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Harry Newton's In Search of The Perfect Investment Newton's In Search Of The Perfect Investment. Technology Investor.

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8:30 AM EST, Thursday, November 8, 2007: I have never seen more great investment opportunities. There's the alternate energy idea. There's the new Internet site. There's the new investment bank. There's the new publishing company. There's the new bridge loan on a commercial property. I'm not complaining. Life is a balance. Do I drop all the important things in life -- like playing tennis, bicycling in this gorgeous fall weather, being with my family, sitting in on two of my son's business school classes (tomorrow) -- and spend my life doing due diligence into these great investment opportunities? Or do I seek a balance (whatever that is)?

I used to work 100 hours a day. But my family complained. Now they actively conspire to fill up my days with weddings, marathons, attending classes, trips to exotic places, movies, theater, I'm not objecting. I'm adjusting.

One good thing about all this activity (and the planning for it) is that it distracts me from the daily freneticism that our stockmarkets have become. For example, yesterday the Dow, Nasdaq and the S&P 500 fell 2.6%, 2.7%, and 2.9% respectively. For a one day fall of that magnitude, the pundits were out in force, blaming variously escalating oil (on its way to $150), the dropping dollar (another 15% drop coming). glistening gold (now about $800 and going who knows where), the widening subprime cockroach (Morgan Stanley just announced a $3.7 billion writeoff and said more was coming) and the alignment of the stars and the moon.

If you take a deep breath and step back, things don't look bad. Look at my little blue line. The market has been on a tear since the summer of last year. You gotta expect pullbacks. Nothing goes up forever, even my stocks.

A broker friend wisely intoned yesterday:

Every pullback has been the beginning of the end, according to the media, which needs desperately headlines. .

In reality, every pullback (like yesterday) has been a buying opportunity.

Two pieces of simple evidence that support that:

1. There are now three 24-hour a day business channels. Count them -- CNBC, Fox and Bloomberg. All have beefed up their reporting and their freneticism. Personally I can't tell the difference between them, though CNBC has the prettiest anchors. Often I run my TV with the sound off, so pretty and blonde work for me.

2. Apple looks good..

But, Garmin doesn't, providing I'm a true genius and 15% Stop Losses work.

Frankly, I don't know why Apple is up so strongly and Garmin is down so strongly. Nor do I know why the market fell so strongly yesterday. It does suggest a certain wisdom to owning index ETFs like EWA, which were a serious buying opportunity on their pullback in August.

Meantime, last night Cisco posted a 37% jump in profit and a 17% rise in revenue but kept its sales forecast, but its shares were down 9.2% after hours. It seems investors these days not only want to hear blow-out numbers, but also blow-out forecasts. I think Cisco is a buy here.

Performance-Pay Perplexes: This is Jim Surowiecki's latest excellent piece from the New Yorker. Read it. You'll learn a lot. .

The havoc on Wall Street following the collapse of the subprime-mortgage market boils down to a simple truth: for years, lots of very smart people took lots of very foolish risks, betting borrowed billions on dubious mortgage derivatives, and eventually the odds caught up with them. But behind that simple truth is a more surprising one: the financial whizzes made bad decisions in part because that’s what they were paid to do.

Not literally, of course. The way that hedge-fund managers and investment-bank C.E.O.s get paid is supposed to make them perform better for the investors they serve. Hedge-fund managers, for instance, typically are paid “2 and 20”: they get two per cent of total assets as a management fee, and they keep twenty per cent of their investment gains (above some agreed-upon benchmark). Letting hedge-fund managers keep a chunk of their winnings gives them an incentive to do well for their clients: in theory, they get rich only if their clients do.

In practice, though, things don’t always work that way. Fund managers get bonuses at the end of each year, and they keep those performance fees even if the fund eventually goes south. So if a billion-dollar hedge fund rises twenty per cent in its first year and falls twenty per cent in its second, its investors will have lost money, while the fund’s manager might earn forty million dollars in performance fees. Hedge funds do have a rule that’s meant to deal with this problem: when a fund loses money, it yields no performance bonus until investors get back to even. The catch is that nothing prevents a hedge-fund manager from simply shutting down after a bad year and walking away with the fees he’s already accrued. Sometimes this happens out of necessity: the two subprime-focussed funds at Bear Stearns whose closure precipitated this summer’s market mayhem had seen their assets annihilated. But sometimes it happens because a manager has no incentive to keep supervising a fund that won’t generate a decent performance fee. In either case, the managers keep what they’ve earned and investors are left holding the bag. In short, a hedge-fund manager can do a lousy job and still become very wealthy.

Because fund managers reap large rewards on the upside without a correspondingly punitive downside, they have a much greater incentive to take big risks than ordinary investors do. Hedge funds generally leverage their bets with large amounts of borrowed cash—one Bear Stearns fund, for instance, borrowed ten times its capital—which makes it possible for them to turn small gains into enormous ones. Of course, leverage can also turn small losses into enormous ones. That helps explain why bad bets by hedge funds have been at the heart of the biggest financial-market meltdowns of the past decade.

