price. Do-overs
that sweet seem to be only in the purview of insiders.
is not a victimless crime. There is already a cost associated with unaltered
options grants and for many technology company shareholders it has been high.
Backdating only adds to the price tag.
Now that accounting
rule makers have required companies to deduct options costs from revenue,
as they do for other employee expenses, options effects on corporate
income statements have become clearer. But you can also weigh option costs
another way by analyzing how much money companies must spend to buy
back shares that the granting of options creates. Amounts spent on these buybacks
keep share counts from ballooning too high, but also reduce a companys
net worth (or what investors the companys real owners
like to refer to as shareholders equity).
like it when their option programs are described in these stark terms. A tough
analysis of the Altera Corporations high-cost buybacks was behind
its retaliation last July against Tad LaFountain, a technology stock analyst
then at Wells Fargo Securities. Altera, a semiconductor maker, stopped talking
to Mr. LaFountain because he rated the companys stock a sell.
A primary reason
for his pessimism was his view that Alteras stock buybacks were a poor
use of shareholder money. And a great deal of money it was. Alteras
most recent annual report stated that between 1996 and the end of 2005, it
had repurchased 86.6 million shares at a cost of $1.8 billion. That averages
out to $20.78 a share. The stock closed Friday at $17.34.
At the same
time that Altera was buying back its shares in the open market, it was selling
shares to its employees through option grants for far less.
Last year, for example, Altera paid $18.58 on average to buy back 20 million
shares. When employees exercised options in 2005, Altera received only roughly
half that amount $9.32 a share on average. In other words, Altera
and its shareholders swallowed a 50 percent hit on shares the company purchased
to maintain its lush options program while Altera employees and executives
who sold stock after exercising options pocketed that lucrative difference.
are similar in earlier years. In 2004, the company paid $21.36 on average
to repurchase stock while receiving $7.01 a share, on average, from
employees exercising options. And in 2003, Altera paid $19.17 a share in buybacks
versus the $6.23 on average that it received.
Some $155 million
in shareholder money has gone down this particular drain at Altera over the
last three years. That translates to about 22 percent of the companys
net income during that period. Thats real money and Alteras shareholders
are all the poorer for it.
who is no longer an analyst, offers a simple explanation for why this occurred
at Altera and other companies. The whole reason for this vehicle,
he said in an interview last week, is it is a way of channeling excessive
amounts of shareholder wealth to the insiders.
An Altera spokeswoman
declined to comment. Regulators are scrutinizing its options grants for possible
backdating; the company has said it will have to restate 10 years of
financial figures as a result.
The stock option
arithmetic at other companies is similarly eye-opening. Since 2003, for example,
Affiliated Computer Services, an information technology company in
Dallas, has purchased 22 million shares at an average price of $50.27 each.
In fiscal 2004, the companys shareholders paid $49.57 a share to cover
buybacks. Yet the shareholders received just $16.46 a share from employees
exercising their options in 2004. Last year, the company paid $50.95 on average
to buy back shares; it received an average of $19.24 a share from employees
exercising options. Over all, Affiliateds shareholders paid almost $130
million to buy high and sell low the equivalent of 13.5 percent of
the companys net income.
at Broadcom, a semiconductor company in Irvine, Calif., last year paid
on average $42.12 a share, presplit, to buy back 3.6 million of its shares.
They received just $21.09 a share on average from option exercises. Buying
high and selling low cost Broadcoms shareholders $77 million in 2005.
Broadcom has also said it will have to restate its financial results; depending
on how much backdating accompanied its options grants, the cost to shareholders
something wrong with the idea of using shareholders money to turn corporate
insiders into multimillionaires. Wasnt it supposed to be the other way
another reason NOT to buy tech stocks:
Bill getting off on his new Zune.
Microsoft is about
1. introduce an iPod look-alike called a Zune,
2. enter the security arena with its Windows Live OneCare security package,
3. partner with Nortel Networks to jointly develop and sell internet-based telephony
and communications equipment.
In each case it will be competing against companies it has been licensing software
to. I can't see how this wins friends. Nor do I see heavy Microsoft product
design skills (outside mice) that will make Microsoft more money in product
sales than it will lose in licensing revenue.
Sunday on Fire Island.
I love neat signs. This is Leaman Morgan in New York's Penn Station wearing
his favorite t-shirt. Leaman explained that to swagger is to shuffle or walk
in a very special way -- his way. "Jacking" comes from hi-jacking
or car-jacking. It means to steal. Leaman is telling us not to copy his particular
shuffle. He explained, "Only I do, what I do. Not you." He
Leaman Morgan showing how he swaggers.
My favorite sign on New York's Fire Island. The biggest crime in Saltaire
(where we stayed) is bicycle theft.
Sunset last night on Fire Island. It was perfect. You can see the the Robert
Moses bridge in the distance.
Purina Diet. Who knows if this is true. Who cares.
was buying a large bag of Purina at Wal-Mart and was in line to check out. A
woman behind me asked if I had a dog. On impulse, I told her no, and that I
was starting The Purina Diet again, although I probably shouldn't because I'd
ended up in the hospital last time, but that I'd lost 50 pounds before I awakened
in the Intensive Care Unit with tubes coming out of most of my orifices and
IVs in both arms. I told her that it was essentially a perfect diet and that
the way that it works is to load your pants pockets with Purina nuggets and
simply eat one or two every time you feel hungry. Since the food is nutritionally
complete and perfectly healthy, I decided to try it again."
everyone in the line was by now enthralled with my story, just hanging on my
every word, particularly a tall, black guy who was behind the woman I was describing
the diet to."
asked if ended up in intensive care because the dog food poisoned me.
I told her no,
and went on to explain that I'd been sitting in the street licking my balls
when a car hit me.
the black guy was going to plotz as he staggered to the door, laughing uncontrollably."
column is about my personal search for the perfect investment. I don't give
investment advice. For that you have to be registered with regulatory authorities,
which I am not. I am a reporter and an investor. I make my daily column -- Monday
through Friday -- freely available for three reasons: Writing is good for sorting
things out in my brain. Second, the column is research for a book I'm writing
called "In Search of the Perfect Investment." Third, I encourage
my readers to send me their ideas, concerns and experiences. That way we can
all learn together. My email address is .
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