A similar tendency to underplay risk is at work in parts of corporate America, thanks to the ubiquity of stock options. Options, which give executives the opportunity to buy company stock at a predetermined “strike price” within a certain period, seem like an ideal tool for insuring that a C.E.O. cares as much about the company’s stock price as his shareholders do. The problem is that if a company’s stock price is below the options’ strike price when they expire those options become valueless—and they’re just as valueless whether the stock price is a dollar below the strike price or fifteen dollars below it. To a shareholder, the difference between a stock that’s at thirty dollars and a stock that’s at twenty means a lot. But to a C.E.O. who has a pile of options with a strike price of thirty-one dollars, the difference means much less. As a result, that C.E.O. is likely to embrace projects that promise big rewards, even if they also entail a significant chance of failure.

Not surprisingly, a recent study of almost a thousand companies by the management professors W. Gerard Sanders and Donald Hambrick found that C.E.O.s whose compensation was made up mostly of stock options tended to “swing for the fences,” making investments and acquisitions that were riskier than those made by other executives. As a result, the performance of the companies run by the risk-takers was far more volatile, and not for the good of the companies: the risky strategies were more likely to end in a big failure than a big gain. Generous options grants may also encourage fraud; the business professors Jared Harris and Philip Bromiley, who have made a study of hundreds of firms forced to restate earnings after accounting irregularities, found that companies that paid out most of their compensation in stock options were far more likely to end up restating earnings. And, as with hedge funds, the perverse effects of performance pay are exacerbated by the fact that big bonuses are often based on short-term performance. Stanley O’Neal, who was recently forced to resign as the C.E.O. of Merrill Lynch, made eighty-four million dollars in 2005 and 2006, a figure based in part on the huge profits that Merrill booked as a result of its forays into the subprime market. Last week, thanks to those same forays, Merrill announced giant losses and writedowns that obliterated most of those profits. O’Neal, however, won’t be giving any money back.

One lesson of the current market chaos, then, is that it’s hard to get incentives right. Investors, after all, want fund managers and corporate executives to take reasonable risks—that’s the only way to make money—and many of them do just that. But, in trying to reward reasonable risks, we’ve encouraged unreasonable ones as well. And when you make it rational for people to bet the house, you may end up without a roof over your head.

Dealing with your PC: I have a file called techinfo.txt. I dump into it all the techy tips I hear. My latest tip concerns removing software. You should remove it via Control Panel / Add or Remove Programs. But sometimes your program is not listed. (I don't why. It should be. It's Windows.)

Tip: Go find the program under Program Files, find the file UnWise.exe and click on it. That will remove the software.

Teach your salesmen to sell: This is yesterday's true story. A salesman gives me a quote on printing and warehousing next year's Newton's Telecom Dictionary. He emails me a quote. Understand I've never met the guy, never spoken with him on the phone and we're talking a sale of $70,000+.

My first email:
I really want to give you guys my business…. But you’re so sooooo expensive.

His reply (His grammar verbatim):
It cost money to have a warehouse, storage facility and the staff to handle distribution. I don’t think our prices are out of line.

Totally untrue, but funny story:
Just when you have lost all faith in human kindness. An old lady received a new radio at the lunch as a door prize and is writing to say thank you.

Dear Safety Harbor Middle School:

God bless you for the beautiful radio I won at your recent senior citizens luncheon. I am 84 years old and live at the Safety Harbor Assisted Home for the aged. All of my family has passed away. I am all alone and I want to thank you for your kindness to an old forgotten lady.

My roommate is 95 and has always had her own radio, but before I received one, she would never let me listen to hers, even when she was napping. The other day her radio fell off the nightstand and broke into a lot of pieces. It was awful, and she was in tears. She asked if she could listen to mine, and I told her to kiss my ass.

Another dumb blonde joke (but a nice pun):
A blonde heard that milk baths would make her beautiful. She left a note for her milkman to leave 25 gallons of milk. When the milkman read the note, he felt there must be a mistake. He thought she probably meant 2.5 gallons. So he knocked on the door to clarify the point.

The blonde came to the door and the milkman said, "I found your note asking me to leave 25 gallons of milk. Did you mean 2.5 gallons?"

The blonde said, "I want 25 gallons. I'm going to fill my bathtub up with milk and take a milk bath so I can look young and beautiful again."

The milkman asked, "Do you want it pasteurized?"

The blonde said, "No, just up to my breasts. I can splash it on my eyes."

This 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 . You can't click on my email address. You have to re-type it . This protects me from software scanning the Internet for email addresses to spam. I have no role in choosing the Google ads on this site. Thus I cannot endorse, though some look interesting. If you click on a link, Google may send me money. Please note I'm not suggesting you do. That money, if there is any, may help pay Michael's business school tuition. Read more about Google AdSense, click here and here.

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